economics summary - topic 1

7/28/2019 Economics Summary - Topic 1

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Introduction to Economics: Summary

The nature of economics

The economic problem - wants, resources, scarcity

The need for choice by individuals and society

Opportunity cost and its application through production possibility frontiers

Future implications of current choices by individuals, businesses and governments

Economic factors underlying decision-making by:

individuals - spending, saving, work, education, retirement, voting and participation

in the political process business - pricing, production, resource use, industrial relations

governments - influencing the decisions of individuals and business

The operation of an economy

Production of goods and services from resources - natural (land), labour, capital and

entrepreneurial resources

Distribution of goods and services

Exchange of goods and services

Provision of income

Provision of employment and quality of life through the business cycle

The circular flow of income

individuals, businesses, financial institutions, governments, international trade and

financial flows

Economies: their similarities and differences

Examine similarities and differences between Australia and at least one economy in Asia in

relation to:

economic growth and the quality of life

employment and unemployment

distribution of income

environmental sustainability

the role of government in health care, education and social welfare


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The Nature Of Economics

The Economic Problem:

1. Our wants are unlimited2. Resources are scarce: resources used to satisfy our wants are limited3. Can't satisfy all our wants with our limited resources, we must choose between them4. Rank our preferences - choose our highest-preference wants first, and leave some

wants unsatisfied

The study of economics is about the allocation of our limited resources for the satisfaction ofour unlimited and competing wants where individuals must undergo choice, choosing oneoption over an alternative. It is how to organise production in order to satisfy to maximumnumber of wants.

Key Economic Issues:

1. What to produce? - limited resources: what goods and services are produced2. How much to produce? - waste resources or unsatisfied individuals3. How to produce? - most efficient method of production: limited resources to produce

greatest number of wants4. How to distribute production? - equitable/inequitable distribution & equity/efficiency

Opportunity Cost (refer to glossary):

Satisfying one want results in giving up the alternative want: the want we have to forego.

Individuals: limited income - choice between car and overseas holiday, forego holiday

Business: allocation of scarce resources: production of shoes or furniture

Government: limited resources to satisfy community wants - new motorway or school

Production possibility frontier:

demonstrates various combinations of two alternative products that can be produced(highlights opportunity costs due to individuals/community choices)

Shows the upper limit of what an economy can produce at any given point in time.

All points on the frontier represents points where the economy is operating at fullproductive capacity (all resources are employed).

Producing inside the curve: producing less than its maximum possible output &resources would not be fully employed.

Assumptions

economy produces only two goods - e.g. food and clothes

state of technology is constant

quantity of resources available remains unchanged

all resources are fully employed

Changing its production combination: cost involved (opportunity cost)currently producing200 units of food and no clothing, wants to produce 150 units of food and 40 units of clothing.

The opportunity cost of clothing is 1.25 units of food.


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New technology: more efficient methods of production = outwards shift

Discovery of new resources/Expansion of population: increase number of peopleavailable for work = increased production of both goods, push the production frontieroutward

IF our resources are not fully employed, we don't change the frontier itself, we change

our position. Economy would be producing at a point underneath the frontier. Possibility of concave production possibility frontier: some resources are better suited

to a specific type of production.

Future implications of choices:

Economy focuses on capital goods: increase productive capacity & higher level ofeconomic growth

Producing more capital goods now = forego satisfying some wants today, in order tosatisfy a greater number of wants tomorrow

Individual: forego holiday for a mortgage - home ownership improves financial

security, no rent and an asset to pass on to children Business: limited resources - undergo assessment of successful business areas:

investing in communications and IT = financial success

Governments: decide which community wants to satisfy: forego some wants

Economic factors underlying choices:

Individuals: economic choices influenced by age, income, expectations, future plansand family circumstances.-level of income: how much they save, how much they spend-undertake education = forego income for several years for higher income in the long

run Business:

-Pricing: higher price to maximise profits/small impact on level of sales (based onmarketing strategy)-Minimise cost: may purchase better quality equipment but have a longer operatinglife and require less maintenance. Generally choose cheaper resource but may paymore for a reliable supply.-Ethical issues: importance of natural environment (recycled paper/non-recycled

paper)-Industrial relations issues: wage agreements, individual contracts, unionrepresentation

Government: significant influence over the economic choices of individuals andbusiness-discouragement: prohibit certain activities, heavy penalties, taxation-encouragement: incentives e.g. encouraging individuals to join a private healthinsurance scheme - provide 30% rebate & private health insurance coverage is now45% of the population compared to 30% in the mid-1990s


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The Operation of an Economy

Production of goods and services:

Goods and services are the outcome of the production process The quantity and quality of an economy's resources can influence how wealthy/poor

that country will be: abundant, high quality resources = satisfy their wants = higherstandard of living/quality of life

Resource Reward

Natural resources RentLabour WagesCapital Interest

Enterprise Profit

Natural resources (land): resources provided by naturereward covers all the income

rewards derived from the productive use of natural resources.

