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Price determination
- 1. Price Determina,on EdExcel Economics 1.2.6
- 2. Determina,on of Equilibrium Market Prices • Equilibrium means a state of equality or balance between market demand and supply • Prices where demand and supply are out of balance are called points of disequilibrium. • Most demand & supply exam ques@ons present the student with an event(s) that causes either the demand or supply curve (or both) to shiD. The student is then expected to find and analyse the new equilibrium. Market Supply Market Demand
- 3. Equilibrium Market Prices – Supply and Demand Table Price Quan,ty demanded Quan,ty supplied £20 6,000 8,000 £18 7,000 8,000 £16 8,000 8,000 £14 9,000 8,000 £12 10,000 8,000 A football club has a fixed stadium capacity of 8,000 seats and has es@mated the level of demand at different @cket prices as follows: The equilibrium price in this situa@on is £16 where quan@ty demanded and supplied = 8,000 @ckets. Supply & demand in balance.
- 4. Equilibrium Prices in a Supply and Demand Diagram Price of Wheat Quan@ty of wheat Market Supply Pe Qe Equilibrium is a state of balance between market demand and supply – there is no excess demand or supply Market Demand Pe is also known as the “market clearing price”
- 5. Disequilibrium – Excess Supply Price of Wheat Quan@ty of Wheat Market Supply Pe Qe If the current market price was P2, there would be an excess supply – of Q2 – Q3, this will put downward pressure on price Market Demand P2 Q2 Q3 Excess supply
- 6. Disequilibrium – Excess Demand Price of Wheat Quan@ty of Wheat Market Supply Pe Qe If the current market price was P1, there would be an excess demand – of Q1 – Q4, this will put upward pressure on price Market Demand P1 Q1 Q4 Excess demand
- 7. Equilibrium Market Prices – Changes in Demand Price per kg Quan,ty demanded (1) Quan,ty supplied Quan,ty demanded (2) £10 100 380 240 £9 130 340 270 £8 160 300 300 £7 190 260 330 £6 220 220 360 £5 250 180 390 The demand for and supply of fresh fish in a local market is shown in the table below. The original equilibrium price is £6 per kg If market demand rises by 80kg at each and every price, then the new equilibrium price will be £8 with 300kg bought and sold
- 8. Changes in Equilibrium Prices – Increasing Demand Price of Coffee Quan@ty of Coffee Market Supply P1 Q1 An outward shiD of market demand (ceteris paribus) leads to a rise in equilibrium price and an expansion of market supply Market Demand (1) Market Demand (2) P2 Q2 If price did not rise from P1 aDer a shiD in demand from D1 to D, there would be excess demand
- 9. Equilibrium Market Prices – Changes in Supply Price per kg Quan,ty demanded (1) Quan,ty supplied Quan,ty Supplied (2) $40 2,000 3,800 4,700 $35 2,500 3,400 4,300 $30 3,000 3,000 3,900 $25 3,500 2,600 3,500 $20 4,000 2,200 3,100 $15 4,500 1,800 2,700 The demand for and supply of cocoa beans in a local market is shown in the table below. The original equilibrium price is $30. If market supply increases by 900 tonnes at each price, then the new equilibrium price will be £25 with 3,500 tonnes bought & sold
- 10. Changes in Equilibrium Prices – Increasing Supply Price of Coffee Quan@ty supplied Market Supply (1) Pe Qe An outward shiD of market supply (ceteris paribus) will lead to a fall in equilibrium price and an expansion of market demand Market Demand (1) P2 Q2 Market Supply (2) 0
- 11. Changes in Equilibrium Prices – Decreasing Demand Price of Coffee Quan@ty supplied Market Supply (1) Pe Qe An inward shiD of market demand (ceteris paribus) leads to a fall in equilibrium price and a contrac@on of market supply Market Demand (1) P2 Q2 Market Demand (2) 0
- 12. Changes in Equilibrium Prices – Decreasing Supply Price of Coffee Quan@ty supplied Market Supply (1) Pe Qe An inward shiD of market supply (ceteris paribus) leads to a rise in equilibrium price and a contrac@on of market demand Market Demand (1) P2 Q2 Market Supply (2) 0
- 13. Moving from one Market Equilibrium to another Price of Rubber Quan@ty P1 Q1 An increase in demand in the immediate period leads to the price rising to P2, before an expansion of supply takes effect Demand (1) P3 Q2 Supply (1) Demand (2) P2 A B C 0
