Competitive markets & how they work OCR Economics AS Level F581 Microeconomics

Lesson 1 Objectives To be able to explain what exactly we mean by a market To be able to explain the difference between notional and effective demand To be able to explain the relationship between price and quantity demanded, using a graph to display a demand curve

To begin You have 5 minutes to come up with as many uses of the word ‘market’ as you can (in relation to the world of Business, Commerce & Economics)

Definition of ‘Market’ Market: where or when buyers and sellers meet to trade or exchange products & services Examples include the stock market, housing market, local high streets, e-bay, the labour (jobs) market Within markets the level of demand and supply fluctuate and as a result so do prices

Who would like one of these?

Who can afford to buy one of these?

Definitions of Notional & Effective Demand Notional Demand : the desire for a product Effective Demand : desire for a product backed up by a willingness and ability to pay Demand : the quantity of a product that consumers are able & willing to purchase at various prices over a period of time

An example of a lack of effective demand

Relationship between price & quantity demanded We assume ceterus paribus (that all other factors remain equal) We focus on a period of time (e.g. a day, a week, a month, a year) We assume that consumers are rational, seeking the cheapest purchase There is an inverse relationship between price and quantity demanded – as prices rise, demand falls

Task: Look at table 2.1 and Fig 2.1 on Page 25 Turn over to Page 26 and complete the Benidorm holiday activity

Definitions of Demand Curve & Demand Schedule Demand curve : this shows the relationship between the quantity demanded and the price of a product Demand schedule : the data that is used to draw up a demand curve Movements along the demand curve : a change in quantity demanded in response to a change in price

Pass the Buck What can you recall from Lesson 1?

Lesson 2 Objectives To be able to define and explain what we mean by consumer surplus To recognise how price and quantity demanded can be used to calculate total revenue/total expenditure To be able to describe the range of factors other than price that influence demand

How much would you pay to use Facebook or Twitter?

Globally, it’s estimated that we get €100 billion more in value from use of the internet than we pay for (click on the image below to read live on line)

Definition of Consumer Surplus Consumer Surplus : the extra amount a consumer would be willing to pay for a product and service over and above the amount that actually is paid Consumer Surplus Price Quantity P Q

How have the following affected consumer surplus? The introduction of a congestion charge in London The arrival of Amazon and others in to the market for books Price discrimination by low-cost airlines who charge different prices depending upon how far in advance customers book We’ll return to this concept later to see how consumer surplus is affected by market developments

Calculating Total Revenue/Total Expenditure A demand curve is plotted against two axis –Price –Quantity By multiplying price per unit by the number of units sold, we can determine the total revenue earned by firms which is also the total expenditure by consumers, at a given price E.g. 200 units x £1.50 per unit = £300

Why is this important? We will discover in future lessons how different products/services have demand that is more or less sensitive to price changes Total revenue/expenditure can vary quite dramatically if demand and or prices fall There may be an increase in revenue even if prices are cut, or a decrease in revenue even if prices are increased

Other factors that influence demand

Key income definitions Disposable income : Income after taxes on income have been deducted and state benefits have been added Real disposable income : As per disposable income but further adjusted to take account of changes in price level (inflation) Normal goods : goods for which an increase in income leads to an increase in demand e.g. Plasma TV Inferior goods : goods for which an increase in income leads to a fall in demand e.g. ‘Basics’/’Value’ branded foods Substitutes : competing goods e.g. i-tunes vs CDs Complements : goods for which there is joint demand e.g. houses and mortgages

The effect on the demand curve Change in demand due to Effect on the demand curve An increase in consumer income Demand at the same price is HIGHER than before, and the curve shifts to the RIGHT A rise in the price of substitutes A fall in the price of complements A positive change in tastes & fashion A fall in consumer income Demand at the same price is LOWER than before, and the courve shifts to the LEFT A fall in price of substitutes A rise in price of complements A negative change in tastes & fashion D D1 D2

Real Life Examples What examples of these factors in action do you recall from the commodity presentations you did last term?

Talkabout I’d like a volunteer to talk about factors other than price that influence demand They have to talk for a minute and hopefully hit 6 key words

Lesson 3 objectives To be able to understand how a supply curve is drawn from a supply schedule To be able to explain what is meant by the producer surplus To be able to describe the main influences on supply levels other than price

A supply curve Price Per Person (£) Quantity Supplied Price P Quantity S

Definition of supply curves/schedules Supply curve : this shows graphically the relationship between the quantity supplied and the price of a product Supply schedule : the data from which a supply curve is drawn

The Producer Surplus Watch this video for an explanation of the producer surplusthis video pajholden is a channel on YouTube worth looking at to support your studies (jodiecongirl is a better looking alternative!) Producer surplus : the difference between the price a producer is willing to accept and the actual price

What effects supply levels other than price?