Labour: determined by the countrys population: provides human effort (physical/mental) reward includes executive salaries, commissions, fees for professionals and the earnings ofself-employed people

Capital: 'produced means of production' (not for immediate consumption, for the productionof other g&s) E.g. machinery, factories, infrastructure (owned by the community)

Increase the productivity of other resources: increase output to satisfy more wants

Owners of capital rewarded by earning interest: borrow the excess savings in theeconomy, they pay interest on their loans where this interest = price of capital

Enterprise: involves organising the other resources for the purpose of producing g&s

Entrepreneur decides the management of the factors of production

Reward: entrepreneurs are entitled to receive rent for the use of any owned land,wages from work effort and interest from capital.

Problem of Scarcity - Limited supply: Factors of Production

Limits to the amount of natural resources available for production E.g. land, fossilfuels, clean air & water

Supply of labour is limited to our population size, labour market skills & people'swillingness to work

Supplies of capital are limited by the extent to which governments & the privatesector are willing to invest, as well as the level of domestic (overseas) savingsavailable for the investment

Supply of entrepreneurial skills - limited by size of population & range of othercultural and economic factors including the ability and willingness of individuals toinnovate and take risks.

Allocation of scarce resources is determined by consumers spending patterns. Firms respondto consumer demand - obtain resources to produce wants. Efficient industries facing growing

consumer demand and higher prices = attract more resources.


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Distribution and exchange of goods and services

Market economies provide people with income as a reward for their contribution tothe production process: where they exchange income for g&s

Owners of factors of production receive income based on the value of their input.

Workers' income levels are influenced by: how much they work, their skills &expertise, educational qualifications and their bargaining power in wage negotiationswith employers.

Benefit of system: provides incentives for people to obtain better skills and workharder = improve resource base & encourage innovation& technological advancement

Unfair: illness, age, disability - government may intervene to assist (take money fromhigh income earners to give to lower income earners)

The business cycle

Cyclical pattern causes significant disruptions for both individuals and businesses

where the negative consequences result in a lower quality of life Boom in economic growth is associated with increase investment and production.

Governments economic aims = smooth out the cycle: stimulate economic growthduring recession/sustain economic growth

Table: Impacts of the business cycle

Recession Boom

Falling production of goods and services Increasing production of goods and servicesFalling levels of consumption and investment Rising levels of consumption and investment

Rising unemployment Falling unemployment

Falling income levels Rising income levelsFalling quality of life Rising quality of life

Circular flow of income: five-sector circular flow of income model

describes the operation of the economy and the linkages between the main sectors

Five sectors: individuals, businesses, financial institutions, governments andinternational trade & financial flows.

Individuals: Activities in earning an income & spending on g&s where they are owners of

productive resources and the consumers.

supply factors of production (labour/enterprise) to produce g&s then rewarded withincomes - rent, wages, interest and profit

Income - consumption of locally produces goods, savings, paying tax or purchasing

imports.

Businesses: engage in the production and sale of g&s - buying resources to produce & sell

Businesses and individuals have a interdependent relationship: individuals supply

resources for the production process and consume g&s - individuals depend on

businesses to produce g&s they demand and provide the income to buy them.

Circular flow depicts the flow of money between individuals and businesses.


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Financial institutions (capital market): engaged in the borrowing and lending of money

Act as intermediaries between savers & borrowers of money (undertake savings and

investment) : E.g. banks, finance companies, credit unions, life insurance companies

Savings = leakage, involves money put aside and withdrawn from the circular flow

and disrupts the state of equilibrium

Act of saving and investment = vital for the growth and prosperity of our economy

(savings lead to the creation of new capital goods)

Investment is an injection and increases the size of the circular flow and level of

economic activity, counteracts leakages

Firms undertake investment expenditure, increase the demand for capital goods -

stimulates production in the firms who demand more resources - more resources

employed, individuals income will increase - further increase in demand for consumer

g&s

Individuals, businesses and financial institutions = private sector

Governments: commonwealth, state and lawsatisfy community wants and obtain resources

through tax

Imposes taxes on individuals & businesses and undertakes various government

expenditures

Taxation = leakage; reduces money spent on g&s (individuals) and reduces funds for

resources (businesses)total: reduction in level of economic activity (falling income,

output and employment opportunities)

Majority of tax revenue from individuals

Government expenditure = injection;

-spends revenue on collective g&s, provides income to government employees &

employees of the private businesses from which it purchases g&s

-uses tax revenue to transfer payments (pensions/unemployment benefits)represents

income to the recipients

Government = public sector & together with the private sector, makes up the domestic

sector

International trade and financial flows: covers transactions (exports, imports, internationalmoney flows)

Imports = leakage; money is withdrawn from the economy and paid to businesses

overseas (reduces size of circular flow, decrease level of economic activity with

falling income, output and employment opportunities)

Exports = injection; money is paid to Australian businesses and the income stimulates

production & employment opportunities.


