Georgia White 3.

Markets

Demand – the quantity of a particular good or service that consumers are willing and able to
purchase at various price levels at a given point in time

6.1 Factors effecting market demand

The price of the g/s itself  Must decide if willing + able to pay nominated price for item
 Will buy necessities regardless of price changes
 Likely to ↓ demand for luxury goods if price ↑
The price of other g/s  ↑ price → ↑ demand for its substitute
 ↑ price → ↓ demand for good + complement
Expected future prices  Price expected ↑ near future → consumers bring forward
consumption → ↑ current demand
Changes in consumer  Change over time → change demand
tastes/preferences  Innovation + technological progress → consumers demand
new + better products at expense of superseded ones
Level of income  ↑ Y → more willing and able to purchase g+s that previously
couldn’t afford
 ↑ Y → ↑ demand for luxury goods
 Y distribution + consumer expectations about Y also change
demand
Pop. size and age distribution  Pop size – affect quantity of goods demanded
 Age distribution – affect type of goods demanded

Ceteris paribus – an assumption used to isolate the relationship between 2 economic variables (Latin
= ‘other things being equal’)
 Focus on 1 factor at a time and analyse response of demand to change in this factor,
assuming all other factors remain constant

6.2 Movements along the demand curve

Demand schedule – can be constructed making the assumption that all factors that could affect
demand (except price) remain constant
 Show quantity of a good that will be demanded over a range of prices at a given point in
time

The Law of Demand states:

 The quantity demanded by consumers falls as price rises
 More people are willing and able to buy a g/s at a lower price
 Some exceptions for some luxury items e.g. eating at a fashionable restaurant – may
experience increased demands as prices rise, because it is a status symbol

The demand curve

1
Georgia White 3. Markets

 Slopes downwards, left to right – as the price of a product rises, consumers will demand less
of that product

Movements along demand curve

Assuming all factors (except price) remain constant →

change in quantity demanded in opposite direction to
price change → movement along demand curve =
expansion/contraction of demand

Expansion of demand – when a decrease in the price of

a g/s causes an increase in the quantity demanded

Contraction of demand – when an increase in price of a

g/s causes a decrease in the quantity demanded

6.3 Shifts of the demand curve

A change in any of the factors (other than price of g/s itself) → shift of demand curve =
increase/decrease of demand

Increase in demand – movement to the right, means

consumers are:
 Willing and able to buy more of the product at
each possible price than before
 Willing to buy a given quantity at a higher price
than before

Decrease in demand – movement to the left, means

consumers are:
 Willing and able to buy less of the product at
each possible price than before
 Willing and able to buy a given quantity at a
lower price than before

Factors causing shifts of the demand curve:

 Changes in factors apart from price of good itself

2
Georgia White 3. Markets

Increase in demand Decrease in demand

Prices of other goods and services
 Rise in price of substitute good  Fall in price of substitute good
 Fall in price of complementary good  Rise in price of complementary good
Expected future prices
 Expect increase of price in near future –  Expected decline in price in near future
bring forward purchase → ↑ current
demand
Consumer tastes and preferences
 Fashion – increase demand for  Product becoming less fashionable
fashionable products
 New technology – increase demand for  A good becomes superseded due to
technologically advanced products improve technology
Consumer incomes
 Rise in level of income – can afford to  Fall in level of income
buy more at the same price
 Change in income distribution in favour  Change in income distribution less
of higher incomes – ↑ demand for more favourable to demand
expensive products
 Improved consumer expectations about  Poor expectations about future
future income economic prospects
Size and age distribution of population
 Increase in pop → ↑ demand for all  Decrease in population
products
 Change in age distribution → ↑ demand  Change in age distribution less
for certain types of products favourable to demand

6.4 Price elasticity of demand

 The responsiveness/sensitivity of the quantity demanded to a change in price

Elastic demand – a strong response to a change in price

Unit elastic demand – a proportional response to a price change (total amount spent by consumers
remains unchanged)

Inelastic demand – a weak response to a price change

3
Georgia White 3. Markets

Importance of price elasticity of demand

Firms:
 Need to understand the price elasticity of demand for g they sell
 Decide on optimal pricing strategy
 If demand elastic – ↓ price → expand volume of sales → ↑ total revenue
 If demand inelastic – ↑ price → ↓ sales would be less than price increase → ↑ total revenue
 Important to have awareness of elasticity of demand in different price ranges, important to:
o Determine best pricing strategy
o Decide whether to change prices

Governments:
 Need to understand price elasticity of demand for g+s it provides for community
 Need to be able to predict effect of changes in level of taxes + gauge responsiveness of
demand to estimate revenue

Measuring price elasticity of demand

The total outlay method TO = total outlay

 Look at effect of changes in price on total revenue earned P = price
Qd = quantity demanded
TO = P x Qd
If TO moves in same direction as price change – demand = relatively inelastic

If TO moves in the opposite direction to price change – demand = relatively elastic

If TO remains the same following a price change – demand = unit elastic

e.g.

