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Demand and supplyMarket failure: Price mechanism takes into account private benefits and costs of production to consumers Law of demandright16510000TerminologyLaw of Demand: Inverse relationship b/wn price and demand, assuming ceteris paribus (All other affecting factors remain the same)Individual demand: Demand of an individual consumer for a particular good or service at a particular priceMarket demand: Demand by all consumer for a particular good or serviceFactors influencing demand PriceNecessities: Goods necessary to survival, bought regardless of price changesLuxury goods: Goods that are higher in quality, ↑ P = ↓ DIncomeHigh: Increased purchasing power, increased demand for g/s (mostly luxury) Low: Decreased purchasing power decreased demand for g/s (for luxury. inferior) Shift in YDistribution Altered demand for goods and servicesExpected future income affects demand for certain types of goodsPopulationSize: Affects total quantity of goods demandedSmall population Small QD of goodsLarge population Large QD of goodsAge distribution: Affects type of goods demandedAgeing population = ↑ Demand for nursing homes/hospitalsTastesDemand for particular goods will change over timeFashion industryClothes in fashion = high demandClothes out of fashion = low demandInnovation and technological progressNew/better products > Old productsMp3 players in comparison to music CDsPrices of substitutesDefinition: Goods bought in place of anotherPrice increase of substitute Demand increase of goodPrice decrease of substitute Demand decrease of goodExamples: Coke and Pepsi, tea and coffee, butter and margarinePrice of complementsDefinition: Goods bought in conjunction with anotherPrice increase of complement = Demand decrease of goodPrice decrease of complement = Demand increase of goodExamples: Printers and cartridges, cars and petrol, milk and cerealFuture expectations of pricePrice increase in near future Current demand increases (e.g. Tax)Price decrease in near future Current demand decreasesright11433700Movements and shifts of the demand curveMovements (Only price-related changes: ceteris paribus)Contraction: An increase in price (0P1 to 0P2) causes the quantity demanded to fall (0Q1 to 0Q2)Expansion: A decrease in price of a (0P1 to 0P2) causes the quantity demanded to rise (0Q1 to 0Q3)right912200Shifts (caused by factors other than price)Increases in demand: Consumers are willing and able to buy more of the product at each possible priceShift of demand curve to the right (D1 D2)Increase in quantity demanded (0Q1 to 0Q2) at the same price (P1)Willing to pay higher price (0P2 instead of 0P1) to buy the same quantity of goods (Q1)right1039300Decreases in demand: Consumers are willing and able to buy less of the product at each possible priceShift of demand curve to the left (D1 D2)Decrease in quantity demanded (0Q1 to 0Q2) at the same price (P1)Willing to pay lower price (0P1 instead of 0P2) to buy the same quantity of goods (Q2)SupplyLaw of supplyTerminologyLaw of Supply: As the price of a certain product rises, the quantity supplied will riseMore profitable, attract new firms to the industryIndividual supply: Supplies of individual producers at various price levelsMarket supply: Total supply of all producers for a particular product1384300825500Factors influencing supplyMarket priceInfluences producer’s ability and willingness to supply the g/sToo low = Producers may not be able to cover production costsCosts of factors of productionDecrease: Allows firms to supply more of a particular goodIncrease: Difficult for firms to maintain present supply, leads to decrease in supplyLarge production companies sharply increase movies that small cinemas buyForces smaller, less profitable cinemas out of businessLower market supply of movies to consumers (fewer places)Price of other goods/servicesPX unchanged, PY increasedFirms less willing to supply Good X, more willing to start producing/suppling Good YMore profitable (Business goal)Future expectations of priceIncrease in near future Current supply increases (possibility of increased profits)Decrease in near future Current supply decreases Number of suppliersIncrease in suppliers = Increase in supplyDecrease in suppliers = Decrease in supplyImprovements in technologyLower production costs, allow more firms to supply more goods at a given priceAutomated production-line techniques in motor vehicle industryAdjust production runs (accommodate changing demand patterns)right769000Movements along and shifts of the supply curveMovements (Only