Essay on supply and demand and price elasticity

1 Competitive markets: Demand and supply

2 Elasticity

3 Government intervention

4 Market failure

11 Supply-side policies

The law of demand

Demand: is the total amount of goods and services that consumers are willing and able to purchase at a given price in a given time period.

The Law of Demand: states that «as the price of a product falls, the quantity demanded of the product will usually increase, ceteris paribus».

The demand curve

Demand curve: represents the relationship between the price and the quantity demanded of a product, ceteris paribus.

Figure 1.1 — A demand curve

The non-price determinants of demand (factors that change demand or shift the demand curve)

The non-price determinants of demand (shifting) for normal & inferior goods:

  1. Income: As income rises
    • demand for normal goods rises, demand curve shifts to the right
    • demand for inferior goods falls, demand curve shifts to the left (when income gets to certain level, demand will become zero and so the demand curve disappears)
  2. Taste & Preferences: Change in tastes in favor (i. e. advertising campaign) demand curve shifts to the right
  3. Price of substitutes and complements:
    • As price of substitutes increases (movement along the curve) the demand shifts to the right
    • As price of complements increases (movement along the curve) the demand shifts to the left
  4. Demographic changes: if population grows, the demand for most products will increase, thus the demand curves shift to the right ? more will be demanded at each price level

Movements along and shifts of the demand curve

Movement along the demand curve:

  • A change in price of the good itself leads to a movement along the existing demand curve (price is the axes), while a change in any other determinants of demand will always lead to a shift of the demand curve to either left or to the right.

Linear demand functions (equations), demand schedules and graphs

Linear demand functions:

  • a = quantity demanded when price is zero
  • b = slope of the curve

1 Competitive markets: Demand and supply

2 Elasticity

3 Government intervention

4 Market failure

11 Supply-side policies

The law of supply

Supply: is the total amount of goods and services that producers are willing and able to purchase at a given price in a given time period.

The law of supply: states that «as the price of a product rises, the quantity supplied of the product will usually increase, ceteris paribus».

  • price rises but costs do not change → profitability increases → supply more (increase profits)

The supply curve

Supply curve: represents the relationship between the price and the quantity supplied of a product, ceteris paribus.

The non-price determinants of supply (factors that change supply or shift the supply curve)

The non-price determinants of supply (shifting):

  1. Changes in costs of factors of production: Increase in costs of production → supply shifts to the left
    • land
    • labor
    • capital
    • entrepreneurship (human capital or intellectual capital)
  2. State of technology: Improvements in technology → supply shifts to the right (natural disasters may move the technology backwards → supply shifts to the left)
  3. Price of relating product (joint/competitive supply): if producer could produce another product with higher profit, due to limited resources, the supply for the existing product decreases.
  4. Expectations: if demand for the product is likely to rise → supply increases (ready to supply more in the future and gain higher profit)
  5. Indirect taxes & subsidies:
    • Indirect taxes → increase costs → supply shifts left
    • Subsidies → reduce costs → supply shifts right
  6. Number of firms in the market: more firms producing → supply shifts to the right → more are being supplied at each price level

Movements along and shifts of the supply curve

Movements along the supply curve:

  • A change in price of the good itself leads to a movement along the existing supply curve (price is the axes), while a change in any other determinants of supply will always lead to a shift of the demand curve to either left or to the right.

Linear supply functions, equations and graphs

Linear Supply functions:

  • c = quantity supplied when price is zero
  • d = slope of the curve

ECONOMICS PAST PAPER QUESTIONS WITH ANSWERS — price elasticity and inflation.

Extracts from this document.

ECONOMICS PAST PAPER QUESTIONS WITH ANSWERS. Q1) Discuss whether inflation is necessarily harmful. (12) ANS 1:- Inflation is usually defined as a situation in which there is a persistent increase in the general price level. During inflation, cost of living rises, and hence, the purchasing power or the value of money falls. Usually inflation is an evil to an economy, and hence, reducing inflation is one of the macro-economic aims of every government. However, the effects of inflation depend on its level, whether it is constant or accelerating and whether it is anticipated or unanticipated. There are lots of economic costs associated with inflation:- 1. Shoe-leather costs: High rates of inflation mean that people and companies may lose considerable purchasing power if they keep money lying idle and not earning interest. Inflation erodes the value of cash and therefore, firms and households prefer to hold less cash but more interest bearing deposits / assets. Shoe leather costs are the costs involved in moving money from one financial asset to another in search of the highest rate of interest. 2. Menus costs: Firms will also suffer from menu costs. . read more.

Those unable to pay a higher prices will be eliminated from the market. Price rations scarce goods to those who can afford to pay the price. Hence, for price to act as a rationing mechanism, the effect of a rising price must be to reduce the quantity demanded by some individuals. Secondly, prices act as signals and guides to firms about what should be produced in the future. Producers aim at profit maximisation. If consumers wish to consume more of a particular commodity then its price will tend to rise. This indicates to firms that more should be produced; at the same time it provides and incentive for more factors of production to move into that line of production. Firms making the good will be earning high profits. They will wish to expand output. To obtain more of the new materials, machinery and workers wanted they will be prepared to offer higher prices and thus more resources will be drawn to this line of production to meet the increase in demand. In the process we see the operation of what to Adam Smith was like and? invisible hand? by which individuals, following their own self interest , led to pursue the interests of the community. . read more.

This is a statistical measure that expresses the average price of some group of commodities in some year as a percentage of the average price of the same commodities in some other year. Problems in measuring inflation accurately can arise from the following reasons 1. The choice of the base year: The selection of the base year is a very complicated task. The prices in the chosen base year should be reasonably steady. Periods of severe inflation, deflation or recession should be avoided. 2. The price index is not able to take into account changes in quality: A commodity may not have changed in price but its quality may have fallen. Conversely, a good may be more expensive because it is of a better quality than before. Such changes in quality affect the consumer? s standard of living but cannot be reflected in the price index. 3. Finding a representative group of commodities: In selecting commodities to include in the basket of goods, accurate information on expenditure patterns of households is needed. But there are great difficulties in collecting such data. People are unwilling to disclose their expenditure truthfully. Besides, different income groups do not share the same basket of goods. Even people with the same income do not buy the same commodities in the basket. Thus, the construction of consumer price index involves a lot of guesswork. . read more.

This student written piece of work is one of many that can be found in our AS and A Level Macroeconomics section.