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# How prices are determined

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Demand and Supply
Price Elasticity of Demand and Supply

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### How prices are determined

1. 1. What is demand?• Demand is the want or the willingness of consumers to buy goods and services.
2. 2. Effective Demand• When willingness to buy is backed/supported with the purchasing power, it becomes an effective demand.
3. 3. Price mechanism• Prices act as the signals for producers.• It is based on the price signals that they decide how to use their scarce resources.
4. 4. Quantity demanded• The amount of a good or service consumers are willing and able to buy is known as the quantity demanded.• Eg: Number of oranges bought per week.
5. 5. Individual demand and Market demand• Individual demand: The quantity of a good/service that an individual is willing and able to buy for different prices over a particular period of time.
6. 6. Individual demand and Market demand• Market Demand: The sum of all individual demand or total demand for the product from all consumers
7. 7. Demand Schedule• Demand schedule is the tabular presentation of quantity demanded and price of a good or service. Price of Chocolate Bar(Pence) Your demand per month 200 150 50 30 10 5 1
8. 8. Demand Curve• A Demand Curve is the diagrammatical representation of price and quantity demanded for a good or service over a period of time.
9. 9. Extension and Contraction of Demand• An extension of demand or increase in quantity demanded refers to the way in which demand changes with a fall in price, with no change in any other factor that could affect demand.• A contraction of demand or decrease in quantity demanded refers to the way in which demand changes when prices rises, with no change in any other factor that could affect demand.
10. 10. Extension and Contraction of Demand
11. 11. The market demand curve• The market demand curve for a particular good or service will display the demand of all the consumers of that commodity given a set of possible prices.
12. 12. Shifts in Demand• When there is a change in the factors influencing the demand other than price (like income, advertising, changes in population etc)changes, it leads to a shift in demand curve.
13. 13. Increase in demand• An increase in demand means that consumers now demand more of a product at each and every price than they did before.• Eg: Market Demand for chocolate bars:• Draw two demand curves for the data given. Price of chocolate Original demand Increased demand 50 100 000 200 000 40 150 000 250 000 30 200 000 300 000 20 260 000 360 000 10 330 000 430 000 5 400 000 500 000
14. 14. Fall in Demand• A fall/ decrease in demand means that consumers now demand less of a product at each every price than they did before. Possible price per Original demand Decreased demand DVD disc(pence) per week per week 100 10 000 5 000 80 15 000 10 000 60 20 000 15 000 40 25 000 20 000 20 30 000 25 000
15. 15. What causes a shift in demand?• 1. Changes in consumers income:• As income rise consumers will be able to buy more, while a fall in incomes will cause demand to fall.• But it is depended on the type of product concerned.
16. 16. Normal Goods and Inferior Goods• Normal Goods: If the demand for a product tends to rise as income rise, the product is called to be a normal good.• Inferior Goods: If demand tends to fall as income rise, the product is said to be an inferior good.
17. 17. What causes a shift in demand?• 2. Changes in taxes on incomes• Any change in the level of income tax rates and allowances results in a change in the quantity of goods and services demanded.Disposable income:• The income people have left to spend or save after taxes on their incomes have been deducted.
18. 18. What causes a shift in demand?• 3. The prices and availability of other goods and services:• Substitutes: A product is a substitute when its purchase can replace the want for another good or service. Eg: Butter and Margarine, Tea and Coffee• Complementary goods: A pair of goods consumed together. Eg: Car and Petrol, DVDs and DVD player.• Joint Demand
19. 19. What causes a shift in demand?• 4. Changes in tastes, habits and fashion:• Changing tastes, habits and fashion can play a big change in demand.
20. 20. What causes a shift in demand?• 5. Population Change:• An increase in population will tend to increase the demand for many goods and services.• Size and nature of population growth matters.
21. 21. What causes a shift in demand?• 6. Other factors:• Weather• Interest rates• Changes in laws
22. 22. What is supply?• Supply refers to the amount of a good or service firms or producers are willing and able to sell at a number of possible prices.
