DEMAND SUPPLY MARKET EQUILIBRIUM

MARKET a place where buyers and sellers come

5- GOVERNMENT INTERVENTION
-

together to carryout economic

see topic 1.3
exchange

DEMAND 6- DEMOGRAPHIC CHANGES

population T I' demondasmore

c o good n s ul
-

the various quantities of a consumer a

mess are available
is willing and/or able to buy at different
prices in certain period of time ceteris
SUPPLY
a ,

paribus ( holding all other things equal)

The law of demand as price increases - Quan

Lthe
- -

willingness and ability of producers to provide a

tity demanded decreases ( negative casual
quant.it/ofagoodorseruiceat different prices
relationship )
overtime , ceteris paribus
WHY ?
'
e The law of supply -
as price increases / the quantity
Income effect substitution effect

laspricedecreases.consum-laspriceoecreases.me Supplied decreases ( positive casual relationship)

er real income increases product becomes more
I. increases the chance attractive than other
WHY ?
that more consumers
similar products which
&
will buy the product derive similar
utilities e
Profit Motive
it costs of production
satisfaction 1 price =P potential to make
from consumption
TsUPPH=T price to cover profit more profit
margain

Non price determinants of demand Non price determinants of supply

( influence demand other than price ) ( influence supply other than price )

1- PREFERENCES AND TASTES 1- Costs of factors of production

A- chasse in preference favouring a product will
increase its demand 2- Technology 4=4 SUPPLY
EXAMPLE :
pretence towards non dairy milk has increased
- with new

health trends towards veganism 3- Producer expectations

2- PRICE OF SUBSTITUTES 4- Government intervention

An increase in price of product A- will decrease ( Tta×- 1^1,1 subsidy 11 ) _-

demand of product B
-

EXAMPLE : cocacoiaanaper.si
EQUILIBRIUM
3- PRICE OF COMPLEMENTARY GOODS ( maximising production by producers and utility of
An increase in price of product C will increase consumers
demand of product D The price mechanism uses price signalling in order
EXAMPLE : DVDs and DVD Players to allocate resources in response to price

4- INCOME SURPLUS ( QdsQs)

4. 1- NORMAL GOODS

when income increases . demand for no -

SIGNAL :
signal to producers that price is too high
rmai schools increases ( excess stock )
EXAMPLE : In 2019 demand for Spanish holidays
increased
,

intneukastneuaweof
INCENTIVE incentive to change ( lower> price due to
:

the pound rose profit margains

4. 2- INFERIOR GOODS RATIONS : rationing of excess supply
opposite of normal goods such as cheap
wine ALLOCATE

[email protected]
:

> studies
 SHORTAGE (Qd > Qs ) social surplus - CS + PS

SIGNAL :
signals producers that price is too low ( non welfare marginal benefits
: -
marginal cost
-

rationing methods such as long toes ) social surplus is maximised and

INCENTIVE :
prices rises to increase profit society is making the best use of
its scarce resources
RATIONS :
excess demand ☒ reduced

ALLOCATE :
allocates scarce resources perfectly productive efficiency _-
maximising output at

the lowest possible cost

total price paid
consumer surplus ((5)
_

=
benefits for product
Allocative efficiency -
when a market alto -

Price lowest Price

producer surplus ( Ps)= -
Cates resources to achieve an optimal com -

sold willing to
bination Of goods for society
accept

ELASTIC / TIES DETERMINANTS OFPEDISPLAT )

PRICE ELASTICITY OF DEMAND SUBSTITUTES AND CLOSENESS

" substitutes
Lameasureofthe responsiveness in quantity =P elastic demand
+ closeness
demanded in response to price changes
consumers can easily switch between cheaper
① 2- Q ' substitutes
i. ☐ Qd
PED=%☐p
=
Q'
☒ 100 PROPORTION OF INCOME
Pz -
P,
II. of consumer income _- Pelagic
P,

