Last minute life saving econs notes Definitions (spam ah) Market system: System where resources are

allocated according to demand and supply which determine the price and quantities of good traded. Price mechanism: The changing in prices that lead to resulting in changes to supply and demand, aka reallocation of resources. Market equilibrium: A situation where the prices and quantity reaches a stable position which has no inherent tendency to change. Equilibrium price and output: Quantity demanded is equal to quantity supplied (market equilibrium) Demand: The amount that consumers are willing and able to purchase at a given price over a given period of time. (real intentions backed by purchasing power) Law of consumer Demand: Quantity demanded of a good is inversely related to its price, ceteris paribus. Income effect: Effect of a change on real income (purchasing power) e.g. price of good fall, or income rises and price of good stay constant, ceteris paribus. Substitution effect: Effect of change in price on quantity demanded by consumers switching to alternative products (rise in price result in lower demand in order to maximize satisfaction) Change in quantity demanded: Response of consumers to changes in the price of the commodity, ceteris paribus Change in demand: Increase or decrease in demand brought by a change in conditions or non-price determinants of demand. Factors affecting Market demand Taste and preference Population - Absolute increase in total population or chance in composition of population. (aging population, baby bloom etc) Income - Increase in money income leads to increase in real income, ceteris paribus. - Changes in income affects expenditure patterns (depending on normal, inferior or luxury goods) (Normal: demand increase as income increase, vice versa aka positive relationship) (Inferior: Demand fall as income increase, vice versa. Aka negative relationship) (Luxury: Demand increase as income increase)

Direct tax policy - Tax on peoples income. Directly affects peoples disposable income (income available after payment of income tax) - Increase in income tax reduces disposable income, vice versa, which determines level of demand. Subsidy Policy - Payments by government to reduce price consumers pay and costs incurred by producers. - Increase real income. - Redistribute income from rich to poor. (impact mainly on poor and little on rich) Prices of interrelated goods - Demand of a good may change due to change in price of another interrelated good, either substitutes or complements. Interest rate - Price of borrowing or using money. - Affect level of demand (eg car purchase in monthly installments, thus increasing price) Exchange rate Rate of currency: affect foreign demand. Expectations of future - Expectations of future changes in price (if foresee increase in price in future, demand in current market will increase) Seasonal changes (subset of taste and preference) - Climatic conditions - Festivals Consumer surplus - The difference between maximum amount consumers are willing to pay for a certain quantity of good and what they actually pay. - Consumer will but till the last unit that gives him a value of satisfaction equal price he pays (marginal cost of purchase) - Measure of consumer welfare. The bigger the surplus the higher the level of consumer welfare/satisfaction. Supply: The quantity of a good or service that producers are willing and able to offer for sale at each given price over a given period of time. Law of supply: Quantity supplied is directly related to the price of product. The higher the price of a good the greater the quantity supplied and vice versa, ceteris paribus. Factors affecting Market supply: Cost of production/Prices of production - Changes in price of factor inputs such as raw materials, fuel and power, cost of labor (wage rates) and cost of capital (rate of interest) will change the cost of production, causing changes in the level of profits and this in turn affects the supply of the good. Other Prices/Prices of Interrelated Goods - Changes in prices of interrelated goods affect supply of that good, depending on the nature of the inter-relationship. - If of joint supply, increase in quantity supplied of one good result increase of other good. - If of competitive supply, one is produced at the expense of another,

Innovation/State of technology - Knowledge of how resources are combined most efficiently. - With new inventions or advancements, productivity is increased, thus supply can increase at a same price. Natural factors - Favorable climatic conditions can increase supply of agricultural products. - Natural disasters can reduce supply of agricultural products and other goods. Government Policies - Indirect taxation and subsidies affect costs of production of firms and thus the supply price of a good. Expectation of future price changes - If price expected to rise, producers may temporarily reduce supply. Vice versa Producers Surplus - The difference between the amount received by the producers and the minimum amount that they are willing and able to accept for the supply of a commodity. Significance of consumer/producer surplus: Welfare effects are measured in terms of gain and loss in consumer and producer surplus. Interrelated Demands: Joint demands, Competitive demands. Derived demands (used in the production of other goods e.g labor) Interrelated Supply: Joint supply, Competitive supply. Elasticity of Demand: Price elasticity of demand (PED) is the measure of the degree of responsive of the quantity demanded of a good to a change in its price, ceteris paribus. Formula: PED = Percentage change in Qd / Percentage change of Price = Note: Coefficient of PED normally negative due to inverse relationship between price and quantity demanded, but negative sign is ignored and absolute value is taken. PED: >1, price elastic demand. <1, Price inelastic demand. Infinity: Perfectly elastic. 0, perfectly inelastic. 1, Unitary price elastic demand. Determinants of PED Availability of substitutes - More substitutes, more elastic demand. Habitual Consumption - For habitual consumption or necessity, demand is inelastic. Proportion of income spent on the good - The higher the proportion of income spent on good, the more people will be forced to reduce consumption when price increases, thus more price elastic. Vice versa. Time Period - When price of good rises, consumers take time to respond to the price change eg search for substitutes. The longer the period, the more likely consumers can find alternatives and thus demand is more price elastic. Vice versa. Usefulness of PED Government taxation policies - Government aim to raise revenue(indirect tax, lead to increase in price and a less than proportionate fall in quantity demanded) or discourage consumption of goods(taxes imposed

on goods with price-elastic demand or take steps such as education to make consumers more sensitive. The more price elastic the demand, the greater will be the effect of the indirect tax on quantity demanded. Firms Pricing Policy. - There is a relationship between price elasticity and total revenue, thus knowledge of PED can help firms formulate pricing strategy to increase total revenue. - If demand for product is price inelastic, firms should raise its price to increase total revenue. However, for price elastic demand, firm should lower price to increase total revenue. Relationship Between PED and firm total revenue: - If demand is price elastic, price and TR move in opposite direction. - If demand is price inelastic, Price and TR move in same direction. Effectiveness of trade union PED effect on price stability. Income elasticity of demand (YED) - Income elasticity measures the degree of responsiveness of demand of a good to a change in consumers income, ceteris paribus. - YED helps us predict how much demand will shift for a given change in income. Formula: YED = (%change in Qd)/(%change in income) = Interpretation of Sign and Coefficient - If YED is negative, the commodity is an inferior good. (increase income cause fall in demand) - If YED is positive, the commodity is a normal good. (increase income increase demand) - If coefficient positive but less than one, Demand is income inelastic and responds less than proportionately to changes in income. - If coefficient positive and greater than one, the demand for that good income elastic and responds more than proportionately to changes in income. Such goods are luxury goods. Determinant of YED - Degree of necessity of the good - Nature of good depends on level of income on consumer. Applications of YED For Firms: - Production Plans - Responding to changes in income - Targeting different income groups in different locations For Government: - Predict demand patterns according to changes in income levels, thus adjusting government policies.