Cba 1104 - Theory of Price Determination - Copy (2)

7/21/2019 Cba 1104 - Theory of Price Determination - Copy (2)

http://slidepdf.com/reader/full/cba-1104-theory-of-price-determination-copy-2 1/46



THE THEORY OF PRICE DETERMINATION

DEFINATION OF A MARKET:Means by which buyers and seers are br!u"h#

in#! c!n#ac# wi#h each !#her and "!!ds andser$ices are e%chan"ed&

The #er' !ri"inay re(erred #! a )ace where)r!duc#s were b!u"h# and s!d* #!day a 'ar+e# isany arena, h!we$er abs#rac# !r (ar-reachin", inwhich buyers and seers 'a+e #ransac#i!ns&

A market is !ne !( 'any $arie#ies !( sys#e's,ins#i#u#i!ns, )r!ceduresand in(ras#ruc#ures whereby )ar#ies en"a"e ine%chan"e&

/



FI0E CONDITION OF THE MARKET

There are 2$e c!ndi#i!ns which (acii#a#e #hee%is#ence !( #he 'ar+e#& These are-

1& C!nsu'ers, cus#!'ers !r de'anders

/& Fir's, su))iers !r )r!ducers3& Pr!duc#, c!''!di#y !r ser$ice

4& Price, e%chan"e ra#e, wa"e, ren#, (ees, (ares,e#c

5& Aids #! #rade 6ban+s, insurance c!')anies,#rans)!r# c!')anies, e"a sec#!r, e#c7

3



DEMAND

This re(ers #! an ac#i$e search (!r a "!!d !r aser$ice c!u)ed wi#h #he 2nancia !r '!ne#aryabii#y #! ac8uire #ha# "!!d !r ser$ice&

THE DEMAND C9R0E OR DEMAND CHED9E

T! c!'e u) wi#h a de'and cur$e #w! +eyc!nce)#s need #! be c!nsidered:

Firs#, ce#eris )aribus: A !#her in;uences!n 8uan#i#y de'anded are hed c!ns#an#&Ony #he )rice !( a "!!d is a!wed #! $ary&

4



DEMAND CONT<D

ec!nd, 'ar"ina anaysis: in ec!n!'icse')hasis is )aced !n #he chan"e in 8uan#i#y,n!# #he abs!u#e 8uan#i#y !( a c!''!di#y&

I# is #his chan"e in res)!nse #! a chan"e in

)rice which is anaysed by ec!n!'is#s #!)r!duce a de'and cur$e&

A priori 8uan#i#y de'anded !( a "!!d ise%)ec#ed #! be in$ersey=ne"a#i$ey rea#ed #!

chan"e in )rice& Hence #he de'and cur$e is e%)ec#ed #! ha$e

a ne"a#i$e=d!wnward s!)e&

5



DETERMINANT OF DEMAND

A "!!d<s !r c!''!di#y<s !wn )rice 6P%7

Prices !( c!')e'en#s !r subs#i#u#es 6Py7

Inc!'e 6Y7

Tas#es !r (ashi!nNu'ber !( )e!)e in a h!useh!d

>ea#her c!ndi#i!ns

?!$ern'en# )!icies e&"& #a%es, subsidies, )ricec!n#r!s, e#c

!cia and cu#ura (ac#!rs i+e rei"i!n and race!( cus#!'ers !r )!#en#ia cus#!'ers

@



THE INDI0ID9A DEMAND C9R0E

The de'and (unc#i!n can be wri##en in i')ici# (!r'as (!!ws:

Bd (6P%, Py, Y, T,,?!$#7

where Bd - 8uan#i#y de'anded !( B

( (unc#i!n !( P% Price !( B

Py Price !( Y

Y inc!'e

T Tas#es?!$# "!$ern'en# )!icies

N: Ony P% $aries, a !#her (ac#!rs are hedc!ns#an#

G



THE DEMAND C9R0E CONT<D

The de'and cur$e is !(#en "ra)hed as a s#rai"h#ine !( #he (!r' a - bP where a and b are)ara'e#ers& The c!ns#an# a e'b!dies #heeJec#s !( a (ac#!rs !#her #han )rice #ha# aJec#

de'and&I( inc!'e were #! chan"e, (!r e%a')e, #he eJec#!( #he chan"e w!ud be re)resen#ed by a chan"e in#he $aue !( a and be re;ec#ed "ra)hicay as a

shi(# !( #he de'and cur$e& The c!ns#an# b is #he s!)e !( #he de'and cur$eand sh!ws h!w #he )rice !( #he "!!d aJec#s #he8uan#i#y de'anded&




