Economic Issues: An Introduction Outcome one The Market Mechanism Interaction of Market Forces

2 Objectives Outline the main determinants of demand Outline the main determinants of supply Draw a demand curve Draw a supply curve Draw a diagram showing equilibrium price and quantity

3 Objectives Illustrate how equilibrium price and quantity changes with changes to determinants of demand/supply Explain how the changes in demand/supply and resultant changes in price affect the allocation of resources

4 The Market Mechanism Three Parts: Part One: Demand Part Two: Supply Part Three: Interaction of Demand and Supply

5 Market: Definition Markets are places where people come together to buy and sell goods and services They can be physical places such as a street market or through computer communication, e.g. internet markets We have demand and supply in the market and their interaction brings about a price

6 The Market Mechanism The market (price) consumer to satisfy wants supplier to make profits Demand Supply demand and pricesupply and price demand and supply

7 Part One: Lesson Structure 1. Introduction- why study consumer demand? 2. Demand: Definition 3. Individual versus Market Demand 4. The Relationship between Demand and Price 5. The Demand Curve

8 Part One: Lesson Structure 6. Why Does the Demand Curve Slope Downwards? 7. A change in price: extension and contraction 8. A change in the conditions of demand

9 1. Why Study Consumer Demand? The study of demand allows economists: To understand the factors which influence consumer demand To examine the reasons why consumers demand more or less of a particular good

10 The Market Mechanism: Demand The market (price) Consumer to satisfy wants Demand demand and price We will be looking at demand from the consumer angle as if we are buying the goods

11 2. Demand: Definition Demand can be defined as: The quantity of a good or service which consumers are willing and able to buy at a particular price in a certain period of time

12 3. Individual versus Market Demand Individual demand: the demand of an individual consumer for a product Market demand: the sum of all individual consumer’s demand for a product i.e. total demand

13 4. The Relationship between Demand and Price Most obvious influence on consumer demand is the price of a good Price and demand are inversely or negatively related: If the price of a good rises, the quantity demanded will fall If the price of a good falls, the quantity demanded will rise

14 Example: The Demand for Oranges A local supermarket decides to examine the demand for oranges at different prices over a period of several months.

15 The table below is known as a demand schedule and details the quantity of oranges demanded at different prices. Price (pence)Demand (Per Week)

16 5. The Demand Curve This information can also be plotted to construct a demand curve Convenient way of describing the relationship between demand and price: Vertical axis: measures the price of oranges Horizontal axis: measures the quantity of oranges demanded at different prices

17 The Demand for Oranges in a Supermarket (per week)

18 The Demand Curve An easy way to remember the direction of a demand curve: D for ‘Demand’ = D for ‘Downward Sloping’ 0 Quantity Price

19 The Demand Curve A change in price from 40p to 20p causes quantity demanded to rise from 200 to Quantity Price (pence)

20 6. Why Does the Demand Curve Slope Downwards? This happens due to two main reasons: a. Income effect b. Substitution effect The income and substitution effects cause individuals to buy more of a good or service when it becomes cheaper

21 A. Income Effect As the price of a good or service rises then an individual’s ability to buy goods and services will decrease They are not able to buy the same thing! What happens to an individual’s buying power if the price of postcards: Increase? Decrease?

22 B. Substitution Effect As the price of a good or service rises, individuals may switch to a substitute at a lower price If the price of haddock rises, individuals may switch to buying cod

23 7. A Change in Price: Extension and Contraction A change in the price of a good will result in a movement along the demand curve: Extension in Demand Contraction in Demand

24 Change in Price: Extension in Demand If price falls from P1 to P2, Demand will expand and result in a movement down the demand curve from point A to point B. Price 0 Q1 Q2 Quantity P1 P2 A B

25 Change in Price: Contraction in Demand If price rises from P1 to P2, Demand will contract and result in a movement up the demand curve point A to point B. Price 0 Q2 Q1 Quantity P2 P1 B A

Demand and Price Questions Explain, with the aid of a diagram, what would happen to demand in the following situations: 1. Demand for single-use cameras if the price decreased. 2. Demand for tickets to the Science Centre in Glasgow if the price of entrance tickets increased. 3. Demand for DVD players if the price increased. 4. Demand for washing machines if the price decreased. 5. Demand for shortbread if the price decreased. 26

27 Ceteris Paribus When economists examine the relationship between demand and price they make a basic assumption: All the other influences on consumer demand remain unchanged It is only the price of the good which has changed Known as ceteris paribas, Latin for ‘all other things remain equal’

