Market economyUnit 02 part 01

Prepared by; RASHAIN PERERA077 059 37 52rashainperera@gmail.com

Consumer objectives and decisions

The underlying assumptions of rational decision making

Consumers aim to maximize utility Utility is the satisfaction derived from consumption

of a bundle of goods On the other hand producers try to maximize the

profits So as we can see both consumers and producer

actions are based on their self interests

Topics covered

Market Demand Supply Elasticity Equilibrium Changes to equilibrium

Natural changes Government intervention

What is a market?

Any situation where buyers and sellers meet would be known as a market in simple.

Characteristics of a market; Existence of buyers Sellers Something of value to trade

Classify the market

Commodity market Here consumers demand for goods and services for

final consumption purposes Has a direct demand Consumer’s purchase decisions are based on marginal

utility gained through the consumption of the product

Classify the market

Factor market The market where factors of production are traded. These goods are mostly purchased by producers for

further production purposes Has an indirect demand Producers purchase decisions are based on the

marginal productivity of the factors.

Question 01

What are the Differences between factor market and commodity market? 4 marks

Needs, wants, purchasing power and demand

Needs are the basic human requirements

Wants are the different ways we satisfy our needs

Purchasing power is the ability to buy, availability of funds in hand to make a purchase decision

Demand; the wants that are backed by purchasing power.

Question 02

Explain the inter-relationship among needs, wants, demand and purchasing power? 4 marks

Demand

What is demand?

When other things remain constant the quantities of goods or services bought at a given price in a given time period.

The products that are bought by consumers differs according to the, Willingness Purchasing power

Types of demand

Effective demand- Consumers’ desire to buy something is backed up by willingness and ability to pay for it could be simply known as effective demand.

Latent demand-This exists when there is willingness to purchase a good or service, but where the consumers lack the real purchasing power to be able to afford the product.

What is individual demand?

This refers to the quantity of goods a single individual will buy at certain price levels

What factors affect individual demand?

Price of the relevant good (Px) Price of other goods. (Pn)

Substitute goods- goods that can be used instead of another good.

Complementary goods- goods that are used together with another.

Consumer tastes and fashions (T) Future expectations (E) Consumer income (Y) Advertising and branding

Price of the relevant good

When the price of the relevant good increase, the quantity demand decreases as purchasing power decrease.

When the price of the relevant good decrease, the quantity demand increase

Therefore we can see a negative relationship

Price of substitutes

When the prices of substitutes rise, the demand for our product is higher and vice versa

Therefore we can see a positive relationship between the price of substitutes and the QD for our product.

Price of complements

Complements are those goods which are used together

If prices of complementary goods increase, the QD of relevant good will decrease and vice versa

Negative relationship

Consumer income level

Higher the consumer income more the QD will be as higher income levels increase the purchasing power and vice versa

Positive relationship

Consumer’s tastes

When there is a higher preference to a particular good the QD is higher

Positive relationship

Consumer’s expectations on future prices If consumers expect the future price to go up they

will demand more now so that they can use them in future when the prices are higher.

If consumers expect the future prices to go down they will buy less now to gain the advantage of buying it at a lower future price.

Advertising and branding

Advertising and branding can influence the customers to purchase goods and therefore higher the advertising and branding activities higher the demand will be

Individual demand function

QDx = f ( Px, Pn T, Y, E)

What is market demand?

Market demand is the total quantity of goods and services which all the consumers or customers will buy at various price levels in a specific market. In other words it is the totality of all individual demands.

What factors affect market demand?

Price of the relevant good (Px) Price of other goods. (Pn)

Substitute goods- goods that can be used instead of another good. Complementary goods- goods that are used together with another.

Consumer tastes and fashions(T) Future expectations (E) Consumer income (Y) Advertising and branding Number of buyers (N)

Market demand function

QDx = f ( Px, Pn T, Y, E, N)

Market demand Vs Individual demand

Market demand

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Law of demand

At a certain time period under “ceteris paribus” concept the negative relationship between price of the relevant good and the quantity demanded of it could be simply known as the law of demand.

Presentation of law of demand Schedule method Graphical method Equation method

QDx = a - bp

P QD102030405060

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Theoretical reasons for the negative relationship between price and demand

Income effect Substitution effect Diminishing marginal utility

Income effect

This states when income is held constant if a price of a commodity increases the real purchasing power declines and so does the demand.

Substitution effect

This states that when price of the substitute good remains constant decrease in the price of the good will create a higher demand as people shift to our product as they see our product as cheaper to that of the substitute.

Things that are held constant when explaining the substitution effect

Substitute’s price Taste Income

Diminishing marginal utility theory This states that when a person consumes a certain

product more and more his or her extra utility which is known as marginal utility declines after a certain point.

