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

The Nature Of Economics

The Economic Problem: 1. 2. 3. 4. Our wants are unlimited Resources are scarce: resources used to satisfy our wants are limited Can't satisfy all our wants with our limited resources, we must choose between them 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 of our unlimited and competing wants where individuals must undergo choice, choosing one option over an alternative. It is how to organise production in order to satisfy to maximum number of wants. Key Economic Issues: 1. What to produce? - limited resources: what goods and services are produced 2. How much to produce? - waste resources or unsatisfied individuals 3. How to produce? - most efficient method of production: limited resources to produce greatest number of wants 4. 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 full productive 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 producing 200 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.

New technology: more efficient methods of production = outwards shift Discovery of new resources/Expansion of population: increase number of people available for work = increased production of both goods, push the production frontier outward 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 of economic growth Producing more capital goods now = forego satisfying some wants today, in order to satisfy 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 plans and 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 on marketing strategy) -Minimise cost: may purchase better quality equipment but have a longer operating life and require less maintenance. Generally choose cheaper resource but may pay more for a reliable supply. -Ethical issues: importance of natural environment (recycled paper/non-recycled paper) -Industrial relations issues: wage agreements, individual contracts, union representation Government: significant influence over the economic choices of individuals and business -discouragement: prohibit certain activities, heavy penalties, taxation -encouragement: incentives e.g. encouraging individuals to join a private health insurance scheme - provide 30% rebate & private health insurance coverage is now 45% of the population compared to 30% in the mid-1990s

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 = higher standard of living/quality of life

Resource Reward Natural resources Rent Labour Wages Capital Interest Enterprise Profit Natural resources (land): resources provided by nature reward 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 of self-employed people Capital: 'produced means of production' (not for immediate consumption, for the production of 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 the economy, 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, fossil fuels, clean air & water Supply of labour is limited to our population size, labour market skills & people's willingness to work Supplies of capital are limited by the extent to which governments & the private sector are willing to invest, as well as the level of domestic (overseas) savings available for the investment Supply of entrepreneurial skills - limited by size of population & range of other cultural and economic factors including the ability and willingness of individuals to innovate and take risks.

Allocation of scarce resources is determined by consumers spending patterns. Firms respond to consumer demand - obtain resources to produce wants. Efficient industries facing growing consumer demand and higher prices = attract more resources.

Distribution and exchange of goods and services Market economies provide people with income as a reward for their contribution to the 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 negotiations with employers. Benefit of system: provides incentives for people to obtain better skills and work harder = improve resource base & encourage innovation& technological advancement Unfair: illness, age, disability - government may intervene to assist (take money from high 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 growth during recession/sustain economic growth

Table: Impacts of the business cycle Recession Boom Falling production of goods and services Increasing production of goods and services Falling levels of consumption and investment Rising levels of consumption and investment Rising unemployment Falling unemployment Falling income levels Rising income levels Falling 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 and international 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 with incomes - 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.

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 law satisfy 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, international money 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.

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

Consumers in the Market Economy

Consumer 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 their design 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

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 influence 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 less likely 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. Income: 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.

Age Age plays a role in savings and consumption patterns. Individuals consumption and saving patterns are not constant throughout their 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:

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.

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

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.

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 it increasing in price in the future.

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.

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. Consumer expectations 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.

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 ($) $20 200

Quantity Demanded

$40 $60 $80 $100

160 120 80 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.

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

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

Increases in demand

When the demand curve shifts to the right its 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.

Decreases in demand

When the demand curve shifts to the left its 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.

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 An increase in the price of a certain substitute good will effectively increase the demand for other substitute goods.

Decrease in demand A decrease in the price of substitute goods.