LUXURY OR NECESSITY
inelastic : OCPEDCI Elastic :1< PEDC a
luxury -- telastic
Perfectly inelastic :PED=O Unit elastic :PED=1
Necessities - Inelastic as they are essential and
perfectly elastic :PED=① people will buy the same amount

Inelastic PED a change :

Ofa good or servi
in price -
for survival

celeadstoa Proportional "sm° " "

decrease in quantity demanded DDICTNENESS
Elastic PED a :
change inpriceofagoodorseruicetaddictive-trelasticcu.ee versa )
leads too proportionally larger
decrease
quantity demanded in
TIME PERIOD
Unit Elastic PED :O Change in price Ofa good or
service leads to @ proportional
SHORT TERM - trelastic (vice versa )

decrease in quantity demanded lnotimetotind substitutes and change

P
P
buying habits

py
"

1
,

I
,

-
-
Q
- Q
Q
INELASTIC ELASTIC UNIT ELASTIC

⑥ eren.lbstud.es
Primary commodities goods made directx
:

from natural resources YED > 0 YEDLO

tho substitutes
Normal goods Inferior goods
Lneccesities
TY=TQd(and vice versa) TY=tQd
Manufactured commodities subject to :
lower quality and

extensive product differentiation ( TPED ) NECCESITIES Cheaper substitutes

LUXURY
Of normal goods
GOODS ☐ < yep , /
" " "" •
CROSS ELASTICITY OF DEMAND H=TQa
TY=TTQd slightly
la measure of how demand for a product very elastic elastic
changes in response to changes in price
Of another product (XED )

a- Q PRICE ELASTICITY OF SUPPLY

✗ fD=%☐d✗=
%☐py
Qi
* 100
L measure of the responsiveness in quantity
supplied in response to price changes
Pz -
P,
The value classifications for PES are the same as
P,
PED

①" Q'
✗ ED > 0 XED.CO %☐Qs
PES -
=
Q'
(substitute) ( complementary goods) i. ☐ P ☒ 100
Pz -
P,
TPof9oodX=TQdof TPofgood✗=fQdof
GOODY Pi
goody

tPof9OOd✗=fQdof fPofgood✗=TQdof
9009T goody
DETERMINANTS OFPES :

Goods ✗ and ✗ PRODUCTION LA0

are jointly
1 production / 99=11%5 lanaviceversa)
"

demanded and derive the

same utility Its hard to immediately change production and ad .

✓
just to reach a newmarket equilibrium
consumers experience an increase in disposable

income upon consuming product ✗ as its price STOCKS

✗ more than ✗ to TS1-0CK - TPES lanaviceversa )

decreases They will consume
-

East to respond to an increase in price or demand

maximise utility at the lowest possible price .

SPARE CAPACITY
TCapacity-TPESlanavicevers.ae )
INCOME ELASTICITY OF DEMAND spare capacity can be utilized in response to an

lmeasureof increase in price and demand

how much the demand Ofa good ,
service in response to change in consumer
income SUBSTITUTABILITYOFFACTORSOF
PRODUCTION
Qz Qi
-

YED=%☐⑨d✗=
t.BY
Q,
* too
TSUbstitutability-t.PE
Resources can be shifted out and in more easily in
Y2 Y
-

, production increasing responsiveness to price

,

changes
Y ,
 TIME
In the long run - Pelagic supply

Firms have the time to change their scale of operation and factors of production to change output
in response to price changes

lntheshortrun-kelasticsut.PH
Firms cannot immediately vary output in response to price due to the number of factors of production
they need to employ

GOVERNMENT INTERVENTION
EVALUATION KLASPP)
INDIRECT TAXATION
L payment imposed on expenditure

ADVALOREMTAXES SPECIFIC TAX B

L
percentage of selling price ( fixed amount imposed
-
E- if
I
TAXES IMPOSED ?
☐
WHY ARE
1- source of government revenue ,
Method Of discouraging consumption of harmful could be asian of unemployment forced
' '

2- E. F- as firms are

GOODS to let workers 90 from higher costs of production and

3- Corrects negative externalities
decreased market equilibrium quantity
S,

É%
"

I
stakeholders
"
" " " " " " "" " "" " " " "+ ☐ + £
P,
consumer surplus After :*
P -
- -
-

-1
,

Producer surplus Before :( + Dtf

÷
☐
☐ Producer surplus After :D
.

