Putting Demand and Supply together • For any given set of factors (consumers incomes; suppliers costs etc), there must be one price where Quantity demanded(Qd) = Quantity supplied (Qs) • This price is called the Equilibrium Price (Pe) and the quantity it represents is called the Equilibrium Quantity (Qe) • This is where the ‘market clears’ This can be shown on a diagram such as this: The Market for French Wine Price (£) S Pe (£5) D Qe Quantity 4000 What happens if the price is set wrongly by the producer? • If too high, then surplus goods will not be sold • If too low, then there will be a shortage of goods • In normal circumstances, market pressures will force the price back to the equilibrium. • How does this look on diagrams: The Determination of Market Price Price The Market for French Wine (£) S Excess Supply 6 5 D 3000 4000 5000 Quantity (000’s) The Determination of Market Price (2) Price The Market for French Wine (£) S Excess Supply 6 5 D 3000 4000 5000 Quantity The Determination of Market Price (3) Price The Market for French Wine (£) S 5 4 Excess Demand D 3000 4000 5000 Quantity The Determination of Market Price(4) Price The Market for French Wine (£) S 5 4 Excess Demand D 3000 4000 5000 Quantity The Determination of Market Price Assumptions • Excess Supply - price will fall as producers unable to sell some of their goods may begin to ask a lower price for them or consumers noticing glut may offer lower price • Excess Demand - price increases as individuals bid up price and suppliers realising they could sell more than their total production may ask higher prices The Determination of Market Price Price above equilibrium price tends to fall Price below equilibrium price tends to rise Equilibrium Price market remains static At equilibrium no tendency to change Quantity demanded(Qd) = Quantity supplied (Qs) What if something other than price changes? • One of the curves will shift to the right or left, creating a new, different equilibrium price and equilibrium quantity • Which direction?: – Shift to the Right - more is demanded or supplied – Shift to the Left - less is demanded or supplied • Using logic, work out what the change is, then move the relevant curve Using Supply and Demand Analysis Consider the impact on the market for HD televisions following a decrease in the price of Wii. P s Pe D Qe Q Assume HD televisions are considered ‘complementary’ to the new wave of electronic games. An reduction in price of the Wii will lead to an increase in the quantity demanded. This will lead to an increase in demand for complementary goods (therefore a shift out to the right) leading to a new equilibrium price Pe1 and equilibrium quantity Qe1 P s Pe1 Pe D1 D Qe Qe1 Q Market for HD Televisions The Determination of Market Price • Explain the effects on the market for rented accommodation in the West End of Glasgow following the introduction of more generous housing benefits for students Income D Pe and Qe • Explain the effects on the market for flights from Glasgow International Airport following the attack on the airport in July 2007. Taste D Pe and Qe Fixing the market - Government Intervention to achieve its aims • Not all markets outcomes are necessarily good ones. Sometimes prices may be too high or too low to achieve various social aims. • Governments sometimes intervene to fix prices above or below a ‘market’ equilibrium • Price Floors - Minimum Wage – Price set at minimum and not allowed to fall below this level • Price Ceilings - Rent Controls – Price set at upper limit and not allowed to rise above this level • Which will be above equilibrium and which will be below? Elasticity • Economists use the term elasticity to refer to the measurement of the responsiveness of a variable to a change in another – Price elasticity refers to how much the quantity demanded changes when the price changes • For instance - if the price of the following 2 goods increased by 30 percent, which one would suffer the biggest drop in sales?: – A) Petrol or – B) Oddbins own brand Vin Rouge Elasticity continued • Similarly, if the government wished to increase its revenue, which of the following would it put tax onto?: – A) Cigarettes – B) Air Travel • When we consider the differences between these different types of goods we find they relate to various factors: What determines a consumer’s reaction to these price increases? - The number and closeness of substitute goods - the more substitutes, more choice, the greater the impact on our demand for the original good - The proportion of income spent on the good - the more spent, the greater the impact on our demand for the original good - The time period – the more time to adjust - the greater the impact on our demand for the original good • The greater the impact, then the more ‘price elastic’ we say the good is. Giving elasticity a figure • We can give elasticity a figure between zero and infinity. We are normally interested in whether it is below 1 or above 1 (ignore any negative sign - it is only the absolute size of the number we look for) • We calculate price elasticity by: PercentageQd PercentageP • To make it work accurately, it is essential to use percentages Measuring Elasticity • If there is a bigger change in Qd than in price (ie if the resultant figure is >1), we call the good a price elastic good (we can think of consumers tending to move away from it considerably) • If there is a smaller change in Qd than in price (ie if the resultant figure is <1), we call the good a price inelastic good (we can think of consumers tending to stick with it) • If both balance out, then we say the situation is one of unitary elasticity Measuring Elasticity • This is crucial for knowing which direction to alter price in order to take in more money • For price inelastic goods - put the price up (consumers still tend to ‘stick’ to the goods to a great extent) • For price elastic goods - put the price down (consumers will leave other goods and buy this instead) Elastic Demand Elastic demand between two points PQd (∆QD >∆P)TR p PQd (∆QD >∆P)TR TR changes in same direction as Qty b 5 a 4 D 10 20 qty Inelastic Demand Inelastic Demand between two points P PQd (∆QD <∆P)TR 8 PQd (∆QD <∆P)TR TR changes in same direction as Price 4 D 15 20 Qty Some special cases to be aware of • Totally inelastic demand (Ped = 0) when your demand stays exactly the same irrespective of price – Consider lifesaving medicines? • Infinitely elastic demand (Ped = ) when the demand is zero at every price but one, and at that certain price it then becomes infinite – You examine this in the theory of perfect competition • Totally inelastic supply – Consider car parking on campus Other Elasticities to be aware of • Price Elasticity of Supply – How responsive is quantity supplied to a change in selling price? • Income Elasticity of Demand – How much does the quantity we demand of something change when our income changes? • Cross Price Elasticity of Demand – How much does the quantity we demand of one thing depend on the price change of another?