ECON Module-2 2
ECON Module-2 2
ECON Module-2 2
OVERVIEW
Supply and demand are an economic theory that's used to explain the
relationship between the availability of a commodity and the willingness of consumers
to buy that commodity.
LEARNING OUTCOMES
LESSON 1. DEMAND
A. LEARNING OUTCOMES
B. TIME ALLOTMENT
C. DISCUSSION
DEMAND
If you have the desire to buy a certain commodity, say, a tractor, but do not have
an adequate means to pay for it, it will simply be a wish a desire, or a want, and not a
demand.
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LAW OF DEMAND
The law of demand states that other factors being constant (ceteris peribus),
price, and quantity demand of any good and service are inversely related to each other.
When the price of a product increases, the demand for the same product will fall. The
negative relationship between price and quantity demanded.
The law of demand explains consumer choice behavior when the price changes.
In the market, assuming other factors affecting the demand are constant, when the
price of good rises, it leads to a fall in the demand for that good. This is the natural
consumer choice behavior. This happens because a consumer hesitates to spend more
for the good, fearing going out of cash.
DEMAND SCHEDULE
Individual demand
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Refers to the demand for a good or a service by an individual (or a household).
Individual demand comes from the interaction of an individual's desires with the
quantities of goods and services that he or she can afford. By desires, we mean the likes
and dislikes of an individual.
Market Demand
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Change in Quantity Demanded vs Change in Demand
Note:
A change in demand occurs when the demand curve shifts left or right due to a
determinant of demand.
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DETERMINANTS OF DEMAND
1. Consumer taste
2. Number of buyers in the market
3. Consumer income
4. Price of related goods
5. Consumer expectations
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➢ Consumer taste: if consumers like a particular good or service more than
before, the demand curve will shift to the right.
Substitute good. Goods that can serve as replacements for one another, when
the price of one increase, demand for the other increases.
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LESSON 2. SUPPLY
A. LEARNING OUTCOMES
B. TIME ALLOTMENT
C. DISCUSSION
SUPPLY
Supply is defined as the quantity of goods or services that suppliers are willing
and able to provide to customers.
LAW OF SUPPLY
The law of supply states that other factors remaining constant, price and
quantity supplied of a good are directly related to each other.
In other words, when the price paid by buyers for a good rise, then suppliers
increase the supply of that good in the market.
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Description: Law of supply depicts the producer behavior at the time of changes in
the prices of goods and services. When the price of a good rises, the supplier increases
the supply in order to earn a profit because of higher prices.
The above diagram shows the supply curve that is upward sloping (positive relation
between the price and the quantity supplied). When the price of the good was at P3,
suppliers were supplying Q3 quantity. As the price starts rising, the quantity supplied
also starts rising.
Supply Schedule
In economics, a demand schedule is a table that shows the quantity
demanded of a good or service at different price levels. A demand schedule can be
graphed as a continuous demand curve on a chart where the Y-axis represents the
price and the X-axis represents the quantity.
A supply schedule shows how much of the product firms will sell at alternative
prices.
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Change in Quantity Supplied vs Change in Supply
A change in supply refers to a shift in the entire supply curve, which can happen due
to factors such as changes in production costs or taxes. A change in quantity supplied,
on the other hand, refers to movement along the curve due to changes in price.
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Determinants of Supply
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If a similar good is at a higher price AND makes you more profit, the supply
of the original good would fall while the supply of the similar good rises.
Imagine that a firm produces laptops, but also produces alternative goods
like cell phones and televisions. If the prices of cell phones and televisions
go up, then the firm will increase the supply of other goods and decrease the
supply of laptops. This will occur since the firm will want to take advantage
of the higher prices of cell phones and televisions to increase its profit.
4. Producer expectations
If the expected price of a good is greater than the current price, suppliers
will hold back their goods so that they can sell them later at higher prices.
This results in a drop of CURRENT supply.
6. Technology
When a technology makes it cheaper or easier to produce a good, you can
make more. Therefore, the amount of that good that can be produced
increases, and the supply rises.
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LESSON 3. MARKET EQUILIBRIUM
A. LEARNING OUTCOMES
B. TIME ALLOTMENT
C. DISCUSSION
MARKET EQUILIBRIUM
Market equilibrium is a market state where the supply in the market is equal to the
demand in the market. The equilibrium price is the price of a good or service when the
supply of it is equal to the demand for it in the market.
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Example: Qd = 16- 2P Qs = 2+5P
Substitute P:
Qd = 16-2P
= 16- 2( 2) = 16- 4= 12
Qs = 2+ 5P
= 2 + 5( 2) = 2 + 10 = 12
CHANGES IN EQUILIBRIUM
Changes in the equilibrium price occur when either demand or supply, or both, shift
or move.
NOTE:
An increase in demand, all other things unchanged, will cause the equilibrium
price to rise; quantity supplied will increase. A decrease in demand will cause the
equilibrium price to fall; quantity supplied will decrease.