The effect on the supply curve Change in supply due toEffect on the supply curve A fall in raw material costs Supply at the same price is HIGHER than before, and the curve shifts to the RIGHT An improvement in labour efficiency A reduction in indirect taxation A positive technological advance An increase in raw materials Supply at the same price is LOWER than before, and the curve shifts to the LEFT An increase in labour costs An increase in indirect taxation A failure in technological advances S S1 S2

Next week… Some practice paper questions to take stock How demand & supply interact to create a market equilibrium price

Lesson 4 Objectives To understand how to draw supply and demand charts that ‘commentate’ on changes in markets To do this by watching a segment of ‘Trading Places’ together and drawing supply and demand charts that describe what happened To be able to define and use the terms market equilibrium and market disequilibrium

Watch the section of Trading Places and note what’s happening What are the key moments when – demand rises? – demand falls? – supply rises? As we watch it again, draw a supply and demand diagram to comment on what is happening

‘Trading Places’ in Supply & Demand Graphs The market opens, with price set at the level previous close (market equilibrium) Duke & Duke start buying frozen OJ contracts and others follow suit believing the know something about the impending crop report (creating market disequilibrium) The real crop report is released and proves to be a good one with a healthy crop. Buyers realise there won’t be a shortage of OJ afterall and want to get rid of frozen OJ contracts rather than be left with them. They start selling, flooding the market and resulting in demand falling (new market disequilibrium)

Key definitions Market equilibrium Market equilibrium : the price and quantity at which supply and demand are level (also known as the ‘clearing price’) Market disequilibrium Market disequilibrium : any position in the market where demand and supply are not equal Surplus Surplus : an excess of supply over demand Shortage Shortage : an excess of demand over supply

Homework In October 2007, on the day of the World Cup Final, it was reported that English rubgy fans were prepared to pay as much as £1000 for a ticket for the match. The actual price was £60. Use demand & supply concepts/diagrams to explain the situation By contrast, earlier in the year it was reported that local cricket fans in Barbados were being offered tickets to watch World Cup matches for as little as $10. The actual price was $80. Again, use supply & demand concepts and diagrams to explain the situation Due in on Friday Day5

Lesson Objectives To understand the term elasticity in an Economics context To consider how variables have relationships with each other To understand that some of these variables will react with each other in more dramatic or less dramatic ways

Match these in to pairs that may be responsive to each other Eating hamburgers Getting a snog! Money spent on a date Time spent in the gym The shape & tone of your body Time spent at the driving range Golf handicap Working outdoors Getting Skin Cancer Amount of sleep Level of productivity at work Becoming obese

What Economic ‘relationships’ can you think of?

Key Definition Elasticity : the extent to which buyers and sellers respond to a change in market conditions

Plot these demand schedules on the same demand curve diagram PriceQuantity demanded £ £ £ £ £ PriceQuantity demanded £ £ £ £ £ PriceQuantity demanded £ £ £ £ £ Describe how each differs

Demand/Supply Curves and Elasticity The steeper the curve the less sensitive the quantity of demand or supply is to a change in price: price inelastic The shallower the curve the more sensitive the quantity of demand or supply is to a change in price : price elastic

Key definition Price Elasticity of Demand (PED) : the responsiveness of quantity demanded to a change in the price of the product Formula: % change in quantity % change in price Ignore whether it’s a negative or positive change Example Quantity demanded changes from 1000 units to 1400 units = 40% change This happens as a result of a price change from £20 to £15 = 25% change 40/25 = 1.6

Elasticity = % change in Q % change in PRemember! You QUEUE before you PEE

Calculate the price elasticity of demand PriceQuantity demanded £ £ £ £ £ PriceQuantity demanded £ £ £ £ £ PriceQuantity demanded £ £ £ £ £ Outcome of 1 = unit elasticity Outcome of >1 = demand is ‘price elastic’ Outcome of <1 = demand is ‘price inelastic

Key Definitions Price elastic : where the percentage change in quantity demanded is sensitive to a change in price Price inelastic : where the percentage change in quantity demanded is insensitive to a change in price

Why might quantity demanded be more price sensitive for some products than others? vs

Match each picture to the elasticity outcome PriceQuantity demanded £ £ £ £ £ PriceQuantity demanded £ £ £ £ £

Put the items in order, in terms of sensitivity of demand to a change in price

Lesson Objectives To understand the term income elasticity of demand To be able to calculate income elasticity of demand To be able to describe the link between income elasticity and normal goods and inferior goods

July 7, 2010 Consumer Demand Rising Among Urban and Rural Chinese Nearly one in five rural Chinese plan to buy a computer in the next two years by Tao Wu and Steve Crabtree BEIJING -- Economists and Chinese leaders for years have worried that China's predominantly export-driven growth is unsustainable, with poverty, the isolation of its rural citizens, and a culture of thriftiness hampering domestic demand. A Gallup survey of Chinese consumers conducted in 2009 suggests this mindset is changing. Chinese intent to buy several items previously considered luxury goods -- including computers, digital cameras, and cell phones -- has increased significantly since 2004.

