Week 2: Market Failures and Public Goods (Demand & Supply) Flashcards
Demand
The quantity of a good or service that customers are willing and able to buy at given prices in a particular period of time.
Price
The amount of money a customer pays in order to purchase a good or service
Effective Demand
When customers distinguish their demand from a want or desire to buy something.
Law of Demand
The quantity demanded of a good or service increases as the price falls, ceteris paribus.
3 assumptions underlining the law of demand
- Income effect
- Substitution effect
- Law of diminishing marginal utility
Income effect
When the price of a good or service falls, the real disposable income of customers increases. Therefore, they are able to purchase more goods and services at lower prices.
Substitution effect
As the price of a good or service falls, the more customers are able to pay, so they are most likely to buy the product and choose this over the substitute/rival they may have previously bought.
Law of Diminishing Marginal Utility
As individuals consume more of a particular good or service, the utility (return or satisfaction) gained from the additional unit of consumption declines, so customers will only purchase more at lower prices.
At some point, customers will not want more because the marginal utility of consumption drops to zero.
Normal Goods
Products that have higher demand when real disposable income increases. (e.g smartphones)
Complementary Goods
Products that are jointly demanded as they go well together. (Phone + apps, cinema + popcorn, doritos + salsa dip, wedding dresses + wedding rings)
Substitutes
Products that are in competitive demand. These are rival products that can be used as alternatives of one another. (E.g tea or coffee, Coca Cola and Pepsi, BMW, MB or Audi)
List the non-price determinants of demand (RIPEN)
- Related products (substitutes and compliments)
- Income
- Preferences and Tastes
- Expectations of future prices
- Number of consumers
Related products (subs + complementary goods)
- When the price of a good increases, the demand for its complementary good will decrease and vice versa
(e.g. when there is an increase in the price of the cinema, there is a decline in popcorn sales).
- When the price of a good increases, the demand for the substitute increases.
(e.g when the price of pepsi cola increases, the demand for coca cola increases as people go for the cheaper alternative)
Income
Higher levels of real income mean that customers are able and willing to buy more goods and services, owing to their greater purchasing power, ceteris paribus.
e.g in economically developed societies with rising average real incomes, the demand for smartphones has risen steadily.
Preferences and Tastes
Products that become fashionable (e.g smartphones) cause an increase in demand whereas unfashionable items (e.g last szn clothes) reduce the level of demand
Expectations of future prices
- Consumer expectations of prices in the future can influence the demand for many products, especially in the case of expensive and luxury goods, such as consumer electronics products, motor vehicles and housing.
- If people expect that the value of a good or service will increase in the foreseeable future, they will demand more of it now, ceteris paribus.
- Similarly, there will be less demand in the market for stocks and shares if people expect prices will drop in the near future.
Number of consumers
A change in the total number of consumers of a product = entire demand curve shift.
As more buyers enter the market, or existing customers buy more, the demand curve shifts to the right as in demand increases.
List other non-price determinants of demand.
- Advertising
- Gov policies
- Economy
Advertising
Marketing messages - used to inform, remind and persuade the audience to buy a firm’s products.
McDonald’s and Samsung spend hundreds of millions of dollars each year on advertising to increase demand for their products.
Gov policies
Rules and regulations e.g legal age on the purchase of tobacco + alcohol affect the demand for certain products
gov encourages people to use more energy-efficient cars to save env - increase demand
Economy
Demand depends on whether economy is in boom or recession
e.g global financial crisis of 2008 caused demand for most goods and services to decline.
Shift of demand curve is caused by?
Change in non-price factors
Movement along the demand curve caused by?
Change in price
A price rise will cause?
Contraction in the quantity demanded of the product
A price fall will cause?
Expansion in the quantity demanded
Rightwards shift in the demand curve from D1 to D3 represents?
Increase in demand
Leftwards shift in the demand curve from D1 to D2 represents?
Decrease in demand
Supply
Refers to the quantity of goods or services that firms are willing and able to sell at any given price, per time period.