23. 23. Quantity supplied• The amount of a good or service producers are willing and able to make and sell to consumers in a market is known as the quantity supplied.
24. 24. Movement along the supply curve• Any price change to the product causes a movement along the supply curve.
25. 25. Extension of supply• As the price increase, the quantity supplied also rises along with it. This is called an extension of supply.
26. 26. Contraction of supply• As the price of the product decreases, the supply also decreases with it. This is called a contraction of supply.
27. 27. Exercise 1 Construction of Supply CurvePossible price of ice cream Market supply per month20 160016 110012 7008 3004 100
28. 28. Exercise 2• What will cause an extension of supply?• What will cause a contraction of supply?• Use your graph to work out how many ice cream will be supplied at a price ofa. 6 dollarsb. 10 dollars
29. 29. Exercise 3• Using the market supply schedule, (given in Ex No:1)complete the table and explain why the market supply curve slopes upward from left to right. Output per Total cost Total Profit (\$)Possible price Market supply month (\$) Revenue(\$of ice cream per month ) (PxQ)20 1600 100 100 400 30016 1100 300 28012 700 700 4208 300 1100 5804 100 1600 760
30. 30. Shifts in Supply• Changes in things other than price of a good can cause its market supply curve to move. This is called a shift in supply curve.
31. 31. An increase in supply• An increase in supply means that the producers are now more willing and able to supply a product than they were before at all possible prices.• Draw supply curves for the schedule given below: Possible price of Original supply Increased supply razors (pence) per month per month 50 10 000 12 000 40 8 000 10 000 30 6 000 8 000 20 4 000 6 000 10 2 000 4 000
32. 32. A fall in supply• A fall in supply means that producers are now less willing and able to supply a product at each and every price than they were before at all possible prices.
33. 33. What causes a shift in supply?• 1. Changes in the cost of factors of production.• Payments for:• Raw materials• Land• Labour• Interest• Tax…….
34. 34. What causes a shift in supply?• 2. Changes in price of other goods and services:• Price acts as the signals.• Resources are allocated to those goods and services that will yield the most profit.
35. 35. What causes a shift in supply?• 3. Technological advance• Technological improvement improves the performance of machines, employees, production methods, management control, product quality etc.
36. 36. What causes a shift in supply?• 4. Business optimism and expectations• Fears of economic downturn may cause some firms to move their resources to more safer products.(Left ward shift)• Expectation of economic recovery may result in reallocation of resources.(Right ward shift)
37. 37. What causes a shift in supply?• 5. Global factors• These factors can not be controlled by producers. Sudden climatic change Trade sanctions Wars Natural disasters Political factors
38. 38. Market Price• When quantity demanded and quantity supplied becomes equal then the market price is fixed for the product.
39. 39. Finding the market pricePrice Qty Qty Demande Supplied d Find the market price. 50 100 000 420 000 Price at which there is an excess demand. 40 150 000 300 000 Prices at which there is an excess supply. 30 200 000 200 000 If there is excess demand what will happen to price? If there is excess supply what will happen to price? 20 260 000 120 000 10 330 000 60 000 5 400 000 40 000
40. 40. Equillibrium• The price at which the quantity demanded and quantity supplied gets equal is called the equilibrium price or market price.
41. 41. How do market prices change?• A shift in demand:• An increase in demand for a commodity (increase in income /rise in price of substitutes..) will shift the demand curve to outwards.
42. 42. How do market prices change?• A shift in supply:• An increase in supply of product (due to low wages/technical progress..) supply curve shifts outwards.
43. 43. What is price mechanism?• The forces of demand and supply establish the market price of a product automatically. This is called price mechanism.• A free market economy allows the freedom of demand and supply in the market.
44. 44. Elasticity…..how much do consumer’s react?
45. 45. Elasticity – the concept • Elasticity is the responsiveness of quantity demanded to a price change • E.g. When price rises what happens to demand? BUT…. Demand falls By how much does demand fall?
