1. THE PRICE SYSTEM & THE MICROECONOMY
Objectives: To describe:
The concept of demand
The concept of supply
Determination of equilibrium prices & quantities
The elasticity of demand(dd) & supply(ss)

3. The price system/mechanism
Means of allocating resources in a market economy.
Price & output are determined by the invisible hands of the market.
i.e. _________ & ______________

4. What is a market?
All the mechanisms through which buyers & sellers get together to trade.
Give examples of various markets in the world.
Forex market
Housing market
E-market e.t.c.
Self assessment task page 39

5. A market has two main sides:
1. Supply side( dealing with production)
2. Demand side (dealing with consumption)

6. Sub markets  These are market segments(niche) within a broad market.
i.e. the computer market/industry may have several submarkets:
E.g. Pc’s, tablets, laptops, notebooks…….

7. Demand:
Quantity of a product consumers are willing & able to buy at various prices per period of time ceteris paribus.
Concepts;
Products
these are items of trade i.e.
goods (tangible) eg..chairs, Pc’ IPod's, pens…..
services(intangible) e.g teaching, insurance, health care….

8. ceteris paribus
Implies that we assume other factors affecting dd are held constant & consumers will buy depending on price alone.
Consumer:
The end user of goods and services. they achieve utility ie satisfaction from the use of goods & services.

10. Types of demand

11. Types of demand Notional demand:
Occurs when there’s willingness to buy without the ability to pay i.e. speculative demand
Effective demand:
Occurs when there’s willingness & ability to pay (purchasing power).
Joint demand
occurs for jointly consumed products eg car & petrol (complimentary products)

12. Composite demand;
Occurs when a particular commodity is demanded to be put to multiple uses.
eg crude oil is demanded because it produces petrol, diesel, kerosene and bitumen
Derived demand:
Its the demand for a product/factor of prodn not for its own sake but because of the value it gives.

13. Eg demand for natural gas leads to derived demand for mining.
Demand for gold led to the derived demand for Picks and axes in the industrial age
Top tip 
The quantities bought by a single consumer forms the “individual dd’’ while the totality of all individual demands in a market forms the “market/aggregate dd”….

14. Q5/9708/11/M/J/2012 What is a market demand curve?
A the demand for all of a country’s products
B the total sum of individual demand curves for a product
C the output of all the firms in an industry
D the stocks of a particular good available for sale

15. Q4/9708/12/M/J/2011
What is consistent with an individual demand curve that slopes down from left to right?
A As price falls, a person switches away from rival products towards the product.
B As price falls, a person’s willingness and ability to buy the product will decline.
C As price rises, a person becomes less sensitive to price changes.
D As price rises, a person’s opportunity cost of purchasing the product falls.

16. The demand schedule:
It’s a tabular representation of the quantities demanded of a product at various prices in a given time.
Eg. Draw the table 2.1 on page 40
What is the relationship between price of PC’s and Quantity of PC’s bought.

17.  Demand curve:  It’s a graphical representation of
dd schedule by plotting prices against quantity demanded
Task:
Plot price against quantity demanded using the dd schedule drawn
Self assessment task 2.2. page 41

18. Observations
There’s an inverse/negative relationship between prices & quantity demanded
When prices go up, there is a decrease in quantity demanded (less pc’s are bought)
When prices go down, there is an increase in quantity demanded (more pc’s are bought)
This relationship is called the law of dd.

19. Law of demand:
It states that, ceteris paribus, greater quantities of a product will be demanded at lower prices than at high prices.
Or….as price increases, quantity demanded reduces & vice versa ceteris paribus.
The dd curve is negatively sloped and may be a line or a curve.