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Economies: Their Similarities And

Differences

Comparing Economies

Economic growth and the quality of life

Asian economic region = fastest growing economic region, newly industrialised

economies

Australia: 3.2% GDP, slower than most Asian economies

Australia is ranked 2 in the HDI Index

Employment and unemployment

Australias unemployment rate: 5% which is similar to other Asian economies E.g.

Japan, 4.9%

Employment patterns in Australia are similar to most advanced economies, with the

majority of people employed in services industries E.g. retail trade, real estate and

business services

Distribution of Income

Measure by the gini index

In comparison, general industrialised economies in Asia and Australia have a

relatively equal distribution of income

Environmental Sustainability

Climate Change

Relatively bad sustainability in Australia

Compared through CO2 emissions

Role of the government in health care, education and social welfare

Government spending e.g. welfare, education Measured/compared through government budget spending

In comparison, Australia has more characteristics of a market economy with more

government aid than Asia


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Consumers in the Market Economy

Consum er sovereignty

One main assumption in a market economy is that consumers will determine

what is produced.

Consumers will ultimately decide what will be produced through their

freedom of choice.

Consumer sovereignty is based on consumers sending signals to producers

through their demand of goods and services.

However, consumer sovereignty is not absolute. There are ways in which the market

economy can decrease it.

Marketing: Advertising and direct marketing influence the spending patterns of

consumers. Market strategies manipulate the behaviour of consumers- changing from

a want into a need through extensive research

Misleading or deceptive conduct: Consumers can be deceived by false or dishonest

claims of a product.

Planned obsolescence: Firms sometimes produce goods that are designed to wear out

or go out of date. This is designed so consumers are encouraged to purchase more

from a particular company. For example, phone companies frequently update theirdesign of their phone to encourage people to buy a new phone.

Anti-competitive behaviour: Firms may operate in areas that have less competition.

Firms do this so they can have more power over the consumer. For example, for some

service businesses such as banks may provide a low quality customer service because

they know customers do not have a large range of other supplies.

Decisions to spend or save

After consumers have received their income, they have a choice whether to spend or save it.

This can be expressed in the following equation:

Y=C+S

Where Y = Disposable income after tax

Where C = Consumption

Where S = Savings


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Average propensity to consume : This is the proportion of total income that is spent

on consumption.

Average propensity to save: This is the proportion of the total income where the

income is not spent but saved.

Factors that inf luence the decision to spend or save:

Cultural factors: A person may decide to spend or save depending on Cultural

influences.

Personality factors: This is depends on personal preference. Some people prefer to

save in case of a future need, while others prefer to send for immediate satisfaction.

Expectations of the future: People who expect their income to rise in the future as lesslikely to worry about saving now.

Any specic future spending plans: Individuals might save more in the present in them

are planning to spend a major expense in the future.

Tax policies: The tax system can influence an individuals consumption patterns. For

example, taxes can be made to make savings look attractive.

Availability of credit: Spending is likely to be higher if credit is readily available.

This creates a new source of money for expenditure.

However, the most significant factors that influence an individual to spend or save is their

level of income and age.

I ncome:

As income rises, people tend to save a higher proportion of their incomes: ie. APS

rises and APC falls. This is because consumers on lower incomes need to spend more

for their essential needs. For example, a person who only earns $300 will need to

spend all of it on basic cost of living where as a person earning $3000 might

comfortably save 50% of that income.

The marginal propensity to consume is the portion of each extra dollar that goes into

consumption.

The marginal propensity to save (MPS) is the proportion of each dollar that goes into

savings.

Since each dollar of income earned must either be spent or saved, the sum of MPC

and MPS is always one.


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Age

Age plays a role in savings and consumption patterns.

Individuals consumption and saving patterns are not constant throughouttheir lifetime.

When people are young, they tend to receive lower income lower

education and lack of skills. Therefore they spend all of their income and

save very little.

When we get older, we are more educated or have more skilful, our income

increases and we tend to consume a smaller amount of our income.

In retirement, we no longer earn an income and we consume through the

remainder of our lives.

Chapter 6 (Demand)

This chapter wont make much sense without knowing what demand means. Demand is the

relationship between the quantity of a goods or services consumers will purchase and the price

charged for that good or service.

Factors affecting demand

There are six factors that can affect market demand:

1 The given price of the good/service - This factor comes down to needs and wants. Needs

are vital to living everyday life and are bought regardless of the price change. However

wants are not vital for living life and have many substitute goods.