Qz Q, Qz Q Leven though producers charge Pz.theyonhtecieue.PT as the

distance between Pzanaptisthetax Value

when PED.is/'helastic,ptOducetspassonthemajoritYOf Government Revenue Before :O

the tax burden to consumers
Government Revenue After :Btc

i¥"
"""" "" " " ""
2.9%+06.5%1-0 increase government revenue Total surplus :AtBtCtDt
"""" """ " " " ☐
welfare LOSS : Etf
<
Areas of surplus society was benefiting from are lost and
society is worse off overall
I
1
-1
- - -

'
Priorities
1
The government must beat in mind if the welfare loss
to society is worth the increase in revenue and
when PEDI.se/astic.prooucerscannotp1acethe
decreased demand
-

majority of the burden on consumers as quantity

demanded would decrease proportionally greater Assumptions
"""" "" "" "" " "" "" " "" "" "" """"" """" "" "" " "°
maximise revenue and ufiliytespectiue.LY
L
producers bear the majority of the taxation
 L
producers may not use it for intentions the government
SUBSIDIES implies it for and keep benefits from the subsidy

taper unit payment to producers by the government +

WHY ARE SUBSIDIES IMPOSED ?

e - -

¥ °"
1- lower the prices of desirable goods to society making them ,

more accesiblefor lower income households

2- Guarantee the supply of the product the government p,

I
D
feels is desirable for the economy
0 Q
EXAMP Influenza vaccination subsidy in Hong Kong for
> 50ns $210 Perouse
,

producer Revenue Before : Pia Qi .

'

0
pA S

s,
Producer Revenue After : e. d. 012.0
L they are
charging Pz but relieve "e " as there is
a subsidy

.
Government spending Before :O
o">Q Government spending After : d- b
EVALUATION KLASPP) ( opportunity cost on subsidy in terms of
spending other government related
stakeholders on

projects
consumer surplus Before : At ☐
After :AtDtCtFtG
I

¥
consumer surplus
. -

Producer surplus Before :( + D

Producer surplus After :B + CTDTE

Government Revenue Before :O

B- -1

F1-6TH )
- -
-

Government Revenue After :( BTCTE

☐

Oa'Q
+

Pa
s

"

"
PRICE CEILING
A maximum price set by the government below the
market equilibrium price

-1
P A
- -
- -

☐ ☐

0€ >
Q

consumers Before :P ,
at QI

;
a
consumers After :P> at 012 ( shortage)

they save P, .Pz .

a. C pm

s
( extra units are being produced so they pay

01.02 -

c
-

b extra Qd

the true price passed down to consumers

WHY are price ceilings imposed ?
should have been B. they would be fully benefitting
< 1- Ensures the provision of goods that are normally
Pz B
-

is being kept BY the producer

under provides such as merit goods
,
2- TO control equity bt allowing goods to be more
LQ ,
→ Q > indicates a fall in output : some workers

affordable for lower income households

may be fired - unemployment

EXAMPLE : venue / a price ceiling on basic goods to

-
Total surplus Before AtBtCtDtEtF :

make them improve affordability

Total surplus After :AtBtCtD

SOLUTIONS welfare loss : Etf

SUBSIDIES :
to shift the supply curve to the right too , I can lead to the emergence of the black ma -

copportunitl cost 1-Ket as producers carryout economic exchange

DECREASE DEMAND with consumers unable to enjoy benefits from the
L goes against government aims
shortage and are willing and able to bathe good
n
s

|
p ,
°

PRICE FLOOR
" " " " °"

"
"

price above
""
When the government sets
pm
a minimum

. ④ the market equilibrium Price

P ✗

EVALUATION KLASPP) s

stakeholders ;;
'
P A ☐ l
t
l D

P,
06,1¥ >
Q

pmax WHY are price floors imposed ?

