Studied by 3 peopleLaw of demand
There is an inverse relation ship between price and quantity demanded.
Law of supply
there is a direct relationship between price and quantity supplied
Relationship between an individual consumer's demand and market demand
Market demand = sum of all individual consumers' demands
Non-price determinants of demand
Income, taste/preferences, Future price expectations, Price of substitutes or compliments, Number of consumers
Non-price determinants of supply
Cost of factors of production, competitive supply, joint supply, supply side shocks, changes in technology, inderect taxes and subsidies, future price expectations, number of firms
Competitive supply
A situation where two goods compete for the same resources.
Joint supply
A situation where two goods are produced from the same resource.
The price mechanism
shows the way in which changes in price affect the supply and the quantity demanded.
rationing
an artificial control on the supply or demand of a good/service
marginal cost
the cost of producing one more unit of a good
marginal benefit
the additional benefit to a consumer from consuming one more unit of a good or service
individual producer's supply vs. market supply
Market supply = sum of individual producers' supply
consumer surplus and producer surplus
Consumer surplus measures the benefit consumers receive from buying goods and services in a particular market.
Producer surplus measures the benefit producers receive from selling goods and services in a particular market.
Social/Communtiy surplus
Consumer surplus + producer surplus
Functions of the price mechanism
Rationing-Scarce resources are divided among their competing uses according to what is demanded
Signalling-The price of a product reflects the market conditions and signals if producers should increase or decrease production
Incentive-Prices act as an incentive for both consumers and producers, low prices encourage consumers to purchase more and suppliers will leave the market due to low profit margins forcing the price back up, whilst high prices encourage producers to enter the market or produce more, increasing supply and pushing the price back down.
When does marginal benefit = marginal cost?
at the competitive market equilibrium
When is allocative efficiency achieved?
at the competitive market equilibrium / MSB=MSC / MB=MC / welfare is maximized
When is social/community surplus maximized?
at the competitive market equilibrium
Reasons for government intervention
earn government revenue
support firms
support households on low incomes
influence level of production/consumption
correct market failures
promote equity
What are the main forms of government intervention?
Price controls (ceilings and floors)
Indirect taxes and subsidies
Direct provision of services
Command and control regulation and legislation
Define an indirect tax
Indirect taxes refer to taxes on expenditure. They are not charged directly on people's incomes or wealth. They are paid indirectly by consumers when they purchase a good, as indirect taxes are included in the price of the good.
Define subsidy
This an amount of money granted by the government towards producers. It is often given per unit of output and causes the producers to be able to produce more at a lower price.
Define a price ceiling and a price floor
When the government sets a minimum/maximum price on a product which all producers must legally set their price above/below.
Negative externality of production graph
examples: air pollution
MSC>MPC
all units produced from Q optimal to Q actual have a higher cost to society than a benefit to society so its market failure - welfare loss
government response to example: carbon tax (generates tax revenue, and easy to apply)
negatives of government response: hard to measure the amount of pollution produced and put a value on it, and doesn’t actually stop firms from polluting
Negative externality of consumption graph
MPB>MSB
example: Cigarettes - second hand smoke is affects non-smokers
government response to example: restricting the good by age, negative advertising, imposing an excise tax
negatives of government response: cost of enforcing the legislations, “restriction on liberties”, prices are inelastic for addictive goods so people will pay the tax, high cost of advertisement and limited effectiveness, rise of black markets
Q act > Q opt therefore overconsumption of goods
Positive externality of production graph
MPC>MSC
Example: Bee-keeping/farming honey
benefit of example: pollination of surrounding crops by bees
government responses: subsidising firms
negatives for government response: opportunity cost of subsidy, money could have been used for healthcare, education, etc.
Q actually produced is less than Q opt and therefore under allocation of resources and potential for welfare gain
Positive externality of consumption graph
MSB>MPB
example: Vaccine
Benefit of example: reduces the spread of illness
government responses: subsidising pharmacies, legislations/mandates, positive advertisement
cost of government response: cost of enforcing laws, cost of creating advertisements, costs of subsidising pharmacies, people dont like being told what to do
When is a market optimal/allocatively efficient
MSC=MSB
Marginal social/private benefit/cost
benefit/cost to society or individuals/firms
Define social surplus
The sum of the consuer and producer surplus. The total welfare or benefit gained by society at a certain price.
What is PED and how to calculate
a measure of how responsive Quantity demanded is to Change in price
PED = Percentage change in quantity demanded / Percentage change in price
ALWAYS A POSITIVE NUMBER
Value of PED is between 0 and 1
Price inelastic demand - relatively unresponsive
Value of PED is >1
Price elastic demand - relatively responsive
Determinants of PED
Number and closeness of substitutes
Degree of neccessity
Proportion of income spent on the good
Time
What is YED and how to calculate it
A measure of how responsive quantity demanded is to change in income
YED= Percentage change in quantity demanded / Percentage change in income
Positive/negative sign matters
Positive YED
normal good
Negative YED
inferior good
-1<YED<1
income inelastic demand - proportionally smaller change in Qd than income
income elastic demand - proportionally greater change in Qd than income
What is PES and how to calculate it
A measure of how responsive quantity supplied is to changes in price
PES = Percentage change in quantity supplied / Percentage change in price
PES > 1
Supply is elastic
PES < 1
Supply is inelastic
Primary commodities
A good sold for production or consumption just as it was found in nature.
They are neccesities and have no substitutes.
Private goods
A good that is rivalrous and excludable e.g. apple
Public good
A good that is non rivalrous and non exludable
benefits all members of society
there is little incentive for people to pay for the good (free rider proble
Typically a merit-good
e.g. streetlights, national security, policing and law enforcement
Quasi public goods
Club goods and common pool resources
Club goods
Excludable but non-rivalrous
e.g. movie theatres, gated parks
Common pool resources
non-excludable but rivalrous
e.g. fish in the ocean
Explain with the free rider problem why public goods are a market failure
The freerider problem exists because no one is willing to pay for a good or service when they think someone else will pay for it, which means in a free market public goods would not be provided.
Because the free market is unable to provide these goods without intervention, public goods are an example of market failure.
Government intervention in response to externalities and common pool resources
indirect taxes
carbon taxes
legislation and regulation
education
advertising
subsidies
government provision
tradable permits
international agreements
collective self-governance
Pros of government provision of public goods
Improves social welfare as consumption is increased
allows for economies of scale
free rider problem is eliminated to a large extent
Cons of government provision of public goods
opportunity cost - it must be financed
May not be economically efficient as government is unable to determine the optimal output
Some quasi-public goods, like toll-roads, could be provided more efficiently by firms
Why does the government contract out to the private sector to provide public goods
Firms can be more efficient in provision than the government
Profit motive gives firms incentive to raise capital and be efficient
how ever the extent of this increased efficiency is debated in real world
Price ceilings effect on stakeholders
Consumers - Pay lower price but decrease in consumer surplus due to shortage
Producers - increased demand but selling at a lower price = less revenue, therefore producer surplus decreases
Note
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