The "ra)h !( #he de'and cur$e uses #he in$ersede'and (unc#i!n in which )rice is e%)ressed as a(unc#i!n !( 8uan#i#y&

The s#andard (!r' !( #he de'and e8ua#i!n can

be c!n$er#ed #! #he in$erse e8ua#i!n by s!$in"(!r P !r P a=b - =b&

On #he ab!$e s#a#e'en# a=b is #he $er#icain#erce)#&

On #he e8ua#i!n:d 1/L 1LP where d 8uan#i#y de'anded

and P is )rice& 1/L=1L 1/ is #he $er#icain#erce)#&




1L



HIFT OF A DEMAND C9R0E

The shi(# !( a de'and cur$e #a+es )ace when#here is a chan"e in any n!n-)rice de#er'inan# !(de'and, resu#in" in a new de'and cur$e&

N!n-)rice de#er'inan#s !( de'and are #h!se#hin"s #ha# wi cause de'and #! chan"e e$en i()rices re'ain #he sa'ein !#her w!rds, #he #hin"swh!se chan"es 'i"h# cause a c!nsu'er #! buy'!re !r ess !( a "!!d e$en i( #he "!!ds !wn )ricere'ained unchan"ed&

!'e !( #he '!re i')!r#an# (ac#!rs are #he )rices!( rea#ed "!!ds6b!#h subs#i#u#es and c!')e'en#s7, inc!'e,)!)ua#i!n, and e%)ec#a#i!ns&

11



HIFT OF THE DEMAND C9R0E CONT<D

Chan"es in c!nsu'er dis)!sabe inc!'e 6Y-T7& Y-Inc!'e T-Ta%=#a%es

Chan"es in #as#es and )re(erences - #as#es and)re(erences are assu'ed #! be 2%ed in #he sh!r#

#er'=sh!r#-run& This assu')#i!n !( 2%ed )re(erences is a

necessary c!ndi#i!n (!r a""re"a#i!n !( indi$iduade'and cur$es #! deri$e 'ar+e# de'and&

Chan"es in e%)ec#a#i!ns&Chan"es in #he )rices !( rea#ed "!!ds

6subs#i#u#es and c!')e'en#s7

P!)ua#i!n sie and c!')!si#i!n

1/



HIFT OF THE DEMAND C9R0E CONT<D

13



MO0EMENT AON? THE DEMAND C9R0E

14



MARKET DEMAND C9R0E

The indi$idua c!nsu'er, h!we$er, is !ny !ne!( 'any )ar#ici)an#s in #he 'ar+e# (!r "!!d X &

The market demand curve (!r "!!d X incudes#he 8uan#i#ies !( "!!d X de'anded

by all )ar#ici)an#s in #he 'ar+e# (!r "!!d X. The 'ar+e# de'and cur$e is (!und by #a+in"

#he horionta! "ummation !( a indi$iduade'and cur$es&

F!r e%a')e, su))!se #ha# #here were Qus# #w!c!nsu'ers in #he 'ar+e# (!r "!!d X , C!nsu'er1 and C!nsu'er /&

15



MARKET DEMAND C9R0E CONT<D These #w! c!nsu'ers ha$e diJeren# indi$idua

de'and cur$es c!rres)!ndin" #! #heir diJeren#)re(erences (!r "!!d X.

The #w! indi$idua de'and cur$es are de)ic#ed!n #he "ra)h !n #he ne%# side , a!n" wi#h #he'ar+e# de'and cur$e (!r "!!d X.

N: h!ri!n#a su''a#i!n i')ies #ha# we add#he 8uan#i#ies !( #he #w! c!nsu'ers ass!cia#edwi#h a "i$en )rice&

Tha# is, we h!d )rice c!ns#an# and add #hediJeren# 8uan#i#ies #! "e# 'ar+e# 8uan#i#yde'anded a# a )ar#icuar )rice&

1@



MARKET DEMAND C9R0E CONT<Dde'and (unc#i!ns

1 1L - P/ /L - /P3 4L - 4P

Mar+e# de'and is h!ri!n#a su' !( indi$idua de'and (unc#i!ns: 8

Thus:1 1L - P where P S L * 1L * S 1L * L / /L - /P where P S L * 1L * S /L * L 3 4L - 4P where P S L * 1L * S 4L * L

1 U / U 3

Mar+e# de'and: GL - GP where P S L * 1L and S GL * L I# is c!''!n d!wnward-s!)in" inear de'and wi#h P a%isin#erce)# a# P1L and a%is in#erce)# a# GL