2 The price of competitor goods - Consumers will always consider buying substitute goods. If

the price of a good goes up, the demand for other substitute goods will increase because


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they are cheaper. However complement goods would also be affected because the increase

in price of a good would decrease the demand for its complement goods.

3 Expected future prices - If the consumers expected the price of a good to increase in the

future they would be influenced to buy that particular good to take advantage of itincreasing in price in the future.

4 Consumer trends change - Consumer taste changes over time which causes increases and

decreases in the demand for certain goods. Innovation and technological progress influence

consumers to demanding new and better products at the expense of superseded ones.

5 Income levels - As consumers get more income they will have more disposable income to

spend which in effect will increase their demand for necessities and luxury goods. Consumerexpectations also affect demand because if the consumers expect their incomes to rise in

the future they will be influenced to buy goods. However if consumers knew that their were

going to lose their jobs or if the economic outlook was uncertain it would influence them to

not buy goods.

6 Population and age distribution - The size of our population will affect the amount of

quantity demanded while age distribution will affect the types of goods demanded.

Ceteris paribus

Ceteris paribus is a technique used to find the outcome of a combination of variables while all other

variables that could affect the outcome remain constant.

The demand schedule

For this example let us assume ceteris paribus and compare price to quantity demanded.

Price ($) Quantity Demanded

$20 200


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$40 160

$60 120

$80 80

$100 40

The table above is referred to as a demand schedule. It displays the quantity demanded by the

consumers over a range in prices. From this table we can see a pattern, as price increases the

quantity demanded decreases. This is called the Law of demand.

The demand curve

We now move from the demand schedule to the demand curve. The demand curve is simply a

graphical representation of the data displayed in the demand schedule.


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As you can see, the demand curve slopes downwards from the left to the right. This is present in all

demand curves due to the relationship between price and quantity demanded.

Movements along the demand curve


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Let us now consider what would happen to the graph if price were to change.

As you can see when price is changed we move up and down the demand curve. If price increases

we contract up the demand curve because less is demanded. While if price decreased we expand

down the demand curve because more is demanded.

Shifts in the demand curve

Now that we have looked at the effect price has on the demand curve let us see what effect the

other variables have on the demand curve assuming ceteris paribus. Well keep price the same and

introduce the other variables. A change in any of the other factors will either call an increase or

decrease in supply which will shift the demand curve


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Increases in demand

When the demand curve shifts to the rightits called an increase in demand.

By observing this graph we can see that there has been an increase in quantity demanded for the

same price. We can also see that the consumers are willing to pay a higher price for the same

quantity of goods.


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Decreases in demand

When the demand curve shifts to the leftits called an decrease in demand.

By observing this graph we can see that there has been an decrease in quantity demanded for the

same price. We can also see that the consumers are willing to pay a lower price for the same

quantity of goods.


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Factors that cause shifts of the demand curve

The following table is full of factors that can cause a change in the market demand and cause shifts

in the demand curve

Increase in demand Decrease in demand

An increase in the price of a certain substitute good

will effectively increase the demand for other

substitute goods.

A decrease in the price of substitute goods.

A decrease in the price of complementary goods

will increase demand of the good because it

encourages consumers to take advantage of the low

complementary good prices.

A increase in the price of complementary

goods.

If the consumers expect the price of a certain good

to rise in the future they will demand more of the

good now to take advantage of the expected rise.

Consumers may expect the price of a certain

good to decrease in the future.

New technology might improve goods which can

create increased demand.

Technological progress that causes a good to be

superseded.

Goods can go in and out of fashion which could Goods can go in and out of fashion which could


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effectively increase or decrease demand depending

on consumer trends.

effectively increase or decrease demand

depending on consumer trends.

Consumers could expect their incomes to rise and

therefore increase their demand for goods.

A decrease in the level of income.

Income distribution can change to favour the higher

income earners and in effect would increase the

demand for high standard goods.

A change in the distribution of income being

less favourable to the demand.

A rise in the level of income will result in a large

demand as consumers have more disposable

income.

Decrease in the size of the population and a

change in the age distribution.

Increases in the population can increase the

demand for goods. Age distribution will lead to an

increase in demand of certain types of goods.

.

Price elasticity of demand

Price elasticity of demand measures the responsiveness of quantity demanded to the change in price.

This figure is given as a percentage and given by the percentage change quantity demanded divided

by the percentage change in price.

Elastic demand Elastic demand is when the percentage change in quantity

demanded is greater than the percentage change in price. The goodwould be considered very responsive (relatively elastic) to the price

change

Unit elastic demand Unit elastic demand is when the percentage change in price is equal

to the percentage change in quantity demanded.

Inelastic demand Inelastic demand is when the percentage change in quantity

demanded is less than the percentage change in price. The good

would be considered not very responsive (relatively inelastic) to

the price change.


