AS chapter 2 summary.

Definitions:

- Market: Where or when buyers and sellers meet to trade or exchange products. Markets use the price system, which reflects the price suppliers wish to sell their products for and the price buyers are willing to pay for it.
- Sub-market: A recognized or distinguishable part of a market. Also known as a market segment.
- Demand: The quantity of a product that consumers are able and willing to purchase at various prices over a period of time. This splits up to two things:

1) Notional demand: The desire for a product. (= want, will always be there)
2) Effective demand: The willingness and ability to buy a product. If you want the product, are you actually willing to pay the price for it? Demand mostly refers to effective demand.
- Ceteris paribus (assumption): Leaving all the other things out. (everything is fixed except for the thing you’re looking at.
- Demand schedule: Data used to draw the Demand curve. ( as shown below.)



Note: The move from the price of $400,- to $200,- is called a movement along the demand curve. The move upwards along the demand curve ( from $200,- to $400,-) is called an extension in demand. And a move downwards(from $400,- to $200,-) is referred to as a contraction of demand.
Also note: The shape of the demand curve isn’t always straight, it can also be curved.

There are three non-price factors affecting demand which are:
1) Consumer Income (causing income elasticity)
2) The prices of other goods (causing cross-elasticity)
3) Tastes and fashion

- Consumer surplus: The extra amount that a consumer is willing to pay for a product above the price that is actually paid.



Imagine this demand curve shows the demand(per month) for the cinema. If the price is $2,- the demand will be 4 times per month. However, the demand for a price of $3,- would have been 2 times. The person who goes 4 times per month would have been prepared to pay $3,- for the first two visits each. The consumer surplus of the first two visits will therefore be $2,-. The total consumer surplus at a price of $2,- is the total colored area, the total consumer surplus at the price of $3,- is the light-gray colored area.

- Total revenue = Price*Quantity = area under curve.
- Disposable income: Income after tax on income have been deducted and state benefits have been added. (= spendable income)
- Real disposable income: Inflation corrected disposable income.
- Normal goods: Normal goods are goods for which an increase of income results in an increase in demand
- Inferior goods: goods for which an increase of income will lead to a fall in demand.
- Substitutes: Competing goods. (apples and banana’s)
- Complements: Goods for which there is joint demand. ( Printer and cartridge )
- Change in demand: This is where a change in a non-price factor leads to an increase or decrease in demand for a product. This makes the demand line shift!

Summary of demand line shifts.

Demand line shifts to the RIGHT(more demand @ same price) if there is:
1) An increase in consumer income.
2) A rise in the price of substitutes.
3) A fall in the price of complements
4) A positive change in tastes and fashion
Demand line shifts to the LEFT(less demand @ same price) if there is:
1) A fall in consumer income
2) A fall in the price of substitutes
3) A rise in the price of complements
4) A positive change in tastes and fashion.

- Supply: The quantity of a product that producers are willing and able to provide at different market prices over a period of time.
- Profit: The difference between the total revenue of a producer and total costs.

To make profit, firms have to apply the various factors of production. Let’s take mobile phones for example, you’ll need:
1) Capital: The assembly of components and parts.
2) Labour: Employing skilled labour.
3) Land: Producing at a suitable location.
4) Entrepreneurs: Having the business skills and contacts to survive.

- Supply schedule: the data used to draw up the supply curve of a product.
- Supply curve: This shows the relationship between the quantity supplied and the price of a product.
The supply curve looks like:



- Producer surplus: the difference between the price a producer is willing to accept and what is actually paid.
The producer surplus is the gray part in the picture below. P is the market price, producers are willing to supply from the price P,1. Everything they get ‘extra’ is the producer surplus.



There are some other factor affecting supply such as:
1) Costs of production: E.G. oil prices go up, increase of labour prices but also positive effects such as improving technology.
2) Size and nature of the industry, monopolistic companies can easily charge more for their goods if oil prices go up.
3) Government policy, increase in taxes.
4) Other factors, like the weather ruining the Caribbean’s banana’s.

- Change in supply: occurs when a change in a non-price influence leads to an increase or decrease in the willingness of a producer to supply a product. This makes the supply line shift!

Summary of supply line shifts.

Demand line shifts to the RIGHT(more supply @ same price) if there is:
1) A fall in raw material costs.
2) An improvement in labour efficiency.
3) A reduction in the rate of indirect taxation
4) A positive technological advance.
Demand line shifts to the LEFT(less supply @ same price) if there is:
1) An increase in cost of raw materials
2) An increase in labour costs.
3) An increase in the rate of indirect taxation
4) A failed technological advance.

