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  • 1. Economics for Management GSB728 Topic 2: Markets and Prices 1
  • 2. Note: This lecture note was prepared based on the teaching material provided by the publisher of the textbook Principles of Economics. 2
  • 3. Learning Objectives 1. Economic systems – How do countries differ in the way their economies are organised? 2. Demand and Supply – How much will people buy and offer of any item? 3. The free market economy – How well does it serves us? 4. The determination of price – How much of any item will actually be bought and sold, and at what price? 5. Price elasticity of demand – How responsive is demand to a change in price? 3
  • 4. Learning Objectives (contd.) 6. Price elasticity of demand & total consumer expenditure – How much do we spend on a good at a given price? 7. Price elasticity of supply – How responsive is supply to a change in price? 8. Other elasticities – How does demand respond to changes in income and to changes in the price of other goods? 9. Markets and adjustment over time – How do markets respond in the longer term to a change in demand or supply? 10. Government fixes prices – Markets where prices are controlled – What happens if the government fixes prices? 4
  • 5. Economic Systems • How do countries differ in the way their economies are organised? • Types of economy: – Classification by degree of government control: • Command economies. • Free-market economies. • Mixed economies. 5
  • 6. Economic Systems (contd.) 1980s Australia N. Korea China UK France Poland Cuba Totally planned economy USA Hong Kong Totally free-market economy Source: Sloman et al. (2014). 6
  • 7. Economic Systems (contd.) 1980s N. Korea China Poland Australia France UK USA Cuba Hong Kong Totally free-market economy Totally planned economy N. Korea Cuba China Poland France UK USA China Australia (Hong Kong) 2000s Source: Sloman et al. (2014). 7
  • 8. The Free Market Economy – Free decision making by individuals: • Firms seek to maximise profits. • Consumers seek value for money from purchases. • Workers seek to maximise wages. – The price mechanism: • Shortages and surpluses. – Shortage – Surplus price rises. price falls. • Equilibrium price: – Where demand equals supply. • Equilibrium: – A position of balance. 8
  • 9. The Free Market Economy (contd.) – Effects of changes in demand and supply: • A change in demand. • A change in supply. – Interdependence of markets: • Effects of a rise in demand. – In the goods market. 9
  • 10. The Price Mechanism: Effect of a Rise in Demand Goods Market: Sg Dg Shortage (Dg > Sg) Pg Dg until Dg = Sg Source: Sloman et al. (2014). 10
  • 11. The Free Market Economy (contd.) – Effects of changes in demand and supply: • A change in demand. • A change in supply. – Interdependence of markets: • Effects of a rise in demand. – In the goods market. – In the factor market. 11
  • 12. The Price Mechanism: Effect of a Rise in Demand (contd.) Goods Market: Shortage (Dg > Sg) Dg Sg Pg until Dg = Sg Dg Factor Market: Sf Sg Df Shortage (Df > Sf) until Df = Sf Pf Df Source: Sloman et al. (2014). 12
  • 13. The Free Market Economy (contd.) – Competitive markets: • Perfectly competitive markets. • Everyone is a price taker. • Why study perfect markets? 13
  • 14. Demand and Supply The Demand Curve 14