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Importance of price elasticity of demand

Price elasticity of demand is important to businesses and governments.

Businesses - Business firms can use the price elasticity of demand of the goods they sell to

decide their pricing strategy. If their price elasticity of demand was elastic, firms would look

to decreasing the price of their goods. While if their price elasticity of demand was inelastic,

they would look to increasing the price of their goods.

Governments - Governments can use the price elasticity of demand for when they price

community goods. It can also be used to predict the effects of changes in the level of any

indirect taxes. (Eg. Tobacco) Governments tend to impose indirect taxes on inelastic goods in

order to increase revenue. While if they imposed indirect taxes on elastic goods they would

see a decrease in sales and a smaller revenue margin.

Measuring price elasticity of demand

A method known as the total outlay method is used to measure price elasticity of demand. It simply

tells whether demand is elastic or inelastic, or unit elastic to price changes.

Price ($) Quantity demanded Total outlay (price x

quantity)

5 50 250 - Inelastic

6 45 270 - Inelastic

7 40 280 - Unit elastic

8 35 280 - Unit elastic

9 30 270 - Elastic


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10 25 250 - Elastic

To determine elasticity of a good:

Ifprice increases and revenue increases it is Inelastic

Ifprice increases and revenue decreases it is elastic

Ifprice increases and revenue stays the same it is unit elastic

Perfectly elastic demand

When a good is perfectly elastic the demand curve is a straight horizontal line. This means that

consumers demand an infinite quantity at a given price. This is a totally unrealistic situation andmerely theoretical.


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By observing this graph we can see that a certain good is sold at a certain price and the quantity

demanded is infinite. The price of the good cannot exceed the given price as substitute good will

appeal to the consumers due to them being a lower price. From this we can see that this graph is

elastic.

Perfectly inelastic demand

When a good is perfectly inelastic the demand curve is a straight vertical line. This means that

consumers are willing to pay whatever price for a certain quantity demanded.


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By observing this graph we can see that a certain good can be sold at any particular price for a

certain quantity demanded. The quantity cannot exceed a certain amount and is in short supply.

From this we can see that this graph is clearly inelastic. (Eg. A person with a life threatening illness

will need medication and will pay whatever it costs)

Factors affecting elasticity of demand

Elasticity of demand can be affected by five factors:


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1 Whether the good is a luxury or necessity - If a good is a necessity it is essential for

everyday life. (Eg. Bread) These types of goods would be considered inelastic because if their

was an increase in price the quantity demanded wouldnt fall as much as a luxury good

because they are essential for everyday life. (Eg. Restaurants)

2 Whether the good has any substitutes - A good with lots of substitute goods is considered

an elastic good as there are many other goods in which the consumers can buy. Therefore if

the price of a good increases, the consumer will just go to one of its competitors for a

cheaper price. However some goods dont have substitutes in which case are considered

inelastic as the consumers have no choice but to use that good despite the change in price.

(Eg.Local water supply)

3 The expenditure on the product as a proportion of income - Goods that take up a small

proportion of a consumer's income tend to have lower price elasticity of demand. (Eg. Gum)

However goods that take up large proportion of a consumer's income tend to have higher

price elasticity of demand. (Eg. Cars)

4 The length of time subsequent to the price change - When the price of a good/service

increases consumers take time to adjust to this change. They may seek out substitute

goods/service. The same concept applies if the price decreases. This in effect makes the

market more responsive. However the way in which the consumers respond to the price alsodepends on the durability of the product. Durable products tend to be more elastic than non

durable.

5 Whether a good is habit forming or not - Habit forming goods tend to have an inelastic

demand because the consumers who use them continue these habits, even following the

price increases. (Eg. Alcohol)

Glossary!!!!!!!!!!!!!!!


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Chapter 7 (Supply)

I could easily of copied the demand section and pasted it in here and replaced the word demand

with supply. ITS EXACTLY THE SAME! Supply is the quantity of product producers are willing and able

to sell at a given price, all other factors being held constant.

Factors affecting Market supply

There are six main factors that affect market supply:

1 The price of the good or service - The price of a good or service influences the willingness of

the supplier to supply a particular good or service. If the price is low, suppliers will be less

willing to supply while if the price is high they would be willing to supply as much as they can.

The expected future price also influences the suppliers willingness as if its expected to

increase in price the supplier would be more willing to supply as opposed to the good or

service decrease in price in the future which would influence the supplier to not supply the

good or service.

2 The price of other goods or services - Producing a good or service which has a high price is

more profitable than producing a good or service with a lower price. Firms are less willing to

supply the lower priced good because they are less profitable from it.

3 The state of technology - An improvement in technology would lower production costs

which would allow for an increase in supply.

4 Changes in the cost of factors of production - The cost of production directly affects the

quantity supplied.Adecrease in production costs means an increase in supply while an

increase in production costs means decrease in supply.