20. The area under the dd curve:
Its given by the price quantity level under the demand curve
Its used to calculate the total revenue received from the sale of products or the expenditure incurred by consumers
Total revenue= selling price X Quantity
Q12/9708/11/M/J/2013

21. Example
Consider the following dd schedule for the market of the Big Mac in US. Calculate the TR when P= $2 and P =$8
Market dd schedule for the Big Mac in the US in 2014
Price ($) 2 4 6 8 10
Quantity
1000
800
600
400
200

22. Example
Consider the following dd schedule for the market of the Big Mac in US. Calculate the change in TR when P= $2 and P =$8
Market dd schedule for the Big Mac in the US in 2014
Price ($) 2 4 6 8 10
Quantity
1000
800
600
400
200

23. Consumer surplus

24. Think about this!!
Imagine that Apple PLC has announced that during black Friday this year the new iphone 7 will be offered for $ 400 with a free home delivery

25. Consumer surplus (C.S) Occurs when consumers pay less
for a product which they expected to buy for more.
It’s the difference btn the value a consumer places on units consumed and the payment needed to actually purchase that product.
Eg during valentines day, KFC may offer a lower price for $18 instead of $ 20!.

26. The excess $2 which a consumer would ‘save’ is the consumer surplus
It’s shown by the area under the dd curve & above the price line
Task: draw diagram page 63 fig 2.19(a)
Draw on the smart board
C:\Users\pnduati.consumer & producer surplus 00:04:36.

27. Top tip Changes in price will affect the consumer surplus in two ways;
1. Increase in price will reduce the CS
2. Decrease in price will increase the CS
Task: Task: draw diagram page 63 fig 2.19(b)

28. Observations Price increases from P1 to P2. Initial CS = P1,E, X
New CS = P2,E’, X
Loss in CS = P1, E, E’,P2
NB: CS= ½ X base X height.
Task: give practical examples from paper 1 booklets…

29. Practice questions.

30. Q12/9708/S/2014 12 What is consumer surplus?
A the difference between the cost of producing a good and what consumers would be willing to pay for it
B the difference between what consumers actually pay for a good and its cost of production
C the difference between what consumers actually pay for a good and the maximum amount they would be willing to pay for it
D the difference between what consumers are willing to pay for a good and the amount required by producers to supply the good

31. Q /12/S/2013
Q /12/W/2013
Q129708/12/S/2012

32. Students task
A group of five business professionals were flying to UAE from Kenya via KLM .
The usual air fare was $500 per person. However, KLM announced that it was giving an offer of $ 487 per person. Calculate the total amount of CS received.
($500-$487) * 5 = ?

33. Video 00:12:23
C:\Users\pnduati Basics of demand
Q13/9708/11/M/J/2013
Q13/9708/12/M/J/2013

34. Movement along the dd curve
Its caused by changes in the price of the commodity only.
This leads to changes in the quantities demanded.
Top tip:
When price increases, Qd reduces and when prices falls, Qd increases
Show diagram…..(

35. Shifts in demand
They occur due to changes in other factors affecting the dd other than the price of the product. i.e. non price factors
They show the changes in demand & not changes in quantities demanded.
A leftward shift denotes a decrease indd while a rightward shift denotes an increase in dd.
Show diagram…..(

36. C:\Users\pnduati. Analyzing shifts
Causes of shifts in dd curve:
These are ‘non price’ factors that influence the dd for products
They are categorized in to three groups:

37. 1. Income
This is the consumers level of income available for spending after taxation i.e. disposable income.
For most products as income increases the consumers dd increases and vice versa.
Such goods are called normal goods which have a direct relationship btn income and dd.
E.g…………… & show income-dd diag

38. Some products have a negative relationship btn income & dd such that as income rises, less units are bought
e.g. As incomes rises dd for box TV’s reduces & pple buy flat screen TV’s
Such products are called inferior goods

39. Summary: Engles curve

40. Observations
The Engels curve is upward sloping for normal goods since they have a positive income effect
It is negatively sloping for inferior goods since they have a negative income effect

