The Allocation of

Resources
Macro/microeconomics, role of markets, demand&supply,
price determination&changes, PED/PES, market economic
system, market failure, mixed economic system
Chapter 5: Micro and Macroeconomics
Microeconomics: the study of the behaviour and decisions of households and firms, and the performance of
individual markets

Macroeconomics: the study of the whole economy

Market: an arrangement which brings buyers into contact with sellers

Economic agents: those who undertake economic activities and make economic decisions

Households: Firms: Government:

● Buyers: consumers, savers, ● Business concerns that ● The system which rules a
and workers produce goods and country/region
● Seek low prices and good services, and employ ● Produces and provides some
quality products workers and the other products, provides financial
● Workers want good working FOPs benefits, and taxes and regulates
conditions and a high pay ● Try to make as much the private sector
● Savers want their money to profit as possible ● Objectives for the economy: full
be safe and to give a good employment of labour and
return improve the performances of
individual markets
Chapter 6: Role of Markets in Allocating
Resources
Key fundamental economic questions:
1. What to produce
2. How to produce it
3. Who receives the products produced

→ these questions arise because of the basic economic problem of unlimited wants exceeding
limited resources

Economic system: the institutions, organisations, and mechanisms that influence economic
behaviour and determine how resources are allocated

Planned economic system

→ def: an economic system where the government makes the crucial decisions, land and capital
are state-owned, and resources are allocated by directives
→ Directives: state instructions given to state-owned enterprises
Market Economic System
→ def: an economic system where consumers determine what is produced, resources are allocated by
the price mechanism and land and capital are privately owned

● they signal their preferences through the price mechanism

→ price mechanism: the way the decisions made by households and firms interact to decide the
allocation of resources

● government intervention is minimal

● mix of capital-intensive and labour-intensive

→ capital-intensive: the use of a high proportion of capital relative to labour
→ labour-intensive: the use of a high proportion of labour relative to capital

● firms will seek to achieve the lowest cost method of production, while producing the highest quality
of products
→ may involve using new and more productive capital equipment to replace older ones

● those workers whose skills are in highest demand and are the most successful entrepreneurs will
be able to buy more products than those whose skills are in low demand and are unsuccessful
entrepreneurs
The Role of Price Mechanism Main factors that
determines the type of
→ in a market economic system, resources move automatically as a economic system:
result of changes in price ● Who decides what is
→ price changes are determined by the interaction of the market produced?
forces of demand and supply
● How are the
→ if consumers want more of a product, they will be more willing to
pay more for it resources allocated?
→ the higher price offered will encourage firms to produce the ● Who owns the capital
product in larger quantities as they will make more profit and land?

**price will rise if demand increases or supply decreases

Market equilibrium: a situation where a demand and supply are at

equal at the current price

Market disequilibrium: a situation where demand and supply are

not equal at the current price
Chapter 7: Demand Extension in Demand:
A rise in the quantity
Def: the willingness and ability to buy a product demanded caused by
a fall in the price of the
Demand and price are inversely related product itself
→ demand will rise as price falls; and will fall as price rises

Market demand: total demand for a product at different

prices

Individual demand: the amount of a product an

individual would be willing and able to buy at different
prices Contraction in Demand:
A fall in the quantity
Aggregation: the addition of individual components to demanded caused by a
arrive at a total amount rise in the price of a
product itself
Conditions of demand
Increase in demand: a rise in demand at any Decrease in demand: a fall in demand at
given price, causing the demand curve to shift any given price, causing the demand
to the right curve to shift to the left

Increase: shift right Increase: shift left

Causes of change in demand
● Changes in income
→ an increase in income raises consumer’s purchasing power
→ hence an increase in demand
→ normal goods: a product whose demand increases when income increases and
decreases when income falls
→ inferior goods: a product whose demand decreases when income increases and
increases when income falls

● Changes in price of related products

→ an increase in demand can be caused by a rise in the price of a substitute product
→ substitute: a product that can be used in place of another
→ demand will also increase if the price of a complement falls
→ complement: a product that is used together with another product
● Advertising campaigns
→ a successful ad will increase the demands of a product
→ it may bring the product to the notice of some new consumers and may encourage
some existing consumers to purchase more quantities of a product