price-related changes: ceteris paribus)Expansion: An increase in price (0P1 to 0P3) causes the quantity supplied to fall (0Q1 to 0Q3)Contraction: A decrease in price of a (0P1 to 0P2) causes the quantity supplied to fall (0Q1 to 0Q2)right571500Shifts (caused by factors other than price) Increases in supply: Firms are willing and able to supply more of the product at each possible priceShift of demand curve to the right (S1 S2)Increase in supplied (0Q1 to 0Q2) at the same price (P1)Willing to supply given quantity (0P2) at a lower price (0P2 instead of P1)right3301400Decreases in supply: Firms are willing and able to supply less of a good at each price level than beforeShift of supply curve to the left (S1 S2)Decrease in quantity supplied (0Q1 to 0Q2) at the same price (P1)Only willing and able to supply given quantity (0Q2) at 0P2 instead of 0P1 Price elasticity of demandPrice elasticity and the outlay methodPED: The responsiveness of quantity demanded to changes in price%?QD%?PElastic: Strong response to a change in price%?QD > %?P, PED>1 Inelastic: Weak response to a change in price%?QD < %?P, PED<1 Unitary elastic: Proportional response to a change in price%?QD = %?P, PED =1 Perfectly elastic: Consumers demand an infinite quantity at a certain price, e.g. fruit/vegNo individual seller would be able to charge a higher price (lose customers)Farmer selling apples: Higher price = No consumers, Lower price = less revenuePerfectly inelastic: Consumers willing to pay any price to obtain a certain quantity of goodsLife-threatening disease: Particular drug required to treat itCalculation of elasticity using outlay methodEffect of changes in price on total revenue earned by the producer$5-$6: Increase in total outlay Relatively inelastic$7-$8: Total outlay remains the same Unit elastic$9-$10: Decrease in total outlay Relatively elasticPrice ($)Quantity DemandedTotal Outlay (Price x Quantity)Elasticity550250Inelastic645270Inelastic740280Unit Elastic835280930270Elastic1025250ElasticSignificance of PED – Market research Businesses: Deciding on the optimal pricing strategy for the good/s they produceTypesRelatively elastic: Low price More sales More revenueRelatively inelastic: High price More sales More revenueStatistical market research: Determine consumer preferencesGovernmentsPricing g/s that it provides for the communityPublic transport faresPredict effects of changes in indirect taxes (predict how much revenue raised)Sales taxes: Alcohol, tobaccoExcise duties/special levies: PetrolExample:Excise duty on inelastic good: weak response to price, increasing revenue Excise duty on elastic good: strong response to price, reducing revenueFactors affecting elasticity of demandType of goodNecessities: Essential for daily life, relatively inelastic PED e.g. bread and milkLuxuries: Not essential for survival, relatively elastic PED, e.g. expensive dining outExistence of close substitutesClose substitutes: Highly elastic demand, e.g. brands of cerealFew/No substitutes: Inelastic demand, e.g. water supplyProportion of income spent on the goodSmall proportion: Inelastic demand, e.g. disposable lighters and chewing gumLarge proportion: Elastic demand, e.g. holidays and new carsLength of time since a price changePrice increase/decreaseShort-run: Inelastic demand (takes time to become aware of and adjust to ?price)Long-run: Elastic demand (sought out alternatives/substitutes)DurabilityElastic demand, would decline over time, e.g. replacing or repairing carsHabit-forming/AddictiveCigarettes and alcohol: Relatively inelastic demandright1212700Special cases involving PEDPerfectly ElasticConsumers will demand an infinite quantity of the goodBelow/above the price: Not willing to demand any quantityCan be witnessed in fresh fruit markets (example of competitive markets)Lower price = Loss of profitHigher price = Loss of customers (lower price elsewhere)336804010350500Perfectly InelasticConsumers are willing to pay any price in order to obtain a given quantity of a good, represented by a vertical demand curveLife-threatening disease MedicineConcert tickets Limited supply Price elasticity of supplyTerminologyPES: The responsiveness of quantity supplied to changes in price%?QS%?PElastic: Strong response (more than proportional) to a change in price%?QS > %?P, PES>1 right41402000Inelastic: Weak response (less than proportional) to a change in price%?QS < %?P, PES<1Special cases involving PESPerfectly Elastic:At price 0P, suppliers would supply an infinite quantity of the goodBelow/above the price: Not willing to supply any quantityHighly unlikely