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Microeconomics
Economics: a social science that studies the allocation of scarce resources to the production of goods
and services used to satisfy consumers’ unlimited wants.
Scarcity, Choice and Opportunity Cost:
Definitions:
Factors of Production:
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Land – all productive resources supplied by nature
Labour – human effort, physical and mental, directed to the production of goods and services
Capital – man made resource used in the production of goods and services
Entrepreneurship – organizes and manages factors of production, innovation etc.
Opportunity Cost:
Refers to the real cost in terms of the next best alternative that has to be forgone
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Free Goods – free goods incur no opportunity cost whatsoever
Economic Goods – production that incurs an opportunity cost, but is not charged to the
consumer, or “free of charge” goods,
3 Main Questions:
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What and how much to produce? Allocative efficiency
How to produce? Productive efficiency
For whom to produce? Distributive efficiency
3 Main Decision-Making Bodies:
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Households – aim to maximise satisfaction/utility from consuming a combination of goods
given their limited income
Firms – aim to maximise profits from production of goods and services subject to the costs
of scarce factors of production
Government – need to allocate tax revenue to fund projects and initiatives that fulfil
microeconomic and macroeconomic objectives, social welfare
Absolute Advantage: perform activity with less resources
Comparative Advantage: perform activity at lower opportunity cost
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Marginalist Principle
Undergirded by the assumption of Maximising Behaviour – that all rational actors will aim to
maximise certain objectives, generally known as utils. The rational decision for a self-interested actor
would be the optimal combination of resource allocation that maximises utility.
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Production/Consumption makes sense if Marginal Benefit(MB) > Marginal Cost (MC)/
Marginal Private Benefit(MPB) > Marginal Private Cost (MPC)
Firms - producing up to the point where Marginal Cost (MC) = Marginal Revenue (MR)
Governments – considering Marginal Social Benefit (MSB)> Marginal Social Cost(MSC)
The Marginalist Principle is important because it allows us to find this optimal choice whereby utility
is maximised because we will always choose up to the point that the benefits accrued is equal to the
cost incurred.
Hence, most of our economic choices are made at the margin. We consider the “marginal cost” or
the cost of consuming just a bit more against the “marginal benefit”, the benefit of consuming just a
bit more.
This guarantees economic efficiency – and ensures that scarce resources are allocated optimally to
produce the outcome that is optimal to society
Free Market Relies on:
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Private Ownership of Property
Freedom of Choice and Enterprise
Pursuit of Self-Interest
Competition
Price Mechanism – Price functions as both a signal and incentive. Decisions of producers
determine supply and buyers determine demand. The interaction of demand and supply
determines the price. Hence, the Price Mechanism allows for allocative, productive and
distributive efficiency.
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Production Possibility Curve:
a graph that shows the maximum attainable
combinations of output that can be produced in an
economy within a specific period of time, when all
available resources are fully and efficiently employed,
at a given state of technology.
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Any point on the curve is a maximised
efficient use of resources in a binary
allocation between two types of goods
Any point inside the curve is an attainable but inefficient combination
Any point outside the curve is an unattainable combination
Unemployment: the situation in which not all available resources are used in the production of goods
and services
Underemployment: the situation in which resources are engaged in production but operating below
their production capacity.
The PPC is concave to origin due to the increasing opportunity cost, as not all resources are perfectly
transferable to the production of both goods
1. Increase in the Quantity and/or Quality of Resources
Shift in the PPC outwards, the shift may be skewed according to the
suitability of the resource increased to the good produced.
2. Consumer Goods vs Capital Goods
The production of more capital goods in one period will find that it can
produce more output in the next period, productive capacity increase,
however the opportunity cost of such a decision is a reduction in
present consumption.
3. Technological Improvement
If technological improvement favours either good, the PPC curve may
be skewed.
Unemployment – not all the available resources are used in the production of goods and services
Underemployment – resources are engaged in production but are operating below their production
capacity.
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Demand-Supply Model:
Definitions:
Free Market Economy: an economy where all economic decisions are taken by individual households
and firms, with no government intervention, resources are allocated according to market forces of
demand and supply.
Characteristics:
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Private ownership of property – Land and capital are owned by individuals, not collectively.
