DEMAND
• The basic law of demand states that as the price of a good falls people will
buy more of it. (Certainly Michael O’Leary of RyanAir believes in this law
with his persistent emphasis on low air fares as the means to boost
consumer demand!)
• Alternatively when the price rises the quantity demanded will fall
Therefore we can see that the Government in its attempt to reduce cigarette
smoking keeps increasing the price in the budget!
• The demand curve shows the relationship between price and quantity of the
good in question (assuming all other factors affecting demand remain
unchanged)
• It slopes down from left to right showing that as the price falls more will be
demanded
• Alternatively as the price rises typically less will be demanded of a good
Market demand for potatoes (monthly)
100
Price (pence per kg)
Market demand
Point
Price
(pence per kg) (tonnes 000s)
E
D
80
C
60
A
20
700
B
C
D
E
40
60
80
100
500
350
200
100
B
40
A
20
Demand
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
OTHER FACTORS AFFECTING DEMAND
• Income is very important. When income goes up people will generally buy
more of a good e.g. motor cars. Exceptions are inferior and Giffen goods
• The prices of substitute (and complementary) goods are also significant. If
the price of coffee was to rise sharply it would help tea sales (substitutes).
If the price of petrol was to rise it could damage car sales (complementary)
• Tastes are important. Goods - not just clothes - can come in and go out of
fashion (e.g. the recordings of various pop stars)
• Advertising can influence demand. One of the reasons why Coca Cola
remains so much in demand is due to successful advertising
• Also the weather can be a factor. For instance a long hot Summer would
help beer sales!
• In economics these other factors are shown through shifts in the demand
curve (either left or right).
Changes in price are represented by movements along the same demand
curve
An increase in demand
Price
P
D0
O
Q0
Q1
Quantity
D1
SUPPLY
Similar dynamics work on the supply side as with demand.
• The supply curve is based solely on the relationship between
price and quantity supplied (assuming other factors remain
unchanged)
• Thus when the price rises firms will be willing to produce more
(due to the prospect of higher profit margins)
The supply curve thus slopes up from left to right
Thus a change in the price of a product produced is associated with
a movement along the supply curve
Market supply of potatoes (monthly)
100
e
Supply
d
Price (pence per kg)
80
P
a 20
b 40
c 60
d 80
e 100
c
60
b
40
a
20
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
Q
100
200
350
530
700
OTHER FACTORS AFFECTING SUPPLY
• As with demand other factors however can affect supply
• For example costs of production are often critical. Thus if a firm
can reduce costs it will be willing to supply more (as with
RyanAir) at the given price. This causes the supply curve to shift
to the right
• Improvements in technology are also important (as they affect
costs)
• Weather conditions are very important especially in agriculture
• Also the government can affect supply through measures such as
subsidies and taxation.
• Thus a change in some factor other that price causes a shift in
the supply curve
Shifts in the supply curve
P
S2
Decrease
O
S0
S1
Increase
Q
DETERMINATION OF PRICE
•
The price in an market is determined by the intersection of
demand and supply.
•
The market comes into equilibrium at the price where supply
= demand.
•
If the demand initially exceeds supply then this will lead to a
shortage in the market with consumers willing to pay more.
This will cause prices to rise!
•
If however supply exceeds demand this will lead to a surplus
thus causing prices to fall
The determination of market equilibrium
(potatoes: monthly)
E
e
100
Price (pence per kg)
Supply
d
D
80
Cc
60
b
40
B
a
A
20
Demand
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
The determination of market equilibrium
(potatoes: monthly)
E
e
100
Price (pence per kg)
Supply
d
D
80
Cc
60
b
40
SHORTAGE
B
(300 000)
a
A
20
Demand
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
SHORTAGES
•
Due to market price being artificially low which creates situation of excess demand
•
Examples
- tickets for a big match
- Government controlled prices e.g. food and currency rates
Manner of dealing with situation
•
Rationing
- without any formal system of control this leads to queueing; when controlled e.g.
through ration coupons it can be more orderly through expensive to administer
- rationing usually leads to the formation of an underground market, where free
market forces operate with respect to sale of some of the product e.g. ticket touts
selling at inflated prices
•
Increase price to free market level
- in economic terms this is the best solution (though can be socially inequitable)
The determination of market equilibrium
(potatoes: monthly)
E
e
100
Price (pence per kg)
Supply
D
80
SURPLUS
d
(330 000)
Cc
60
b
40
B
a
A
20
Demand
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
SURPLUSES
•
Due to market price being artificially high, which creates situation of excess supply
•
Examples
- Common Agricultural Policy
- Unemployment
Manner of dealing with situation
•
Maintain price supports
- by providing appropriate level of subsidies to producers prices can
be maintained at high level
•
Take surplus off market
- this enables consumers to buy a smaller amount at artificially high price;
however it requires authorities to destroy, store or get rid of surpluses in
alternative markets
•
Reduce price to free market level
- the most satisfactory economic way of dealing with problem
EFFECTS OF SHIFTS IN DEMAND AND SUPPLY
CURVES
• If the demand curve moves outwards to the right e.g. through an increase in
income, the price will rise (ceteribus paribus)
• If the demand curve moves inwards to the left e.g. through a fall in price of
a substitute good, then price will fall (ceteribus paribus)
• If the supply curve moves outwards to the right e.g. through a fall in costs
of production, then price will fall (ceteribus paribus)
• If the supply curve moves inwards to the left e.g. through adverse weather
conditions),then price will rise (ceteribus paribus)
• In reality however several factors may be working simultaneously on both
demand and supply sides (as in housing market)
Therefore the real task is to estimate the likely effects of shifts in demand
and supply - in both directions - so as to estimate likely effects on price
Effect of a shift in the demand curve
P
S
i
Pe2
g
h
Pe1
D2
D1
O
Q e1
Q e2
Q
Effect of a shift in the supply curve
P
S2
S1
k
Pe3
j
g
Pe1
D
O
Q e3
Q e1
Q
FREE-MARKET ECONOMY
Advantages
• It functions automatically (without the need for bureaucratic control)
• Markets respond quickly to changes in demand and supply (and all the
factors responsible for these changes)
• When markets are competitive no one has great power; competition keeps
prices low; firms are more responsive to consumers and have an incentive
to become more efficient
The more efficient firms tend to make higher profits; more efficient
workers generate higher earnings and careful consumers get better value
for money
Thus people pursuing their own self-interest minimise the central problem
of scarcity
FREE-MARKET ECONOMY (con)
Problems
• In practice competition between firms is often limited with a few giant
firms dominating most industries; in the case of services though there may
be many firms, local accessibility can reduce competition
• Lack of competition may then remove incentive to be more efficient which
is a major problem in Irish economy at present
• Power and property may be unequally distributed
• The adverse environmental consequences of industrial actions may be
ignored
• Socially desirable goods may not be produced by private sector in
sufficient numbers
• May lead to macroeconomic instability
• Can be ethically objectionable in rewarding greed and encouraging a
philosophy of materialism
MIXED ECONOMY
Because of problems of both free-market and command economies, all realworld economies are a mixture of both systems
In mixed market economies, the government may control the following:
• Relative prices of goods and inputs through taxes, subsidies or price
controls
• Relative incomes by the use of income taxes, welfare payments or direct
controls over wages, profits, rents etc.
• The pattern of production and consumption through legislation or direct
provision of certain goods and services
• The use of fiscal (tax and government expenditure) and monetary (money
supply and interest rates) to control the overall macroeconomy