Notesale: Turn your study into money

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DEMAND AND SUPPLY
DEMAND

DETERMINANTS OF DEMAND

SUPPLY

The quantity of a good or service that consumers are
willing and able to purchase at a given price in a given
time period
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The quantity of a good or service that producers are
willing and able to produce at a given price at a given
time period, cetarus parabus
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DETERMINANTS OF SUPPLY

MARKET EQUILIBRIUM

ELASTICITIES
ELASTICITIES

PRICE ELASTICITY OF DEMAND (PED)

PED/PES VALUES

PERFECTLY INELASTIC DEMAND
PERFECTLY ELASTIC DEMAND
INELASTIC DEMAND

UNIT ELASTIC DEMAND

Income
Price of other products
- Substitutes
- Complements
- Unrelated Products

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Costs of factors of production
The price of other products the producer
produces
State of technology
Government intervention Tax, Subsidies
Number of firms in a market

Occurs where the forces of demand and supply are
equal, i
...
where the willingness and ability of
consumers to buy is the same as the willingness and
ability of suppliers to supply
A measure of the responsiveness of a variable to the
change in another variable or one of its determinants
A measure of the responsiveness of the quantity
demanded of a product when there is a change in price
of that product
 0 –Perfectly Inelastic
 0-1 Inelastic
 1 – Unit elastic
 1 - ∞ - Elastic
 ∞ Perfectly elastic
Where a change in price has no effect in the quantity
demanded of the product
...
g Coke and Pepsi
 Could encourage businesses with high XED to
merge to eliminate competition
 Business could create its own complements,
e
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Apple
 Can predict how a tax placed on a good with a
high negative XED will affect the demand for its
product e
...
tax on petrol and fast cars
A measure of the responsiveness to the quantity
demanded of the product when there is a change in
income
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Negative – Inferior good
Positive – Normal good
0 – Necessity

A measure of the responsiveness to the quantity
supplied when there is a change in price
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Time – longer time more elastic
Mobility of factors of production – higher
mobility more elastic supply
Space capacity – more capacity, more elastic
The ability to store stock – easier to store,
more elastic

GOVERNMENT INTERVENTION
INDIRECT TAX

A tax that is placed on consumer spending
...
This is to lower their costs of
production and increase production

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SUBSIDIES

PRICE CONTROLS
PRICE CONTROL
MAXIMUM PRICE

PRODUCER
Revenue increases
Profit should increase, can use money to
innovate in more efficient capital and become
more productively efficient
 Goods become more internationally
competitive
 Increase market size – Increase in employment?
 Could lead to a disincentive to innovate and
become more efficient, lack of allocative
efficiency
 CONSUMER
 Consume more at a lower price, if good is a
necessity will proportionally benefit lower
income groups more, is it fair higher income
groups benefit as well?
 Increase in consumer surplus
 May indirectly pay for subsidy through an
increase in taxes, if the tax is progressive then
proportional benefit will ensue
 Gain to the consumer will depend on PED, the
more inelastic the more the consumer will gain
(Reverse incidence of tax)
 GOVERNMENT
 Have to pay subsidy – Opportunity Cost
 May result in an increase in domestic
employment and an increase in exports
 Achieve Macro Objectives
 Could lead to tariff wars
 Political, can be done to stay popular, placate
population e
...
fuel subsidies in Indonesia
 Overproduction could lead to dumping –
international tension and environmental
concern of grain mountain and milk lakes
When the government intervenes in a market by setting
either a minimum or a maximum price for a good or
service
Where the government sets a price below the
equilibrium that producers are not allowed to charge
above

MAXIMUM PRICE
CONSEQUENCES

HOW TO SOLVE EXCESS DEMAND (INCREASE
SUPPLY)

MINIMUM PRICE

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PRODUCER
Revenue shrinks
Market shrinks – unemployment
Loss of Producer surplus
CONSUMER
Consumers who have access to the good now
pay less, benefits lower income people
disproportionally
 Excess demand could lead to black/parallel
markets
 Non price rationing systems such as first come
first served, food coupons, queues – unfair, will
higher income groups have priority?
 Inefficient/under resource allocation
 Dead weight welfare loss
 SUBSIDY (See above)
 GOVERNMENT PROVISION
 Must get the balance right
 Overprovision could leave to dumping,
underprovision will still result in excess demand
 If they get the balance wrong, allocatively
inefficient
 Politically popular, as will benefit everybody
 Opportunity cost, governments are less
efficient than firms
 Distorts signalling power of the market
A minimum price is when the government sets a price
above the equilibrium that producers are not allowed
to charge below