Economic freedom – People are free to use their factors of production as they see fit,
producers are free to produce what they like, how they like, etc. Consumers are free to buy
what they please – consumer sovereignty
Self interest – everyone acts in own self interest. Producers seek to maximise profit,
consumers seek to maximise satisfaction, workers try to maximise their incomes
Competition – everyone competes in producing goods, offering labour and buying goods.
Limited role for Government – Government provides legal framework to protect property
rights, but beyond that keeps out of economy
Price Mechanism – Prices act to coordinate the whole system, Changes in S and D cause Ps
to alter and consumers and producers respond accordingly (prices convey information)
o Role of price in conveying information to buyers and sellers
Market Equilibrium – a position from which there is no inherent tendency to change, where buyers
and sellers are on aggregate satisfied with the current combination of price and quantity of a good
bought or sold (Ceteris Paribus)
Equilibrium Price – Price at which quantity demanded is equal to the quantity supplied, i.e. the price
at which equilibrium quantity is traded OR market clearing price.
Market is said to be at disequilibrium where quantity demanded and supplied are not the same. This
results in shortages or surpluses.
At prices above equilibrium, there
will be a surplus in the market,
exerting downward pressure on the
price as suppliers compete with each
other and lower prices.
At prices below equilibrium, there
will be a shortage in the market,
exerting upward pressure on the
price as consumers compete
amongst each other and offer higher
prices
Price levels tend toward equilibrium in dynamic markets.
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Demand and Supply:
An increase in demand will raise the equilibrium price and
quantity, conversely a decrease in demand will lower the
equilibrium price and quantity. Ceteris Paribus.
D1 moves to D2, resulting in an increase of price from P1 to P2,
and an increase in quantity from Q1 to Q2
An increase in supply will lower the equilibrium price but still
increase the equilibrium quantity, in contrast a decrease in
supply will result in a lower equilibrium quantity but a higher
equilibrium price.
S1 moves to S2, resulting in a decrease of price from P1 to P2,
and an increase in quantity from Q1 to Q2
Simultaneous increases in D and S will result in greater quantity
supplied but an uncertain price change
Simultaneous decreases in D and S will result in a lesser quantity supplied but an uncertain price
change.
An increase in D but a decrease in S will result in a definite price increase but an indeterminate
equilibrium quantity.
A decrease in D but an increase in S will result in a definite price fall but an indeterminate
equilibrium quantity.
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Demand Theory:
Definition:
Demand: refers to the amount that consumers are willing and able to purchase at any given price
over a given period of time. (for demand to be effective, willingness to pay must be supported by
ability to pay)
Real income: Real purchasing power
Normal Good: demand for good varies proportionately with income
Inferior Good: demand falls as income increases
The quantity demanded of a good and service is inversely related
to its price, ceteris paribus.
Exceptions? Vablen and Giffen(inferior) goods
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A movement along the demand curve is a change in the
quantity demanded
A movement of the demand curve is a change in demand
o Any factor that influences buying plans other than
the price of a good.
Substitution Effect: the effect of a change in price on quantity demanded arising from the consumer
switching to or from alternative products
Income effect: the effect of a change in the price of a commodity on quantity demanded arising from
the consumer becoming better or worse off(change in real income) as a result of the price change.
An increase in price leads to a decrease in Purchasing power.
Factors Influencing Market Demand (Non Price Determinants):
1. Taste and Preferences
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The effect of advertisements, education, culture and age group
Temporary increases in demand due to fads
Permanent decreases in demand for old technology as a result of new inventions
Seasonal Changes – climactic conditions and/or festivals
2. Expectations of Future Prices
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If people expect the price of the good to increase, they will increase demand in current
market even when prices have not increased yet, ceteris paribus
3. Income in the case of normal goods
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An increase in income leads to a rightward shift in the demand curve, and a decrease in
income leads to a leftward shift
The converse is true for inferior goods as consumers switch to better substitutes
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4. Prices of Interrelated Goods
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Changes in the price of substitutes or complements can also affect demand.
Prices of Substitute Goods
A substitute is a commodity that can be used in place of another, it satisfies the same want and are
competitive in demand.
e.g. Coca-Cola and Pepsi, MRT and Taxi Services, Cadbury’s and Nestle Chocolate, Milk and Yoghurt
Hence, an increase in the price of one good results in a rise in the demand for its substitute, as
consumers switch from one good to another
Prices of Complementary Goods
A complementary good is a good that is used in conjunction with another, they are jointly demanded
to satisfy the same want, and are thus in joint demand.
e.g. tea and sugar, cars and petrol, digital cameras and memory sticks, DVD and DVD players,
computers and computer software
A fall in the price of one good leads to an increase in demand for a complement good, this is because
a fall in the price of one good leads to a bigger quantity of the quantity good and that good being
purchased, which increases demand.
