Unit 2 Allocation of Resources

The 3 basic problems 1) What to Produce? 2)How to Produce? 3) For Whom to Produce? We have to allocate resources The allocation of resources in a country can be done in 3 ways: 1)Market Economic System 2) Mixed Economic System 3) Planned Economic System

Which one do you like?

Market Economy Consumers decide what to produce. Private property Changes in supply and demand control the prices No Government Intervention Market economy is an ideal which does not exist today

Advantages………. Freedom for everyoneFreedom for everyone No Government InterventionNo Government Intervention Variety of goods and services are produced – Consumer ChoiceVariety of goods and services are produced – Consumer Choice High consumer satisfactionHigh consumer satisfaction It is EfficientIt is Efficient

Has Private Sector – privately owned Public Sector – owned by govt. Govt produces some goods. Eg: Roads, Hospitals, Schools, etc Government intervention is very less. Mixed Economy

Government decides what to produce Government decides what to produce Everything owned by government – No private ownership Everything owned by government – No private ownership Government decides the prices Government decides the prices No consumer choice No consumer choice Planned Economy

The amount of money a product is worth is called its “Price” A place (any size) where a buyer buys & seller sells is called MARKET

What is Demand? Demand is the quantity of a product that consumers are – Willing to buy – Able to buy – At a price – Over a period of time

Individual demand - the demand of one consumer Market demand is the total demand of all the consumers.

 When goods are cheap, People buy more  When goods are expensive, People buy less

The Demand Curve D Price ($) Quantity The demand curve shows the quantity demanded at any given price. The Demand Curve Q P R

The Demand Schedule The Demand Schedule shows quantities demanded at given price (usually set by the producer)

Changes in Demand Curve The changes can be Movement along Demand Curve Shifts of Demand Curve

Price Quantity Movement of Demand Curve

As the price changes, the quantity demanded will also change. Price Quantity

Price Quantity Shift of Demand Curve

At the same price, a different quantity is demanded. Price Quantity

Why Demand Changes? Income Population Other factors Taste & Fashion Prices of Related Goods

Fashion of cloth changes  Demand changes A research shows that dark chocolate is healthy  Demand ↑ More people want to become vegetarian  Demand of meat ↓ If Advertising of a product is successful  demand ↑ Taste & Fashion

Disposable income = Income – Tax Income ↑  Demand↑ Income ↓  Demand ↓ Income

If population is more  Demand is more Population

Price of Related Goods Related Goods Substitute Goods Goods which can replace each other Complement Goods Goods used together Price of Related Goods

Substitute Goods P ↑ D ↑ P↓ D ↑ P ↑ D ↓ P↓ D ↓ D↓

Complement Goods

Weather Expectations of future prices changes If consumers expect prices ↑  D emand ↑ now If consumers expect prices ↓  D emand ↓ no w. Other Factors

The supply curve Supply is the quantity of a product that suppliers are – willing to sell – Able to sell – At various prices – Over a period of time What is Supply?

Individual Supply - the supply of one Firm/ Producer Market Supply is the total Supply of the Market

 When goods are cheap, producer sell less  When goods are expensive, producer sell more

The Demand Curve The Supply curve shows the quantity supplied at any given price. The Supply Curve S Price 0 Quantity

The Supply Schedule The Supply Schedule shows quantities supplied at given price

Changes in Supply Curve The changes can be Movement along Supply Curve Shifts of Supply Curve

Movement of Supply Curve Price Quantity $15 A 1,2501,500 B $30 S As the price changes, the quantity supplied will also change.

Shift of Supply Curve Price Quantity S S1S1 $15 AB 1,2501,500 S2S2 At the same price, a different quantity is supplied.

Why Supply Changes? Taxes Subsidies Other factors Taste & Fashion Cost of Production

Cost of Production (COP) COP↑  supply ↓ & COP ↓  supply ↑ COP may change due to change in……. – Wages (Salary) – Productivity (output per worker) – Raw material – Energy costs (Electricity) – Transport costs

If government puts taxes  COP ↑  Supply ↓ Income Taxes

If the government gives a subsidy then the Cost of production ↓ and Supply ↑ Population Subsidies

Price of Related Goods Related Goods Profitability of goods in joint supply Profitability of substitutes in supply Price of Related Goods

The Profitability of Goods in Joint Supply DVD Players and DVD are produced together. When the Price of DVD Players ↓  Demand of DVD Players ↑  So more DVDs are needed  So the Supply of DVDs ↑) also increase.