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MINIMUM PRICE
CONSEQUENCES

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HOW TO SOLVE EXCESS SUPPLY (INCREASE
DEMAND)

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CONSUMER SURPLUS

PRODUCER SURPLUS

COMMUNITY SURPLUS

PRODUCER
Gain, now receive a higher price and a larger
quantity
Increase in revenue
Protected against low cost producers
Disincentivised to innovate
Protected against unstable prices and supply
side shocks e
...
weather
Increase in employment
Could result in global misallocation of resources
as high cost producers able to sell more than
low cost producers
CONSUMER
Lose, now pay a higher quantity for less
Loss of consumer surplus
GOVERNMENT
If government buys excess supply, opportunity
cost – higher taxes?
POSITIVE ADVERTISING
GOVERNMENT DEMAND
Governments then ‘dump’ – sell abroad below
the costs of production (Illegal)
Can destroy goods
Can pay the farmer not to produce the product
Buy and store for another year
PROBLEMS
Storing – cost, perishable, don’t know if market
will return
Destroy goods – waste of resources

The extra satisfaction or utility gained by consumers
from paying a price lower than they were prepared to
pay
The extra revenue received by firms from a given
quantity of output that is above the revenue they were
prepared to accept for that amount of output

Producer surplus + consumer surplus

EXTERNALITIES
PARATO OPTIMUM LEVEL OF OUTPUT

NEGATIVE EXTERNALITIES OF CONSUMPTION

When community surplus is maximised, also known as
the socially efficient level of output
Where consumption of a good or service leads to
external costs to a third party i
...
society

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SOLUTIONS TO NEGATIVE
EXTERNALITIES OF CONSUMPTION I
...

CIGARETTES

POSITIVE EXTERNALITIES OF CONSUMPTION

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INDIRECT TAX
Government gets revenue they can use to
subsidise other markets, e
...
eCigarettes or
hospitals
Internalised the externality
Problems
Cigarette demand is inelastic, significant tax
needed for Q*
Taxes are regressive – affects poor people the
most
Decrease in output leads to unemployment
SHIFT DEMAND LEFT
Negative advertising
Substitute products
Age restrictions
Ban on positive adverts
Public smoking ban
Education
LEGISLATION – BAN IT
Problems:
Creates an illegal market
People will still be addicted
Unemployment issues as market is lost

Overall: Need a mixture of all these policies, best ot
target young people who haven’t started smoking yet
due to inelastic
Where consumption of a good or service leads to
external benefits to a third party i
...
society

SOLUTIONS TO POSITIVE EXTERNALITIES
OF CONSUMPTION E
...
HEALTHCARE,
EDUCATION, VACCINATIONS

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NEGATIVE EXTERNALITIES OF PRODUCTION

NEGATIVE EXTERNALITIES OF
PRODUCTION SOLUTIONS E
...

POLLUTION

SUBSIDIES
Problems:
Don’t know where Q* is, how much to subsidies
Opportunity cost
MAKE THE PRODUCT COMPULSORY
Problems:
Often involves making it free – opportunity cost
Free will
GOVERNMENT PROVIDE THE GOOD OR
SERVICE
Problems:
Opportunity costs
Firms may be better at producing the good or
service than the government
As firms are better they should be able to
provide it for less
POSITIVE ADVERTISING
Problems:
Opportunity cost
Effectiveness

Where production of a good or service leads to external
costs to a third party i
...
society

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ADD A TAX ON OUTPUT
Problems:
Difficult to work out damage of pollution
Difficult to work out who’s polluting
Pollution still exists, but market pays for it
TAX ON POLLUTION

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POSITIVE EXTERNALITIES OF PRODUCTION

SOLUTIONS TO POSITIVE EXTERNALITIES
OF PRODUCTION E
...
TRAINING STAFF
RECEIVE

MARKET FAILURES
MERIT GOODS

Increases costs so shifts MPC to MSC = MPC +
tax
...

This shifts MSC=MPC right, creating a new
parato optimum, Q*2 and P*2
CAP AND TRADE
Upper limit for the carbon produced is set
Then distributed, firms can trade the right to
pollute – market for carbon permits with
perfectly inelastic supply
Provides firms with an incentive to not pollute –
profit of selling permit vs profit of producing
and polluting
Leads to pollution being caused by those who
value it the most
Encourages technological innovation, again lead
to Q*2
Negatives
Issue of measuring pollution, controlling
pollution, how much to cap? How to distribute
permits? Only works if government isn’t corrupt
Still polluting, just making firms pay for it
Can only innovate so much within an airline
industry
LEGISLATION
Ban the product, production process or set legal
limits
Problems:
Good or service may bring benefits, or be a high
employer in the country

Where the production of a good or service leads to
external benefits of a third party i
...
society

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SUBSIDISE
GOVERNMENT PROVISION

A merit good is a good the government thinks is good
for us and society and is underprovided and under
produced and therefore under consumed in a free
market system
...