1G



FACTOR AFFECTIN? MARKET DEMAND

Factor" a#ectin$ market demandMar+e# !r a""re"a#e de'and is #he su''a#i!n

!( indi$idua de'and cur$es&

In addi#i!n #! #he (ac#!rs which can aJec#

indi$idua de'and #here are #hree (ac#!rs #ha#can aJec# 'ar+e# de'and 6cause #he 'ar+e#de'and cur$e #! shi(#7:

a chan"e in #he nu'ber !( c!nsu'ers,

a chan"e in #he dis#ribu#i!n !( #as#es a'!n"c!nsu'ers,

a chan"e in #he dis#ribu#i!n !( inc!'e a'!n"c!nsu'ers wi#h diJeren# #as#es&

1



FACTOR AFFECTIN? MARKET DEMAND CONT<D

!'e circu's#ances which can cause #hede'and cur$e #! shi(# in incude:

decrease in )rice !( a subs#i#u#e

increase in )rice !( a c!')e'en#

decrease in inc!'e i( "!!d is n!r'a "!!d

increase in inc!'e i( "!!d is in(eri!r "!!d

Chan"es in wea#her c!ndi#i!ns

1



THE 9PPY F9NCTION

in ec!n!'ics, "u%%!& is #he a'!un# !(s!'e )r!duc# )r!ducers are wiin" and abe#! se a# a "i$en )rice a !#her (ac#!rs bein"hed c!ns#an#&

9suay, su))y is )!##ed as a su))y cur$esh!win" #he rea#i!nshi) !( )rice #! #hea'!un# !( )r!duc# businesses are wiin" #!se&

A su))y schedue is a #abe which sh!wsh!w 'uch !ne !r '!re 2r's wi be wiin"#! su))y a# )ar#icuar )rices&

/L



THE 9PPY F9NCTION CONT<D

The su))y schedue sh!ws #he 8uan#i#y !("!!ds #ha# a su))ier w!ud be wiin" and abe#! se a# s)eci2c )rices under #he e%is#in"circu's#ances&

!'e !( #he '!re i')!r#an# (ac#!rs aJec#in"su))y are #he "!!ds !wn )rice, #he )rice !(rea#ed "!!ds, )r!duc#i!n c!s#s, #echn!!"yand e%)ec#a#i!ns !( seers&

In !#her w!rds #! c!'e u) wi#h a su))y cur$e!r (unc#i!n 6in #he sh!r# run7 !#her (ac#!rs !(su))y are hed c!ns#an#& Ony )rice $aries&

/1



DETERMINANT OF 9PPYA commodit&'" o(n %rice) The basic

su))y rea#i!nshi) is be#ween #he )rice !(a "!!d and #he 8uan#i#y su))ied&

A#h!u"h #here is n! Vaw !( u))yV,

"eneray, #he rea#i!nshi) is )!si#i$e !rdirec# 'eanin" #ha# an increase in )ricewi induce and increase in #he 8uan#i#ysu))ied&

Price o* re!ated $ood") F!r )ur)!ses !(su))y anaysis rea#ed "!!ds re(er #!"!!ds (r!' which in)u#s are deri$ed #! beused in #he )r!duc#i!n !( #he )ri'ary "!!d&

//



DETERMINANT OF 9PPYCondition" o* %roduction) The '!s# si"ni2can#

(ac#!r here is #he s#a#e !( #echn!!"y& I( #here is a#echn!!"ica ad$ance'en# in !nes "!!ds)r!duc#i!n, #he su))y increases&

F!r a"ricu#ura "!!ds, wea#her is crucia (!r i# 'ay

aJec# #he )r!duc#i!n !u#)u#s&E+%ectation") eers e%)ec#a#i!ns c!ncernin"

(u#ure 'ar+e# c!ndi#i!n can direc#y aJec# su))y&

I( #he seer beie$es #ha# #he de'and (!r his

)r!duc# wi shar)y increase in #he (!reseeabe(u#ure #he 2r' !wner 'ay i''edia#ey increase)r!duc#i!n in an#ici)a#i!n !( (u#ure )rice increases&

The su))y cur$e w!ud shi(# !u#&

/3



DETERMINANT OF 9PPYPrice o* in%ut") In)u#s incude and, ab!r, ener"y

and raw 'a#erias& I( #he )rice !( in)u#s increases #he su))y cur$e

wi shi(# in as seers are ess wiin" !r abe #! se"!!ds a# e%is#in" )rices& F!r e%a')e, i( #he )rice

!( eec#rici#y increased a seer 'ay reduce hissu))y because !( #he increased c!s#s !()r!duc#i!n&