, 1- Raises incomes for producers

"
Qd 2- Protects workers by setting a minimum
wage
EXAM Ivory Coast and Ohana representing 60%
consumer surplus Before : A- + ☐ + E
of global cocoa supply have set a minimum price

consumer surplus After At ☐ + C

:
raised by $1.37 $1.48 respectively to protect
w o r t
and

price rationing methods resulting from the

non -
Restroom falls world in prices

shortage such as goes ,emptY shelves and producer

selling preferences results in "E

"
amount of consumers
SOLUTIONS
1- Government buying excess SUPPLY produced by
to remain unsatisfied
price floor
" "
L
C , lower price benefits these consumers who are able
lshadedareacpmin.az Q3 ) ) -

to BUY goods
L opportunity cost

2- Government can store , destroy or sell it abroad

Producer surplus Before : ☐ + Ctf
(
destroying - wasteful resources could be used
Producer surplus After :D
,

when firms experienced shortage in the future

L Revenue drops from Pio , to Pmax .Q > as they sell
L
selling abroad would harm domestic industries
a smaller quantity :
less profitable for firms at Pmax
as foreign governments feel as if products are dumped
and they prefer to allocate resources to the production
3- Positive Advertising to increase demand
of other goods
(
opportunity cost
 Total surplus Before :AtBtc+D+E
EVALUATION KLASPP)
Total surplus After :
At Btc
stakeholders welfare loss : ☐ + E
consumer surplus Before :AtBtD L society would be better off iflessofthe 9009

consumer surplus After :-X were produced

"
P
Producer surplus Before :( t E
welfare loss

Producer surplus After : Btc "

:"
decreased
L Despite producers being better off ,
as demand

from consumers preferring substitutes C

I , I

due to higher price some producers are unable to sell I

,
, ☐

their goods
Fq'Q

MARKET ÉA ☒£
"

welfare loss :e
. Lteductioninsocia / benefits from amisallocatiot
of tesootces
NEGATIVE PRODUCTION EXTERNALITY i.
society would be better offiflesswas Produced

when the consumption of a good / service harms

any third Party not involved in the industry / production
SOLUTIONS
I -

Indirect Taxation
THEORY :

Liaising MPCTOMSC
Above the firms private costs of production there are /

additional cost that spillover to society Example :

UK fizzy drink taxoflspat 5-89 Of
sugar
( from the harm caused to third parties when producing t.es/-imatingualueoftaxbasedonthe
the good
external cost is almost impossible
LMS.CH external costs) > MPC ( also dependent on PED

✓
MSC 2- Direct Regulation
Px

MPC :S 3- Advertising / Eduction

a

tatters preferences and tastes against

good ( Dshiftstooi)

EXAMP Bad publicity on polluting companies

g
D=MSBjyp☐
NEGATIVE CONSUMPTION EXTERNALITY
consumer surplus at social optimum :
9
When the consumption ofagooaorseruiceharms
producer surplus at social optimum .
btf
athirdpartt member uninvolved in the market
Total surplus :atbtf
and consumption
consumer surplus :
atbtctd
THEORY :

producer surplus :
ft 9th
consumption creates external
value of external cost Msc : -