5. Government Policies
Direct Tax Policy
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Direct tax is a tax on people’s incomes. Changes in direct tax rates affect people’s
disposable income (the income available for spending after payment of income tax)
An increase in the income tax rate will reduce people’s disposable income. This reduces
purchasing power, leading to a decrease in a demand for goods and services.
Direct Subsidy Policy
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Direct subsidies are payments made by the government to the consumers.
Direct subsidies increases purchasing power of consumers and hence demand
6. Population
Affects the number of potential consumers or the size of the market
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Absolute increase or decrease in total population
Change in demographic/composition of the population
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7. Interest Rates
Rate of interest is the price of borrowing or using money
Changes in the rate of interest affect the level of demand by consumers, especially those than rely
on loans or hire purchase
8. Exchange Rates
Changes in the rate of exchange will affect foreign demand for a country’s goods and services.
Strong currencies find it easier to import whereas weak currencies find it easier to export.
Consumer Surplus:
Consumer Surplus: is the difference between the
maximum amount that consumers are willing to pay
for a given quantity of a good and what they actually
pay
In a competitive market, the price is actually
determined by the market and demand and supply
forces, the maximum amount that consumers are
willing to pay gives an indication of the value of
benefit (satisfaction) that consumers derive from
buying the good.
Consumer surplus is also the measure of consumer welfare, the bigger the surplus the higher the
level of consumer welfare.
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Supply Theory:
Definitions:
Supply: refers to the quantity of a good or service that producers are
willing and able to offer for sale at each given price over a given
period of time.
The quantity supplied is directly related to the price of a product. The
higher the price of a good, the greater the quantity supplied and viceversa, ceteris paribus.
The supply curve represents the minimum price at which producers
are willing and able to supply each good or service, it is upward
sloping, the higher marginal cost of supplying the additional unit can
be covered by the marginal benefit.
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A change in quantity supplied refers to a shift along the supply curve
A change in supply refers to a change of the supply curve due to non-price determinants.
Factors Influencing Market Supply (Non Price D eterminants):
1. Costs of Production/Prices of Factors of Production
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Changes in price of factor inputs such as raw materials, fuel and power and cost of
labour and cost of capital changes cost of production, in turn affects the supply of the
good
Increase in factor price results in a decrease in supply and vice versa
2. Innovation/State of Technology
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Technology determines how efficiently resources can be used to produce goods,
improvements in techniques of production will increase productivity of factors of
production, cost per unit output will be lower
Producers are willing to increase the supply of a good at a given price, causing the curve
to shift to the right
3. Natural Factors
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Favourable Climatic Conditions such as abundant and reliable rainfall as well as absence
of pests increases the supply of agricultural products
Occurrence of natural phenomena such as natural disasters will reduce the supply of
agricultural produce.
4. Number of Firms
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An increase in the number of firms producing the good increases supply and gives a
rightward shift in the supply curve and vice-versa
This follows from the fact that market supply is the sum of all individual supplies
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5. Government Policies
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Government policies on indirect taxation and subsidies affect the cost of production of
firms and therefore the supply of a good
Indirect Taxes taxes imposed on expenditure of goods and services for example GST,
increases the cost of production for firms leading to fall in supply and leftward shift in
supply curve
o Ad Valorem Taxes = Percentage Taxes
o Unit Tax
Indirect Subsidy is a payment made to producers by the government and is equivalent to
a decrease in the cost of production. This leads to a rise in supply and a rightward shift in
the supply curve.
6. Prices of Related Goods: Joint Supply
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Joint Supply: production of goods that are derived from a single product, so that it is not
possible to produce more of one without producing more of the other.
E.g. Butter and skimmed milk, petrol and diesel, beef and leather.
Increase in the price of one leads to an increase in its quantity supplied and also an
increase in supply of the other joint product
7. Prices of Related Goods: Competitive Supply
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Competitive Supply: production of one OR the other by the same firm, the goods
compete for the use of the same resources and producing more means producing less of
the other.
E.g. wheat or corn, farmer may choose to switch from one to the other according to
price fluctuations.
