Section 1: Microeconomics - 1.1 Competitive Markets : Demand and Supply

Market

Market is where buyers and sellers meet to exchange goods for money. There are many types of market such as physical market; online market (goods exchanged for money through credit transfer for example); product market is where goods are bought and sold ; labour market where factors of production are bought and sold; financial market is where internationally currencies are traded, and finally stock market where stocks are bought and sold


Demand

The Law of Demand
The simple law of demand is that " As prices decreases, general demand increases, ceteris paribus" . It can also be explained as " the demand curve always slopes down, ceteris paribus". What it simply means is that as price increases, demand decreases. For instance the demand for a $2 soft drink would be 100 units, but if the soft drink costs $3, the demand will fall to 70 units as less people can afford it. Thus customers must have "willingness and ability" to purchase a product

Individual demand is the demand of an individual or of a firm. The market demand is the combination of all individual demand. There are two types of market demands : Primary
and selective demand. Primary is the demand of a product, for instance demand for soft drinks or cell phones. Selective demand is the demand for specific brands, for instance coca-cola or iPhone

The Demand Curve
The demand curve shows the relationship between price and demand, ceteris paribus. The more the price, the lesser the demand (lesser quantity sold). A demand curve can be straight or curved. You would be required to draw a demand curve

1.1 Credit: http://2012books.lardbucket.org/books/theory-and-applications-of-economics/section_12/f0b85e6fafd658768fa0f63b08786788.jpg

                     

1.2 Credit: http://personal.psu.edu/~dxl31/econ4/Fall_2014/coffee_demand_curve2.png

The Non-price determinants of demand (factors that change demand or shift the demand curve)
Demand can change , or the demand curve itself can shift due to many reasons. For instance a rise in income would lead to an increase in demand for normal goods, such as luxury watched. However, there are also inferior goods, which has a opposite effect of normal goods, the demand decreases as income rises for instance. And example would be that if income rises, demand for public hospitals will decrease and private hospitals will increase. Other factors can also effect demand, for instance government policies, demographic change and prices of related items. For instance, if a government policy says tax would be applied on cars, the demand would decrease, and the curve will shift. If the population ages, less demand would be for fashionable goods. And if the price of bike increase, less people will buy bike-related goods as less bikes are in demand


Movements Along and Shift of The Demand Curve
Sometimes there can be movement on the demand curve, and sometimes demand curve can shift in itself.  A price change can cause movement on the demand curve ; other factors such as an implementation of policy in which bikers have to wear helmet will cause a shift in the demand curve, as despite the price of the helmet, the demand will increase.

1.3 http://img.sparknotes.com/figures/0/039bab1e6f1ef2a65b5f4c8ddc66073a/beanie.gif

An example of shifting demand curve. In this case, the demand increases (D1 to D2), like the example of the bike helmets.

HL: Linear Demand Functions (Equations), Demand Schedules and Graphs

An equation is used to show the relationship between the demand and other individual detrminants. It is known as the Demand Function and the equation for it is :

Qd=a-bP

Qd- quantity demand

a- quantity demand if price was zero

b- set point for demand curve/line (coefficient of P)

P-price of the product

An example of a demand function may be Qd=500-10P

so if the price of the product is:

Once calculated, you may have to construct answers for other functions, after which you have to draw a demand schedule graph.

Once different lines are drawn on the graph, it will be noticed that "b" changed the slope of the graph (gradient) and 'a' gives it a parallel shift. "a" gives it a parallel shift because if for example a product is liked, demand will increase despite it being for the same price. "B" changes the gradient of the graph as price may influence the demand. 


Supply

The Law of Supply

When two variables change in the same direction, they are known as positive relationships. The law of supply, shown in diagram 1.4 shows that changes in prices causes changes in quantity supplied, this is knows as a casual relationship. Thus, the positive casual relationship is states in the law of supply, which is : As price increases, quantity supplies increases and as price decreases, quantity supplied decreases.

1.4 Credit: http://i.investopedia.com/inv/dictionary/terms/economics4.gif

Market supply is the sum of all individual firms supply for a good. For instance, if at $3 firm a produces 300 candies, firm B produces 200 and the rest produce 100, the total market supply would be 600.The market supply curve illustrates the law of supply.

The Supply Curve

The supply is the quantity of goods a firm is willing and able to produce and supply to the market for sale at different possible prices during a time period, ceteris paribus. 

The supply curve shows that quantity supplied increases as price for a product increases. This is because if prices increase, the firm gets more profit, thus gets motivated to produce more. 