28 To Summarise: A change in the price of a good, all other things remaining equal, will result in a movement along the demand curve: Price decrease = an extension along the demand curve Price increase = a contraction along the demand curve

29 7. A Change in the Conditions of Demand There are a number of other influences on consumer demand Based on the assumption that the price of the good remains unchanged A factor other than price causes demand to change

30 Influences on Consumer Demand a. Prices of other goods: Substitutes Complementary goods b. Changes in tastes, habits and fashion c. Advertising d. Consumer incomes e. Seasonal factors f. Expectation of future price changes

31 Example One: Increase in Consumer Demand Price 0 Q1 Q2 Quantity D1 D2 P1

32 Example Two: Decrease in Consumer Demand Price 0 Q2 Q1 Quantity D2 D1 P1

Change in the Conditions of Demand Questions Explain, with the aid of a diagram for each question, what would happen to demand in the following situations: 1. A hotel in the highlands is criticised in a Scottish travel brochure. 2. The demand for tailored suits if they become more fashionable. 3. The demand for ice creams during the winter months. 4. Demand for I-pods if consumer income increases. 5. A new restaurant receives positive advertising. 33

34 Summary: Consumer Demand Demand curves mostly slope downwards from top left to bottom right Remember D for ‘Demand’, D for ‘Downward Sloping’ Inversely (Negatively) related: As price rises demand falls, as price falls demand rises

35 Summary: Consumer Demand Changes in price will cause a movement along the demand curve: Contraction in demand: price rises and will result in a movement up the curve Extension in demand: price falls and will result in a movement down the curve

36 Summary: Consumer Demand A change other than price will cause a change in the conditions of demand This will shift the entire demand curve:

37 Summary: Consumer Demand If demand increases due to a change in the conditions, the demand curve will shift to the right If demand decreases due to a change in the conditions, the demand curve will shift to the left

38 Part Two: Lesson Structure 1. Introduction 2. The relationship between supply and price 3. The supply curve 4. A change in price: extension and contraction 5. A change in the conditions of supply

39 The Market Mechanism: Supply The market (price) Supplier to make profits Supply supply and price We are looking at supply from the angle of the supplier who aims to maximise profits!

40 2. The Relationship between Supply and Price The supply of a good is also influenced by price Price and supply are directly or positively related: When the selling price of a good rises, the supply will rise When the selling price of a good falls, the supply will fall

41 Example: The Supply of Oranges A local supplier decides to examine the supply of oranges at different prices over a period of several months.

42 The table below is known as a supply schedule and details the quantity of oranges supplied at different prices. Price (pence)Supply (Per Week)

43 3. The Supply Curve This information can also be plotted to construct a supply curve Convenient way of describing the relationship between supply and price: Vertical axis: measures the price of oranges Horizontal axis: measures the quantity of oranges supplied at different prices

44 The Supply of Oranges in a Supermarket (per week)

45 The Supply Curve An easy way to remember the direction of a supply curve: UP in ‘Supply’ = UP for ‘upward Sloping’ 0 Quantity Price

46 The Supply Curve A change in price from 10p to 30p causes quantity supplied to rise from 100 to Price (£) Quantity

47 4. A Change in Price: Extension and Contraction A change in the price of a good will result in a movement along the supply curve: Extension in Supply Contraction in Supply

48 Change in Price: Extension in Supply Price Quantity Q1 Q2 P2 P1 A B If price rises from P1 to P2, supply will expand and result in a movement up the supply curve from point A to point B..

49 Change in Price: Contraction in Supply Price Quantity Q2 Q1 P1 P2 B A if price falls from P1 to P2, Supply will contract and result in a movement down the supply curve from point A to point B.

Supply Questions Instructions: Explain, with the aid of a diagram for each question, what would happen to the supply of DVD players for if: b. The cost of a vital component used in the production of DVD players increases? c. There is an investment in new technology? d. Labour costs increase by 10%? e. A government subsidy is offered to firms producing DVD players. 50

51 Therefore: A change in the price of a good, all other things remaining equal, will result in a movement along the supply curve: Price decrease = a contraction along the supply curve Price increase = an extension along the supply curve

52 5. A Change in the Conditions of Supply There are a number of other influences on the supply of a good Based on the assumption that the price of the good remains unchanged A factor other than price causes supply to change

53 Changes in Production Costs An important influence on supply If the costs of production rise, suppliers will be forced to produce goods at a higher unit cost than before Suppliers need to protect their profit margins