  • 15. Demand • The relationship between demand and price: – Law of demand. – Income effect. – Substitution effect. • The demand curve: – Assumptions (all other things (determinants) equal). – The axes. – Illustrates how much would be demanded at each price. 15
  • 16. The Demand Curve: The Demand for Potatoes (Monthly) Price ($ per kg) Tracey's Demand Darren's Demand Total Market Demand (kg) (kg) (tonnes: 000s) A 0.40 28 16 700 B 0.80 15 11 500 C 1.20 5 9 350 D 1.60 1 7 200 E 2.00 0 6 100 Source: Sloman et al. (2014). 16
  • 17. Market Demand for Potatoes (Monthly) (contd.) 2 Point Price ($ per kg) 1.6 Price Market Demand ($ per kg) (tonnes 000s) A 0.40 700 1.2 0.8 A 0.4 Demand 0 0 100 Source: Sloman et al. (2014). 200 300 400 500 Quantity (tonnes: ‘000s) 600 700 800 17
  • 18. Market Demand for Potatoes (Monthly) (contd.) E 2 Price Market Demand Point ($ per kg) (tonnes 000s) A B D 1.6 Price ($ per kg) C C 1.2 D E 0.40 700 0.80 1.20 500 1.60 2.00 200 100 350 B 0.8 A 0.4 Demand 0 0 100 Source: Sloman et al. (2014). 200 300 400 500 Quantity (tonnes: ‘000s) 600 700 800 18
  • 19. Demand and Supply Shifts in Demand 19
  • 20. Demand • Other determinants of demand: – – – – – – Tastes. Number and price of substitute goods. Number and price of complementary goods. Income. Distribution of income. Expectations of future price changes. • Movements along and shifts in the demand curve. 20
  • 21. Increase in Demand Price P D0 O Q0 Source: Sloman et al. (2014). Q1 D1 Quantity 21
  • 22. Decrease in Demand Price P D1 O Q1 Source: Sloman et al. (2014). Q0 D0 Quantity 22
  • 23. Demand and Supply The Supply Curve 23
  • 24. Supply • Supply and price: – As price rises, firms supply more. • It is worth incurring the extra unit costs. • They switch from less profitable goods. • In the long run, new firms will be encouraged to enter the market. • The supply curve: – Assumptions (all other determinants are constant). – The axes. – Illustrates how much would be supplied at each price. 24
  • 25. The Supply Curve: The Supply for Potatoes (Monthly) Price of Potatoes Farmer X's Supply Total Market Supply ($ per kg) (tonnes) (tonnes: 000s) a 0.40 50 100 b 0.80 70 200 c 1.20 100 350 d 1.60 120 530 e 2.00 130 700 Source: Sloman et al. (2014). 25
  • 26. Market Supply for Potatoes (Monthly) (contd.) Supply 2 1.6 Price ($ per kg) P Q a 0.40 1.2 100 700 800 0.8 a 0.4 0 0 100 Source: Sloman et al. (2014). 200 300 400 500 Quantity (tonnes: 000s) 600 26
  • 27. Market Supply for Potatoes (Monthly) (contd.) e 2 Supply d 1.6 Q P Price ($ per kg) a b c d e c 1.2 b 0.8 0.40 100 0.80 200 1.20 350 1.60 530 2.00 700 a 0.4 0 0 100 Source: Sloman et al. (2014). 200 300 400 500 Quantity (tonnes: 000s) 600 700 800 27
  • 28. Demand and Supply Shifts in Supply 28
  • 29. Supply • Other determinants of supply: – Profitability of alternative products. – Profitability of goods in joint supply. – Nature, random shocks and other unpredictable events. – Aims of producers. – Expectations of future price changes. – The number of suppliers. • Movements along and shifts in the supply curve. 29
  • 30. Shifts in The Supply Curve P S2 Decrease in supply O Source: Sloman et al. (2014). S0 S1 Increase in supply Q 30
  • 31. Determination of Price • Equilibrium price and output: • Response to shortages and surpluses. • Market clearing. • Significance of ‘equilibrium’. – Demand and supply curves. 31
  • 32. Equilibrium Price and Output: Market Demand and Supply of Potatoes (Monthly) Price of Potatoes Total Market Demand Total Market Supply ($ per kilo) (Tonnes: 000s) (Tonnes: 000s) 0.40 700 (A) 100 (a) 0.80 500 (B) 200 (b) 1.20 350 (C) 350 (c) 1.60 200 (D) 530 (d) 2.00 100 (E) 700 (e) Source: Sloman et al. (2014). 32