- Price: The amount of money that is paid for a given amount of a particular good or service.
- Equilibrium price/ Clearing price: The price where demand and supply are equal.
- Equilibrium quantity: The quantity that is demanded and supplied at the equilibrium price.
- Disequilibrium: Any position in the market where demand and supply are not equal.
- Surplus: An excess of supply over demand
- Shortage: And excess of demand over supply.

Market pricing in free market will look like:



Note: Pe = price equilibrium , Qe = quantity equilibrium
Demand and supply curves may shift; causing new equilibria. Therefore, a shift from the demand curve to the right will make the Pe an Qe rise. Also, both can be shifted simultaneously (supply-line shift to the left and demand line shift to the left) causing lower Qe but the same Pe.

Elasticities.

- Price Elasticity of Demand(PED) is something used in microeconomics to see how much a change in price affects the demand.

The formula for PED = %change Demand/ %change price
Since changes in price and demand nearly always move in opposite direction economists mostly don't bother to put in the '-' sign.

There can be 4 outcomes of this formula:

1) PED= 0, the demand is perfectly elastic. The graph will show a vertical line.
2) PED is between 0 and 1,inelastic. The graph will show a steep line.
3) PED=1, demand is unit elastic, 15% increase in price will make demand fall for 15%.
4) PED is greater than 1, demand is elastic. The graph will show a (nearly) flat line.

In case of outcome 2 and 4 producers will be able to raise the total revenues by using the PED.



The situation shown on the left shows a relatively inelastic demand. In the picture it shows that a move from P1 to P2 caused the move from Q1 to Q2. However, due to the inelasticity of this good the move from P1 to P2 is way bigger than the move from Q1 to Q2. That's why the total revenues are increased going from situation 1 to situation 2.( Dark area shows total revenues in situation 1, light area shows total revenues in situation 2)
So for an inelastic environment producers should increase prices to make total revenues increase.

The situation shown on the right shows a relatively elastic demand. In the picture it shows that a move from P1 to P2 caused the move from Q1 to Q2. However, due to the elasticity of this good the move from P1 to P2 is way smaller than the move from Q1 to Q2. That's why the total revenues increase going from situation 1 to situation 2.( Dark area shows total revenues in situation 1, light area shows total revenues in situation 2)
So for an elastic environment producers should decrease prices to make total revenues increase.

- Price Elasticity of Supply (PES) measures the relationship between the change in quantity supplied and change in price.
The formula for PES = %change quantity supplied / %change price

There can be 4 outcomes for this formula:

1)PES = 0, supply is perfectly inelastic.
2)PES is bigger than 1, the supply is price elastic. Producers can increase output without a rise in cost or a time delay.
3)PES is less than 1, the supply is price inelastic. Firms find it hard to change production in a given time period.
4)PES = infinity. Supply is perfectly elastic following a change in demand.

There are four main factors that influence the PES, those are:

1) Spare production capacity.
If there is spare production capacity the business is able to increase the output without a rise in costs and therefore supply will be elastic in response to demand. This happens mostly during recession because there is plenty of spare labour and capital resources available.
2) Stocks of finished products and components.
If stocks are on a high level, businesses are more able to respond to a change in demand quickly. Therefore the businesses with big stocks will be elastic in response to demand, and businesses with small stocks will be inelastic in response to change in demand.
3) The ease and cost of factor substitution.
If labour and capital can easily be switched businesses are more able to respond to a changing demand, those business are elastic in response to change in demand.
4) Time period involved in the production process.For many agricultural products there are time lags in the production process which means that elasticity of supply is very low.

I stated companies that have a relatively elastic demand would be able to increase their total revenues by lowering their price. However, knowing this, there is just one thing to mention. To be able to respond to the higher demand companies will have to be elastic in response to demand. Companies are able to influence this and become more elastic by increasing stocks and increasing production capacity. However, companies won’t be able to fully influence this. That’s why the most companies have a non-linear supply curve.



- Income elasticity of demand(YED): Measures how responsive demand is following a change in income.
Formula: %change demand / %change income; a positive outcome of the income elasticity’s shows the good is a normal good.

There may be two outcomes:

1) Outcome smaller than 1: Good is income inelastic; inferior good.( goods for which an increase in income leads to a fall in demand)
2) Outcome greater than 1: Good is income elastic; normal good.

- Cross elasticity of demand(XED): Measures the responsiveness of demand for one product following a change in the price of another related product.
Formula: %change demand product A / %change price product B

There may be three outcomes:

1) Outcome positive: Products are substitutes. (E.G. Mercedes and Renault)
2) Outcome negative: Products are complements. (E.G. printer and cartridge)
3) Outcome 0: Products don’t have any particular relationship ( E.G. paper and airline tickets)