46. 46. Elasticity – the concept• If price rises by 10% - what happens to demand?We know demand will fall Elastic• By more than 10%?• By less than 10%? Inelastic• Elasticity measures the extent to which demand will change
47. 47. Price ElasticIf a small change in price causes abig change in quantity demanded,then the product is said to beprice elastic. The demand curve is flat. %change in price is less than %change in demand.
48. 48. • If a big change in price Price Inelastic causes a small change in quantity demanded, then the product is said to be price inelastic. The demand curve is steep.%change in price is more than%change in demand.
49. 49. A ‘stretching’ exerciseproduct Small/large change Price why in quantity elastic/inelastic demandedOilDVD recordersBreadCarsNewspapers Situation: rise in price about 10%
50. 50. ConclusionAn increase in price have very small impact ondemand• Price inelasticAn increase in price have very big impact ondemand• Price elasticAn increase in price have very small impact on demandPrice inelastic
51. 51. How to measure PED?
52. 52. How to calculate percentage changes? • % change in quantity demanded= Change in quantity 100 ---------------------------- X ------- Original quantity 1  % change in price= Change in price 100 ---------------------------- X ------- Original price 1
53. 53. Using the formulaPrice of beans (per Market Calculate thetin) demand(per week) PED(use 4040 pence 1 000 pence as your original price)30 pence 1 500 Draw a demand curve for the If PED is 1, demand is data. price elastic . If PED is 1 demand is price inelastic Comment on the PED value.
54. 54. • It is very important for a firm to know whether an increase or decrease in price will cause their total revenue to rise or fall.
55. 55. Look at these two scenarios and answer for the following questionsPrice per loaf of Quantity Price per DVD Quantitybread demanded per recorder demanded per month month*25 pence 10 000 *\$500 1 00020 pence 10 500 \$400 1 800
56. 56. Questions Would you advise bread maker toCalculate PED and reduce the comment on the price from 25 to 20 pence? value. Why?Calculate the total Would yourevenue for Bread advice the DVD and DVD recorderrecorders at each manufacturers to cut price price.(PxQ) from 500 to 400 dollars? Why?
57. 57. Decisions If demand is If demand is price price elastic, inelastic, a a cut in price cut in price increases thereduces total total revenue. revenue. If demand is If demand is price price elastic, inelastic, a a rise in price rise in price decreasesincreases the the totaltotal revenue revenue.
58. 58. Factors affecting Price Elasticity of Demand• The number of substitutes:• When consumers can choose between a large number of substitutes for s particular product, demand is likely to be price elastic. (soft drinks, cosmetics etc)• When there are few substitutes, demand becomes price inelastic. ( milk, medicines etc)
59. 59. • Infinitely price elastic:• Product is demanded at one particular price only.• A small change in price will cause quantity demanded to fall to zero.• PED=∞
60. 60. • Unitary elastic:• A percentage change in price will cause an equal percentage change in quantity demanded.• PED=1
61. 61. FormulaPES
62. 62. CalculatePrice Quantity supplied per month100 cents 10 000200 cents 12 000
63. 63. Factors affecting PES• Time• Momentary period• Supply will be fixed at any one moment.(Perfectly inelastic)• Short run• Only some changes.(Inelastic)• Long run• Can increase in large quantity.(Elastic)
64. 64. Factors affecting PES• Availability of resources.• If resources are not available, output cannot be increased in response to price.(Price inelastic)• If resources are available, output can be increased in response to price.(Price elastic)
65. 65. CalculatePrice per KG Quantity supplied of natural rubber per month Calculate the PES for naturalRs.80 1000 rubber and man-made rubber.Rs.100 1100 Comment on their values and suggest reasons why they differ.Price per KG Quantity supplied of man-made rubber per monthRs.80 2000Rs.100 2800
66. 66. • Perfectly price inelastic: Quantity supplied remains the same whatever its price. PES=0• Perfectly price elastic: At one particular price, producers are willing to supply as much as they can. PES=∞
67. 67. Tax IndirectDirect Tax Tax
68. 68. Indirect TaxAd valorem Tax Specific Tax (VAT)
69. 69. -