An increase in supply, all other things unchanged, will cause the equilibrium
price to fall; quantity demanded will increase. A decrease in supply will cause the
equilibrium price to rise; the quantity demanded will decrease.
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Decrease in supply Increase in supply
GRAPHS TO REVIEWED
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LESSON 4. DEMAND AND SUPPLY APPLICATIONS
A. LEARNING OUTCOMES
B. TIME ALLOTMENT
C. DISCUSSION
The market system, also called the price system, performs two important and
closely related functions. First, it provides an automatic mechanism for distributing
scarce goods and services. That it serves as a price rationing device for allocating
goods and services to consumers when the quality demanded exceeds the quantity
supplied. Second, the price system ultimately determines bot the allocations f
resources among producers and the final mix of output.
Price rationing works like this. If the quantity of a given commodity becomes
increasingly limited, then the price rises. Only the buyers most willing and able to buy
the commodity, and pay the higher prices, obtain the good. The limited quantity is
automatically rationed to the highest bidder.
Back in history, rationing began on 8th January 1940 during the second world
war when bacon, butter and sugar were rationed. By 1942 many other kinds of stuff,
including meat, cheese and cooking fat were also on the ration.
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In the banking sector, credit rationing is used to limit the supply of loans to
consumers.
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Laws enacted by the government to regulate prices are called price controls. Price
controls come in two flavors. A price ceiling keeps a price from rising above a certain
level—the “ceiling”. A price floor keeps a price from falling below a certain level—the
“floor”.
Price Ceiling
A price ceiling can be defined as the price that has been set by the government
below the equilibrium price and cannot be soared up above that.
Price ceilings are typically imposed on consumer staples, like food, gas, or
medicine, often after a crisis or event sends costs skyrocketing.
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The following are some common examples of price ceilings.
1. Rent Ceilings
Some areas have rent ceilings to protect renters from rapidly climbing
rates on residences. Such rent controls are a frequently cited example of the
ineffectiveness of price controls in general and price ceilings in particular.
In the late 1940s, rent controls were widely implemented in New York
City and throughout New York State. In the aftermath of World War II,
homecoming veterans were flocking and establishing families—and rent rates
for apartments were skyrocketing, as a major housing shortage ensued. The
original post-war rent control applied only to specific types of buildings.
However, it continued in a somewhat less restricted form, called rent
stabilization, into the 1970s.
The aim was to help maintain an adequate supply of affordable housing
in the cities. However, the actual effect, critics say, has been to reduce the
overall supply of available residential rental units in New York City, which in
turn has led to even higher prices in the market.
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German government pledged to cap energy prices due to the shortage of
Russian natural gas.
4. Rideshares
As popularity of Uber and other rideshare services proliferated, these
rideshare services could charge much higher fares during peak hours. This price
variability concerned India, and the Karnataka government decided to
implement the price per kilometer Uber and other rideshares could charge. In
the long-run, the government noted that even though more passengers
demonstrated interest in using rideshare services, passengers often needed to
wait longer to get an Uber because fewer drivers were incentivized.
5. Salary Cap
Popular in professional sports, price ceilings may relate to the maximum
amount a single employee may receive in compensation. Consider the
agreement between the National Basketball Association and the National
Basketball Players Association. The collective bargaining agreement between
the two associations outlines a number of situations where a player is eligible
to receive a maximum salary. Below is a snipped for newer players in the league
with less than seven years of service.
The shortages created by price ceilings can be resolved in many ways without
increasing the price. Following are the ways that can be used to resolve shortages:
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• First come first serve: This is the most common way of resolving the
shortage, wherein, the person who comes first gets to buy the product.
• Lottery: It is a type of lucky draw, where one lucky person who picks, the right
numbers is allowed to make the purchase. The lottery system could be a way to
dole out a product that is facing a shortage.
• For example, some chargers may use this system to determine the persons who
could buy the limited tickets to a special game of football.
• Sellers’ selection: Another way of resolving the shortage due to price ceiling
is allowing sellers to select the buyers to whom they want to sell their products.
• For example, many landlords select renters to rent based on certain criteria
(such as preference for the married couple and without pets).
• For example, to deal with the shortage of gasoline in 1979, the California
government allowed the sale of gasoline to those who had license plates of their
vehicles ending in an odd number on the odd days of the month.
Price Floor
A price floor is said to exist when the price is set above the equilibrium price
and is not allowed to fall. It is used by the government to prevent the prices from hitting
a bottom low.
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A price floor is the lowest legal price that can be paid in markets for goods and
services, labor, or financial capital. Perhaps the best-known example of a price floor is
the minimum wage, which is based on the normative view that someone working full
time ought to be able to afford a basic standard of living.
Price floors are sometimes called “price supports,” because they support a
price by preventing it from falling below a certain level. Around the world, many
countries have passed laws to create agricultural price supports. Farm prices and thus
farm incomes fluctuate, sometimes widely. So even if, on average, farm incomes are
adequate, some years they can be quite low. The purpose of price supports is to prevent
these swings.
