Equilibriums

The term equilibrium refers to the point at which demand = supply.

– It is believed that if you leave markets to their own devices, this will result in a market performing at an equilibrium level. This is based on the assumption that all other things are equal (Ceteris Paribus) such as that perfect competition exists in the market place.

– We can clearly see from any demand and supply diagram that if we operate at a price higher than the equilibrium price than this will result in excess supply. This is because if you look at the x-axis you can see that quantity supplied is greater than quantity demand. It is obvious from my other post that the reason for this is that as price increases less people are able  or willing to afford the good.

– Similarly, if a market operates at a price lower than that of the equilibrium price then this will result in excess demand. This is because again if we looked at a demand and supply diagram we can clearly see that the quantity demanded is greater than the quantity supplied. I can think of a great example to reflect this imbalance, when Topshop have a sale the price of their goods is reduced, the demand for sale products is great but the amount of goods that are available (the pretty ones that is) is very low. This results in people having their demand not met.

Important to note: That all movements along the curve are down to price changes. All shifts are down to non-price determinants such as weather, tastes, incomes, price of substitutes and complements etc.

The Theory of Supply

What is the theory of supply?
At higher prices, a larger quantity will generally be supplied than at lower prices, ceteris paribus (all other thing being constant). So at a lower price a smaller quantity is produced.

This simply describes the upward sloping supply curve. The curve denotes that there is a ‘positive’ or ‘direct’ relationship between price and quantity. As one factor increases so does the other.

But why does this happen?

Suppliers have the incentive of profits, if a crop is doing well they will try and shift supply up so that they can make more profits.
The law of increasing opportunity costs means that as you increases supply of one good you must sacrifice greater and greater amounts of other resources. Therefore, as output increases , costs of producing goods increases thus the supplier must charge higher prices.

The supply curve

A supply schedule is simply a table of data showing the quantity that suppliers plan to supply at each level e.g.

A supply curve is a line which shows the quantity that suppliers plan to supply at each level e.g.:

Notice that as price increases the level of supply increases. (Positive correlation)

Shifts

The supply can shift left of right if there is a change in the quantity that supplier would supply at every price.

For example in this diagram we can see that the supply shifts to the right which is an increase in supply.
At price of P1, we can see supply increase (Sorry not that clear on this particular diagram) Notice a shift in the opposite direction from S1 to S0 would be a decrease in supply.

What causes these shifts to occur?

A shift in supply is caused by non-price determinants. There are 5 main ones you need to know:

1. Changes in costs of production: The lower the costs the greater the profit for producers. Examples of this are; input prices (raw material, rent etc.) , changes in technology (e.g. internet) , organisational changes , subsidies and taxes.

2. Profitability of alternatives; if another good becomes more profitable then a firm will switch t produce more of that e.g. the transition between cd players to MP3 players.

3. Profitability of goods in joint supply; If the supply of one good e.g. cattle increases then so will the joint good e.g.leather

4. Random shocks e.g. strikes, weather, wars, earthquakes etc.

5. Expectations of future price changes; for example if a firm expects price to rise they will either produce more or hold onto stock.

IMPORTANT:
NON-PRICE DETERMINANTS CAUSES SHIFTS AND PRICE DETERMINANTS CAUSES MOVEMENTS ALONG SUPPLY CURVE.

Need more help…check my video out!

Production Possibility Frontiers (PPFs)

What is a PPF?

A PPF is an economic model which shows all the maximum possibilities of two goods that an economy can produce

Why is the frontier downward sloping?

That as you go further on the frontier you will incur more opportunity cost, which is benefits foregone from the next best opportunity.

How can we calculate oppurtunity cost?

Total given up / total gained
(total given up divided by total gained)

What happens when the frontier is a straight line?

This tells us that the opportunity cost at every point is the same whereas on a curve we see that the opputunoity cost changes as you travel across the curve.

Why the frontier normally bowed outwards?

This is do with the increasing oppurtunity cost. The further you travel on the curve the bigger oppurtunity one has.

Explain why (a) points can be inside of the PPF? (b) points can be outside the PPF?

(a) This can be if resoures are not used to the their optimal level. For example labour is a resource and if unemployment is there then what happens is that the resources are not being used to maximum potential so the economy is working at a point below the optimal level which is depicted on the curve.

(b) This is not possible. It is not possible for an economy to operate at a level outside of the curve because the curve show the maximum points so outside it would be impossible. However, if resources are increased then the curve shifts.

Why does the frontier (a) shift right? (b) shift left?

(a) The frontier as we mentioned before can shift to the right if resources are increased. If resources are increased then there will be a new maximum level as more can be produced therefore the curve shifts right.
(b) The frontier can shif tothe left hand side. If resources can be increased then they can also be decresed too. For example, if a natural disaster takes place then the amount of resources will decreases and this means that optimal levels will decrease too so the curve is shifted inward.

 

How does resources such as; (a) land (b) labour (c) capital (d) technology increase in order to shift the frontier outward?
 

 

(a) Land can be increased in many ways e.g. if brownfield sites are generified, if other countries are invaded or new land like mountains are formed.

 

(b) Labour can be increased in several ways too e.g. if immigration increases, training/education increases or in the long-term a baby-boom will cause labour increase.