Num,er o* "u%%!ier") The 'ar+e# su))y cur$e

is #he h!ri!n#a su''a#i!n !( #he indi$iduasu))y cur$es& As '!re 2r's en#er #he indus#ry#he 'ar+e# su))y cur$e wi shi(# !u# dri$in" d!wn)rices&

/4



9PPY C9R0E A?ERAICAY

s a U cP>here s 8uan#i#y su))ied

a- in#erce)# !( #he su))y cur$e

c- s!)e !( #he su))y cur$eP- )rice !( #he "!!d bein" su))ied

>ri##en #he !#her way, #he su))y cur$e is:

P s=c - a=c This (!r' !( #he su))y cur$eis i')!r#an# when ascer#ainin" #he i')ac#!( a #a% !r a subsidy

/5



9PPY C9R0E ?RAPHICAY

/@



HIFT OF THE 9PPY C9R0E

/G



MARKET E9IIRI9MMarket e-ui!i,rium in #his case re(ers #! a

c!ndi#i!n where a 'ar+e# )rice is es#abished#hr!u"h c!')e#i#i!n such #ha# #he a'!un# !("!!ds !r ser$ices s!u"h# by buyers is e8ua #! #hea'!un# !( "!!ds !r ser$ices )r!duced by seers&

This )rice is !(#en caed #he com%etitive%rice !r 'ar+e# cearin" )rice !r Qus# #hee8uiibriu' )rice and wi #end n!# #! chan"euness de'and !r su))y chan"es&

The e8uiibriu' )!in# is a si#ua#i!n in which #w!!))!si#e (!rces are in baance !r are e8ua !ra"ree&

/



MARKET E9IIRI9M CONT<D

.hree ,a"ic %ro%ertie" o* e-ui!i,riumare)

E8uiibriu' )r!)er#y P1: The beha$i!ur !(a"en#s is c!nsis#en#&

E8uiibriu' )r!)er#y P/: N! a"en# has anincen#i$e #! chan"e i#s beha$i!ur&

E8uiibriu' Pr!)er#y P3: E8uiibriu' is #he

!u#c!'e !( s!'e dyna'ic )r!cess 6s#abii#y7& The as# )r!)er#y i')ies #ha# e8uiibriu' is

arri$ed a# a(#er a )r!cess !( adQus#'en#&

/




3L




8uan#i#y de'anded and su))ied

su))y cur$e

D de'and cur$e

PL e8uiibriu' )riceA e%cess de'and when PWPL

e%cess su))y when PXPL

31




Mar+e# e8uiibriu' !ccurs a# #he in#ersec#i!n!( 'ar+e# su))y and de'and 6 D7

?i$en:

d 15 /LP

s 5 U 3LP

E8uiibriu' !ccurs when:

15 /LP 5 U 3LP 15 /L

6/7 5LP 1LL 15 4L

P / 145

3/




L /L 4L @L L 1LL 1/L 14L 1@L 1L /LLL

1

/

3

4

5

@

G

1L

/uantit&

PriceQs = 85+30P

Qd = 185 – 20P

33




I( X D , #here is a 'ar+e# surplus= QS-QD

I( W D , #here is a 'ar+e# shortage D

-

I( D , #here is a 'ar+e# equilibrium D- D L

Fr!' a )rice !( / #! 5 #here is a sur)usin #he 'ar+e#& This is as! caed e%cesssu))y&

34



MARKET E9IIRI9M ?RAPHICAY

35



CHAN?E IN E9IIRI9MI( #here is a chan"e in !ne !( #he !#her

de#er'inan#s !( su))y !r de'and, #here wibe a chan"e in 'ar+e# e8uiibriu'&

u))!se #here is an increase in taste, or income,or prices of substitutes or expected price.

Then #he market demand cur$e wi shi(# u),eadin" #! a new in#ersec#i!n !r e8uiibriu' wi#h

#he "i$en su))y& The e8uiibriu' )!in# chan"es as a resu#& This

is ius#ra#ed !n #he ne%# side&

3@



CHAN?E IN E9IIRI9Me!w b!#h )rice and 8uan#i#y chan"e, i&e&,

b!#h )rice and 8uan#i#y increase

3G



?O0ERNMENT INTER0ENTION IN THE MARKET

?!$ern'en# in#er$en#i!n 'ay #a+e 'any(!r's& These are )rice ceiin", )rice ;!!r,#a% !r subsidy&

A %rice cei!in$ is a "!$ern'en#-i')!sed

i'i# !n #he )rice char"ed (!r a )r!duc#&Price ceiin": #he 'a%i'u' )rice a seer is

a!wed #! char"e (!r a )r!duc# !r ser$ice&

Price ceiin"s are usuay se# by aw andi'i# #he seer )ricin" sys#e' #! ensure (airand reas!nabe business )rac#ices&