Price $ Quantity demanded Total outlay

(units)
5 50 250
6 45 270 → inelastic
7 40 280 → inelastic
8 35 280 → unit elastic
9 30 270 → elastic
10 25 250 → elastic

4
Georgia White 3. Markets

Perfectly elastic demand

 Demand curve = horizontal straight line
 Consumers will demand an unlimited quantity a
certain price but nothing at a price above this

Perfectly inelastic demand

 Demand curve = vertical straight line
 Consumers are willing to pay any price to obtain a
given quantity of a good

6.5 Factors affecting elasticity of demand

Whether the good is a luxury  Necessities – inelastic demand

or necessity  Luxuries – elastic demand
Whether the good has any  Goods with close substitutes – elastic demand
close substitutes o Can switch products
 No close substitutes – inelastic demand
o Can’s switch
Expenditure on the product  Small proportion of Y – inelastic demand
as a proportion of income  Large proportion of Y – elastic demand
The length of time  When price increases consumers may take time to respond →
subsequent to a price Qd may not change immediately
change o Price increase – consumers take time to seek
alternatives – demand more responsive
o Price decrease – take time for consumers to become
aware now cheaper → switch to cheaper product –
demand more responsive
 After initial price change durable goods have more elastic
demand that non-durable
o Rise in price of durable good → repair not replace –
demand elastic
Whether the good it habit  Inelastic demand – people with habits tend continue with
forming (addictive) or not habit even after price increase

5
Georgia White 3. Markets

Supply – the quantity of a good or service that all firms in a particular industry are willing and able to
offer for sale at different price levels, at a given point in time

7.1 Factors affecting market supply

The price of the g/s itself  Market price influences producer’s ability + willingness to
supply g/s
o Price to low → unable to cover costs of production →
don’t supply item
 Expectation of suppliers about future prices of g/s
o Price rises in future → ↑ supply
The price of other g/s  May be more profitable to supply a different good → less
willing to supply g
The state of technology  Improvements → ↓ prod costs → ↑ firms supply good at given
price
Changes in costs of factors of  ↓ cost → firms supply more of a particular good
production  ↑ cost → more difficult to maintain supply → ↓ supply
Quantity of g available  Actual quantity of g available = limiting factor
 ↑ suppliers → ↑ supply
Climatic and seasonal influence  e.g. affect agricultural production i.e. drought → ↓ supply

7.2 Movements along the supply curve

Supply schedule – can be constructed making the assumption that all factors that could affect
demand (except price) remain constant
 Show quantity of a good that will be supplied over a range of prices at a given point in time

The Law of Supply states:

 As the price of a product rises the quantity supplied will increase
 Firms already in industry – producing good becomes more profitable → ↑ production
 Higher price → more profitable → new firms attracted to industry

6
Georgia White 3. Markets

The supply curve

 Slopes upwards, left to right – as the price of a product rises, suppliers will supply more of
that product

Movements along supply curve

Assuming all factors (except price) remain constant →

change in quantity supplied in same direction to price
change → movement along supply curve =
expansion/contraction of supply

Expansion of supply – when a decrease in the price of a

g/s causes a decrease in the quantity supplied

Contraction of supply – when an increase in price of a

g/s causes an increase the quantity supplied

7.3 Shifts of the supply curve

A change in any of the factors (other than price of g/s itself) → shift of supply curve =
increase/decrease of supply

Increase in supply – movement to the right, means

firms are:
 Willing and able to supply more of a product at
each possible price than before
 Willing to supply a given quantity at a lower
price than before

Decrease in supply – movement to the left, means

firms are:
 Willing and able to supply less of a product at
each possible price than before
 Willing and able to supply a given quantity at a
higher price than before

7
Georgia White 3. Markets

Factors causing shifts of the supply curve:

 Changes in factors apart from price of good itself

Increase in supply Decrease in supply

 Fall in price of other goods – making  Rise in price of other goods
the prod of these less profitable
 Improvement in technology used in  Certain technology no longer available
prod process
 Fall in cost of factors of prod  Rise in cost of factors of prod
 Increase in quantity of resources  Decrease in quantity of resources
available available
 Climatic conditions/seasonal change  Climatic conditions/seasonal change
that is more favourable to prod process less favourable to prod process