8. Expectations of Future Price Changes
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If the price is expected to rise, producers may temporarily reduce the amount they sell
in the market, building up stocks and only releasing them when the price rises.
At current prices, producers are willing to supply less than they otherwise would, this is
represented by a leftward shift in the supply curve.
The opposite would be true if producers expect prices to fall.
Producer Surplus:
The difference in the amount received by producers for
selling their good and the minimum amount that they are
willing and able to accept to produce the good (does not
refer to profits = total revenue – total cost)
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Role of Price Mechanism in Resource Allocation:
Free Market Economy: an economy where all economic decisions are taken by individual households
and firms, with no government intervention, resources are allocated according to market forces of
demand and supply.
Characteristics:
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Private ownership of property – Land and capital are owned by individuals, not collectively.
Economic freedom – People are free to use their factors of production as they see fit,
producers are free to produce what they like, how they like, etc. Consumers are free to buy
what they please – consumer sovereignty
Self interest – everyone acts in own self interest. Producers seek to maximise profit,
consumers seek to maximise satisfaction, workers try to maximise their incomes
Competition – everyone competes in producing goods, offering labour and buying goods.
Limited role for Government – Government provides legal framework to protect property
rights, but beyond that keeps out of economy
Price Mechanism – Prices act to coordinate the whole system, Changes in S and D cause Ps
to alter and consumers and producers respond accordingly (prices convey information)
o Role of price in conveying information to buyers and sellers
Price Mechanism:
Price as Signal – prices communicate information to decision makers
Price as Incentive – prices motivate decision makers to respond to the information
Product Market vs Factor/Resource Market
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factor resources are allocated according to the forces of demand and supply in both the
factor resource markets and the final product markets. Changes in the final product markets
can have effects on the factor resource markets. Resource movements.
Demand for factors of production is a derived demand; refers to demand for one good or
service that occurs as a result of the demand for another intermediate/final good or service.
An increase in demand for a product will result in an increase in a demand for the factor
good.
Economic Efficiency in Competitive Markets
Efficiency: best possible use of resources; allocative and productive efficiency
Allocative Efficiency: society produces and consumes a combination of goods and services that
maximises welfare. Right goods in right quantities
This is achieved when Price = Marginal Cost, valuation of last unit of good consumed is equal to the
opportunity cost in producing that last unit of good.
Marginal Social Cost = Marginal Social Benefit, when the additional
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Productive Efficiency: situation where firms produces goods by using the fewest possible resources.
Alternatively it could be interpreted at given output at lowest possible cost
This is achieved when: Firms produce at the lowest point on the long run average cost curve from
Society’s point of view, or when Firms produce at any point on the long run average cost curve from
firm’s point of view.
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Elasticities of Demand and Supply:
Definitions:
Elasticity: is a measure of the responsiveness of a variable to changes in price or any of the variable’s
determinants.
Price Elasticity of Demand (PED): is a measure of the responsiveness of the quantity demanded of a
good to a change in its price, Ceteris Paribus.
Income Elasticity of Demand (YED): is a measure of the responsiveness of demand of a good to a
change in consumers’ income, ceteris paribus.
Cross Elasticity of Demand (XED): is a measure of the responsiveness of demand of a good to a
change in price of another good, ceteris paribus.
Price Elasticity of Supply (PES): is a measure of the responsiveness of the quantity supplied of a good
to a change in its price, Ceteris Paribus
Price Elasticity of Demand:
Formula:
PED
= Percentage Change in Qd/Percentage change in P
= Q/Q0 + P/P0
=Q/P x P0/Q0
The coefficient of PED is normally negative because of the inverse relationship between price and
quantity demanded. The negative sign is thus ignored and the absolute value is considered.
Note: Elasticity of Demand is always considered in relation to a change in supply, and vice versa.
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Coefficient
PED > 1
Interpretation
Price Elastic Demand
- A change in price leads to a greater
than proportionate change in
quantity demanded
PED < 1
Price Inelastic Demand
- A change in price leads to a less than
proportionate change in quantity
demanded.
PED = infinity
Infinitely price elastic demand
- A change in price leads to an
infinitely large change in quantity
demanded. An infinitely small
increase in price will cause quantity
demanded to fall infinitely to zero.
PED = 0
Perfectly price inelastic demand
- No change in quantity demanded in
response to a change in price. Same
quantity is demanded regardless of
the price of the good
- For example, heroin
PED = 1
Unit price elastic demand
- A change in price leads to a
proportional change in quantity
demanded.