You must be able to draw a supply curve for your exam. So for example, the following supply curve 1.4 is drawn on the basis of the following data

The Non-price determinants of supply (factors that change supply or shift the supply curve) 

Factors other than  the price cause the supply curve to shift. These factors may incude:

The cost of factors of production- if there is an increase in the price of the resources, a unit will contribute less profits, therefore, the firm will produce less, shifting the curve to the left. A fall in the cost will cause it to shift to the right.

Price of other products- if the price of a competitor product decrease, there will be less supply as it is likely that the price of the product decreased in the whole market. This causes the curve to shift left. However if the price of a product decreases, the firm may choose to make a alternative. For instance, if the price of white bread decreases, firms may choose to increase supply of of brown breads which have more price, thus shifting the curve of white breads to the left. 

State of technology- if a product is made more efficiency, cost of production decreases, increasing profit per unit, so supply increases.

Expectations- If prices of a product is expected to rise, the firm may choose to expand early on to increase supply in the future. This shifts the curve to the right.

Government Intervention- If government implements tariffs, cost increases, so less profit made thus curve shifts to the left as there is less supply. However, if government offers subsidies, the cost falls per unit, so more profit gained, thus supply increases, shifting curve to the right.


Movement along and shift of the supply curve
A movement along the curve only happens due to change in price. A shift in the curve happens due to all other factors except of price. Figure 1.4 shows a movement along the curve and figure 1.5 shows a shift of the curve.

1.5 Credit: http://i.investopedia.com/inv/tutorials/site/economics/economics11.gif

HL: Linear Supply Functions, Equations and Graph

The supply curve function is of the form : 

Qs=c+dP

Where:

Qs = quantity supplied (which also is the dependent variable since it depends on price)

C = The Q-intercept (or the horizontal intercept)

d = the slope (~gradient) 

P = price per unit (independent variable)

A change in the value of 'c' means that there will be a shift in the curve, as it is meant to be a constant variable (Q intercept). If 'c' increases, there is shift rightwards, and if 'c' decreases, there is a leftward shift. 
The value of 'd' represents the slope, therefore changing the value means a change in slope of the graph. An increase in the value of 'd' means that there is flatter curve, while a decrease means a steeper curve. (Basic Maths: Gradient = RISE/RUN , Therefore a larger D means that either there is a extension in the y axis, or a shorter x axis). 

To plot a supply curve, make the Y variable Price (P) and the x axis Quantity Supplies (Qs) 


Market Equilibrium

Market Equilibrium

In order to understand how a free market reaches equilibrium, it is vital to acknowledge the basics of demand and supply.

Firstly, in case of a surplus/excess supply , in which there is more supply than what is demanded. For instance, if a CD is demanded at 400 units $5, but 1200 units are supplied , the firm would have to lower its price to be able to sell its product, causing the supply to reduce along with the price, until it equals equilibrium where demand=supply.

Contrastingly, if there is a shortage/excess demand (demand more than supply), the ability to make profits will encourage firms to increase their prices, which would reduce the demand. Therefore there will be an upward move along the supply curve, which causes a downward move on the demand curve.

As such, the forces of demand an supply obligate a market to reach equilibrium price=equilibrium quantity.


Changes in Market Equilibrium

Although it is rare for there to be a change in market equilibrium due to a shift in any of the demand or supply graph, it does happen occasionally.


Changes in Demand 

It is possible for their to be an increase/decrease in demand overtime.

For instance, during the Rio Olympics in 2016, there would've have been an increase in demand for tickets in the city, as a matter of increased tourism, and a bigger market. This would shift the curve right and thus, creating a new equilibrium at a higher price

In contrast, there can be an occasion where there is a drop in demand, cause there to be a leftward shift of the demand curve, meaning, that less people are willing and able to purchase the good/service. Therefore, there is a new equilibrium at a lower price as firms, to be able to sell their stocks would have to make it more affordable.

Changes in Supply 

For instance, a rare instance would be during the 2010 Japanese tsunami, in which the supply for food suffered as the crops were inedible, therefore shifting the supply curve left. This means that if the price was to be the same, there would be a shortage. Therefore, due to market forces, the price rises and reaches a new equilibrium.

There can also be an increase in supply, in which case there is a surplus, therefore prices will be decreased prices to be abel to suit the increased demand, therefore reaching a new equilibrium.

HL: Calculating and Illustrating Equilibrium using Linear Equations. 

As stated previously, Market equilibrium is when Qd=Qs , therefore to find the equilibrium price make the two equations equal each other, 

For instance, 

Qd = 14 - 2P
Qs = 2 + 2P

Therefore, 

1. Qs= Qdc and dd)
2. 2 + 2P = 14 -2P
3. (+2P and -2) ; 4P = 12 
4. (/4) ; P = 3

Now that you found the equilibrium price, sub in the value to either, the Qs or the Qd equation to find the equilibrium value. 