8.1 The concept of market equilibrium

Assumptions
 Pure competition in market place
 No gov intervention

Price mechanism
 Determines equilibrium

Market equilibrium – the situation where, at a certain price level, the quantity supplied and the
quantity demanded of a particular commodity are equal. This means the market clears (there is no
excess supply or demand) and there is no tendency for change in either price or quantity

8.2 Establishing market equilibrium

Occurs where the demand and supply curves intersect

Occurs when
1. Qd = Qs
2. The market clears
3. There is no tendency to change

8
Georgia White 3. Markets

Explain how is market equilibrium is achieved in a situation of

a) excess demand at P1 – disequilibrium – Qd>Qs
. = excess demand
. = shortage

1. raise price to PE
2. expansion in supply
3. contraction in demand
4. Qd=Qs → equilibrium

b) excess supply at P2 – disequilibrium – Qs>Qd

. = excess supply
. = surplus

1. lower price to PE
2. expansion in demand
3. contraction in supply
4. Qd=Qs → equilibrium

9
Georgia White 3. Markets

8.3 Changes in equilibrium

Changes in factors other than price can cause a shift in either the demand or supply curves
→ change in equilibrium price and quantity

Explain how the following changes equilibrium

a) increase in demand increase in demand
→ need to raise price
→ expansion in supply
→ contraction in demand
→ new point of equilibrium –
with higher equilibrium
price and quantity

b) decrease in demand decrease in demand

→ need to lower price
→ expansion in demand
→ contraction in supply
→ new point of equilibrium –
with lower equilibrium
price and quantity

c) increase in supply increase in supply

→ need to lower price
→ expansion in demand
→ contraction in supply
→ new point of equilibrium –
with lower equilibrium
price and higher
equilibrium quantity

d) decrease in supply decrease in supply

→ need to raise price
→ expansion in supply
→ contraction in demand
→ new point of equilibrium –
with higher equilibrium
price and lower equilibrium
quantity

10
Georgia White 3. Markets

8.5 Government intervention in the marketplace

Market failure – occurs when the price mechanism may take into
account private benefits and costs of production to consumers and
producers, but it fails to take into account indirect costs such as
damage to the environment

 The socially optimum price level is above the market price

(price mechanism undervalues the natural environment)
 Market forces result in the overuse of natural resources

Summary of government intervention in marketplace

Problem Government action Outcome

market price too high price ceiling reduces price, quantity
shortage (disequilibrium)
market price too low price floor increases price, quantity
excess (disequilibrium)
market quantity too high taxes increased equilibrium price,
(negative externalities) reduces equilibrium quantity
market price too low (positive subsidies reduces equilibrium price,
externalities) increases equilibrium quantity
market doesn’t provide good government provides good or government must collect
or service (public good) services taxation revenue to finance its
supply of public goods

Price intervention
 Price ceilings will redistribute money from sellers to buyers
 Price floors will redistribute money from buyers to sellers

Price ceilings
 The maximum price that can be charged for a particular
commodity
 At Pmax there is a shortage of supply
 Qc > Q p

Price floors
 The minimum price that can be charges for a particular
commodity
 Only worrying about suppliers – guaranteeing them a
minimum price
 At Pmin there is excess supply
 Qp > Q c

11
Georgia White 3. Markets

Quality intervention

Externalities – social costs and benefits (not taken into account in the operation of the price
mechanism)

Negative externalities
 E.g. pollution, environmental damage
 Gov can restrict production levels through laws or impose taxes of firms (which ↑ production
costs and ↓ production)
 Making individuals pay for the social costs created by production = internalising the
externality

Positive externalities
 Positive social benefits from consumption of goods and services e.g. museums, public parks,
art galleries, public transport
 Gov may intervene to encourage the provision of these merit goods and services through
subsidies to consumers (or producers) – ↓ price and ↑ consumption

8.6 Competition and market power

Market structure Number and Product Barriers to Examples

size of firms characteristics entry
pure competition – a many same product none fruit and vegetables,
theoretical model of perfect very small fish markets
competition
monopoly – only one one no close substitutes extremely water supply
producer in the industry large high
monopolistic competition many differentiated easy motels, restaurants
– many small firms in the small products
industry
oligopoly – a small number few usually high supermarkets,
of large firms dominate the large differentiated banks, oil
industry products companies, airlines

12