  • 33. Determination of Market Equilibrium e E Supply 2.00 1.60 Price ($ per kg) d D Cc 1.20 b B 0.80 a A 0.40 Demand 0 100 200 Source: Sloman et al. (2014). 300 400 500 Quantity (tonnes: 000s) 600 700 800 33
  • 34. Determination of Price (contd.) • Equilibrium price and output: • Response to shortages and surpluses. • Market clearing. • Significance of ‘equilibrium’. – Demand and supply curves. – Effect of price being above equilibrium. • Surplus price falls 34
  • 35. Determination of Market Equilibrium (contd.) E e Supply 2.00 D Price ($ per kg) 1.60 SURPLUS d (330 000) Cc 1.20 B b 0.80 A a 0.40 Demand 0 100 Source: Sloman et al. (2014). 200 300 400 500 Quantity (tonnes: 000s) 600 700 800 35
  • 36. Determination of Price (contd.) • Equilibrium price and output: • Response to shortages and surpluses. • Market clearing. • Significance of ‘equilibrium’. – Demand and supply curves. – Effect of price being above equilibrium. • Surplus price falls. – Effect of price being below equilibrium. • Shortage price rises. 36
  • 37. Determination of Market Equilibrium (contd.) e E 2.00 Price ($ per kg) d D 1.60 Supply C c 1.20 b 0.80 SHORTAGE (300 000) a 0.40 B A Demand 0 100 Source: Sloman et al. (2014). 200 300 400 500 Quantity (tonnes: 000s) 600 700 800 37
  • 38. Demand and Supply Market Equilibrium 38
  • 39. Determination of Price (contd.) • Equilibrium price and output: • Response to shortages and surpluses. • Market clearing. • Significance of ‘equilibrium’. – Demand and supply curves. – Effect of price being above equilibrium. • Surplus price falls. – Effect of price being below equilibrium. • Shortage price rises. – Equilibrium: where D = S. 39
  • 40. Determination of Market Equilibrium (contd.) E e Price ($ per kg) 2.00 d D 1.60 Supply 1.20 B b 0.80 A a 0.40 Demand 0 100 Source: Sloman et al. (2014). 200 300 Qe 400 500 Quantity (tonnes: 000s) 600 700 800 40
  • 41. Determination of Price (contd.) • Movement to a new equilibrium: – Effects of shifts in the demand curve: • Movement along S curve and new D curve. • Rise in demand (rightward shift) • Fall in demand (leftward shift) P rises. P falls. 41
  • 42. Demand and Supply Effect of a Shift in the Demand Curve 42
  • 43. Effect of a Shift in the Demand Curve P S i Pe2 Pe1 g h D2 D1 O Source: Sloman et al. (2014). Qe1 Qe2 Q 43
  • 44. Demand and Supply Effect of a Shift in the Supply Curve 44
  • 45. Effect of a Shift in the Supply Curve S2 P S1 k Pe2 Pe1 g j D O Source: Sloman et al. (2014). Qe3 Qe1 Q 45
  • 46. Markets, Demand and Supply Economic Systems 46
  • 47. The Free-Market Economy • Advantages of a free-market economy: • Transmits information between buyers and sellers. • No need for costly bureaucracy. • Incentives to be efficient. • Competitive markets respond to consumer wishes. • Problems with a free-market economy: • Competition may be limited. • Inequality. • Environment and social goals may be ignored. 47
  • 48. The Mixed Economy – Types of intervention: • Use of taxes, subsidies and benefits. • Legislation and regulation. • Direct provision by the government. 48
  • 49. Elasticities Elasticities of Supply and Demand 49
  • 50. Price Elasticity of Demand • Defining price elasticity of demand (P D): – Responsiveness of quantity demanded to a change in price. 50