Key Definition Income Elasticity of Demand (YED) : the responsiveness of quantity demanded to a change in price Formula: % change in quantity % change in price Ignore whether it’s a negative or positive change Example Quantity demanded changes from 1000 units to 1400 units = 40% change This happens as a result of an increase to average household income of 15% 40/15 = 2.67

Key definition Normal Goods: An increase in income leads to an increase in quantity demanded. A fall in income leads to a fall in quantity demanded. Outcome of formula is positive >1 = Income elastic (more sensitive to income change) <1 = Income inelastic (less sensitive to income change, but demand still increases with income)

Plot these data on a chart Quantity Demanded (index) Income (index) Quantity Demanded (index) Income (index) Quantity Demanded (index) Income (index)

Key Definition Inferior goods : A fall in income leads to an increase in quantity demanded. An increase in income leads to a fall in quantity demanded. Outcome of formula is negative

Plot this data on a chart Quantity Demanded (index) Price (Index)

Caution! YED is relative, depending upon current level of income One person’s normal good is another person’s inferior good

Lesson Objectives Be able to define the term Cross Elasticity of Demand (XED) Be able to explain and identify examples of substitute and complement goods Be able to interpret XED calculations to identify the nature and strength of relationship between two goods

Watch the video (we’ll replay it if necessary)

Key Definitions Cross elasticity of demand : the responsiveness of quantity demanded of one product to a change in price of another product %Change P ProductA %Change P Product B Substitute Good : competing goods (will have a positive XED, the higher the more they compete) Complement Good : goods which have joint demand (will have a negative XED, the lower the number the closer the relationship)

Using this knowledge, answer the following questions Product A has a XED of -1.6 in respect of Product B. Is it a complement or a substitute? Product C has a XED of 2.5 in respect of the same Product B as in the previous question. –Is it a complement or a substitute? –Is the strength of this relationship between Product A and C stronger or weaker than the relationship between A & B? Using the data below, calculate the XED of Product D in respect of Product E –Product E changes in price from £1.50 to £1.75 –Product D quantity demanded changes from 1000 units to 1200 units Comment on the relationship that would appear to exist between the two products D & E If the calculation led to an outcome of zero, what does this tell you about the extent of any relationship between two products? Come up with your own examples of complement and substitute goods. Be as inventive as you like. I will consider offering a prize for the most novel suggestion.

The relevance of XED Especially important in competitive markets where there are many substitute goods Firms can both anticipate how their own prices cuts/rises might affect demand, & how competitors actions may impact upon them Not as obvious with complements, but a change in price may lead to a change in demand for a complement. Firms will need to be ready to meet new supply levels if possible

Lesson Objectives

Objectives To be able define the term price elasticity of supply To be able to carry out a price elasticity of supply calculation and interpret it To be able to explain the relevance of this estimate to business/industry To be able to define the term allocative efficiency

What effects supply levels other than price?

Key Definition Price Elasticity of Supply (PES) : the responsiveness of quantity supplied to a change in price level % change in Q supplied % change in P level (As with PED ignore negative values) Inelastic = 0 to 1 : supply is not very responsive to a change in price Elastic = above 1 : supply is responsive to a change in price

How steep will the curves be?

Short term vs Long term Service businesses like airlines need to sell seats in short term or they will make a loss. Over the medium/long term they can reduce capacity if necessary Farmers cannot change their supply levels in short term as they are committed to certain types of crop

Influences on elasticity of demand Availability of stocks – can a firm add new supply to the market quickly? Availability of factors of production – does a firm have labour, land, capital available as required to increase supply? Can it easily decrease supply by reducing these inputs? Time period – what time period are we discussing?

Relevance PES always positive reflecting that as price increases supply will be more attractive to firms Reflects the availability of factors of production in short term and long term in order to respond to price changes with a change in supply levels Firms will try and make their supply as elastic as possible so they can react quickly. This means holding stock but this can be risky

Key Definition Allocative Efficiency : where resources are used to produce goods and services that maximise consumer satisfaction