● Changes in population
→ if there is an increase in the number of people in a country, demand for most products
will increase
→ ageing population: an increase in the average age of the population
→ birth rate: the number of live births per thousand of the population in a year

● Changes in taste and fashion

● Other factors
→ change in weather
→ expectations about future prices
→ special events
Chapter 7: Supply Extension in Supply:
A rise in the quantity
Def: the willingness and ability to sell a product supplied caused by a
rise in the price of the
Supply is directly related to price product itself
→ a rise in price will lead to a rise in supply

Market supply: total supply for a product

supplied by all the firms in the industry

Contraction in Supply:
Aggregation: the addition of individual A fall in the quantity
components to arrive at a total amount supplied caused by a
fall in the price of a
product itself
Conditions of demand
Increase in supply: a rise in supply at any given Decrease in supply: a fall in supply at any
price, causing the supply curve to shift to the given price, causing the supply curve to
right shift to the left

Increase: shift right Increase: shift left

Causes of Change in Supply
● Changes in the costs of production
→ if it costs more to produce a product, suppliers will want a higher price for it
→ reasons for a change in COP: -a change in price of any of the FOP
-a change in their productivity
→ unit cost: the average cost of production. It’s found by dividing total cost with output

● Improvements in technology
→ raises productivity of capital
→ reduces cost of production
→ results in an increase in supply
→ much cheaper to produce a range of products due to the availability of more efficient capital
goods and methods of production

● Taxes
→ a rise in the rate of an existing tax or the imposition of a new tax will make it more expensive
to supply a product, hence reducing supply
→ a cut in tax or its removal will increase supply
● Subsidies
→ def: a payment by the government to encourage the production or consumption of a
product
→ granting a subsidy will cause an increase in supply
→ the removal of a subsidy causes a decrease in supply

● Weather conditions and health of livestock and crops

● Prices of other products

→ a rise in the price of one product will cause an extension in supply of the other product

● Disasters and wars

● Discoveries and depletions of commodities

→ the supply of some commodities such as coal, gold, and oil is affected by discoveries of
new sources
→ for example, the discovery of new oil-fields will increase the supply of oil
→ in contrast, if coal is used up in some mines, the supply of coal will be reduced in the
future
Chapter 9: Price Determination
Equilibrium price: the price where demand and supply are equal

→ market forces move price towards the equilibrium

Disequilibrium:
A situation where
demand and supply
are not equal
(disequilibrium) (back to equilibrium)

→ if a firm sets the price above the equilibrium level, it will not sell → price will fall, causing
all of the products it offers for sale
demand to extend and
→ excess supply (surplus): the amount by which supply is greater
supply to contract until price
than demand
→ to ensure a firm sells all of the product it wants to, it will lower reaches the equilibrium level
price until the market clears, with the QD equalling QS
(disequilibrium) (back to equilibrium)

→ market forces will move the price if it’s → some consumers anxious to buy
initially set below the equilibrium level the product will be willing to pay a
→ this case, there will be a shortage of the higher price and suppliers
product with demand exceeding supply recognising this excess demand will
→ excess demand(shortage): the amount by
raise the price
which demand is greater than supply
Chapter 10: Price Changes

● An increase in demand will raise price and cause an

extension in supply
● A decrease in demand will lower price and cause a
contraction in supply

● An increase in supply will lower the price and cause

an extension in demand
● A decrease in supply will raise the price and cause
a contraction in demand
Chapter 11: Price Elasticity of Demand
PED: a measure of the responsiveness of the quantity demanded to a change in price
Example:
The QD rose from 200 to 240 as a result of price falling from $10 to $9. Calculate PED.
Elastic Demand
→ def: when the quantity demanded
changes by a greater percentage than
the change in price
→ PED>1, but less than infinity
→ price and total revenue moves in
opposite directions
→ rise in price causes total revenue to
fall