Qs = 2 + 2(3) 

= 2 + 6 

=8 (units)

  _______________________________________________________________________________

To plot a graph, it is as simple as plotting the Qd graph (given the values a and b are present), and Qs (given the values c and d). Them simply just read off the equilibrium from the graph. 

  _______________________________________________________________________________

To calculate excess demand or excess supply: 

1. Calculate equilibrium Quantity 
2. Calculate the new Qs or Qd by substituting the new price. 
3. Then, subtract the equilibrium quantity from the new Qs or Qd

If subtracted by Qs, and the value is negative, there is a shortage... If value is positive, there is an excess supply. 

If subtracted by Qd, and the value is negative, there is a lack of demand... and if the value is positive, there is excess supply. 

To make it simple, a negative value shows that there is lack of supply (if Qs used), or a lack of demand (if Qd used). A positive value shows an excess supply (if Qs used) or excess demand (if Qd used)

The Role of the Price Mechanism

Resource Allocation

To understand the concept of Resource Allocation, it is firstly important to understand the graph and theory behind the Production Possibilities Curve (PPC).

It must be understood that resources are scarce, in which case only a specific quantity of the resource can be allocated to a specific product. For example, in the following graph, the curve signifies the maximum quantity of a resource. If the production is at point A, the majority of the production is of Product X. If its at point B, the majority of the production is of Product Y. At point C, there is a balance in the production. And at point D, not all resources are being utilised.

Therefore, the allocation of any resource raises the question of 'what to produce?', as any choice would mean that the there is an opportunity cost - the next best alternative has been forgone because resources are scarce. 

(E.g. too much of Product X means not much of Product Y is produced) 

Price as signals and incentives and the allocation of resources

The main comprehension required behind this statement is that prices determine the allocation of resources, as they acts as signals and incentives. 

Demand Change 

In many cases, there can be an increase in demand of a product. For example, there can be an increase in the demand of apples. Therefore the demand increase causes the curve to shift from D1 to D2. At the price P1, this leads to a shortage of Q2-Q1. As the demand is larger than the supply, at point B, the price of apples increases along the D2 curve, until interacts with S curve at point C.

So what exactly happened? The high prices signalled to firms a shortage of apples. Therefore, the high prices acted as an incentive to firms to increase to increase their production of apples, as higher priced strawberries is more profitable. Therefore the supply increases from A to C. As the prices have increased, and is less affordable, it has signalled to consumers to buy less apples, thus changing demand from B to C.

As such, more resources are now allocated to apples production. (What to Produce Question) 

Supply Change 

In the Cambridge IB Economics book, there have given the example of the labour market which I will replicate here. So in this case, the Price (Y axis) signifies the wages, while the quantity (x axis) is the quantity firms require.

The demand for labour by firms is the D curve.

For example, if the Saudi Arabian government eases immigration laws for Indians, Pakistanis and Sri Lankans, there will be a sudden increase in supply from S1 to S2, and there will be an excess supply of Q2 - Q1. The surplus acts as a signal to decrease wages from P2 to P1. The lower wages act as incentives for firms to employ more, thus changing quantity from Q1 to Q3. This makes a new equilibrium at point C.

Remember, the Supple can decrease as well, in which case the equilibrium is at a higher price. Meanwhile, Demand can also decreasing which leads to a equilibrium at a lower price.

Market Efficiency

In efficiency markets there is allocative and productive efficiency. 

Allocative Efficiency is producing an allocating the combination of goods most wanted by society. Therefore the productive efficiency is also realised, as it fulfils the requirement with the fewest resources. These conditions result in Economic Efficiency. 

Consumer Surplus

Consumer Surplus = Price Consumers willing to pay - Price Actually Paid 

Therefore, the benefit a consumer gains by paying a lower price for the same quantity. 

For example, consumers are willing to pay P3 for quantity Q3. Therefore, the difference between P3 and P1 is the consumer surplus for Quantity Q3. The same is for all other prices. 

Producer Surplus

Producer Surplus =  Price good being sold at - Minimum price producer willing is to sell it for. 

Therefore, the marginal profit gained by the producer by selling it for a higher price. 

For instance, producers are willing to sell it for P3 and quantity Q3. Therefore, the difference between P1 and P3 is the producer surplus for quantity Q3. The same concept can be used for other prices. 

Allocative Efficiency

Competitive Market Equilibrium is when Producer Surplus and Consumer Surplus is at maximum (where Marginal benefit = Marginal cost). 

Social Surplus = Consumer Surplus + Producer Surplus

When MB=MC is where economic efficiency is reached. This is where everyone is benefited, and there is 'welfare' in the society.