5 The quantity of goods available - The actual quantity of the good available is an overall

limiting factor that affects supply. The number of suppliers also affects the quantity of a

good or service available. More suppliers means increased supply.


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6 Climatic and seasonal influence - Climatic conditions and seasonal influences will take affect

mainly to the agricultural production. (Eg. Droughts will cause a decrease in supply of crops)

The supply schedule

For this example let us assume ceteris paribus and compare price to quantity supplied.

Price ($) Quantity supplied

$100 200

$80 160

$60 120

$40 80

$20 40

The table above is referred to as a supply schedule. It displays the quantity supplied that will be

supplied over a range of prices. From this table we can see a pattern, as price increase so does

quantity supplied. This is called the Law of supply. This occurs because of two reasons:

1 For firms, producing the good becomes more profitable, so they increase their production

for that good.

2 The higher price also makes producing this good more profitable for other businesses, which

will attract new firms into the industry, this will also cause an increase in the quantity

supplied.


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The supply curve

We now move from the supply schedule to the supply curve. The supply curve is simply a graphical

representation of the data displayed in the supply schedule.


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As you can see, the supply curve slopes upwards from left to right. This is present in all supply curves

due to the relationship between price and quantity supplied.

Movements along the supply curve

Let us now consider what would happen to the graph if price were to change.


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As you can see when price is changed we move up and down the supply curve. If price increases we

expand the supply curve because more is supplied. While if price decreased we contract down the

supply curve because less is supplied.

Shifts in the supply curve

Now that we have looked at the effect price has on the supply curve let us see what effect the other

variables have on the supply curve assuming ceteris paribus. Well keep price the same and

introduce the other variables. A change in any of the other factors will either call an increase ordecrease in supply which will shift the supply curve

Increase in supply

When the supply curve shifts to the rightits called an increase in supply.


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By observing this graph we can see that there has been an increase in quantity supplied for the same

price. We can also see that firms are willing to supply a given quantity at a lower price than before.

Decrease in supply

When the supply curve shifts to the leftits called an decrease in supply.


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By observing this graph we can see that there has been a decrease in quantity supplied for the same

price. We can also see that firms are willing and able to supply a given quantity at a higher price than

before.


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Factors that cause shifts in supply

The following table is full of factors that can cause a change in the market supply and cause shifts in

the demand curve

Increase in supply Decrease in supply

A fall in price of other goods, which makes

production of other goods less profitable.

A rise in the price of other goods.

An improvement in the technology used in the

production process.

A certain technology no longer being available.

A fall in the cost of factors of production such as

labour or capital.

A rise in the cost of the factors of production.

An increase in the quantity of resources available

to be used in production.

A decrease in the quantity of resources available.

Climatic condition or seasonal change that is

more favourable to the production process.

Regulations restricting the sale of a good because

its risks health and safety.

Climatic condition or a seasonal change that is

less favourable to production of a particular good.


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Price elasticity of supply

Price elasticity of supply measures the responsiveness of quantity supplied to the change in price.

This figure is given as a percentage and given by the percentage change quantity supplied divided

by the percentage change in price.

Elastic Supply Elastic supply is when the percentage change in quantity supplied is

greater than the percentage change in price. The good would be

considered very responsive (relatively elastic) to the price change

Unit elastic Supply Unit elastic supply is when the percentage change in price is equal

to the percentage change in quantity supplied.

Inelastic Supply Inelastic supply is when the percentage change in quantity supplied

is less than the percentage change in price. The good would beconsidered not very responsive (relatively inelastic) to the price

change.


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Perfectly elastic supply

When the supply is perfectly elastic the supply curve is a straight Horizontal line. This means that the

suppliers are willing to supply an infinite amount of good or services at a fixed price.

By observing this graph we can see that the producers are willing to supply an infinite quantity of a

good or service at a particular price but nothing at all under that price.

Perfectly inelastic supply

When the supply is perfectly inelastic the supply curve is a straight vertical line. This means that the

quantity supplied remains the same regardless of the price.


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By observing this graph we can see that the producers are willing to supply a given quantity of a

good or service regardless of price. (Eg. The supply of scarce goods such as oil are the closest goods

to being perfectly inelastic)

Factors affecting elasticity of supply

There are three main factors that can affect the repsonisvemenss of supply to price changes:

1 Time lags after price change - The greater the amount of time that produces have to

respond to a price change, the more elastic the supply for a product in question. If there is a

price increase producers will try to use their limited inputs to maximize their outputs to

supply for the increased price. This can be accomplished through maximising production

through being efficient with resources. After the price increase the supply of most products

would be perfectly inelastic because producers cannot increase any of their equipment by

working them harder. In the short run, producers can vary some of the inputs to production

process so that they can respond to the price changes more readily. In the short run the

price elasticity of supply increases although it is likely to be relatively inelastic. in the long

run, however the producer would be able to increase any of the inputs including the size of


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the production plant or the amount of machinery and thus facilitate a greater increase in

production in response to a price change, making supply relatively elastic.