NON-EXCLUDABLE GOOD

It is impossible to stop people consuming the good or
service once it has been provided

NON-RIVALROUS GOOD

Where one person consuming the good or service does
not stop another person from consuming it
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SOLUTIONS TO LACK OF PUBLIC GOODS

COMMON ACCESS RESOURCES

PROBLEMS WITH COMMON ACCESS
RESOURCES
ASYMMETRIC INFORMATION

GOVERNMENT PROVISION – through collecting
tax
 GOVERNMENT SUBSIDISES firms to provide
them
 BUT Opportunity cost
Natural resources which are available to all in a free
market system
...
g
...
All production takes place in the short run
...
All planning takes place in the long run

COST THEORY
TOTAL PRODUCT

The total amount of the good or service that a firm
produces in a given period of time

AVERAGE PRODUCT

The total amount of the good or service that is
produced on average by each unit of the variable factor

MARGINAL PRODUCT

The additional output produced when an extra variable
factor is added

TOTAL FIXED COSTS (TFC)

The total spending on fixed assets (FOPs) that a firm
uses in a given time period – Constant, as the number
of fixed assets remain the same in the short run

TOTAL VARIABLE COSTS (TVC)

The total spending on variable assets (FOPs) that a firm
uses in a given time period – Changes, because variable
costs change as output increases

TOTAL COST (TC)

A firms total fixed cost added to is total variable costs in
a given time period

AVERAGE FIXED COSTS (AFC)

The variable cost per unit of output
...


AVERAGE TOTAL COSTS (ATC)

MARGINAL COSTS (MC)

The extra costs incurred by the firm by producing one
extra unit of output – as q increases, marginal costs will
decrease, until we reach the point of diminishing
marginal returns, and then marginal cost increases
...
The price level
that allows a firm to cover its average variable costs in
the short run
...
g
...
e
...
Occurs where MC = MR
as there is no additional profit gained by producing the
next level of output
...
Where AC = MC
Where a firm is using the optimum amount of resources
to produce their good or service, i
...
where producers
are producing the optimal amount of goods and
services
...
Where MC=AR
 There are a large number of small firms
therefore firms are ‘price takers’
 They all produce a homogenous product
 There are no barriers to entry or exit i
...
firms
are able to freely enter or leave the market
 There is perfect knowledge
 Possible to make abnormal profit, normal profit
and losses in the short run
 SHORT RUN ABNORMAL PROFIT TO LONG RUN
NORMAL –
 Perfect knowledge, so more firms enter the
market, increasing supply so price decreases to
equal ATC (draw backwards)
 SHORT RUN LOSSES TO LONG RUN NORMAL
PROFIT –
 Perfect knowledge, unsustainable nature of
making a loss, firms leave the market
 Decreases supply, increases price to equal ATC

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ADVANTAGES
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MONOPOLY
ASSUMPTIONS

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BARRIERS TO ENTRY
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All firms in the long run achieve normal profits
– industry can carry on existing ,firms aren’t
making abnormal profit at the expense of the
consumer
Firms in perfect competition are allocatively
efficient in the long AND short run
Firms in perfect competition are productively
efficient in the short run
One firm, or one dominant firm within an
industry
Barriers to entry exist
Firms sell differentiated products – consumers
can tell between each firm’s products
Firms can make abnormal profit in the long run
because there are barriers to entry

Firms profit maximise, so produce where
MC=MR
Due to high barriers to entry they can make
abnormal profit in the long run
Do not produce at allocatively or productively
efficient level of output (Q2 above)
Welfare loss of red shade as for each level of
output up to Q2 the value society places on it
(D) is higher than cost to society (MC) so society
is losing out
Economies of scale – existing firms will be
larger, more economies of scale, so can lower
price when new firms enter so can’t compete
Brand loyalty – businesses spend vast amount
of money attempting to create brand loyalty –
marketing
Natural monopolies – a market where there
are only enough economies of scale to support
one firm – more than one firm shifts d left
below LRATC – firm receives increasing returns
to scale at every level of output so MC never
crosses LRATC
Legal barriers to entry
Public franchise – trains
Patent – in UK lasts 20 years, allows them to
make abnormal profit, eg pharmaceutical
industry or Dyson, means firms can