54 Production costs may change for one or more of the following reasons: a. Change in the cost of resource inputs b. New technology c. Influence of subsidies and taxation d. Seasonal factors

55 Example One: An Increase in Supply Price 0 Q1 Q2 Quantity P1 S2 S1 A Decrease in Production Costs

56 Price 0 Q2Q1 Quantity P1 S1 S2 Example Two: A Decrease in Supply An Increase in Production Costs

57 Summary: Supply Supply curves mostly slope upwards from bottom left to top right. Remember ‘UP’ in supply, ‘UP’ for Upward sloping Directly (Positively) related: As price rises supply rises, as price falls supply falls

58 Supply: Summary Changes in price will cause a movement along the supply curve: Contraction in supply: price falls and will result in a movement down the curve Expansion in supply: price rises and will result in a movement up the curve

59 Supply: Summary A change other than price will cause a change in the conditions of supply This will shift the entire supply curve:

60 Supply: Summary If supply increases due to a change in the conditions, the graph will shift to the right If supply decreases due to a change in the conditions, the graph will shift to the left

61 Part Three: Lesson Structure 1. Introduction 2. The market equilibrium 3. Movement to a new equilibrium A change in demand A change in supply

62 2. The Market Equilibrium The market (price) consumer to satisfy wants supplier to make profits Demand Supply demand and pricesupply and price demand and supply

63 The Market Equilibrium Equilibrium price: the price level where demand and supply are equal Equilibrium quantity: the quantity consumers are willing to purchase and producers are willing to supply at The market will reach a state of equilibrium

64 Price (pence)Demand (per Week) Supply (per week) The demand and supply schedule details the quantity of oranges demanded and supplied at different prices.

65 The Equilibrium Price and Quantity of Oranges Price Quantity 30 S1 D1 Market for oranges will reach an equilibrium where: Equilibrium Price = 30 Equilibrium Quantity = 300 E

66 Any surpluses or shortages which occur will tend to be automatically eliminated through fluctuations in the market price

67 a. Price Level above the Equilibrium Price Price Quantity S1 D1 Quantity supplied is more than quantity demanded Surplus in supply meaning suppliers will lower their prices 40

68 b. Price Level below the Equilibrium Price Price Quantity 20 S1 D1 Quantity demanded is more than quantity supplied Surplus in demand meaning suppliers will raise their prices

69 c. Price will settle Where Demand and Supply are Equal Quantity A state of equilibrium There are no shortages or surpluses at this point Price 30 S1 D1 E Surplus Supply Shortage Supply

70 3. Movement to a New Equilibrium Equilibrium can only be sustained as long as there are no changes in demand or supply Change in the conditions of demand or supply means… Demand and supply are no longer equal A new market equilibrium will develop

71 What happens to the market equilibrium (point A) when demand increases? 0 Quantity P2 P1 S1 D1 D2 Q1 Q2 A B Price

72 What happens to the market equilibrium (point A) when demand decreases? 0 Quantity P1 P2 S1 D2 D1 Q2 Q1 B A Price

73 What happens to the market equilibrium (point A) when supply increases? 0 Quantity Price P1 P2 S1 D1 Q1 Q2 S2 B A

74 What happens to the market equilibrium (point A) when supply decreases? 0 Quantity Price P2 P1 S2 D1 Q2 Q1 S1 A B

75 To Summarise: A shift in one of the curves equals a movement along the other to a new equilibrium: If there is a change in demand: The demand curve will shift Movement along the supply curve If there is a change in supply: The supply curve will shift Movement along the demand curve

76 Changes in Equilibrium Price and Quantity When drawing changes from one equilibrium to another think of it as a before and after situation Draw original equilibrium point (intersection of demand and supply) and label i.e. D1, S1, P1 and Q1 What is the original equilibrium point? Consider whether demand or supply is affected Does the curve shift to the left or right?

77 Changes in Equilibrium Price and Quantity Is there is a shortage or surplus? What happens to price in order to clear this shortage/surplus (does it increase or decrease)? What happens to the other curve: extension or contraction? What is the new equilibrium point?

Equilibrium Questions Instructions: A new firm produces CD players in a highly competitive market. For each question, explain, with the aid of a demand and supply diagram, the effects of the following situations on the market equilibrium price and quantity: 78

Equilibrium Questions 1. Investment in new machinery? 2. The development of an effective substitute for CD players? 3. An increase in the price of raw materials used in making the CD players? 4. The brand of CD players produced by the firm are criticised in a newspaper article? 5. 10% decrease in employees wages involved in producing the CD players? 79