2 The ability to hold and store stock - It is possible to store goods and not offer them for sale

when there is a downturn in the market condition and the price falls. This stock is known asinventory and can be sold when there is an upturn in the market and price rises. The rule is

that the easier it is to hold stock the more elastic the supply. Therefore the elasticity will

depend on the item, fruit cannot be stored for long periods of time so therefore is relatively

inelastic while furniture can be held for along time and therefore is relatively elastic.

3 Excess capacity - Excess capacity is when a firm is not using its existing resources to their full

capacity. Supply is elastic when a firm has excess capacity because they can respond easily

to a price change by intensifying the use of their resources. Supply is inelastic when a firm is

running at full capacity.


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Chapter 8 (Market Equilibrium)

The Concept of Market Equilibrium

This chapter is all about the the price mechanism determines the equilibrium in the market. The

price mechanism is the combination of supply and demand, which determine the prices at which

commodities will be sold and bought in the market. The market equilibrium is when at a certain

price level the quantity supplied and the quantity demanded for a particular commodity are equal.This means that the market clears, there is no excess supply or demand and there is no tendency for

change in either price or

.

Establishing market equilibrium

Market equilibrium is when the demand curve intersects the supply curve. In other words its when

the quantity demanded is equal to the quantity supplied. From this we can determine how a market

reaches the equilibrium position.

Excess demand

When the quantity demanded exceeds the quantity supplied, this called excess demand.


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By analyzing this graph we can see that the quantity demanded exceeds the quantity supplied. Due

to the large demand and short supply, buyers will start bidding up the price to compete for the short

supply. The suppliers want to satisfy the market as much as they can by

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edition/easing production which increases supply. The suppliers will also increase the price which

causes an expansion in supply and a contraction in demand.

This will occur as long as there is excess demand, till the point of intersection of the supply anddemand curve. When this happens it is referred to as a market clear, which means there is no excess

supply or demand.
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Excess supply

When the quantity supplied exceeds the quantity demanded, this called excess supply.

By analyzing this graph we can see that the quantity supplied exceeds the quantity demanded. The

suppliers will lower the price which results in an expansion of demand and a contraction of supply.

This will occur as long as there is excess supply, till the point of intersection of the supply and

demand curve. When this happens it is referred to as a market clear, which means there is no excess

supply or demand.


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The price mechanism

The previous examples of excess demand and supply show how the price mechanism works. The

market forces of supply and demand interacting to bring about the equilibrium price that clears the

market and eliminates excess supply and demand.

Market equilibrium occurs when:

1 Quantity demanded = Quantity supplied

2 The market clears

3 There is no tendency to change

Changes in the equilibrium

The equilibrium price can be subject to change which could be caused by the factors that affect

demand and supply. We will now look at what happens to the equilibrium if there is an increase and

decrease in both supply and demand.


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Increase in demand

When the demand curve shifts to the right, this is called an increase in demand. In-terms with the

equilibrium, a new point of equilibrium is formed through this increase in demand.


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By analyzing this graph we can see that the there has been an increase in demand and has caused a

shift in the point of equilibrium. The quantity demanded exceeds the quantity supplied. This will

cause competition amongst the buyers for the limited supply which will cause an increase in price

because there is excess demand.

This will occur till the the market clears at a new point of equilibrium. The increase in demand

increases the equilibrium price and the equilibrium quantity.

Decrease in demand

When the demand curve shifts to the left, this is called an decrease in demand. In-terms with the

equilibrium, a new point of equilibrium is formed through this decrease in demand.


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By analyzing this graph we can see that the there has been an decrease in demand and has caused a

shift in the point of equilibrium. The demand decreases because the supply exceeds the demandwhich lowers the price of the good because there is excess supply.

This will occur till the the market clears at a new point of equilibrium. The decrease in demand

lowers the equilibrium price and the equilibrium quantity.

Increase in supply

When the supply curve shifts to the right, this is called an increase in supply . In-terms with the

equilibrium, a new point of equilibrium is formed through this increase in supply.


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By analyzing this graph we can see that the there has been an increase in supply and has caused a

shift in the point of equilibrium. The supply increases because the supply exceeds the demand which

lowers the price of the good because there is excess supply.

This will occur till the the market clears at a new point of equilibrium. The increase in supply lowers

the equilibrium price and raises the equilibrium quantity.

Decrease in supply

When the supply curve shifts to the left, this is called an decrease in supply. In-terms with the

equilibrium, a new point of equilibrium is formed through this decrease in supply.


