Demand, Supply & Elasticity Concepts

Question 1

society faced with scarcity must address 3 questions

Answer 1

what and how much to produce –> based on price signals –> when dd rise, upward pressure on P –> signals to profit driven producer to allocate more resources away from less profitable goods to these goods –> Qs ↑ to meet ↑ in dd –> AE

how to produce –> producers driven by profits –> choose least cost method to minimize cost –> PE

for whom to produce –> for those with the willingness and ability to pay

Question 2

when Y ↑, the impact on P and Q on different goods depends on

Answer 2

extent of shift –> YED –> lux, nec, inf

lux –> when Y ↑, consumers have greater willingness and ability to consume goods of higher quality to derive higher levels of satisfaction –> dd ↑ MTP

nec –> once basic needs are satisfied, willingness and ability to consume much more is limited –> dd ↑ LTP

inf –> consumers switch away to goods of higher quality –> dd ↓

dd shift –> PES [gestation period, factor mobility, spare capacity] –> (eg) PES < 1 –> producers’ responsiveness is poor –> when P ↑, Qs ↑ LTP –> P ↑ sigly to get rid of the shortage

Question 3

when P of steel ↑, the impact on P and Q on car producers depends on

Answer 3

ss shift –> PED [substitutes, proportion of income, degree of necessity] –> e.g. PED < 1 –> consumers’ responsiveness is poor [necessity: consumers are less able to ↓ C sigly without compromising basic SOL + no close sub: consumers are less able to switch to alternatives to derive similar levels of satisfaction + small % of Y: PP of HHs is less affected by price changes] –> when P ↑, Qd ↓ LTP –> prices ↑ sigly to get rid of the shortage

extent of ss shift –> factor intensity [is steel a major FOP?] –> if yes, ss ↓ more –> larger shortage –> P ↑ more

Question 4

the relative significance of dd and ss factors depends on

Answer 4

extent of dd and ss shift

• dd: YED, XED
• ss: factor intensity

PED and PES

• dd: extent of shift + PES
• ss: extent of shift + PED

time horizon [SR vs LR]

• dd: (SR) Y changes, novelties; (LR) population, fundamental shifts in TnP [consumers more health/environmentally conscious]
• ss: (SR) ss shocks [nat disasters]; [LR] technological advances

Question 5

to help consumers deal with higher prices of necessities, govts can

Answer 5

SR

• subsidies
• price ceiling

LR
- RnD –> improve productivity/state of technology

imports

• exr appreciation –> ↓ P of M
• FTAs –> diversify import sources
• RnD –> develop domestic substitutes

market structure
- liberalization –> increase level of competition –> MP of incumbent firms are eroded –> P ↓

Question 6

to help firms deal with rising competition, govts can

Answer 6

ssp

• process innovation –> lower COP to boost product competitiveness
• product innovation –> improve quality –> dd ↑ or PED ↓ –> MP ↑

market structure
- mergers –> more IEOS –> lower P or more profits –> more ability to do RnD

foreign

• exr depreciation
• tariffs

Question 7

why is govt intervention in markets sometimes necessary

Answer 7

price mechanism may fail
- efficiency can only be achieved under a number of very strict conditions that are unlikely met in the real world: perfect competition + absence of externalities and public goods –> market failure –> justifies govt intervention

inequity
- competitive market is unable to provide a satisfactory answer to the ‘for whom to produce’ question –> those with more money will be able to consume more of the goods produced –> unfair distribution of goods: wealthy consuming a disproportionately large share of what is produced –> invites govt intervention

Question 8

how does the price mechanism achieve economic efficiency

Answer 8

economic efficiency

• AE: achieved when society produces and consumes a combination of gds and svcs that maximizes its welfare –> CS and PS are max
• PE: achieved when all resources are fully and efficiently utilized

AE

• price mechanism achieves AE by clearing shortages / surpluses in markets through signalling
• e.g. shortage –> P ↑ –> signals to producers that a shortage has emerged and incentivizes them to increase Qs [movement along ss curve] + signals to consumers that prices are more expensive and induces them to decrease Qd [movement along dd curve] –> price adjustment process stops when Qd = Qs –> reallocation of resources through price mechanism –> AE

PE
- price mechanism achieves PE as the adjustment of factor prices in factor markets act as a signal and incentive for producers to adjust their production methods in deciding how to produce with the least cost method of production