- The curve is a rectangular hyperbola
Diagram
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Determinants of Price Elasticity:
THIS
1. Availability of Substitutes
The more substitutes there are for a good, and the closer they are, the more likely consumers are to
switch to these alternatives when the price of the good increases. The greater number of substitutes
available for a good and the greater the substitutability among these goods, the more price elastic is
the demand.
The availability of substitutes is dependent on how the good is defined
2. Habitual Consumption
Demand tends to be price inelastic if the good is considered a necessity or bought habitually. For e.g.
petrol, medicine, food.
It may depend on habits, such as a consumer’s addiction to the good.
3. Proportion of Income Spent on the Good
The higher the proportion of income spent on a good, the more people will be forced to reduce their
consumption when price increases; hence the more price elastic will be the demand. This is because
small increases in price will take up more of the consumer’s available income. For example, price
increases in cars and luxury goods.
4. Time Period
When the price of a good rises, the consumer will take time to respond to price changes, adjust their
consumption pattern and find alternatives, the longer the time period the more price elastic
demand will be.
Usefulness of PED
PED is able to analyse the effects of a price change arising from a change in government policy or
firms pricing policy, (Ceteris Paribus).
PED and Firms Pricing Decisions
Relationship between PED and Total Revenue: Price x Quantity
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If demand for product is price inelastic, ceteris paribus, then firms should raise price to
maximise total revenue.
If demand for product is price elastic, ceteris paribus, then firms should lower its price so as
to increase total revenue.
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If demand is price elastic, then price and Total Revenue move in opposite directions, an increase in
price leads to a decrease in total revenue and vice versa
If demand is price inelastic, then price and Total Revenue move in the same direction, an increase in
price leads to an increase in total revenue and vice versa
Primary commodities: goods arising directly from the use of natural resources, have a lower PED
compared to PED of manufactured products
Low Price elasticity of demand, together with fluctuations in supply over short periods of time
creates serious problems for primary commodity producers due to large fluctuations in prices which
affect incomes
PED and Marketing Strategies
Firm may seek to make demand for good less price elastic, it can do so through
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Reducing the substitutability by other products, creating real or perceived differences
between his product and the substitutes
Timing of Pricing and Marketing Decisions
Short run – demand relatively price inelastic, firm can adopt price adjustment strategy
Long run – demand being more price elastic, focus on product innovation and promotional and
marketing strategies.
PED and Indirect Taxes
Lower the price elasticity, the greater government revenue. Price Inelastic Goods usually taxed
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Income Elasticity of Demand
Income Elasticity of Demand (YED) measures the responsiveness of demand of a good to a change in
consumers’ income, ceteris paribus.
YED helps us predict how much the demand curve will shift for a given change in income, ceteris
paribus.
Formula:
= (% in quantity demanded/%  in income)
YED
=Q/Qo divided by Y/Yo
=Q/Y x Yo/Qo
Coefficient of YED can either be positive, negative or zero.
If YED is negative (YED <0), the good is an inferior good, an increase in income will lead to a fall in
demand for the good
If YED is positive (YED>0), the good is a normal good, an increase in income will lead to an increase in
demand for that good.
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If it is positive but less than one (0 < YED < 1), demand for good is income inelastic, a
percentage increase in income produces a smaller percentage increase in quantity
demanded. E.g. necessities.
If it is positive and greater than one (YED > 1), the demand for that good is income-elastic, a
percentage increase in income produces a larger percentage increase in quantity demanded.
E.g. Luxury goods.
Determinants of Income Elasticity of Demand:
Mostly determined by the degree of necessity of the good. The more basic an item is in the
consumption pattern of households, the lower is its income elasticity of demand.
The nature of a good is dependent on the level of income of the consumer, a good can be a luxury
good at low income levels, a necessity at middle income levels and an inferior good at very high
income levels.
