64 1.1.3 What makes the market price change? 1) Start Copyright Mark Van Couwenberghe, 2017 64 1.1.3 What makes the market price change? 1) Start Sea cruises have evolved… What makes the market price change? PRICE MECHANISM ON COMPETITIVE MARKETS

Copyright Mark Van Couwenberghe, 2017 65 2) Theory The market price in a competitive market will change as a results of shifts in demand and/or supply. - factors that have an impact on the demand: income of buyers 1 expectations of buyers 2 price of substitute product 3 price of complementary product 4 preference of buyers 5 number of buyers 6 Substitute products are: Complementary products are: What makes the market price change? PRICE MECHANISM ON COMPETITIVE MARKETS

66 - factors that have an impact on the supply: production costs 7 Copyright Mark Van Couwenberghe, 2017 66 - factors that have an impact on the supply: production costs 7 technological innovation 8 productivity 9 number of sellers 10 1 6 2 7 3 8 4 9 5 10 What makes the market price change? PRICE MECHANISM ON COMPETITIVE MARKETS

67 Impact on market price of parallel shifts of the demand curve (1): Copyright Mark Van Couwenberghe, 2017 67 Impact on market price of parallel shifts of the demand curve (1): if the demand curve shifts to the right, DEMAND RISES the market price will rise to P1 the equilibrium quantity will rise to Q1 P1 Pe Qe Q1 What makes the market price change? PRICE MECHANISM ON COMPETITIVE MARKETS

68 Impact on market price of parallel shifts of the demand curve (2): Copyright Mark Van Couwenberghe, 2017 68 Impact on market price of parallel shifts of the demand curve (2): if the demand curve shifts to the left, DEMAND DROPS the market price will drop to P2 the equilibrium quantity will drop to Q2 Pe P2 Q2 Qe What makes the market price change? PRICE MECHANISM ON COMPETITIVE MARKETS

69 Impact on market price of parallel shifts of the supply curve (1): Copyright Mark Van Couwenberghe, 2017 69 Impact on market price of parallel shifts of the supply curve (1): if the supply curve shifts to the right, SUPPLY RISES the market price will drop to P1 the equilibrium quantity will rise to Q1 Pe P1 Qe Q1 What makes the market price change? PRICE MECHANISM ON COMPETITIVE MARKETS

70 Impact on market price of parallel shifts of the supply curve (2): Copyright Mark Van Couwenberghe, 2017 70 Impact on market price of parallel shifts of the supply curve (2): if the supply curve shifts to the left, SUPPLY DROPS the market price will rise to P2 the equilibrium quantity will drop to Q2 P2 Pe Qe Q2 What makes the market price change? PRICE MECHANISM ON COMPETITIVE MARKETS

coordination function Copyright Mark Van Couwenberghe, 2017 71 The market price mechanism in a competitive market has two functions: coordination function signal function demand and supply always evolve towards an equilibrium the market price sends signals to buyers and sellers example: rising price >>> signal to buyers: buy less signal to sellers: sellers sell more What makes the market price change? PRICE MECHANISM ON COMPETITIVE MARKETS

72 1.1.4 What is price elasticity? 1) Start What is price elasticity? Copyright Mark Van Couwenberghe, 2017 72 1.1.4 What is price elasticity? 1) Start What is price elasticity? PRICE MECHANISM ON COMPETITIVE MARKETS

73 What is price elasticity? PRICE MECHANISM ON COMPETITIVE MARKETS Copyright Mark Van Couwenberghe, 2017 73 What is price elasticity? PRICE MECHANISM ON COMPETITIVE MARKETS

Copyright Mark Van Couwenberghe, 2017 74 2) Theory The price elasticity of demand illustrates the “strength” of the reaction of a buyer (change in quantity demanded) as a result of a price change. Formula: P 0 = original price P 1 = new price Q 0 = original quantity Q 1 = new quantity P E D value: the outcome of this calculation will always be < 0 the interpretation of the “strength” of the seller’s reaction is therefore based on the absolute value What is price elasticity? PRICE MECHANISM ON COMPETITIVE MARKETS

75 The price elasticity ratio should be interpreted as follows: Ratio Copyright Mark Van Couwenberghe, 2017 75 The price elasticity ratio should be interpreted as follows: Ratio Interpretation Ε < 1 Demand is “price inelastic”: a given price change generates a relatively “weaker” change in quantity demanded E = 1 Demand is “unitary price elastic”: a given price change generates a relatively “proportional” change in quantity demanded E > 1 Demand is “price elastic”: a given price change generates a relatively “stronger” change in quantity demanded E = 0 Demand is “perfectly price inelastic”: a given price change generates no change in quantity demanded E = ∞ Demand is “perfectly price elastic”: a given price change generates a relatively “infinitely strong” change in quantity demanded What is price elasticity? PRICE MECHANISM ON COMPETITIVE MARKETS

76 Price elasticity of demand is an important concept for sellers: Copyright Mark Van Couwenberghe, 2017 76 Price elasticity of demand is an important concept for sellers: If the demand for their product is price elastic, a rise in price will lead to a drop in turnover a drop in price will lead to a rise in turnover If the demand for their product is price inelastic, a rise in price will lead to a rise in turnover a drop in price will lead to a drop in turnover What is price elasticity? PRICE MECHANISM ON COMPETITIVE MARKETS

77 Graphs: Perfectly price inelastic Demand Price elastic Demand (D) Copyright Mark Van Couwenberghe, 2017 77 Graphs: Perfectly price inelastic Demand (D) Price elastic Demand (D) Price inelastic Demand (D) Perfectly price elastic Demand (D) What is price elasticity? PRICE MECHANISM ON COMPETITIVE MARKETS

Copyright Mark Van Couwenberghe, 2017 78 The price elasticity of supply illustrates the “strength” of the reaction of a seller (change in quantity supplied) as a result of a price change. Formula: P 0 = original price P 1 = new price Q 0 = original quantity Q 1 = new quantity P E S value: the outcome of this calculation will always be > 0 the interpretation of the “strength” of the seller’s reaction is therefore based on the absolute value What is price elasticity? PRICE MECHANISM ON COMPETITIVE MARKETS

79 The price elasticity ratio should be interpreted as follows: Ratio Copyright Mark Van Couwenberghe, 2017 79 The price elasticity ratio should be interpreted as follows: Ratio Interpretation Ε < 1 Supply is “price inelastic”: a given price change generates a relatively “weaker” change in quantity supplied E = 1 Supply is “unitary price elastic”: a given price change generates a relatively “proportional” change in quantity supplied E > 1 Supply is “price elastic”: a given price change generates a relatively “stronger” change in quantity supplied E = 0 Supply is “perfectly price inelastic”: a given price change generates no change in quantity supplied E = ∞ Supply is “perfectly price elastic”: a given price change generates a relatively “infinitely strong” change in quantity supplied What is price elasticity? PRICE MECHANISM ON COMPETITIVE MARKETS

80 Graphs: Perfectly price inelastic Supply Price elastic Supply (S) Copyright Mark Van Couwenberghe, 2017 80 Graphs: Perfectly price inelastic Supply (S) Price elastic Supply (S) Price inelastic Supply (S) Perfectly price elastic Supply (S) What is price elasticity? PRICE MECHANISM ON COMPETITIVE MARKETS