A decrease in the price of complementary goods A increase in the price of complementary will increase demand of the good because it goods. encourages consumers to take advantage of the low complementary good prices. 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. Goods can go in and out of fashion which could

Technological progress that causes a good to be superseded. Goods can go in and out of fashion which could

effectively increase or decrease demand depending on consumer trends. Consumers could expect their incomes to rise and therefore increase their demand for goods. Income distribution can change to favour the higher income earners and in effect would increase the demand for high standard goods. A rise in the level of income will result in a large demand as consumers have more disposable income. Increases in the population can increase the demand for goods. Age distribution will lead to an increase in demand of certain types of goods.

effectively increase or decrease demand depending on consumer trends. A decrease in the level of income.

A change in the distribution of income being less favourable to the demand.

Decrease in the size of the population and a change in the age distribution.

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 good would be considered very responsive (relatively elastic) to the price change Unit elastic demand is when the percentage change in price is equal to the percentage change in quantity demanded. 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.

Unit elastic demand

Inelastic demand

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) 250 - Inelastic 270 - Inelastic 280 - Unit elastic 280 - Unit elastic 270 - Elastic

5 6 7 8 9

50 45 40 35 30

10

25

250 - Elastic

To determine elasticity of a good:

If price increases and revenue increases it is Inelastic If price increases and revenue decreases it is elastic If price 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 and merely theoretical.

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.

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:

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)

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)

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)

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 also depends on the durability of the product. Durable products tend to be more elastic than non durable.

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!!!!!!!!!!!!!!!

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:

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.

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.

The state of technology - An improvement in technology would lower production costs which would allow for an increase in supply.

Changes in the cost of factors of production - The cost of production directly affects the quantity supplied. A decrease in production costs means an increase in supply while an increase in production costs means decrease in supply.

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.

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 ($) $100 $80 $60 $40 $20 200 160 120 80 40

Quantity supplied

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:

For firms, producing the good becomes more profitable, so they increase their production for that good.

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.

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.

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.

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 or decrease in supply which will shift the supply curve

Increase in supply

When the supply curve shifts to the right its called an increase in supply.

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 left its called an decrease in supply.

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.

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 A fall in price of other goods, which makes production of other goods less profitable. An improvement in the technology used in the production process. A fall in the cost of factors of production such as labour or capital. An increase in the quantity of resources available to be used in production. Climatic condition or seasonal change that is more favourable to the production process.

Decrease in supply A rise in the price of other goods.

A certain technology no longer being available.

A rise in the cost of the factors of production.

A decrease in the quantity of resources available.

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.

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 is when the percentage change in price is equal to the percentage change in quantity supplied. Inelastic supply is when the percentage change in quantity supplied is less than the percentage change in price. The good would be considered not very responsive (relatively inelastic) to the price change.

Unit elastic Supply

Inelastic Supply

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.

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:

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

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.

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 as inventory 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.

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.

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.

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 incrhttp://leadingedge.com.au/publications/preliminary-economics-workbook-5thedition/http://leadingedge.com.au/publications/preliminary-economics-workbook-5thedition/http://leadingedge.com.au/publications/preliminary-economics-workbook-5thedition/http://leadingedge.com.au/publications/preliminary-economics-workbook-5thedition/http://leadingedge.com.au/publications/preliminary-economics-workbook-5thedition/http://leadingedge.com.au/publications/preliminary-economics-workbook-5thedition/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 and demand curve. When this happens it is referred to as a market clear, which means there is no excess supply or demand.

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.

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 2 3

Quantity demanded = Quantity supplied The market clears 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.

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.

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.

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 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 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.

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.

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 curve represents the the production and supply of firms with limited resources. These two curves help

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. When consumers 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, this means 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

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.

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 the marketplace 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

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 help us 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 Market price too high

Government action Price ceiling

Outcome Reduces price, quantity shortage (disequilibrium) Increases price, quantity excess (disequilibrium) Increases equilibrium price, reduces equilibrium quantity.

Market price too low

Price floor

Market quantity too high (negative externalities)

Taxes

Market quantity too low (positive externalities) Market does not provide goods or services (public goods)

Subsidies

Reduces equilibrium price, increases equilibrium quantity Government must collect taxation revenue to finance its supply of public goods

Government provided goods or services