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By analyzing this graph we can see that the there has been an decrease in supply which has caused a

shift in the point of equilibrium. The supply decreases because the demand exceeds supply which

increases the price because there is excess demand.

This will occur till the the market clears at a new point of equilibrium. The decrease in supply raises

the equilibrium price and lowers the equilibrium quantity.

The role of the market

The price mechanism plays an important role in a market economy as it determines a solution to the

economic problem. The price determined in the market conveys important information that helps in

providing answers to the questions about production, distribution and exchange of goods and

services.

The price mechanism attempts to solve the economic problem in the product market for goods and

services. The wants of individuals are represented as the demand curve and the supply curverepresents the the production and supply of firms with limited resources. These two curves help


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best determine the price that satisfies both the individual and the firms which gives a solution to the

economic problem facing all economies.

A producer will only produce a good or service if there is a consumer demand for it. Whenconsumers are willing and able to buy a product at a certain price, the demand increases. Producers

will then re-allocate their resources into making the product to satisfy the increasing consumer

demand. This means that when consumer demand rises for a certain product, producers will be

more willing to produce and supply that product because there is more demand for it which gives an

incentive to raise the price. The producers will do this because their is a higher opportunity cost in

producing the particular good which is satisfying the most consumer demand.

The price mechanism also plays an important role in the markets for the factors of production, or

factor markets.Demand and supply forces in factors markets determine the price paid for the factors

of production and thus the share of total output that is received by individuals.. Those individuals

who possess resources or produce goods and services that are scarce and in high demand will

command higher incomes and a greater proportion of total output.

It is said that the market mechanism also ensures allocative efficiency in the economy. the market

mechanism ensures that the equilibrium is reached at the intersection of those two curves, thismeans that production continues to increase until the point where the value to consumers of that

last food produced is equal to the cost to producers.

The price mechanism is efficient because

Any consumer willing to pay the market price for a good or service will be satisfied.

Any producer offering goods or services at the market price will be able to sell all they produce.

Competition among producers also ensures that they are responsive to consumer demand and that

they attempt to minimise their cost of production in order to remain competitive in the market and

maintain their profitability. This ensures that the most cost efficient methods of production are

utilised.

Government intervention in the marketplace


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When markets do not produce its desired outcomes, it is called a market failure. This happens

because the price mechanism takes account of the private cost and benefits of production but does

not take into account social costs and benefits . When this occurs, governments may intervene in the

market.

Price mechanism at price ceiling

When governments thinks that the price for some commodities is too high, or that the market

determined price of some new item is too low. Therefore the government may intervene in the

marketplace in order to impose price ceilings which is the maximum price that can be charged for a

particular commodity.

The reason behind influencing the prices in this way is to affect the distribution of income. Price

floors will redistribute money from sellers to buyers but creates an excess demand.


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Price mechanism at price floor

When governments thinks that the price for some commodities is too low, or that the market

determined price of some new item is too high. Therefore the government may intervene in themarketplace in order to impose price floor which is the minimum price that can be charged for a

particular commodity.

The reason behind influencing the prices in this way is to affect the distribution of income. Price

floors will redistribute money from buyers to sellers buy creates an excess supply.

Market disequilibrium

The problem with both of the cases above is that the intervention by the government led to market

disequilibrium, which is caused by the excess demand created by the price ceiling and the excess

supply created by the price floor. Governments now have turned to a more sophisticated approach

of intervention in the market, quantity intervention.

Quantity intervention


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Externalities are the social benefits and detriments of production and consumption of goods and

services. There are both negative and positive externalities. Negative externalities include

detriments that negatively affect our society such as pollution as a result of producing plastic.

Positive externalities include benefits that positively affect our society such as transport which helpus get from A to B. However for negative externalities, Governments can impose taxes on them

making the production costs higher and in effect will reduce production levels. Making the individual

business to pay for the social costs created by the production of the particular good or service. This

is called internalising the externality.

Merit goods are goods that where some government intervention fills in the gaps in the industry

where the private companies have left untouched. The governments intervene to encourage the

provision of these merit goods and services that have positive externalities.

Public goods are goods that the government supply to the public because private firms cannot

benefit and regulate those goods. They can be categorized as positive externalities. The

governments intervene to supply these items and finances them with its tax revenue.

Problem Government action Outcome

Market price too high Price ceiling Reduces price, quantity shortage

(disequilibrium)

Market price too low Price floor Increases price, quantity excess

(disequilibrium)

Market quantity too high

(negative externalities)

Taxes Increases equilibrium price, reduces

equilibrium quantity.

Market quantity too low

(positive externalities)

Subsidies Reduces equilibrium price, increases

equilibrium quantity

Market does not provide

goods or services (public

goods)

Government provided

goods or services

Government must collect taxation

revenue to finance its supply of public

goods


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economics summary - topic 1

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