42. 2. Price & availability of related products
Products are related as substitutes or compliments:
Substitutes are products that can be used instead of each other while providing same level of satisfaction/utility.
They are said to have alternate demand
E.g. Pepsi cola & coca cola.
(Show diagram....+ve dd curve

43. Degree of substitutability may vary from person to person over different brands e.g. Puma Vs addidas trainers.
Compliments are products with joint demand i.e. use of one requires the use of the other.
eg car and fuel, PC’s & software……
( diagram –ve dd curve)

44. 3. Fashions, tastes & attitudes
These are consumer tastes & preferences that may be due to peer pressure, personal likes & dislikes and advertising.
E.g. you may buy apple products because of the reputation of the company or Nike trainers because they are fashionable & you want to look cool.

46.  Other dd influencing factors 
Weather conditions: eg dd for ice cream is high during summer & low during winter.
Future expectations about price changes , unemployment, interest rates..eg if high prices are expected, dd may increase now
Govt policies: laws that may encourage/discourage consumption eg Laws preventing minors from taking alcohol

47. Q5-6/9708/11/O/N/2013
Q5-6/9708/12/O/N/2013

48.  SUPPLY 
Quantity of a product suppliers are willing & able to sell at various prices in a given time, ceteris paribus
Suppliers are the producers who creates products to satisfy consumers needs and wants.
We assume that quantities supplied will depend on price of the product ceteris paribus.

49. Suppliers sell to make profits, hence more quantities will be supplied at higher prices .
Top tip 
The quantities sold by a single producer forms the “individual supply’’ while the totality of all individual supply in a market forms the “market/aggregate supply”

50.  The supply schedule 
It’s a tabular representation of the quantities supplied of a product at various prices in a given time.
Eg. Draw table 2.2 on page 43
Supply curve:
It’s a graphical representation of supply schedule by plotting prices against quantity supplied.

51. Task:   Use a graph paper to draw the supply curve.
Plot price against quantity supplied
Scale :Y axis 2:400 X axis 1:1,000
Self assessment task 2.4 page 43

52.  Observations: 
There’s direct/positive relationship between prices & quantity supplied
When prices go up, there is an increase in qty supplied(more pc’s are sold)
When prices go down, there is decrease in qty supplied (less pc’s are sold)

53. The supply curve is positively sloped and may be a line or a curve.
 The law of supply;
It states that, ceteris paribus, greater quantities of a product will be supplied at high prices than at low prices.

54. The area under the supply curve;
It measures the total revenue received by a producer after selling products.
Total revenue (TR) = Selling Price * quantity sold.
Calculate the TR using the following graph.

55. Task
Consider the following ss schedule for the market of iphone 7. Calculate the change in TR when Price rises from &700 t0 $1000.
Projected Market ss schedule for the Iphone 7 in 2016
Price ($)
600
700
800
900
1000
1100
Quantity(millions) 5 8 9 10
10.5 11

56. Video 00:02:12 C:\Users\pnduati.consumer vs producer surplus
Surplus = excess
Its the difference between the lowest price a producer is willing to accept and the amount that is actually paid.

57. The greater the difference between the two prices, the greater the benefit to the producer
Its given by the area between the supply curve and the price line

59. Example
Assume that KQ baseline air fare from Nrb to Dubai is $800. Late bookings makes the price to rise to $850.
Calculate the PS when 5 clients book one day before the flight.
The producer surplus is $50 assuming one late booking!

60. Top tip Changes in price will affect the producer surplus in two ways;
1. Increase in price will increase the PS
2. Decrease in price will reduce the PS.
PS = ½ X base X height

61. Tasks
Q /12/M/J/2014
Q13/9708/12/M/J/2015

62. Example
A producer is willing to sell 500 widgets at $5 a piece and consumers are willing to purchase these widgets for $8 per widget. If the producer finally sells all of the widgets to consumers for $8, calculate the amount of PS received?
( $4000-$2500)

63. Summary

64. Movement along the supply curve
Its caused by changes in the price of the commodity only.
This leads to changes in the quantities supplied.
Top tip:
When price increases, Qs increases and when price falls, Qs falls
Show diagram…..(

65. Shifts in supply. 
They occur due to changes in other factors affecting the supply other than the price of the product.
These are non price factors
Shifts causes changes in total market/aggregate supply
A leftward shift denotes a decrease in supply
A rightward shift denotes an increase in supply.