  • 51. Price Market Supply and Demand S1 S2 P1 a c P3 D’ b P2 D O Source: Sloman et al. (2014). Q1 Q2 Q3 Quantity 51
  • 52. Price Elasticity of Demand • Measuring price elasticity of demand: % QD / % P – Percentage measure. – Negative sign. – Value: greater or less than 1 (in absolute value). 52
  • 53. Price Elasticity of Demand (contd.) –P D Elastic demand –P D Inelastic demand –P D Unit elastic demand 53
  • 54. Elasticity Measuring Elasticity 54
  • 55. Measuring Elasticity Price 10 m 8 n 6 4 2 Demand 0 0 10 Source: Sloman et al. (2014). 20 30 40 Quantity 50 55
  • 56. Measuring Elasticity (contd.) 10 Price 7/2 -70/30 -7/3 = -2.33 = = 8 P = –2 Mid P 7 10/15 x = m P mid P 2 7 = d Q mid Q 10 15 = P n 6 Q = 10 4 2 Demand 0 0 10 Source: Sloman et al. (2014). 15 20 Mid Q 30 40 Quantity 50 56
  • 57. Price Elasticity of Demand (contd.) • Determinants of price elasticity of demand: – Number and closeness of substitute goods. – Proportion of income spent on the good. – Time period. 57
  • 58. Price Elasticity of Demand and Total Consumer Expenditure • Defining total consumer expenditure: – TE = P × Q • Next slide illustrates TE graphically… 58
  • 59. Total Expenditure Price 4 3 2 1 Consumers’ total expenditure = firms’ total revenue = $2 x 3m = $6m D 0 0 1 Source: Sloman et al. (2014). 2 3 4 Quantity 5 59
  • 60. Price Elasticity of Demand and Total Consumer Expenditure (contd.) • Effects of a price change: Elastic demand. – P rises: TE falls. – P falls: TE rises. 60
  • 61. Effect of Advertising on Demand Curve Source: Sloman et al. (2014). 61
  • 62. Elasticity Elastic and Inelastic Demand 62
  • 63. Price Elastic Demand Between Two Points Total expenditure falls as price rises from $4 to $5: ($4 x 20) > ($5 x 10) 5 b a 4 0 Source: Sloman et al. (2014). D 10 20 Quantity 63
  • 64. Price Elasticity of Demand and Total Consumer Expenditure (contd.) • Effects of a price change: Inelastic demand. – P rises: TE rises – P falls: TE falls 64
  • 65. Price Inelastic Demand Between Two Points 8 c Total expenditure rises as price rises from $4 to $8: ($4 x 20) < ($8 x 15) a 4 D 0 Source: Sloman et al. (2014). 15 20 Quantity
  • 66. Different Elasticities Along a Demand Curve Source: Sloman et al. (2014). 66
  • 67. Price Elasticity of Demand and Total Consumer Expenditure (contd.) • Special cases: – P D = 0 : Totally inelastic demand – P D = - : Infinitely elastic demand – P D = –1 : Unit elastic demand 67
  • 68. Price Totally Inelastic Demand (P D= 0) D P2 b P1 a O Source: Sloman et al. (2014). Q1 Quantity 68
  • 69. D= ) Price Infinitely Elastic Demand (P a b P1 O Source: Sloman et al. (2014). D Q1 Q2 Quantity 69
  • 70. Price Unit Elastic Demand (P 20 D = -1) Total expenditure remains unchanged as price falls from $20 to $8: a ($20 x 40) = ($8 x 100) b 8 O Source: Sloman et al. (2014). D 40 80 Quantity 70
  • 71. Elasticity Elastic and Inelastic Supply 71
  • 72. Price Elasticity of Supply • The elasticity of supply determine how responsive is the quantity supplied to changes in prices. • Measuring price elasticity of supply: % QS / % P – Positive sign. – Elastic and inelastic supply, >1 and <1 respectively. 72
  • 73. Price Supply Curves with Differing Price Elasticity S1 S2 P2 P1 O Source: Sloman et al. (2014). Q1 Q2 Q3 Quantity 73