scenarioright13716000Perfectly inelastic: Quantity supplied is fixed at 0Q regardless of the priceExamplesUnique piece of artTicket prices to a concertFactors affecting elasticity of supplyTime lags after a price changePrice IncreaseRight after: Perfectly inelastic (suppliers can’t increase supply immediately)Short run: Inelastic supply (Increase of resources allocated to existing production capital, e.g. raw materials/additional workers)Long run: Elastic supply (Increase in inputs, e.g. size of production plant/amount of machinery ∴ greater increase in production)Price DecreaseRight after: Perfectly inelastic (suppliers can’t decrease supply immediately)Short run: Inelastic supply (Decrease of resources allocated to existing production capital, e.g. raw materials/additional workers)Long run: Elastic supply (Decrease in inputs, e.g. size of production plant/amount of machinery ∴ greater decrease in production)The ability to hold and store stockPerishable goods: Relatively inelastic (Cannot store when in economic downturn)Durable goods: Relatively elastic (Can put into storage when in economic downturn)Inventory: Total stock of g/s held by a firm at a particular time, intended for sale to consumersExcess capacityDefinition: A firm not using its existing resources to their full capacityExistence: Elastic (Using existing resources more intensively)Absence: Inelastic (Hard to increase resources in a short amount of time)Market priceTerminologyPrice Mechanism: The process by which the forces of supply and demand interact to determine the market price at which g/s are sold and the quantity producedcenter42867400Market Equilibrium: At a certain price level, the quantity supplied and the quantity demanded of a particular commodity are equal (No excess D/S), no tendency for ?P/DMovement to equilibrium Excess demandright16597900At price 0P1, the quantity demanded (0Q2) exceeds the quantity supplied (0Q1)Competition for limited goods Consumers will start bidding up the priceRise in price: Expansion in supply, contraction in demand (Movement along curves)Movement will occur as long as there is excess demandMovement will stop at the intersection of the supply and demand curves (0PE/0QE)Market clears at the price 0PE: No excess demand/supply Excess supplyright16729800At price 0P2, the quantity supplied (0Q2) exceeds the quantity demanded (0Q1)Sellers will offer to sell at a lower price (remove excess supply)Fall in price: Expansion in demand, contraction in supply (Movement along curves)Movement will occur as long as there is excess supplyMovement will stop at the intersection of the supply and demand curves (0PE/0QE)Market clears at the price 0PE: No excess demand/supply Effects of changes in supply and/or demand on equilibrium market price and quantityIncrease in demand: Demand curve shifts to the right (from D1D1 to D2D2)Consumers demand more goods at the old equilibrium price (0PE1)right16637000Quantity demanded (0Qx) exceeds quantity supplied (0QE1)Competition among buyers for the limited quantity of goods will force the price upExpansion in supply (Movement along the supply curve to the right)Market clears at new equilibrium price (0PE2) and quantity (0QE2)Leads to a raise in both equilibrium price and equilibrium quantity Decrease in demandDemand curve shifts to the left (from D1D1 to D2D2) Consumers demand less goods at the old equilibrium price (0PE1)Quantity supplied (0Qx) exceeds quantity demanded (0QE1)right1714500Sellers will offer to sell at a lower price (remove excess supply)Contraction in supply (Movement along the supply curve to the left)Market clears at new equilibrium price (0PE2) and quantity (0QE2)Leads to a decrease in both equilibrium price and equilibrium quantityIncrease in supplySupply curve shifts to the right (from S1S1 to S2S2) Sellers provide more goods at the old equilibrium price (0PE1)Quantity supplied (0Qx) exceeds quantity demanded (0QE1)Sellers will offer to sell at a lower price (remove excess supply)right3238500Expansion in demand (Movement along the demand curve to the right)Market clears at new equilibrium price (0PE2) and quantity (0QE2)Leads to a decrease in equilibrium price and a rise in equilibrium quantityDecrease in supplySupply curve shifts to the left (from S1S1 to S2S2)Sellers provide less goods at the old equilibrium price (0PE1) right18669000Quantity demanded (0Qx) exceeds quantity supplied (0QE1)Competition among buyers for the limited quantity of goods will force the price upContraction in demand (Movement along the demand curve to the left)Market clears at new equilibrium price (0PE2) and