3



?O0ERNMENT INTER0ENTION IN THE MARKETCONT<D

Price ceiin"s are usuay se# (!r essen#ia e%)enses*(!r e%a')e, s!'e areas ha$e Vren# ceiin"sV #!)r!#ec# ren#ers (r!' ci'bin" ren# )rices&

?!$ern'en#s in#end )rice ceiin"s #! )r!#ec#

c!nsu'ers (r!' c!ndi#i!ns #ha# c!ud 'a+enecessary c!''!di#ies una##ainabe&

H!we$er, a )rice ceiin" can cause )r!be's i(i')!sed (!r a !n" )eri!d wi#h!u# c!n#r!ed

ra#i!nin"&Price ceiin"s can )r!duce ne"a#i$e resu#s when #he

c!rrec# s!u#i!n w!ud ha$e been #! increase su))y&

3



?O0ERNMENT INTER0ENTION IN THEMARKET CONT<D

EJec#i$e !r bindin" )rice ceiin" and i#sc!nse8uences&

4L




A )rice ceiin" se# be!w #he (ree-'ar+e# )rice hasse$era eJec#s&

u))iers 2nd #hey can# char"e wha# #hey had been&As a resu#, s!'e su))iers dr!) !u# !( #he 'ar+e#&

This reduces 8uan#i#y su))ied& Meanwhie,c!nsu'ers 2nd #hey can n!w buy #he )r!duc# (!ress, s! 8uan#i#y de'anded increases&

These #w! ac#i!ns cause 8uan#i#y de'anded #!

e%ceed 8uan#i#y su))ied, which causes a sh!r#a"euness ra#i!nin" !r !#her c!nsu')#i!n c!n#r!s areen(!rced& I# ha))ened in Zi'babwe in /LL&

41




Nu'erica E%a')e !n Price Ceiin"s : 6Ren#c!n#r! and sh!r#a"es7

D 1LL 5P 6where P is e%)ressed in

1LL bu# we i"n!re #he er!s7 5L U 5P 6where nu'ber !( a)ar#'en#s

is in 1L,LLL an er!s wi be i"n!red7&

Ceiin" PC 1 6!ne hundred7 as se# by #he

"!$ern'en#& Cacua#e #he #!#a sh!r#a"e&h!w #he c!nse8uences !( #he )rice ceiin"

"ra)hicay&

4/




A %rice 2oor is a "!$ern'en#- !r "r!u)-i')!sed i'i# !n h!w !w a )rice can bechar"ed (!r a )r!duc#&

A )rice ;!!r 'us# be "rea#er #han

#he e8uiibriu' )rice in !rder #! be eJec#i$e&

A )rice ;!!r se# ab!$e #he 'ar+e# e8uiibriu')rice has se$era side-eJec#s& C!nsu'ers 2nd#hey 'us# n!w )ay a hi"her )rice (!r #he sa'e

)r!duc#&

As a resu#, #hey reduce #heir )urchases !rdr!) !u# !( #he 'ar+e# en#irey&

43



?O0ERNMENT INTER0ENTION IN THE

MARKET CONT<DPrice ;!!r: c!nse8uences

O$ersu))y !( a"ricu#ura )r!duce

O$ersu))y !( ab!ur !r une')!y'en#9nder-e')!y'en# in s!'e sec#!rs !( #he

ec!n!'y

>a"e-wa"e s)ira

Deadwei"h# !ss in we(are #! s!cie#y

M!ni#!rin" and e$aua#i!n c!s#s

44



?O0ERNMENT INTER0ENTION: 9IDY

?i$en d 15 /LP

s 5 U 3LPAssu'e a subsidy in#r!duced !( 3

)er uni#&>ha# is #he i')ac# !n su))y[>ha# is #he i')ac# !n #he e8uiibriu'

8uan#i#y and #he e8uiibriu' )rice[Cue: w!r+in" is $ia #he su))y cur$e&

45



?O0ERNMENT INTER0ENTION: TAB

C!''en# !n #he rea#i$e bene2#s !( #hesubsidy #! c!nsu'ers and su))iers&

Assu'e e%cise du#y is i')!sed !n ac!h!icbe$era"es !( 3 )er uni#&

>ha# is #he i')ac# !n e8uiibriu' 8uan#i#yand #he e8uiibriu' )rice[

>ha# is #he rea#i$e share !( #he #a% burdenbe#ween c!nsu'ers and )r!ducers[

Documents

Cba 1104 - Theory of Price Determination - Copy (2)