ELASTICITIES AND EFFICIENCIES

ANTI-COMPETITIVE BEHAVIOUR

REVENUE MAXIMISATION

design/invest in new products to help develop
society
 Trademark
 Copyright
 Licenses
 PED=1 where MR = 0
 Monopolies produce on the more elastic part of
their demand curve by restricting output to
raise price
 Monopolies are neither allocatively nor
productively efficient
When a monopolist attempts to stop competition by
adopting restrictive practices, which may be legal or
illegal
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NATURAL MONOPOLY
NATURAL MONOPOLY

An industry is a natural monopoly is there
are only enough economies of scale available in the
market to support one firm

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COMPARE MONOPOLY WITH PERFECT
COMPETITION

Occurs when marginal revenue = 0
Lowers price to increase quantity
Sacrifices profit to maintain monopoly position
ANTI COMPETITIVE BEHAVIOUR – illegal, a
barrier to entry
Means of preserving profit maximisation in the
long run

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PRICE AND QUANTITY
If monopoly has economies of scale, produce
more for less
If don’t then PC supply = monopoly MC, so
perfect competition produces more for less
PROFIT/LOSS
PC – all outcomes possible in the short run, only
normal profit possible in long
M – all 3 possible in long and short, including
abnormal profit
PC preferable as not making abnormal profit at
the expense of the consumer
How monopolies can use abnormal profit for
research and development
EFFICIENCIES
PC productive and allocatively efficient in the

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MONOPOLISTIC COMPETITION
ASSUMPTIONS
THE LONG RUN

NON PRICE COMPETITION

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EVALUATION

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OLIGOPOLY
ASSUMPTIONS

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long run
Monopoly is neither
NATURAL MONOPOLIES
Products are normally socially desirable so
allowing them to exist is an advantage
Lots of small firms
No barriers to entry or exit
Perfect knowledge
They sell slightly differentiated products
All profit and loss is possible in the short run
Always normal profit as firms enter/leave the
market in the short run, increasing or
decreasing the price
Advertising/branding
Packaging
Product development
Quality of service
PRICE AND QUANTITY
Price decreases -> Monopoly -> Monopolistic
competition -> Perfect competition
EFFICIENCY
Both monopolies and monopolistic competition
are allocatively and productively inefficient
PC is allocatively and productively efficient in
the long run
Monopoly inefficient because the producer
restricts output
BUT Monopolistic competition is inefficient
because the consumer wants to choose etc
NUMBER OF FIRMS
Most firms PC -> MC -> M
More economies of scale M ->MC->PC
BARRIERS TO ENTRY OR EXIT
Only in monopoly – also face sunk costs
(startup costs) more likely to gain back if they
stay in the industry
RESEARCH AND DEVELOPMENT
Occurs in monopoly as abnormal profit
achievable
Some may occur in MC as differentiated
products mean there’s competition of quality –
incentive
But normal profits mean can’t afford to spend
on research and development
MARKET POWER
Most power M -> MC -> PC
A small number of dominant firms (the larger
the concentration ratio of the market, the more
likely it is to be an oligopoly, usually around
50%)
Firms sell differentiated products – some are
homogenous e
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oil
High barriers to entry – e
...
Brand loyalty, High
start-up costs e
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Can help explain price rigidity via a
mathematical relationship

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PRICE LEADERSHIP

If both charge high, receive £10m each
If Firm A tries to undercut by charging low, A
will receive £12m and B will receive £3m
 Firm B will match A’s price, so now they both
receive £6m
 However £6m is less than £10m, so they both
charge high prices
All firms match the price of the market leader – most
powerful – in ‘informal’ or ‘tacit’ collusion, not allowed
to formally discuss it
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COLLUSIVE OLIGOPOLIES (CARTEL)

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When they formally agree to control the market
in some way, allows them to act like a
monopoly and receive abnormal profits
Firms receive profit in proportion to their

market share e
...
OPEC – Oil producing
countries, controls price as controls quantity
released
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NON-PRICE COMPETITION

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BRANDING
Creates brand loyalty – vital
Media, sponsor football teams
Huge costs, push up prices, may not be in
interest of consumer
Creates a lot of jobs, huge market
PRODUCT INNOVATION competing on quality
of product or service
CONVENIENCE
E
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supermarkets – convenience stores, put
yourself where people can access you e
...

Liverpool Street Station has 3 M&S
Online shopping, Location
LOYALTY SCHEMES e
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g

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