Number of Ice Creams Consumed

Total Utility

Marginal utility

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Exceptions for the law of demand “Snob goods”- luxurious items

where satisfaction comes without knowing the price.

“Giffen goods”- goods where QD falls when price falls

“Speculative goods” “High quality products” i.e when

the quality is judged by the price.

Changes in demand and changes in quantity demand

If the amount that is willing to buy is changed because of the change in the price of the concerned good, it is known as changes in quantity demand.

If the amount that is willing to buy is changed due to changes in other factors except price it is known as changes in demand.

Changes in quantity demand Extension of demand

Price

Quantity

Reasons Decrease in price of the good when other things

remain constant Observation

Downward movement along the demand curve

Changes in quantity demand Contraction of demand

Price

Quantity

Reasons Increase in price of the good when other things

remains constant Observation

Upwards movement along the demand curve

Changes in demand

Increase of demand

Price

Quantity

Reasons Change in other factors affecting demand other than

the price of the relevant good Increase in consumer income Increase in taste and fashion Increase in number of customers Increase in prices of substitutes Decrease in the prices of complements

Observation Rightward shift of the demand curve

Changes in demand

Decrease of demand

Price

Quantity

Reasons Change in other factors affecting demand other than

the price of the relevant good Decrease in consumer income Decrease in taste and fashion Decrease in number of customers Decrease in prices of substitutes Increase in the prices of complements

Observation Leftwards shift of the demand curve

Supply

What is supply?

When other things remain constant the quantities of goods or services suppliers are willing to sell at a given price in a given time period could be simply known as supply.

What is individual supply? Or supply of a firm? The quantities of a good, which a

single firm will supply at various price levels, could be simply known as individual supply

What factors affect individual supply?

Price of the relevant good Prices of other related goods Prices of inputs/cost of production Technology Future expectations of suppliers Government policies Other factors

Prices of the relevant good

When the price is high the suppliers are motivated to sell more as it signals a higher level of revenue and profits.

Therefore when the Px is high the Supply will also be high

Price of other goods

Refer to the fact that the prices of substitutes and complementary goods also affect the supply of a product. For example if the price of wheat increases, then farmers would tend to grow more wheat than rice. This would decrease the supply of rice in the market.

Cost of inputs/cost of production An decrease in costs of production, this means

business can supply more at each price. Lower costs could be due to lower wages, lower raw material costs

Technology

Improvements in technology, e.g. computers, reducing firms costs will increase the supply and vice versa

Future expectations of suppliers If the suppliers expect the future prices to go up,

they will supply less now and vice versa

Government policies

Lower taxes reduce the cost of goods and therefore supply increases

Increase in government subsidies will also reduce cost of goods and will increase the supply

Other factors

Climatic conditions Geographic conditions Demographic conditions

Individual supply functionQSx= f(factors affecting a firm’s supply)

What is market supply?

The quantities of a good, which all the firms will supply at various price levels could be simply known as market supply.

In other words it is the totality of all individual supplies .

Market Supply

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What factors affect market supply? Price of the relevant good Prices of other related goods Prices of inputs Technology Future expectations of suppliers Government policies Other factors Number of suppliers in the market

Number of suppliers

An increase in the number of producers will cause an increase in supply

Market supply functionQSx= f(factors affecting market supply)

Theory of supply

The theory of supply explains the relationship between supply of goods and services and the changes of factors affecting to the supply.

Law of supply

At a certain time period when other things remain constant the positive relationship between the price and the quantity supplied of the relevant good could be simply known as the law of supply.

Presentation of law of supply As a schedule As a graph As an equation

QS=a+bp

As a schedule and a graphPrice Supply

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Theoretical reasons for the law of supply

Increasing opportunity costs Increasing profit signals

Changes in supply and changes in quantity supplied If the amount that is willing to sell is

changed because of the change in the price of the concerned good, it is known as changes in quantity supply.

If the amount that is willing to sell is changed due to changes in other factors except price it is known as changes in supply.

Changes in quantity supply

Extension of supply

Price

Quantity

Reasons Increase in price of the good when other things remain

constant Observation

Upward movement along the Supply curve

Changes in quantity supply

Contraction of supply

Price

Quantity

Reasons Decrease in price of the good when other things

remains constant Observation

Downwards movement along the Supply curve

Changes in Supply

Increase of Supply

Price

Quantity

Reasons Change in other factors affecting Supply other than the

price of the relevant good Decrease in cost of inputs Decrease in the price of related goods Improved technology Favorable government policies

Observation Rightward shift of the Supply curve

Changes in Supply

Decrease of Supply

Price

Quantity

Reasons Change in other factors affecting Supply other than the

price of the relevant good Increase in cost of inputs Increase in the price of related goods Outdated technology Unfavorable government policies

Observation Leftward shift of the Supply curve