The Profitability of Substitutes in Supply If Mango Juice becomes more PROFITABLE than Apple Juice, producers will produce more Mango juice. So Supply of Mango juice ↑ & Supply of Apple Juice ↓

War Weather - Earthquakes, floods & fire The breakdown of machinery Expectations of future prices changes – If producers expect prices ↑  Supply ↓ now & will build up STOCKS – If producers expect prices ↓  Supply ↑ now & reduce production Other Factors

Demand & Supply of a product determines the PRICE of a product!!! Demand & Supply of a product determines the PRICE of a product!!! When When Demand = Supply  Equilibrium Demand = Supply  Equilibrium Demand ≠ Supply  Disequilibrium Demand ≠ Supply  Disequilibrium

46 Demand = Supply (Equilibrium Point)

AS Economics Unit 2 Chapter 747 Surplus Surplus – Supply > Demand Shortage Shortage – Demand > Supply

Why the Equilibrium Changes? – Change in Demand – Change in Supply – Change in Demand & Supply

“The responsiveness (changes) in one variable due to the change in the other variable – Elasticity” PED – Price Elasticity of demand PES – Price Elasticity of Supply

When price ↑, what happens to demand? Demand Decreases ↓ BUT! How much does demand decrease? Eg: If price rises by 10% The demand will decrease – By more than 10%? Or – By less than 10%?

“A responsive change in demand with a change in the price is called Price Elasticity of Demand (PED)” If a small change in price, produce a bigger change in demand  demand is elastic. If a large change in price, produce a small change in demand  demand is inelastic.

PED - Formula PED = % change in quantity demanded of a product % change in price of that product PED = % △ Q % △ P PED is always negative

Elastic Demand Price (£) Quantity Demanded D If Producer decrease the pirce from 10 to 7 7 % Δ in Price = - 30% % Δ in Demand = + 300% PED = - 10 (Elastic) A small change in price, produce a bigger change in demand  Demand is ELASTIC.

Inelastic Demand Price (£) Quantity Demanded 10 D % Δ Price = -50% % Δ Demand = +20% PED = -0.4 (Inelastic) If a large change in price, produce a small change in demand  Demand is INELASTIC. If Producer decrease the pirce from 10 to 5

So, the PED can be a)Perfectly Inelastic PED = 0 b)Perfectly Elastic PED = (-) ∞ c)Unitary Elastic PED = (-) 1

Elasticity of Demand Demand does not change with change in price Demand changes infinitely with a change in price Change in Demand is same as change in price (But Inverse)

The range of the Elasticity of Demand Inelastic Unit elastic Elastic This value can range from zero to infinitely (in absolute value) 01 A 1% change in  less than 1% change in quantity A 1% change in price  exactly 1% change in quantity A 1% change in price  larger than 1% change in quantity

When price ↑, what happens to Supply? Supply Increases BUT! How much does Supply Increase? Eg: If price rises by 10% The supply will increase – By more than 10%? Or – By less than 10%?

“A responsive change in supply with a change in the price is called Price Elasticity of Supply (PED)” If a small change in price, produce a bigger change in supply  Supply is elastic. If a large change in price, produce a small change in supply  Supply is inelastic.

PES - Formula PES = % change in quantity Supplied % change in price PES = % △ Q % △ P PES is always Positive PES - Formula

So, the PES can be a)Perfectly Inelastic PES = 0 b)Perfectly Elastic PES = ∞ c)Unitary Elastic PES = 1

Elasticity of Supply Supply does not change with change in price Supply changes infinitely with a change in price Change in Supply is same as change in price

The range of the Elasticity of Supply Inelastic Unit elastic Elastic This value can range from zero to infinitely (in absolute value) 01 A 1% change in Price  less than 1% change in quantity A 1% change in price  exactly 1% change in quantity A 1% change in price  larger than 1% change in quantity

Importance of PED If the firm knows the PED of its product, – If it is elastic It can decide to decrease the price, to maximize sales  maximum profit – If it is inelastic It can increase the price and earn more profits Or can pass the tax to the consumer

Importance of Elasticity of Supply If the Demand increases, a firm will know if it can meet the increased demand with/without changing prices – If Supply is Elastic  Demand is met without increasing price. – If Supply is Inelastic  Demand is met only with a sharp increase in price.