The Allocation Of Resources In Competitive Markets

Content The determinants of demand for goods and services Price, income and cross elasticity's of demand The determinants of the supply of goods and services Price elasticity of supply The determination of market equilibrium prices Cause of changes in equilibrium price Demand and supply analysis in specific markets Interrelationships between markets How markets and prices allocate resources

The determinants of demand for goods and services The demand curve shows the relationship between price and quantity demanded Generally the higher the price of a product the smaller the quantity demanded As price decreases quantity demanded increases Therefore the demand curve has a negative slope

Demand Curve The demand curve shows an inverse relationship between price and quantity demanded If price changes then you would move along the demand curve to calculate any change in quantity demanded

Shifts in the demand curve Changes the following factors causes a shift in the demand curve: Prices of other goods – either substitutes or compliments Incomes Tastes and fashions Consumer expectations Advertising Population level and structure These factors can enable the demand curve to shift to the: Left (less demanded at each price) Right (more demanded at each price)

Shifts in the demand curve These graphs show what would happen if Demand increased Demand decreased

Price elasticity of demand Elasticity looks at the responsiveness of one variable to a change in another Price elasticity: The responsiveness of demand to a change in price %change in quantity demanded / % change in price If PED > 1 it is elastic (flat demand curve) If PED < 1 it is inelastic (steep demand curve)

Price elasticity of demand, revenue and profit If a product is elastic to increase revenue you reduce price The reduction in price increases quantity demanded by a greater amount therefore increasing revenue If a product is inelastic to increase revenue you increase price The increase in price reduces quantity demanded by a smaller amount therefore increasing revenue If costs stay the same then these actions will result in greater levels of profit for the firm

Income elasticity of demand Measures the responsiveness of demand to changes in income % change in quantity demanded / % change in income YED > 0 (positive sign) = Normal goods – as income rises demand rises YED < 0 (negative sign) = Inferior goods – as income rises demand falls

Cross elasticity of demand Measures the responsiveness of demand of one good to changes in the price of another good % change in quantity of good 1 / % change in price of good 2 Cross elasticity < 0 (negative sign) The goods are compliments Cross elasticity < 0 (positive sign) The goods are substitutes

Factors that influence elasticity of demand Number of substitutes – the greater the number of substitutes the more elastic a product is The % of income spent on the product – the smaller the % the more inelastic the good The time period – the longer this is the more elastic the good is Luxury or necessity – Luxuries tend to be more elastic and necessities more inelastic

The determinants of the supply of goods and services The supply curve shows the relationship between price and quantity demanded The supply curve generally slopes upwards at higher prices more is supplied There is a positive relationship between price and quantity supplied As price increases revenues would increase for the supplier If revenues increase then profits would be likely to increase encouraging producers to increase production levels

The Supply Curve If price changes the quantity demanded will change – this will indicate a movement along the supply curve

Determinants of Supply The following factors influence supply: Profitability of other goods in production Technology Costs of production Natural shocks Social factors Expectations of producers Changes to any of these factors will cause the supply curve to shift: Supply curve shifts to the left – less will be supplied at every price Supply curve shifts to the right – more will be supplied at every price

Shifts in the supply curve These graphs show the consequences of: An increase in supply A decrease in supply

Price elasticity of supply This measures the responsiveness of supply to changes in price % change in quantity supplied / % change in price If PES > 1 it is elastic – this means it is easy for suppliers to respond quickly to price changes If PES < 1 it is inelastic – this means it is hard for suppliers to respond quickly to changes in price

Factors influencing Price Elasticity of Supply Spare capacity – if there is lots of spare capacity the business should be able to increase output quite quickly therefore supply will be elastic Ease of factor substitution -If capital and labour resources can easily be switched then the production process is more flexible and elasticity of supply for a product is likely to be higher Stocks – If stock levels are high then supply will be elastic Time period – the longer the time period the more likely supply is likely to elastic as the firm has time to alter production levels

The determination of market equilibrium prices The interaction of the demand and supply curves sets the equilibrium price in a market The equilibrium point is where the supply and demand curves cross Equilibrium price is p* Equilibrium quantity is q* Unless the demand or supply curve shift p* and q* stay the same

Cause of changes in equilibrium price Shifts in the demand or supply curve will cause the equilibrium price to change The extent to which the price changes is dependent on the elasticity of demand / supply

Demand and supply analysis in specific markets Demand and supply may work differently in different markets Governments may pay subsidies to producers in certain markets These reduce producers costs of production and encourage them to produce more therefore the firms supply curve shifts to the right Subsidies are often common in agricultural markets, where industries are struggling e.g. shipbuilding and where goods are perceived as merit goods

Consumer surplus A consumer surplus arises is where consumers are willing to pay more for a good / service than they actually do As the government provides health care free on the NHS this represents a consumer surplus

Different Markets In commodity markets such as coffee and oil demand and supply interact to create an equilibrium price In the housing market prices have risen as demand has outstripped supply causing a shift in the demand curve

Interrelationships Between Markets Changes in one market are likely to influence other markets Composite demand is the demand for a product that has more than one use Derived demand is where demand for one good or service is due to demand of another This may be due to the production process E.g. demand for trainers will increase demand for rubber

Joint demand Joint demand is where the demand of one product is tied to the demand of another Joint demand occurs when products are complements in production or consumption Because the products are used together the demand for one good is tied to the demand for the other good E.g. tea and milk – if there is no milk demand for tea would decline

How markets and prices allocate resources Markets allocate resources as they allow all consumers who are willing and able to purchase goods at a set price to receive them Prices allow a good to be rationed – if the product is in short supply the price of the good will increase so only those willing to pay the highest prices will be allocated the resources

How markets and prices allocate resources Incentives are any factor (financial or non-financial) that provide a motive for a course of action Incentive pricing aims to encourage consumers to purchase a particular product increasing its demand Prices can also be used as a signaling tool Often high prices are seen to reflect high quality

The effectiveness of the market system The allocation of resources in the market system is not always efficient Governments may use taxes and subsidies to try and correct market failure The market system only allocates resources to those who are able to pay

Summary Demand for goods and services is determined by price, tastes and fashions, income etc The demand curve has a negative slope more is demanded at lower prices Elasticity measures the responsiveness of one variable to a change in another PED looks at the responsiveness of quantity demanded to a change in price If a product is elastic quantity demanded is more responsive to a change in price The supply curve has a positive slope as price increases amount supplied also increases Price elasticity of supply looks at the responsiveness of quantity supplied to a change in price Where the supply curve and demand curve interact is market equilibrium Market equilibrium price changes if the demand or supply curves shift The extent of the change in market equilibrium price is dependent on elasticity's Demand and supply analysis can be used in many markets There are Interrelationships between demand and supply in different markets this is due to composite demand, derived demand and joint demand Markets allocate resources to those that are able to pay at a certain price