Markets, Demand and Supply

Demand The relationship between demand and price The demand curve the income effect the substitution effect The demand curve assumptions the axes illustrates how much would be demanded at each price

The demand curve: The demand for potatoes (monthly) 3

Market demand for potatoes (monthly) Point Price (pence per kg) 20 Market demand (tonnes 000s) 700 A Price (pence per kg) A Demand Quantity (tonnes: 000s) 4

Market demand for potatoes (monthly) Point Price (pence per kg) 20 40 Market demand (tonnes 000s) 700 500 A B Price (pence per kg) B A Demand Quantity (tonnes: 000s) 5

Market demand for potatoes (monthly) Point Price (pence per kg) 20 40 60 Market demand (tonnes 000s) 700 500 350 A B C C Price (pence per kg) B A Demand Quantity (tonnes: 000s) 6

Market demand for potatoes (monthly) Point Price (pence per kg) 20 40 60 80 Market demand (tonnes 000s) 700 500 350 200 A B C D D C Price (pence per kg) B A Demand Quantity (tonnes: 000s) 7

Market demand for potatoes (monthly) Point Price (pence per kg) 20 40 60 80 100 Market demand (tonnes 000s) 700 500 350 200 100 A B C D E D C Price (pence per kg) B A Demand Quantity (tonnes: 000s) 8

Demand Other determinants of demand tastes number and price of substitute goods number and price of complementary goods income distribution of income expectations Movements along and shifts in the demand curve

An increase in demand D1 D0 P Price O Q0 Q1 Quantity Possible causes of a rise in demand Tastes shift towards this product Rise in price of substitute goods Fall in price of complementary goods Rise in income Expectations of a rise in price P Price D0 O Q0 Q1 Quantity 10

Q Which way will the market demand for petrol shift if the price of cars rises? Right Left No shift (movement along the curve)

Q Which way will the market demand for petrol shift if petrol becomes more expensive? Right Left No shift (movement along the curve)

Supply Relationship between supply and price The supply curve as price rises, firms supply more it is worth incurring the extra unit costs they switch from less profitable goods in the long run, new firms will be encouraged to enter the market The supply curve assumptions the axes illustrates how much would be supplied at each price

The supply curve: The supply of potatoes (monthly) 14

Market supply of potatoes (monthly) 20 Q 100 a Price (pence per kg) a Quantity (tonnes: 000s) 15

Market supply of potatoes (monthly) 20 40 Q 100 200 a b Price (pence per kg) b a Quantity (tonnes: 000s) 16

Market supply of potatoes (monthly) 20 40 60 Q 100 200 350 a b c c Price (pence per kg) b a Quantity (tonnes: 000s) 17

Market supply of potatoes (monthly) d P 20 40 60 80 Q 100 200 350 530 a b c d c Price (pence per kg) b a Quantity (tonnes: 000s) 18

Market supply of potatoes (monthly) d P 20 40 60 80 100 Q 100 200 350 530 700 a b c d e c Price (pence per kg) b a Quantity (tonnes: 000s) 19

Supply Other determinants of supply costs of production profitability of alternative products profitability of goods in joint supply nature and other random shocks aims of producers expectations of producers Movements along and shifts in the supply curve

Shifts in the supply curve Possible causes of a rise in supply Fall in costs of production Reduced profitability of alternative products that could be supplied Increased profitability of goods in joint supply Benign shocks Expectations of a fall in price S0 Increase O Q 21

Shifts in the supply curve Decrease Increase O Q 22

Q Which way will the market supply of pizzas shift if the price of flour falls? Right Left No shift (movement along the curve)

The Determination of Price Equilibrium price and output response to shortages and surpluses significance of ‘equilibrium’ Demand and supply curves

The determination of market equilibrium (potatoes: monthly) Supply D d C c Price (pence per kg) b B a A Demand Quantity (tonnes: 000s) 25

The Determination of Price Equilibrium price and output response to shortages and surpluses significance of ‘equilibrium’ Demand and supply curves effect of price being above equilibrium surplus  price falls

The determination of market equilibrium (potatoes: monthly) Supply D d SURPLUS (330 000) C c Price (pence per kg) b B a A Demand Quantity (tonnes: 000s) 27