66. Video 06:32:00
C:\Users\pnduati.changes in ss vs quantities ssd
Q9/9708/12/O/N/2014
Q9/9708/11/M/J/2013
Q8/9708/11/M/J/2012
Q6/9708/12/M/J/2012

67. Causes of shifts in supply
1.Production costs:
Production costs are affected by factors like, wage rates, state of technology, raw materials, transport etc
If costs are high, production becomes expensive, supply contracts and the supply curve shifts leftwards & vice versa
Individual task page 60: Assessment task 2.21

68.  2. Size and nature of the industry 
Many similar firms make up an industry
If many firms enter the industry then the market supply will increase & supply curve shifts rightwards.
If firms withdraw from an industry, supply contracts and the curve shifts leftwards
E.g. if a new mobile phone provider enters the Kenyan market; the supply for mobile telecom services would rise.

69. 3. Government policy  
The govt is a chief economic regulator and passes laws that may encourage or discourage production.
It affects production in 3 main ways
Setting laws & regulations
Charging taxes
Giving subsidies (financial grants)
Eg…a law requiring all cars to be fitted with speed governors may increase the supply of the gadgets.

70. Govt. also imposes taxes(direct or indirect) on producers.
High taxes makes production expensive and hence supply reduces
Subsidies reduce production costs making supply to rise
task: copy the key terms from page 60

71. Other minor determinants of supply;
Weather conditions in the Agricultural sector- crops do well during good weather leading to high supply
Ability to switch prodn from one product to another eg Coca cola changing to produce mineral water

72. Joint supply e.g. lumber & saw dust- supply of lumber causes more saw dust to be supplied, soya oil and soya cake etc
Task copy key term from page 61
Video 00:06:12
C:\Users\pnduati.curve shifting

73. Q6 &10&11/9708/13/O/N/2013 Q18/9708/11/M/J/2013 Q6/9708/13/O/N/2012
Revision tasks
Q6 &10&11/9708/13/O/N/2013
Q18/9708/11/M/J/2013
Q6/9708/13/O/N/2012

74. Interaction of demand and supply: The market equilibrium
Equilibrium means a state of rest or balance.
Occurs when the supply side of the market is equal to the demand side of the market.
i.e. total market demand = total market supply
Equilibrium : page 55

76. The market equilibrium
It can be obtained by plotting
the demand & supply curves on the same axis.
Show the diagram
Task: copy key terms from page 55
Equilibrium price; Equilibrium quantity
Disequilibrium

77. Example
The table below shows the projected demand and supply schedules for a new generation of Ipad produced by Apple PLC in the US
Required;
Plot the demand and supply curves on the same axis

78. Y axis: price in $’s
X axis : Quantity demanded & supplied.
Choose an appropriate scale:
Identify the price – quantity level at which demand is equal to supply(equilibrium)

79. Price of an ipad ($)
Quantity supplied per month
Quantity demanded per month
300
100
1000
500
200
900
700
800
400
1100
600
1300
1500
1700
1900
2100

80. Price of an ipad ($)
Quantity supplied per month
Quantity demanded per month
300
100
1000
500
200
900
700
800
400
1100
600
1300
1500
1700
1900
2100

81. Equilibrium Price =
Equilibrium quantity=
Calculate the total consumer expenditure at equilibrium
Top tip
If the demand is not equal to supply the market is said to be in disequilibrium! i.e. a state of imbalance between supply & demand.

