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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