 

(c) Capital can increase too. Capital goods are things like machinery which in the long term help increase productivity. So investment in new capital, technological advances and automation will lead to this. It is important to recognise that consumer goods will provide short-term wealth to the economy but capital goods will bring long-term wealth.

 

(d) Technologicl advancement are similar. However, these include factors like if medical equipment is advanced than it will increase labour as people will be more healthy or if a new type of fast transport is invented then it will enable people to get to work faster – increasing output.

 

Explain how a PPF would be used in the real world?
 
In the real world PPFs are used with axes being ‘consumer goods’ and ‘capital goods’ as an economy can only make these two types of goods (this is a simplistic view). Analyst would see that if we should or shouldn’t, and if we should then by how much we should invest in capital goods as this will in the long-term increase the output of the country. If for example an economy has just incurred a natural disaster then they would have focus more on consumer goods as demand for them would be higher and they need short-term goods like blankets not long-term capital.
 
Does the PPF have any disadvantages?
 
The PPF being an economic model is based on assumption and ceteris paribus. There are three assumptions being made with a PPF and these are:
1. We assume that in an economy there is only two types of goods.
2. That the units measuring one axis are the same units on the other axis. For example if our axis had food and clothes then we are assuming that both are measured in tonnes.
3. We have to also assume that it is over a fixed time period such as a year.
Also, I mentioned above it is based on ceteris paribus, which is all things being kept at a constant. For example if we look at our clothes and food PPF again we will have to take in account that subsidies, taxes etc. are all kept the same so the PPF does not affect it.

Demand

What is demand?

It is desire from consumers for a particular good/service/commodity.
The demand curve…
demand_supply_demand1
The demand curve shows the quantity demanded by consumers at each price of a good/service.
Price and demand are inversely related i.e. as price increases the quantity demand decreases. This describes the demand curve is downward sloping.
There are two reasons one must know for why price and demand have an inverse relationship.

1. The real income effect

As the price of a good/service increases it will eat a bigger chunk of the consumers income making them feel poorer so there are only a few people who are rich enough not to feel this impact. Also, the purchasing power has decreased (and all this means is that only a few people can afford expensive goods and services as they have the financial power.)
2. The substitution effect
This is that in our economy there is a lot of competition which keep prices low which is good for consumers. This means that there are many alternatives to the particular product you are looking for. For example if you wanted to buy window cleaning spray and saw it was £5.99 that may be relatively expensive for you so you might go into another shop and buy a different brand or similar cleaning product which will be cheaper therefore as the price of a good increases the demand decreases as consumers’ will switch to alternatives.

Important key term:

Demand schedule: This is a table showing quantity demanded by consumers at each price level. This is table used to draw a demand curve.

Demand Schedule
What about shifts?
Well a shift in the demand curve will only exist if a non-price determinant changes and the quantity demanded by consumers changes at every price.
shift of demand
In the demand curve above we can see that the demand for shares has decreased and this can be for several reasons.

Why does the demand curve shift?

1. Tastes – social trends and fashion changes and this affects the demand for a good, For example at one point cassettes were very popular but as soon as CDs came the fashion changed to listening to CDs. The demand for cassette tapes decreased.

2. Income – If income increases then people have more purchasing power so the demand at every price level will increase. Vice versa if incomes suddenly decreased than the demand would decrease as people do not have a strong purchasing power.

3. Price of substitutes – substitutes as we mentioned before are alternatives. So if these decrease people are likely too buy more of them as their consumer surplus increases. This means that the good itself will incur a reduction in demand. For example if Pantene Pro-V hairspray became cheaper the demand for L’oreal hairspray would decrease because people would switch to the pantene Pro-V hairspray.

4.The price of complements – these are goods which complement each other i.e. go with each other. For example tea and milk. If the price of complement increases then the demand decreases. So for example if the price of milk rises then the demand for tea will decrease as people may switch tcheapero other cheaper alternative like black coffee or herbal tea,

5. Expectation of future price change – this doesn’t tend to be as big as other factors. But in markets such as the housing industry or the share it has a big impact. If for example houses were supposed to increase prices in the future then the demand for houses will increase because people will wan to buy as they know they can sell it at a later date for a profit.

6. Population increase/migration- If there are more people then the demand for a product is likely to be be bigger. The two main ways in which a population can change are (i) population increase/ decrease through baby boom or increased availability of contraception and (ii) migration – this means people moving in and out of a country.

7. Distribution of income – This is by far the most interesting one. this suggest if the government increased taxes or benefits to the poor then demand for necessities will increase as that is what poor people will demand and the demand for luxuries will decrease as rich people loose some of their purchasing power for it,

Quiz:

1. Demand for a normal product may cause the demand curve to shift outwards if…
a) price increases
b) price decreases
c)the price of a substitute falls
d) the price of a substitute rises.

2.A decrease in income should:
a) Shift demand for an inferior product outwards
b) Shift demand for an inferior product inwards
c) Shift supply for an inferior product inwards
d) Shift supply for an inferior product outwards

Answers under photo…

ANSWERS!

1) D- The demand curve will only shift outwards because of non-price factors such as the price of substitutes. If the price of substitutes increases then people are more likely to switch and buy this product. For example; orange juice and apple juice are close substitutes and if the price of apple juice goes people more people will be attracted to buy orange juice.

2) A – if income decreases then the quantity demand of an inferior will increase as they have an inverse relationship. Supply is not affected by the income elasticity of a product.