An increase in income will produce a small rightward shift in the demand curve for necessities, and a
large rightward shift for luxuries, in the case of an inferior good, an increase in income results in a
leftward shift
Applications of Income Elasticity of Demand:
YED is important to firms when incomes are changing in a country. Firms can ascertain the nature of
their product and plan the future output accordingly. Income elasticity of demand also helps firms in
planning the future size of the market for their product
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Responding to changes in income, if household incomes are rising, firms could
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Produce goods which are income elastic (luxury goods)
Make products more income elastic by making it more prestigious or luxurious
Stock up more of the normal and luxury goods in anticipation of the rise in demand
Plan to expand the number of retail outlets it has
If household incomes are falling or expected to fall, firms could
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Stock up or switch to goods which are more income inelastic in demand e.g. necessities
Focus marketing efforts on groups that view the good as essential
Promote the good as value for money to the budget conscious
Targeting different consumer groups
YED and the Government
Can help the government predict demand patterns and allow government to project changes in
government policies.
Cross Price Elasticity of Demand ( XED)
Cross price elasticity of demand (XED) measures the responsiveness of demand of a good to a change
in price of another good, ceteris paribus.
XED predicts how much the demand curve for a particular good will shift in response to a given
change in the price of another good, ceteris paribus.
Formula:
XED (of good A)
=%in quantity demanded of good A/% in price of good B
=Qa/Qa divided by Pb/Pb
=Qa/Pb x Pb/Qa
Interpretation of Sign and Coefficient
If XED is negative (XED <0), the two goods are complements. An increase in the price of one good
leads to a fall in the demand for the other good. The larger the absolute value of the negative XED,
the greater is the complementarity between the two goods.
If XED is zero (XED = 0), the two goods are unrelated.
If XED is positive, (XED > 0), the two goods are substitutes. An increase in the price of one good will
lead to an increase in the demand for the other good.
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If XED is positive but less than one ( 0 < XED < 1) the two goods are not very close substitutes since
the demand for one does not respond very much to a change in price of the other
If XED is greater than one (XED>1) then the two goods are close substitutes, hence the value of XED
shows the degree of substitutability between the two goods, the larger the value of XED the greater
is the substitutability between the two goods.
Determinants of XED:
The determinants of XED are the relationship between the two goods and the closeness of the
substitute and complement.
Applications of XED:
XED and Firms:
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Pricing Policies: a firm may have a product that has a high positive XED in relation to his
rivals product (close substitutes), in such a case the firm will have to respond to changes in
the price of the rival’s product (price cuts, price raise?)
Should the competitor lower the price of his good, firm has to respond by lowering price of
his good to prevent loss – striving to be as cost efficient as possible
Marketing Sales Strategies:
o Making good less substitutable so that it is less affected by the pricing policies of the
rival firms. Advertising or improving product
o Complementary goods, linking marketing plans to pricing policy of other firms,
collaborations or packaging.
Price Elasticity of Supply (PES)
Price Elasticity of Supply (PES) is defined as a measure of the responsiveness of quantity supplied to a
change in the commodity’s own price, ceteris paribus.
PES gives us an indication of the ease at which a firms production can be expanded when price
changes.
Formula
PES
= (%in quantity supplied)/(% in price)
=Q/Qo divided by P/Po
=Q/P x Po/Qo
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Interpretation of Coefficient
Coefficient
Interpretation
PES > 1
Price Elastic Supply
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A given percentage change in the
price of a good will lead to a greater
percentage change in quantity
supplied
PES < 1
Price Inelastic Supply
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A given percentage change in the
price of a good will lead to a smaller
percentage change in quantity
supplied. All straight line supply
curves passing through negative yaxis are price inelastic
PES = infinity
Perfectly Price Elastic Supply
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Producers are willing to produce any
quantity at the prevailing price. Any
infinitely small decrease in price will
cause quantity supplied to fall
infinitely to zero (free good?)
PES = 0
Perfectly Price Inelastic Supply
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No change in quantity supplied in
response to a change in price. Same
quantity is supplied regardless of the
price of good
PES = 1
Unit Price Elastic Supply
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A given percentage change in the
price of the good will bring about an
equal percentage change in quantity
supplied. All straight line supply
curves from the origin are unitary
price elastic.