82. If market price increases to $1,900, supply increases to ___ units(on the diagram).
Excessive supply =_______
This leads to excess supply since at this price consumers can only afford to buy ____units!
This leads to a disequilibrium of excess supply and companies can reduce the price so as to sell off the excess stocks

83. If price falls a disequilibrium of excess demand arises and it can be resolved by increasing the prices though consumers may later refuse to buy at high prices.
Top tip: 
The market will always seek to return to the equilibrium since that is where the interests of both consumers & suppliers are in harmony!

84. If the equilibrium price falls to $500, calculate the disequilibrium of excess demand
Show the area on your graph paper

85. Class task 
Task; Draw the demand & supply diagram from page 55 figure 2.12
Calculate : 
Equilibrium price = $____
Equilibrium qty = ___ units
Total consumer expenditure $___ X ___units = $____ per week.
This will be the industry's total revenue!- Shade this area on your diagram

86. Class task
Calculate the disequilibrium of excess supply when price rises to $1,600
Calculate the disequilibrium of excess demand when price falls to $ 1,200
Q8-10/9708/11/M/J/2013

87.  Changes in the equilibrium 
They occur when the demand and/or supply curves shifts.
Review:
What factors causes the ss to shift?
What factors causes the dd to shift?
Q11/9708/12/M/J/2012
Q10/9708/12/O/N/2012

88. A change in demand: Discussion point:
What is the difference btn change in dd and change is quantities demanded?
Refers to change in the market/aggregate dd indicated by a shift in the dd curve.

89. An increase in dd will cause the dd curve to shift rightwards as shown below.
Task: draw fig 2.16 page 61
Observations:
An increase in dd causes a shift from D0 to D2.

90. This creates a disequilibrium of excess dd (Q1-Q0) at the initial price.
This causes the suppliers to increase the price & qty supplied until a new equilibrium P* Q* is reached.

91. A change in supply: Discussion point:
What is the difference btn change in ss and change is quantities supplied?
Refers to change in the market/aggregate ss indicated by a shift in the ss curve.

92. An increase in ss will cause the ss curve to shift rightwards as shown below.
Task: draw fig 2.17 page 62
Observations:
An increase in ss causes a shift from S0 to S2.

93. This creates a disequilibrium of excess ss (Q1-Q0) at the initial price.
Excess supply is aka glut/surplus
This causes the market price to adjust downwards until a new equilibrium P* Q* is reached.

94. A change in supply & demand
The change may occur at the same time! Eg a simultaneous increase in dd and decrease in ss.
The dd for a product may increase due to the increase in price of a substitute creating excess supply and later high prices.
High prices may attract more supply leading to excess stocks and later prices will lower.

95. The equilibrium price remains unchanged though the quantity may increase by a small margin.
Task:  Draw the diagram: page 62 fig 2.18

96. OBSERVATIONS
Increase in demand is matched by an equal increase in market supply.
This does not affect the market price.
NB: In practice, the simultaneous changes will not always cancel out

97. Functions of the price mechanism
AKA market mechanism
It refers to the interaction of the “invisible hands” of the market so as to determine market price & quantity.
1. Signaling function:
A rise in QD causes an automatic increase in prices.
This sends signals to producers & consumers as follows:

98. Consumers: buy less due to the law of dd (switch to cheaper alternatives)
Producers : supply more in the market due to the law of ss.
2. Rationing function:
This refers to limiting the market demand for certain products.

99. Exclusive items e.g jewellery; sports cars etc have a very high price so as to limit their dd.
Such goods have a snob value & are called goods of ostentation.

100. 3. Transmission of preferences
Copy the definition from page 63.
If consumers don’t like a product perhaps due to high price or poor quality; the messages is fed back to producers.
They may react by reducing the price, improving the quality or both!