- 14. ShiSs in both Market Supply and Market Demand Price of Buaer Quan@ty P1 Q1 In this example the size of the outward shiD of market supply exceeds the increase in market demand. Both factors cause quan@ty bought and sold to rise; but the market price will fall. D1 P3 Q2 S1 P2 S2 D2 Q3 A B C 0
- 15. Explaining Possible Changes in Beef Prices Price of Beef Quan@ty of beef Average retail price of beef in the UK £ per kg 2010 6.16 2011 6.42 2012 6.99 2013 7.47 What demand & supply factors might explain the rising price of beef? Demand Factors Supply Factors Rise in price of beef subs@tutes Increase in price of animal foodstuffs Rising real incomes if YED > 0 Higher rents paid by beef farmers Change in tastes and preferences Rise in wages of farm labourers D1 D2 S1 S2 P1 P2 0
- 16. Real World: Explaining Changes in UK Footwear Prices 80 85 90 95 100 105 110 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Consumer price index for footwear products in UK Global compe@@on from lower cost countries Intense retail compe@@on on the high street and online Falling input costs have increased market supply Strong exchange rate – which makes imports of shoes cheaper
- 17. Likely Effects of Changes in UK Wheat Prices 0 20 40 60 80 100 120 140 160 180 200 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015* Price per tonne in £s UK wheat price, average price per tonne (£) • Lower prices may cause a contrac@on of wheat supply Produc@on • Lower revenues might damage incomes for farmers Revenues and Profits • Bread manufacturers will benefit from lower wheat prices – their input costs have fallen Manufacturing costs
- 18. Equilibrium Prices and Producer Revenue Price of Rubber Quan@ty supplied P1 Q1 An outward shiD of demand will lead to a higher price, an expansion of produc@on and a rise in total producer revenue Demand (1) P2 Q2 Supply (1) Demand (2) Total revenue at the higher market price 0 Total revenue = market price x quan@ty sold
- 19. Summary of Changes in Equilibrium Prices Equilibrium prices change when condi@ons of demand/supply alter ShiS Equilibrium Price Equilibrium Quan,ty Demand increases Higher Higher Demand decreases Lower Lower Supply increases Lower Higher Supply decreases Higher Lower In analysing price changes, iden@fy relevant supply/demand factors
- 20. Summary of Changes in Equilibrium Prices Demand Supply Equilibrium Price Equilibrium Quan,ty + + ? + + 0 + + + -‐ + ? 0 + -‐ + 0 0 0 0 0 -‐ + -‐ -‐ + -‐ + -‐ 0 -‐ -‐ -‐ -‐ ? -‐ The possible outcomes for price and quan@ty are less certain when there is more than one change in demand and supply condi@ons
- 21. Regulated Prices and Industry Regulators • Not all prices are set by the free-‐ market forces of supply and demand. • In Britain, a number of prices are affected by regulators who may impose a pricing formula on suppliers • Good examples are rail fares, the cost of postage stamps and water bills. • In the UK rail industry, some fares are unregulated allowing train opera@ng companies to set their own prices. • But around half of the fares charged for rail travellers are set by the rail regulator. The EU has capped mobile phone roaming charges Many rail fares in the UK are heavily regulated
- 22. 9 8 6 0 1 2 3 4 5 6 7 8 9 10 July 2012 July 2013 July 2014 Price cap in Euro cents Mobile Phone Price Caps Set by the European Union 70 45 20 0 10 20 30 40 50 60 70 80 July 2012 July 2013 July 2014 Price cap in Euro cents per MB EU Price caps on text messages (SMS) EU Price caps on mobile data roaming ADer interven@on by the EU Compe@@on Commission, from 15 June 2017, those travelling within the EU will be able to use their mobile internet abroad at no extra charge.
- 23. Consumer Price Index for UK Rail Fares 2003-‐2014 92.5 96.3 100 104.2 109.4 114.2 120.6 130.5 139.3 146.3 152 157 0 20 40 60 80 100 120 140 160 180 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Consumer price index for rail fares 2005=100 Around 45 per cent of UK rail fares are subject to regula@on (since 2015 this is limited to the rate of RPI infla@on. All other fares are set at a commercial rate by the train opera@ng companies such as First Great Western and Virgin Trains
- 24. Price Determina,on EdExcel Economics 1.2.6