quantity (0QE2)Leads to a raise in equilibrium price and a decrease in equilibrium quantityRole of the MarketProduct Market: The interaction of demand for and supply of production outputs, i.e. g/sInteraction of demand and supply determines a price and quantity that best satisfies individual wants with the limited resources available to firms, giving a solution to the economic problemProducers will only produce g/s for which there is consumer demandHigher opportunity cost in producing other goods when price of product X risesFactor Market: The market for any input into the production process, aka CELLIndividuals who possess resources (including skills) or produce goods and services that are scarce and in high demand will command higher incomes and a greater proportion of total outputAllocative efficiency: Economy’s ability to allocate resources to satisfy consumer wantsDemand curve: Indication of the value that consumers place on a certain goodSupply Curve: Indication of producers’ costs in supplying that productCompetition among producers: Responsive to consumer demand, attempt to minimise costs of production in order to remain competitive, maintain profitabilityAlternatives to market solutions – the role of government Market Failure - Price Interventionright9222400Market failure: Price mechanism takes into account private benefits and costs of production to consumers and producers, but does not take into account indirect costs (social costs)Price ceilings: Maximum price that can be charged for a particular commodity, e.g. breadDistributes money from sellers to buyersPE: Excessively high, Govt. imposes price ceiling at PmaxProducers willing to produce 0QP, consumers demand 0QCDisequilibrium, with excess demand for bread of QPQC right15035800Price floors: The minimum price that can be charged for a particular good, e.g. wheat/milkDistributes money from buyers to sellers PE: Excessively low, Govt. imposes price floor at PminProducers willing to produce 0QP, consumers demand 0QCDisequilibrium, with excess supply for wheat/milk of QCQP Market failure – Quantity InterventionProducers only consider private costs (labour, raw resources), but not social costs (pollution/environmental damage)Taxes: Increases production costs, reduce production levelsLaws: Issuing pollution emission permitsIndividual consumer do not consider social benefits of some g/sMerit goods: Goods that are not produced in sufficient quantity (Individuals do not place sufficient value on these goods), e.g. Education and Health CareSubsidies (C/P): Lowers price and increases competitionPublic goods: Good that private firms are willing to supply, as usage/benefits cannot be restricted to those who are paying for them, e.g. National defence, police, public roadsGovernment intervenes to supply these items, finances them with its tax revenueVariations in competitionMarket structuresPure competitionMany small buyers, none of them are sufficiently large to be able to affect the market price, e.g. bulk-buyingHomogeneous products (same), Buyers and sellers are aware of prices at which the product is offered for sale throughout the marketBuyers do not incur any cost for moving from one supplier to anotherNo barriers to entry of new firms/exiting of existing firmsSellers can sell as much of their product at market pricePrice takers: Market price determined but forces of supply and demandMonopolistic competitionLarge number of relatively small firms in the industryProducts are similar, not identical (product differentiation: packaging/presenting)Firms have some degree of price-setting powerSmall barriers to entry for new firms (loyal customers, brand loyalty)Advertising: Attracts new customers, Maintains existing onesOligopoliesA few relatively large firms have a significant share of the marketProducts are similar, but differentiatedSignificant barriers to entry: Only a few firmsFirms constantly monitors behaviour of other rival firms, must consider reactions of competitors when changing its pricing/output policiesTend to compete through advertising campaignsSupermarkets: Woolworths, ColesBanks: Commonwealth, NAB, Westpac, ANZAirlines: Qantas, Virgin AustraliaMonopoliesOnly one firm selling the product, no market competitionProduct sold has no close substitutesSignificant barriers to entry, prevents any potential competitors from enteringMonopolist is a price setter, sets price in order to maximise profitAs level of competition within a market increases, prices are likely to fall and output increase ................
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