101. Extension prep task Prep task Page 65
Further reading
Essay Q1 (a) page 66 ( deadline Tomorrow)
Extension prep task Prep task Page 65

102. The concept of elasticity
Introduction:
Springs constant:
Extent of change in prices for various goods e.g. Big mac; rice etc on the QD

103. Elasticity refers to the responsiveness of an economic variable due to changes in another variable ceteris paribus.
The extent of change is very important!
E.g.
Where, a small change in price causes a big change in QD , the relationship is called ELASTIC

104. Where, a big change in price causes a small change in QD , the relationship is called INELASTIC
Copy the key terms from page 44

105. Types of elasticity of dd:
Price elasticity of dd ( PED)
Income elasticity of dd (YED)
Cross elasticity of dd (XED)
Price elasticity of demand(PED):
A numerical measure of the responsiveness of quantity demanded of a product due to change in its own price.
AKA own price elasticity of demand

106. Steeply sloping dd line represents inelastic dd
PED= % change in QD
% change in own price.
Top tip: 
Steeply sloping dd line represents inelastic dd
Gently sloping dd line represents elastic dd.

107. PED is always given in absolute form (ignoring negative sign).
Top tip
PED coefficient is always negative due to the inverse/negative relationship between price and QD
PED is always given in absolute form (ignoring negative sign).

108. Notes
PED > 1 (absolute terms) means that dd is relatively price elastic
PED < 1 (absolute terms) means that dd is relatively price inelastic.

109. Example
Consider two unrelated products eg. Sony car stereo and a designer suit.
Assume that they retail at $100 each & their dd is 1,000 units each pm.
If price increases from $ 100 to $ 105 the dd for stereos falls to 990 while the dd for the designer suits falls to 900.
Calculate the PED

110. Example
Consider two unrelated products eg. Sony car stereo and a designer suit.
Assume that they retail at $100 each & their dd is 1,000 units each pm.
If price increases from $ 100 to $ 105 the dd for stereos falls to 990 while the dd for the designer suits falls to 900.
Calculate the PED

111. PED for Car Sony stereo PED= % change in dd PED =
% change in own price.
PED =

112. Designer suits
PED= % change in dd
% change in own price.
PED =

113. Interpretation for stereos
PED for car stereos = -0.2 is inelastic I.e. a big increase in price (5%) causes small reduction in QD (1%)
Interpretation for designer suits
PED for suits = -2 is elastic i.e. a small increase in price (5%) causes a big reduction in QD i.e. (10%).

114. Top tip
PED > 1 (absolute terms) means that dd is relatively price elastic
PED < 1 (absolute terms) means that dd is relatively price inelastic.

115.  Examples 
Q1. Price of a litre of super petrol in Chicago changed from $ 12 to $15 in 2010 causing the dd to fall from 10, m to 9m litres pm
Q2. Price of a litre of milk in Canada changed from $ 5 to $4 in 2009 leading to a reduction in dd from 100m litres to 150m litres pm
Calculate the PED and compare your results!
Q1 page 46

116.  Examples 
Q1. Price of a litre of super petrol in Chicago changed from $ 12 to $15 in 2010 causing the dd to fall from 10, m to 9m litres pm
Q2. Price of a litre of milk in Canada changed from $ 5 to $4 in 2009 leading to a increase in dd from 100m litres to 150m litres pm
Calculate the PED and compare your results!
Q1 page 46

117. Calculate the PED and compare your results!
Q1 page 46

118. Attention
Please work on the starter worksheet for 5minutes

119.  Special PED values  1. perfectly inelastic dd
Occurs when dd is unresponsive to changes in price i.e. PED=0
Illustration
2. perfectly elastic dd
Occurs when dd is infinitely responsive to changes in price i.e. all that is produced is sold at a given price.
PED = Infinity

120. Illustration
3. unitary elastic dd
occurs when proportional changes in price leads to proportional changes in dd
TR before price change is the same as TR after price change.
PED =1; Shape: rectangular hyperbola:
Q7/9708/12/M/J/2014