Law of Supply
Positive correlation between the quantity supplied of a product and its price, ceteris paribus.
Higher price creates incentives for existing firms to increase output and for new firms to enter the market, thus increasing market supply of a product, ceteris paribus.
2 Assumptions underlining the law of supply
- Law of diminishing marginal returns
- Increasing marginal costs
Difference between the law of diminishing marginal returns and the law of diminishing marginal utility.
DMR - refers to production
DMU - refers to consumption
Law of diminishing marginal returns
Describes how output is affected when a firm uses more variable inputs (factors of production) while maintaining at least one factor of production as fixed in the short run.
The law of DMR states that by employing additional variable factors of production (such as labour), the marginal returns (additional output) for each additional unit of input will eventually decline.
DMR only applies in…
Short run - all factors of production are variable in the long run.
What is usually assumed about capital?
Fixed in the short run - This is because a firm’s real or physical capital (such as buildings, machinery, equipment and vehicles) does not usually change in a short period of time, so is kept fixed when demonstrating this law
An addition of extra workers creates…
Benefit for the firm - makes teamwork and the division of labour possible, improving efficiency and productivity.
DMR in relation to addition of extra workers
Initially, there are increasing marginal returns for each additional worker.
The marginal returns will eventually diminish because each additional worker will gradually contribute less than the one before as work cannot be efficiently divided so well.
Marginal Cost
Cost of producing an additional unit of output.
Increasing Marginal Costs
Marginal costs rise with each successive unit produced owing to diminishing marginal returns.
Hence, firms are willing and able to increase production only if they receive a higher price for the additional units of output.
Movement along the supply curve is caused by?
Changes in price, causing a change in quantity supplied
Shift of the supply curve is caused by?
Non-price determinants of supply, causing a change in supply
Non-price determinants of supply (CISTERN)
- Costs of production of factors of production
- Indirect taxes
- Subsidies
- Technological change
- Expectations of future prices
- Prices of Related products (joint supply or competitive supply)
- Number of firms in the industry
Changes in costs of factors of production
Changes in the cost of any factors of production will shift the supply curve.
- An increase in the cost of FOPs will cause the supply curve to shift to the left (e.g rise in wages and/or increase in rent costs)
- Higher costs of production mean that existing firms cannot produce the same quantity as before and fewer firms are willing and able to supply output.
- Less will be supplied at each price level as costs of prod. rise
Define Indirect taxes
Government levies or changes on expenditure. Imposed on the supplier of a product, which adds to the costs of production, even if the producer can pass on some of the tax to the consumers in the form of higher prices.
Indirect taxes as a non-price determinant of supply
They reduce the profitability of firms and reduce market supply, therefore causing a leftwards shift of the supply curve.
Define subsidies
Form of financial assistance from the government to help encourage output or supply, by reducing costs of production.
Subsidies as a non-price determinant of supply
Subsidies - usually given to producers that provide goods/services beneficial to society as a whole - e.g provision on education, healthcare and training
Technological change
Advances in technology mean there can be greater levels of output at price levels - prod becomes more efficient and so avg costs of prod falls.
Expectations of future prices
Price acts as a signal to producers to allocate their resources to the production of provision of goods and services with greater profitability.
- If sellers expect the demand for their product to increase sharply in the near future (thus causing higher prices), then the firms may choose to increase production in the current time period.
- Similarly, if producers are concerned about future market conditions deteriorating and causing prices to fall, production would fall
Prices of Related products (joint supply or competitive supply)
Competitive Supply - the output of one product (such as apples) prevents or limits the output of alternative products (such as oranges). This is due to competing resources, as producers have limited resources such as land and labour, so cannot supply more of one product without producing less of the other.
Joint Supply - an increase in the production of one product automatically increases the supply of at least another (joint) product, such as cows, milk and leather or lamb and wool.
(less important product is called by-product e.g mutton being main, wool being by-product)
Number of firms in the industry
If the market for a good or service increases, then it is likely that there will be an increase in the number of firms in the industry.
An increase in the number of firms in a market would shift the supply curve outwards to the right.