Factors:
● has substitutes
● Takes up a large proportion
of income
● Luxury goods
● Not addictive
● Purchase can be postponed
Inelastic Demand
→ def: when the quantity demanded changes by a smaller
percentage than the change in price
→ PED<1, but greater than 0
→ price and total revenue (&spending) moves in the same
direction
→ if price is raised, QD will fall (but by a smaller % than the
change in price, hence more revenue is earned)
→ if price is lowered, more products will be demanded but
not enough to prevent total revenue from falling
→ if a firm wants to raise revenue, it should raise it’s price
Factors:
● No close substitutes
● Takes up a small proportion of
income
● Necessity
● Addictive
● Purchase cannot be postponed
Perfectly Elastic Perfectly Inelastic Unit Elasticity of Demand

→ Def: when a change in price → Def: when a change in price

causes a complete change in QD → Def: when a change in price
has no effect on the QD
→ when price is raised, all of the causes an equal change in the
→ consumers buy the same
sales will be lost because QD, leaving total revenue
consumers will switch to rival quantity despite the alteration in
unchanged
products (hence demand falls to price
→ PED is 1 (unity)
zero) → change in price will cause
→ PED is infinity, hence represented revenue to move in the same
in a straight line direction and percentage
→ PED is 0
Changes in PED Implications
● PED becomes more elastic as the price of a product rises (for decision making)
→ if a supplier keeps on raising the price, a point would
come that the product would be priced out of the market ● Consumers are more likely to benefit
→ demand will then be perfectly elastic from lower prices and higher quality
when demand is elastic
● As the price falls, demand becomes more inelastic → because producers would be
reluctant to raise price as demand
● PED changes when there is a shift in the demand curve would contract by a greater
→ the more consumers want and are able to buy a product, percentage and revenue will fall
the less sensitive they are to price changes ● Quality may be high if the elastic
→ a shift in the demand curve to the right reduces PED at demand is the result of the existence
any given price of close substitutes
→ producers have to provide a good
● When demand decreases, consumers become more quality product to remain
sensitive to price changes and demand becomes more competitive
elastic ● A fall in price causes an extension in
demand
● An increase in demand will make the demand more
inelastic
Chapter 12: Price Elasticity of Supply
PES: a measure of the responsiveness of the quantity supplied to a change in
price
Elastic Supply
→ def: when the quantity supplied
changes by a greater percentage than
the change in price
→ PES>1, but less than infinity
→ the higher the figure, the more
elastic supply is

Factors:
● Takes a short time to produce
● Inexpensive to alter production
● Can be stored
Inelastic Supply
→ def: when the quantity supply changes by a
smaller percentage than the change in price
→ PED<1, but greater than 0
→ the supply curve is steep, showing that QS
changes by less than the price in the percentage
terms

Factors:
● Long time to produce
● Expensive to alter production
● Can’t be stored
Perfectly Elastic Perfectly Inelastic Unit Elasticity of Supply

→ Def: when a change in price causes a

complete change in QS → Def: when a change in → Def: when a change in
→ PES= infinity price has no effect on the QS price causes an equal
→ PES may come close to infinity in very → QS doesn’t alter with price percentage change in the
competitive markets changes QS
→ this case, firms would supply whatever → PES is 0 → straight line that goes
quantity people want to buy at the given through the origin
price
→ an increase in demand would not cause a
change in price
→ if demand and price were to fall, supply
would fall to zero
Changes in PES Implications
● The supply for most of the (for decision making)
products become more elastic ● Consumers are more likely to benefit from lower supply being
as the time period increases elastic
→ because more producers → because it means that supply is responsive to consumer
have more time to adjust their demand
supply ● If demand increases, price will rise
→ may involve: ● If supply is elastic, QS will rise by a greater percentage than
-switching production from/to the change in price
● Producers want their supply to be elastic as possible
other products
→ profits will be higher
- building new factories and
→ the quicker and more fully they can adjust their supply in
offices response to changes in demand and hence price
- selling off existing plants ● If govts. want to encourage the output and consumption of a
● Advances in technology, by product they are likely to be more successful giving a subsidy
reducing the production to producers if supply is elastic
period and lowering costs of → they use a variety of policy measures to promote flexibility in
production, makes the supply production (eg. change of law to make it easier for firms to hire
more elastic and fire labour)
Chapter 13: Market Economic System
Def: