Chronology of An Idealised Property Cycle

This video explains the key features of a generic property cycle. It is a specific and interesting example of economics working in real life.

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!

Subsidies

  • A subsidy is opposite to a tax. It is money given by the government to encourage the consumption and production of certain goods.
  • This works something like this : (i) Producers are given money to help them cover costs -> (ii) Costs decrease for producers -> (iii) This increases supply of the good -> (iv) This will decrease the price of the good ->(v) This will increase demand/consumption of the good.
  • Subsidies can also be given to stabilise price, cut down domestic costs of production so that imports are reduced.
A subsidy diagram:

(Diagram by Komilla Chadha)
So this diagram shows a subsidy.
  1. It shows that price has decreased
  2. It shows the quantity has increased
  3. The red arrow shows the subsidy per unit
  4. To get the full subsidy given by the government we multiply subsidy per unit by quantity so the blue rectangle [p1p2(purple dot)(point vertically above purple dot)] is the total subsidy in this image.
  5. The orange square within the total cost of the subsidy is what amount of the subsidy the producer keeps.
  6. The yellow part of the subsidy is what effect the subsidy has had on consumers.
  7. The amount producers and consumers feel all depend on the elasticity of the good.
This is video by an amazing economics teacher explaining subsidies:

Consumer Surplus

This is a short explanation of consumer surplus. I hope this helps make things simpler

In any given product there will be demand no matter what the price. I realise the magnitude of the demand may vary but the point is if, for example we are looking at the demand for exercise machines – whether the price is £400 or £4 there will always be someone ready to buy it (the amount of people who want to buy it will vary with the price).

We can see a similar situation in reality whether it is Primark or Harrods there is still a demand just the amount of it varies.

Now you must be wondering how does consumer surplus fit into this but it does. The market equilibrium for exercise machines may be £100 so the vast majority of supply will sell them for £100. If we imagine that all suppliers sold them for £100 then the consumers who were already ready to pay to pay over £100 will be gaining an advantage. It is almost like a profit they are making.

Subsequently, consumer surplus is defined as the value that consumers gain from consuming a good or service over and above the price paid.

We can see this clearly in a diagram:

The orange bit shows the consumer surplus – the consumers who are benefitting from the current market equilibrium price.

However, this is not all your need to know! You must know how to valuate consumer surplus. This is done through simple maths…calculating area of a triangle.

The formula for the area of a triangle is 0.5 X Base X height…

So in the diagram above the quantity OP1 is equal to the base which in this case is 100. The next bit is to identify the height and this is the difference between the market equilibrium price and the price where the demand is lowest. In this case it is the from £50 to £100 so the height is 50 (100-50).

The we multiply 50 by 100 by 0.5 and we get a consumer surplus of 2500.

That is how simple it is….

However, in exams the may frighten you by shifting the demand curve and saying what is the new consumer surplus. So remember the same principles apply you are looking at the price where there is demand is lowest and the new equilibrium price!

In economics consumers always just feel price changes.

What I have learnt when doing questions is that I miss read the questions so you have to be careful as to whether the question says what is the difference in the consumer surplus and what is the consumer surplus.

I hope this helps 🙂