# The Determination of Market Price

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```					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:
PercentageQd
PercentageP
•   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

PQd (∆QD >∆P)TR
p
PQd (∆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
PQd (∆QD <∆P)TR
8
PQd (∆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?

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