MPC :( tdtet9.tn costs to third parties

Total surplus :( STPS -

external cost consumers remain ignorant of external

:(atbtc.to)t( ft 9th ) ( ctdtet 9th) costs and consume
attheutilitymaximi.at
- -

btf① sing point MSEMPB.GS it is a free

-

market
 s=Msc=Ms☐

É¥☐=µp☐
pm
external Benefits :( tf
Total surplus atbtctetf
/
:

f
consumer surplus :
atbtctd
MSB Producer surplus :
etftg
! I External Benefits :O
0
☒
[email protected]
tb AT SOCIAL OPTIMUM :
welfare loss :
dtg
Producer surplus :[ + dtf consumer surplus :btc
Producer surplus :f cduetounoo.at location of resources
External costs :a+d+e

btctf-e.TO/-aISUtpIUs:btctfthereisanaooitionaIcosttha1-
total surplus :

society
SOLUTIONS
mustbearc.es 1- subsidies
(
increase quantity supplied
SOLUTIONS benefits
incorrect the spillover
1- indirect Taxation
2- Direct Provision
lshiftssuppwtothelefttosoci.at optimum (
L
directly providing at MSC
lower level of consumption

2- Direct Regulation
L
regulating consumption
POSITIVE CONSUMPTION EXTERNALITY
EX0M-1ZE : smoke basin buildings
Occurs when the consumption Ofagoodor service creates
3- D- devising external benefits that third parties not in the consumption

THEORY :

POSITIVE PRODUCTION EXTERNALITY

extm-PE.PH/sicn-iexERcise0CCUrswhenthepr00UCtiOnOfagOOdorseruice creates
'
the consumption of gyms benefits the individual with an

andiualittoflifelgivesn.se
increase lifespan
external benefits that third parties not in the industry
to additional benefits involving greater work
THEORY : productivity and lower absenteeism

costs to society ( + benefits) > private costs '

NHS saves 100 pounds per person from these employer benefits
M5C > MPC benefits to society > benefits .to private consumers
underallocationof resources Msc > MPC

Lunderallocation Of resources

,MPC=S
P
, r
p ⇐ MPC -
MSc
,

"

I : M5C

/
Market
consumer surplus :9
equilibrium .
Producer surplus :b , @
 consumer surplus :b consumer surplus -
a -14 -

Clean Technologies SOLUTIONS

producer surplus -
c producer surplus btctdtf
-
1- legalisation
External benefits -
atd Total surplus -
qtbtctdtetfc-XAM-P.ci making education compulsory

Total surplus - Cbtc )tlatd) 2- Adertisin9

↳ welfare loss etf
-

3- Direct Government Provision

MPBcMSB+e④ lshiftssupplttoMSC.MS/3
4- subsidies

PUBLIC GOODS
when users enjoy the utility from
Public goods are non -
excitable and non -
rival goods THEORY :
ra good without paying for it
-
-
'
when its available to lnon-diminishib.ie good ,
Non -

excwdab.int/leadstothefreeriderpI?Profit-max-
One .it 's available to consumption does not decrease ionising firms will not be willing to produce the good as they are

all theamountavailible.to unable to cover their factors of production and generate revenue

others lunderallocationof resources

SOLUTION : L the market fails to effectively allocate resources

•
Direct Government Provision

subsidies
•

( cost-benefit analysis which compares the estimated benefits

tosociettofagoodanditscos.tl
government must use a -

total benefits > total cost :

provide
L total costs > total benefits : do not provide
L
government decides the amount BY comparing MBANAMC public goods should be provided at MC=MP ,

COMMON ACCESS RESOURCES THEORY :

private individuals exploit and ouerconsume the common

( natural resources not owned by anyone free ,

resource which leads to the depletion of the resource because

EXILE fishing grounds :

they have no
EXAMP Deforestation Kuala Lumpur
• non -

exciuoabk price

lforestsinmatatsiaarenotpri.ua/-eHownedothets(diminishib1e
consumption decreases the amount available to
rivalries
•
:

(
Aggressive palm oil and timer companies have caused a loss
)
in 151 of the forest MPC= current costs
SUSTAINABILITY
MSC -
MPC + future costs i. M5C > MPC
Disrupts ecosystems wildlife and leads to the depletion
•