121. PED =1
Shape: rectangular hyperbola:
Summary: Range of PED along a linear dd curve – Page 9
Q7/9708/12/M/J/2014
Q6/9708/13/M/J/2014

122. Q8 9708/11/O/N/12 The price elasticity of demand for good X is 1.
At a price of $12, quantity demanded is 4000 units. What will be the price when the quantity demanded is units?
A $ B $ C $ D $20.00

123.  Factors affecting the PED 
1. Range & attractiveness of substitutes:
The greater the number of substitutes the higher the elasticity of dd.
E.g. canned soft drinks.
Consumers can quickly switch from monster to red bull & others when price of monster increases & vice versa.

124. NB: substitutability is not always automatic.
This may be due to:
Copy the bullet points from page 46

125. 2 Time factor
It takes time for consumers to adjust to new market prices due to lagged responses.
After price increases consumers may take time to adapt hence PED will increase overtime
PED will be inelastic in the short run due to lack of perfect info about price changes.

126. 3. The relative expense of the product:
If a product claims a small % of consumers income, its dd will be price inelastic since its still affordable even after a slight price increase.
For products claiming a big % of income, their dd is price elastic.

127. Video 00:14:58
C:\Users\pnduati. Elasticity videoPEPONISCHOOL\Desktop\Elasticity videos
Self assessment task 2.6 page 47

128. 2.Income elasticity of demand(YED
Numerical measure of the responsiveness of quantity demanded due to change in consumers income.
State the formulae:
When dd is responsive to changes in income, its said to be elastic and vice versa.

129.  Top tip 
YED coefficient is positive for a normal good ie an increase in income leading to an increase in dd
YED coefficient is negative for an inferior good ie an increase in income leads to a reduction in dd.
Example: assume that after a 2% increase in income the dd for products A, B & C changes as follows. Work out the YED for all of them.

130. Old
new A
100
105 B
200
204 C
1000
900

131. Work out the YED for products A, B, C and explain the nature of the goods

132. Further practice : work out the YED
Assume that there has been 5% increase in income causing dd to change as follows;
Initial demand
New demand
Product A
100units
103units
Product
99units
Product C
101units

133. Further practice : work out the YED
Assume that there has been 5% increase in income causing dd to change as follows;
Initial demand
New demand
Product A
100units
103units
Product
99units
Product C
101units

134. Q9/9708/13/O/N/12
The table gives an individual’s demand for four goods at two income levels.
Over this range of income, for which good does the individual have an income elasticity of demand = 1?

135. TASK: Q8/9708/12/M/J/2014

136. 3. Cross elasticity of demand (XED) 
It’s a numerical measure of the responsiveness of a products demand due to change in price of another related product.
State the formulae:
Top Tip :
XED coefficient is positive for substitutes eg Pepsi cola & Coca Cola

137. XED coefficient is negative for compliments eg Car and petrol.
If XED=0 the products are not related
Q8/12/W/2014:
The price of good X rises by 10%. As a result, the demand for a compliment good Y falls by 20%. Calculate the XED for good Y with respect to price of good X?

138. Calculate the XED Example 2 
The price of a HP desktop is $ 1,000 and current sales are 100 units/day.
Assume a 2% decrease in price of laptop computers causes the dd for HP desktops to fall from 100 to 98 units at the original price.
Calculate the XED
What is the relationship btn the two products.

139. b) . Assume that the price of MS office software falls by 5% causing the dd for the HP desktop PC’s to rise to 101 units at the original price. Work out the XED
What is the relationship btn the two products?

140. Further practice
Q7/9708/12/S/2015
Q8/9708/11/W/2014
Q8/9708/12/S/2013

141. Applications of demand elasticities
Price elasticity of dd (PED)
1. PED & govt tax revenues:
The govt charges high taxes on products whose PED is price inelastic since they will be bought even at high prices

142. 2. PED & price variations Discussion point:
Why are there price variations EPL on tickets?
Variations in PED can be used to explain;
The difference btn peak & off-peak rail travel in the UK.