The most common way price supports work is that the government enters the
market and buys up the product, adding to demand to keep prices higher than they
otherwise would be.
There are some problems due to the surplus (quantity in demand is lesser than
the quantity in supply) created through the price floor. If the surplus exists in the
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market for a long period, the price floor begins to fall below the price of equilibrium,
which can result in market failure. Thus, the government is required to intervene to
avoid the occurrence of surplus. Some of the measures that can be adopted by the
government to deal with the surplus are:
• Purchase of all surplus goods: A way to deal with the surplus is the purchase
of all the surplus goods by the government. The surplus can be sold to other
countries. For example, the US government had bought all the surplus grain in
the US and sold it to Africa.
Supply and demand curves help explain the way that markets and market prices
work to allocate scarce resources. Recall that when we try to understand “how the
system works,” we are doing “positive economics”.
Supply and demand curves can also be used to illustrate the idea of market
efficiency, an important aspect of “normative economics”.
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When producers overproduce or underproduce, resources are misallocated. This
causes the market to be out of equilibrium and creates a deadweight loss. Deadweight
loss is the inefficiency in the market due to overproduction or underproduction of
goods and services, causing a reduction in the total economic surplus.
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LESSON 5. ELASTICITY
A. LEARNING OUTCOMES
B. TIME ALLOTMENT
C. DISCUSSION
ELASTICITY
Elasticity refers to the measure of the responsiveness of quantity demanded or
quantity supplied to one of its determinants. Goods that are elastic see their demand
respond rapidly to changes in factors like price or supply. Inelastic goods, on the other
hand, retain their demand even when prices rise sharply (e.g., gasoline or food).
Where: Q = Quantity
P = Price
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Midpoint Formula for Elasticity
• To erase the natural bias according to base point, we calculate the elasticity of
demand using the Midpoint Formula given by:
Shape of
Type of
Ed Type of Ed Description Demand
Good
Curve
No change in Qty
Perfectly Essential of Vertical
Ed = 0 demanded due to change in
Inelastic life Straight Line
price
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The price elasticity of supply is a measure of how sensitive the quantity supplied
of a good is to changes in price. It is calculated as the percentage change in quantity
supplied divided by the percentage change in price.
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Inelasticity of Supply
• Fidget spinners. These goods are relatively easy to make, requiring only basic
raw materials of plastic. Many manufacturing firms could easily adapt
production to increase supply.
• Taxi services. It is relatively easy for people to work as a taxi driver. People can
work part-time and only need a qualified driving license. With mobile apps like
Uber, it has also become easier to fit consumers with a broader range of
options. If price rises, Uber can offer higher wages and encourage more people
to come out to work. There are still some supply constraints on very popular
days. But, mostly, supply is quite elastic.
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• During recession and excess supply. In a recession with a fall in demand, the
firm will have unsold goods and a large stock.
Formula:
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Inferior Goods vs. Normal Goods
Depending on the values of the income elasticity of demand, goods can be broadly
categorized as inferior and normal goods. Normal goods have a positive income
elasticity of demand; as incomes rise, more goods are demanded at each price level.
Normal goods whose income elasticity of demand is between zero and one are typically
referred to as necessity goods, which are products and services that consumers will
buy regardless of changes in their income levels. Examples of necessity goods and
services include tobacco products, haircuts, water, and electricity.
Formula:
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Substitute Goods
The cross elasticity of demand for substitute goods is always positive because
the demand for one good increase when the price for the substitute good increases.
For example, if the price of coffee increases, the quantity demanded for tea (a
substitute beverage) increases as consumers switch to a less expensive yet
substitutable alternative. This is reflected in the cross elasticity of the demand formula,
as both the numerator (percentage change in the demand of tea) and denominator (the
price of coffee) show positive increases. Items with a coefficient of 0 are unrelated
items and are goods independent of each other. Items may be weak substitutes, in
which the two products have a positive but low cross elasticity of demand. This is often
the case for different product substitutes, such as tea versus coffee. Items that are
strong substitutes have a higher cross-elasticity of demand. Consider different brands
of tea; a price increase in one company’s green tea has a higher impact on another
company’s green tea demand.
Complementary Goods
For example, if the price of coffee increases, the quantity demanded for coffee
stir sticks drops as consumers are drinking less coffee and need to purchase fewer
sticks. In the formula, the numerator (quantity demanded of stir sticks) is negative
and the denominator (the price of coffee) is positive. This results in a negative cross
elasticity.
Companies utilize the cross elasticity of demand to establish prices to sell their
goods. Products with no substitutes have the ability to be sold at higher prices because
there is no cross-elasticity of demand to consider. However, incremental price changes
to goods with substitutes are analyzed to determine the appropriate level of demand
desired and the associated price of the good.
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Elasticity and Total Revenue (summary)
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