Diagram
Bradley 2013
Determinants of Price Elasticity of Supply
1. Time Period
The amount of time firms have to adjust their inputs (resources) and the quantity supplied in
response to changes in price. Over a very short time, firms are unable to increase or decrease inputs
to change the quantity it produces, in this case supply is highly inelastic, may even be perfectly
inelastic
The larger amount of time firms have to adjust their inputs increases, the larger the PES
2. Factor mobility
Factor mobility refers to the ease and speed at which firms can shift resources from one industry to
another. The more easily and quickly resources can be shifted, the greater responsiveness of
quantity supplied to changes in price and hence the higher the value of PES
3. Stocks and Spare Capacity
If the good can be stored with ease, supply will be more price elastic. Likewise if the firm has spare
capacity, production can be increased readily in response to price increases. If capacity is maxed, it
will be more difficult. Hence the greater the spare capacity, the higher the PES
4. Length of production period
The shorter the time period for producers to convert inputs into outputs, the more price elastic is
the supply of the good. Supply of agricultural goods tends to be price inelastic, in contrast
manufacturing goods are more price elastic because the time taken is relatively short
Applications:
In general, primary commodities usually have a lower PES than manufactured products. Hence there
are greater price fluctuations in relatively price inelastic goods.
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Limitations: (Specific limitations to each Elasticity Concept)
Factors affecting supply
CRINGE
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Cost of production
Inter-related goods (competitive supply- chicken and eggs and joint supply- beef and leather)
Innovation- new technology etc
Natural Factors- drought flood etc
Government Policies- subsidies and taxes (when drawing the graph, use the specific tax/ ad
valorem tax graphs if taxes
Consumer expectations (consumer irrationality etc "my bike is outside")
Difficulties in computing exact elasticity values due to income differences/socio-cultural differences
Ceteris Paribus assumption does not hold true in the real world.
PED
Factors affecting demand can range from Income, change in prices of other Goods, etc
Limitations: different changing factors like income (recession) or changes in prices of complements
or substitutes will render PED expectations less accurate.
YED
Which income group do you pick as a representative? To different groups (rich and poor) there will
be fairly different attitudes that exist towards the product.
Defining a target group is difficult, understanding income differences.
XED
Is useful when
(A) Substitute good: tries to either make good more competitive by lowering price or make it less
substitutable. However- cost of making it less substitutable may not be feasible (overall increase of
revenue may not be substantial)
(B) Complement good: tries to joint market the good: however this may not be possible due to
difficulty of working with another company and/or associated cost. Company may not be able to
increase profit or revenue by intended amount due to amount spent on making themselves more
competitive/attractive
Question types:
-how will this market/industry be able to use this information
-how useful will this be to firms (maximise profit maximise revenue minimise cost)
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Bradley 2013
Government Intervention and Impacts on Market Outcomes:
Indirect Taxes
Indirect taxes are compulsory payments levied by the government on expenditure/spending, they can
be classified into 3 types: general expenditure taxes, excise duties and customs duties. These taxes
are paid to government by the producers. Producers may pass some if not all of the tax burden onto
consumers, depending on the relative price elasticity of demand and supply of the good.
Indirect taxes lead to a leftward shift in the supply curve, lead to lower quantity and higher prices,
however the price will not ruse by full amount of tax because demand curve is downward sloping.
An indirect tax can either be a specific tax or an ad valorem tax. A specific tax or a per unit tax is a
constant sum levied on each unit of the good sold and will shift the supply curve vertically upwards
(parallel).
An ad valorem or percentage tax is a tax pegged at a certain percentage price of the good, hence the
curve pivots upwards anti-clockwise.
Incidence of Tax: distribution of the burden of taxation between consumers and sellers.
Price Elasticity of Demand and Supply and Tax Incidence
In the case of a relatively inelastic demand, the producers will bear less of the burden than the
consumers. Vice versa
Indirect Subsidy
A negative tax or payment to the producers by the government, the effect of an indirect subsidy is to
lower the cost of production, thereby shifting the supply curve downwards by the amount of the
subsidy.
Hence the benefit of an indirect subsidy is shared between consumers and producers as well
depending on the price elasticity of demand and supply.
If Supply is Elastic but Demand is Inelastic, consumers receive a greater share of the subsidy when
demand is relatively less price-elastic than supply.
Conversely, if demand is more price elastic than subsidy, producers receive a greater share of the
subsidy.
Price Controls
Price Floors: legally established minimum price to prevent prices from falling below a certain level, to
be effective the price floor must be set above the market equilibrium price
Reasons:
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To provide income support for farmers by offering them prices for their produce that are
above market determined prices
To protect low-skilled, low-wage workers by offering them a wage that is above the level
determined by the market.
There will be a surplus as a result of the imposition of a minimum price (22-20), there will be
a direct effect of a surplus and continuous accumulation of stocks as the quantity supplied
exceeds the quantity demanded each week.