THREATS TO SUSTAINABILITY :
Focusing only on economic
of the ozone layer
Preservation and discarding the environment
•

soil erosion ,
wildlife is endangered from the destruction
Heavy demand for fossil fuels
•

of natural habitats
'
Generates external costs and threats for future generations
SUSTAINABILITY : the ability of something to be maintained
and preserved overtime common access resources
•

( negative externalities
(
joint preservation of the environment and economy
-
Pollution poverty
•

lack of destruction preserve humans ability to provide goods

and services to satisfy human 1- soil erosion
overusing / and -
> , deforestation and land
wants in the future oegration

1- Prioritisation SOLUTIONS : 2- carbon Taxes

losing permits to limit the amount of ltaxingtheuseoffos.si/fUelsbasedontheamountofcozemiHed

common resources used lTCOz=Ttax rate

( emission restrictions
leasxtooesignond.int/ementltheYoonotre4uireasmUChmonitoring

( maybe too low

( lower-income consumers would be largely affected

cihdirecttax result )
(
cannot fix emissions toacetain level like Capena trade
schemes
3- cap and Trade systems
4- Clean Technologies
( (
removes negative externalities by using
setting a maximum amount oncoz emissions
'
Permits to emit CO2 distributed in a free market renewable sources of energy
are
<
Opportunity cost ( sustainability and allocative
( fix total CO2 emissions
( does not affect low-income consumes efficiency is a priority)

•
Requires constant •
capandtrade
6- Education
monitoring toessure systems are only
ceoucatinga more environmentally concioosaltitude
no manipulation Placed 0ha certain
from future generations
and pollution OCOUS
industry ( not society)
above the limit Llongterm

5- Subsidies QzcQ ,
: socially optimum < equilibrium on -

titxofempioxment-inthelabourmarketcowes.CO/-
Of production for firms T SUPPIY
Louoallocationof workers employed
-

( incentive to use higher amounts of clean techologies

workers were information of If given all
w
Opportunity cost or t
King conditions the supply of willing and
,

(
firms might keep benefits of the subsidy instead of using clean ablewotkerswouabeioworlfirmshavetopayhigherwag.ee rates
technologies ( costs of producing goods that use

asbestos would have been higher

( Qof workers demanded would decrease to
⑦2

ASYMMETRIC INFORMATION
whenever the bucrorse.no/'nthemarKethassomeinformati0hsandtheothetsdO not

1
1- I +
RESOURCE MARKET
PRODUCT MARKET
many factory workers in industrialised countri -

vwcheatedon emissions tests ( 2015)

ieswo.ee/posedtOtoxicchemicaIssUChaslconsumersthOughtvwoieselcars
asbestos were more environ -

mentally friendly than they actually were Lchemica / Which is a carcinogen

Demand CMPB > with asymmetric information was greater
if buyers had correct information
POSPeclmorevwdie.se/swerebOU9htands0ldatahi9herpricetiueahd
than it would have been
Employers kept this information from
current workers
than the actual social optimum ( workers believed working in the factory
was safer than it actually was
s=MPc - Msc
p ( supply of willing information higher than

✗
, is

Pss☐,µp
it would be with symmetric information
lwageratesorelowerandquantityotwork.es
employed is higher than the social optimal
Quantity
""
""
Pz
-
-

I
-

wage
MSC ( with asymmetry)
,

¥
Pcmsc, - -
-
-

I cwith asymmetry ) rate ^ I 5, -

MPC
I
-

I I D. 2=14513
, (without )
, >
Q
" "
""

At 2. the marginal social benefit is Pcmsc> but the cost I

,
imposed on society ( MSc) is higher at Pi

( MSc > M5B D= MPB

louerallocationofresourc.es
1 !
0 >
Qz Q, Quatuor)