143. Why airline tickets are cheaper a few months rather than a few days ahead of travel etc
Ticket dd is price inelastic a few days before the travel and hence high price is charged!
These variations helps business to determine when to maximize sales revenues.

144. 3.PED & total expenditure / revenue:
PED helps to understand how consumers expenditure changes as price rises or falls.
Recall TE = PX Q and TE = TR for the business.
TR increases more when PED is highly inelastic following a price rise.
TR increases more when PED is highly elastic following a price reduction.

145. Task: draw fig 2.8 page 51 Observations;
The dd curves represents 2 goods with same price ($10) & quantity traded (100 units).
Assume price rises to $11
Work out the changes in TR/TE and also the PED

147. Income elasticity of dd
YED helps planners in business organization’s & in the govt in decision making regarding production.
E.g. if the YED >1 , normal goods should be produced during a boom
If YED < 1 inferior goods should be produced during a recession.

148. Practical examples
In the emerging economies of china & India pple are demanding more cars hence cheaper NANO cars are being produced and govt is expanding transport networks.
Extension work
Self assessment task 2.12 page 52
Essay Q1 (a &b) page 66

149. Cross elasticity of dd (XED)
XED helps firms to determine the impact of rival pricing strategies on their products dd.
Firms dealing with compliments need to make pricing strategies to promote all their products eg movie tickets & popcorns.

150. Firms dealing with close compliments will set prices such that the XED will be highly negative to ensure that all products are bought e.g. printers & PC’s.
Promotions need to be offered e.g. BOGOF or discounts so as to promote sales

151. If XED is highly positive consumers can switch to substitutes when prices rise.
Task: read the cautionary note from page 52-53
PREP: Q 3 page 66 due on Friday

152. Price elasticity of supply(PES):
It’s a numerical measure of the responsiveness of supply due to change in the products price ceteris paribus.
State the formulae:
PES is always positive since price is directly proportional to QS according to the law of _______

153. Note  PES > 1 supply is price elastic e.g. manufactured goods
PES < 1 supply is price inelastic i.e. unresponsive to price changes. e.g. agricultural goods
Types of PES/Supply curves
Task: draw the diagram and table from page 53
Q10/9708/12/M/J/2014

157. C:\Users\pnduati. PES video
Example:
The price of apples rose from $12 to $15 causing the quantities supplied to change from 200 to 204 units.
Work out the PES
NB: When the supply curves passes thru the origin the PES is always 1 i.e. unitary elastic
Q8/9708/13/S/2013
C:\Users\pnduati. PES video

158. Factors influencing the PES 
PES mainly depends on firms flexibility in their production!
1. Time factor;
It takes time for production to occur e.g. between planting and harvesting of crops
Flexibility to produce occurs in the LR as firms can buy more machinery to increase prodn capacity.
PES is higher in most cases in the LR

159. 2. The ease with which firms can accumulate or reduce stock of goods:
The easier the firms can do this, the higher the PES since stocks allow firms to meet variations in dd.
QUIZ: What about for the service sector e.g. an airline

160. 3. The ease with which firms can increase production:
Firms with extra capacity to produce will have higher PES compared to firms with inferior technologies.
Shortages of factor inputs causes PES to be inelastic e.g. in the A sector where skilled labor is absent

161. Applications of PES
Helps to explain the ease with which businesses can respond to changed market conditions.
A business with spare capacity to produce can easily hire more workers as dd rises

162. Task: draw diag on page 54 Observations
Supply curves Si and Se reacts differently as demand rises.
Se (elastic) is more responsive to price changes & may relate to a firm with spare capacity
Video 00:09:34
C:\Users\pnduati. Applying the concept of elasticity

163. Preps Read the summary from page 66 Coffee break page 50
Rice in Pakistan page 54
Q10/9708/12/O/N/2014

164. The end