  • 74. Price Elasticity of Supply (contd.) • Determinants of price elasticity of supply: – Amount that costs rise as output increases: • Spare capacity. • Access to raw materials. • Ability to switch away from alternative products. • Avoidance of the need to pay overtime. – Time period: • Immediate: Highly inelastic. • Short run: Some responsiveness. • Long run: Highly elastic. 74
  • 75. Elasticity Markets and Adjustment Over Time 75
  • 76. Markets and Adjustment Over Time • Short-run and long-run adjustment: – Short-run and long-run supply curves. – Short-run and long-run demand curves. 76
  • 77. Response of Supply to an Increase in Demand Price S short-run S long-run b P2 P3 P1 c a D O Source: Sloman et al. (2014). Q1 Q2 Q3 D1 Quantity 77
  • 78. Price Response of Demand to an Increase in Supply S S1 a P1 P3 P2 c b D long-run D short-run O Source: Sloman et al. (2014). Q1 Q2 Q3 Quantity 78
  • 79. Speculation Stabilising Speculation Suppliers and/or demanders believe that a change in price is only temporary. 79
  • 80. Stabilising Speculation: Initial Price Rise and Then Fall Price S1 S2 b P2 c P3 a P1 D2 D3 D1 O Q1 Source: Sloman et al. (2014). Q3 Q2 Quantity 80
  • 81. Stabilising Speculation: Initial Price Fall and Then Rise Price S2 S1 a P1 c P3 P2 D1 b D3 D2 O Source: Sloman et al. (2014). Q2 Q3 Q1 Quantity 81
  • 82. Speculation Destabilising Speculation Suppliers and/or demanders believe that a change in price heralds similar changes to come. 82
  • 83. Destabilising Speculation: Price Rise Price S2 S1 P3 c P2 b P1 a D3 D1 O Source: Sloman et al. (2014). Q1 Q2,3 D2 Quantity 83
  • 84. Destabilising Speculation: Price Fall Price S1 S2 a P1 P2 b P3 c D1 D3 O Source: Sloman et al. (2014). Q2,3 Q1 D2 Quantity 84
  • 85. Markets and Adjustment Over Time • Dealing with uncertainty and risk: – Defining risk and uncertainty. – Reducing risks by holding stocks and diversification. – Market information. 85
  • 86. Elasticity Other Elasticities 86
  • 87. Income Elasticity of Demand • Income elasticity of demand. – Measurement: % QD / % Y – Determinants: • Degree of necessity. • Level of income. – Type of good: • Normal goods. • Inferior goods. 87
  • 88. Cross-Price Elasticity of Demand • Cross-price elasticity of demand. – Measurement: % QD of good A / % P of good B – Determinants: • Closeness of substitute goods. • Closeness of complement goods. 88
  • 89. Effect of Imposing Tax on Goods Source: Sloman et al. (2014). 89
  • 90. Price Controls Minimum (High) Price: Price Floor 90
  • 91. Price Minimum Price: Price Floor S Surplus Pmin Minimum Price Pe D O Qd Source: Sloman et al. (2014). Qe Qs Quantity
  • 92. Consequences of Price Floor – Consequences: • Dealing with resulting surpluses. • Inefficiency. • Discourage production of more efficient alternative products. • Higher prices for consumers. – Examples: Common Agricultural Policy (EU). 92
  • 93. Price Controls Maximum (Low) Price: Price Ceiling 93
  • 94. Price Maximum Price: Price Ceiling S Pe Maximum Price Pmax Shortage O Qs Source: Sloman et al. (2014). D Qd Quantity 94
  • 95. Consequences of Price Ceiling – Consequences: • Dealing with resulting shortages. • Preferential treatment to particular customers (firms or government decide who can buy the product and volume). • Rationing. • Black markets. 95
  • 96. References Morales, L. E., Simons, P. and Valle de Souza, S. (2014). GSB728: Economics for Management [Topic Notes]. Armidale, Australia: University of New England, Graduate School of Business. Sloman, J., Norris, K and Garratt, D. (2014). Principles of Economics (4th ed.). French Forest, Australia: Pearson. 96