To deal with surpluses, governments will have to buy up surplus and store it or sell it abroad
in other markets, storage costs vs exporting surplus at a subsidized price to make it
competitive.
Firm Inefficiency – inefficient firms do not face incentives to cut costs by using more efficient
means of production as they have a minimum guaranteed price.
Over allocation of resources – new producers may be attracted, creating even greater
surpluses, too many resources may be allocated and thus resulting in allocative inefficiency,
missing the social optimum
Negative welfare impacts – Changes in consumers and producers surplus, a deadweight
welfare loss is experienced, represents welfare benefits that are lost to society because
resources are not allocated efficiently.
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Labour surpluses and unemployment
Illegal workers at wages below the minimum wage.
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Maximum Price (Price Ceilings)
Legally established maximum price to prevent prices from rising above a certain level, must be set
below market equilibrium price.
Maximum price is usually imposed with the aim of achieving some form of equity, for example rent
controls make housing more affordable to low-income earners or food price controls to make
necessities more affordable.
Consequences:
Shortage:
When a price ceiling is established below equilibrium price, it results in shortages as quantity
demanded exceeds the quantity supplied. Prices are not allowed to rise to eliminate the shortages
Non-Price Rationing:
Rationing refers to a method of dividing something among possible users, this no longer functions
and hence will result in queues, distribution of coupons or restrictions of sales to favoured
customers
Underground or Black Markets:
The emergence of a black market results in producers selling goods illegally at prices above the
maximum price.
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To minimise these problems, the government can encourage supply through drawing on past
surpluses, direct production or giving subsidies or tax relief, alternatively it can reduce demand by
controlling income or producing more alternatives
Under production relative to social optimum quantity, society is worse off to underallocation of
resources, leading to allocative inefficiency.
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Bradley 2013
Labour Market:
The market for labour is a market for a factor of production. It is similar to any other market, in the
labour market, buyers and sellers transact labour for wages
Demand for Labour:
Is a derived demand, therefore demand for labour is intrinsically linked to the monetary value of the
additional goods and services that additional unit of labour producers
Demand for labour is downward sloping in a competitive market.
Supply of Labour:
Made up of individuals who are willing and able to work for a given wage
Supply curve for labour is upward sloping.
Non Wage Determinants of Demand and Supply of Labour
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Changes in price of the final product it produces, the demand for labour is dependent upon
the demand of the goods and services that it produces
Changes in the physical output each unit of labour is able to produce (productivity of labour)
o May be due to advancements in technology or education
o The higher output per worker encourages firms to employ more workers, hence
demand curve for labour shifts to the right
Changes in prices of other factors of production used in production
o Capital can be seen as a substitute for labour in certain production processes, better
capital shifts demand to the left
o Resources may be complementary to labour, the increase or decrease in one of
them employed in production results in the same increase or decrease in labour.
Long Term Supply of Labour:
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Changes in Size of Population, foreign labour policy, birth rates/death rates
Labour Force Participation Rate, retirement age, demographic
Changes in tax and benefits levels
Supply of Labour to a Particular Industry
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Changes in Educational Attainments, Number of people Qualified to hold the job
Changes in job scope/job conditions
o E.g. job satisfaction, working environment, job security, status, power, holidays
Changes in wage rate and non-wage benefits in other industries
Wage Differentials
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Non-Competing Groups – labour market is made out of many sub groups
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Compensating Differentials – jobs differ in attractiveness and are influenced greatly
by non-pecuniary aspects of the job
Labour Market Imperfections (trade unions) and Government Intervention
Non Economic Factors – Such as Discrimination
Wage Determination in Singapore – Govt Intervention
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National Wages Council (NWC) consisting of:
o Ministry of Manpower (MOM)
o National Trade Union Congress (NTUC)
o Singapore National Employers Federation (SNEF)
Bradley 2013
Essay Writing:
1.
2.
3.
4.
Definitions
Diagrams
Discuss Relevant Economic Theory
Distinguish between that which is important and that which is not
important
5. Discern between relatively more and relatively less important
6. Draw appropriate conclusions
Step 1: What is the question asking for?
Step 2: What terms need to be defined?
Step 3: What diagrams need to be drawn (which concepts am I explaining?)
Step 4: What are 2 – 3 important points I must explain?
Step 5: What are the conclusions I must draw specific to the question?
Step 6: How can I evaluate these points? (which is more important, bring in other concepts)