The Determination of Price Equilibrium price and output response to shortages and surpluses significance of ‘equilibrium’ Demand and supply curves effect of price being above equilibrium surplus  price falls effect of price being below equilibrium shortage  price rises

The determination of market equilibrium (potatoes: monthly) Supply D d C c Price (pence per kg) b SHORTAGE (300 000) B a A Demand Quantity (tonnes: 000s) 29

The Determination of Price Equilibrium price and output response to shortages and surpluses significance of ‘equilibrium’ Demand and supply curves effect of price being above equilibrium surplus  price falls effect of price being below equilibrium shortage  price rises equilibrium: where D = S

The determination of market equilibrium (potatoes: monthly) Supply D d Price (pence per kg) b B a A Demand Qe Quantity (tonnes: 000s) 31

The Determination of Price Effects of shifts in the demand curve movement along S curve and new D curve rise in demand (rightward shift)  P rises fall in demand (leftward shift)  P falls

Effect of a shift in the demand curve P S Initial equilibrium at point g g Pe1 D1 O Qe1 Q 33

Effect of a shift in the demand curve P S g Pe1 D1 O Qe1 Q 34

Effect of a shift in the demand curve P S g Pe1 D2 D1 O Qe1 Q 35

Effect of a shift in the demand curve P S i New equilibrium at point i Pe2 g h Pe1 D2 D1 O Qe1 Qe2 Q 36

The Determination of Price Effects of shifts in the demand curve movement along S curve and new D curve rise in demand (rightward shift)  P rises fall in demand (leftward shift)  P falls Effects of shifts in the supply curve movement along D curve and new S curve rise in supply (rightward shift)  P falls fall in supply (leftward shift)  P rises

Effect of a shift in the supply curve g Initial equilibrium at point g Pe1 D O Qe1 Q 38

Effect of a shift in the supply curve g Pe1 D O Qe1 Q 39

Effect of a shift in the supply curve g Pe1 D O Qe1 Q 40

Effect of a shift in the supply curve k Pe3 j g New equilibrium at point k Pe1 D O Qe3 Qe1 Q 41

Q The diagram shows the market for cocoa Q The diagram shows the market for cocoa. Equilibrium is currently at point x. To which equilibrium point (1, 2, 3, 4, 5, 6, 7 or 8) will the market move if there is a rise in the cost of producing cocoa? 1. 2. 3. 4. 5. 6. 7. 8.

Q The diagram shows the market for cocoa Q The diagram shows the market for cocoa. Equilibrium is currently at point x. To which equilibrium point (1, 2, 3, 4, 5, 6, 7 or 8) will the market move if there is a rise wages in the chocolate industry? 1. 2. 3. 4. 5. 6. 7. 8.

Q The diagram shows the market for cocoa Q The diagram shows the market for cocoa. Equilibrium is currently at point x. To which equilibrium point (1, 2, 3, 4, 5, 6, 7 or 8) will the market move if there is speculation that the price of cocoa will fall? 1. 2. 3. 4. 5. 6. 7. 8.

Q The diagram shows the market for cocoa Q The diagram shows the market for cocoa. Equilibrium is currently at point x. To which equilibrium point (1, 2, 3, 4, 5, 6, 7 or 8) will the market move if there is increased demand for chocolate and a new tax on cocoa? 1. 2. 3. 4. 5. 6. 7. 8.

The Free-market Economy Advantages of a free-market economy transmits information between buyers and sellers no need for costly bureaucracy incentives to be efficient competitive markets respond to consumer wishes

The Free-market Economy Problems of a free-market economy competition may be limited inequality environment and social goals may be ignored

Behavioural Economics What is behavioural economics? Looks at the way people actually behave individuals subject to impulses and seemingly irrational behaviour people do not always learn from their mistakes do assumptions of ‘rationality’ lead to errors in modelling and forecasting? The growing interest in behavioural economics important to understand the role of incentives

Behavioural Economics Explaining irrational behaviour understanding why people behave the way they do framing options effects of too much choice bounded rationality problem of imperfect information use of past experience and rules of thumb understanding the different responses of different types of people to the same set of circumstances

Behavioural Economics Explaining irrational behaviour (cont.) relativity matters people affected by the choices of others herding and ‘groupthink’ fashion and trends destabilising speculation people influenced by sunk costs