Economics iGCSE The Allocation of Resources Price Elasticity of Demand Price Elasticity of Supply Market Failure Externalities

Economics iGCSE

The Allocation of Resources

Price Elasticity of DemandPrice Elasticity of Supply

Market FailureExternalities

Price Elasticity of Demand (Year 10 Economics)References: ECONOMICS (Moynihan & Titley) Ch 7, Section 4: p122-127

iGCSE Economics/Yr10/SH/24-10

• Price Elasticity of Demand – what is changing? • What happens to consumer demand when prices rise? • Quantity moves the opposite way to price moves (has an inverse relationship)• PeoD is negative sign (there are exceptions):

• Veblen goods - conspicuous consumption (status goods ) demand rises as price rises

• What’s the formula for PEoD?% Change in Qty D% Change in Price

Determinants of PeoD:• Availability of substitutes:

• Proximity and number .. What does that mean?

• Time period to look for substitutes:• Are you constrained?• E.g. peak hour toll-road charges are higher (motorist has no choice)

• Proportion of income devoted to this product:• Coffee Vs annual vacation

Price Elasticity of Supply (Year 10 Economics)References: ECONOMICS (Moynihan & Titley) Ch 7, Section 5: p128-134


• Who decides what is supplied in the economy?• The producers• What are they motivated by? • Profits (and sales)• Who decides what is demanded in the economy? • The consumers• What are they motivated by?• Fulfilling their wants• What happens to both groups when prices rise?

What is the difference between price elasticity of supply and price elasticity of demand?

• What’s the formula for PEoS?% Change in Qty S% Change in Price

•PeoS is likely to be a positive number: • When prices rise supply INCREASES (when prices fall, supply DECREASES)



•What are the possible range of values for PeoS?•Exercise: Fill in the box …

PeoS value Describe Term

Zero Qty S# does not change when P# change

Perfectly inelastic

<1 % changes in Qty S less than % change in price

inelastic

1 % changes in Qty S the same amount as % change in price

Unitary

>1 % changes in Qty S more than % change in price

elastic

infinity Qty S# changes infinitely when P# changes

Perfectly elastic



• If prices increase the producer increases supply - IF POSSIBLE - what does this mean? • What are the assumptions behind any Supply curve?

• What availability of the factors of production (fop):• Hire new staff .. Are they properly trained?• Get hold of the right ingredients/raw materials/inputs .. At what price?

• What time period:• How quickly can I make or get access to new supply/products (i.e. how quickly can

supply be ‘made’ and reach the market)?• Paperclips Vs aeroplanes?• Paperclips Vs strawberries?

• What stocks – what stock is available? • Is the stock ‘useful’ (gone off, last season style, wrong colour etc)

• What is the ease of supplying more:• Is it worth the hassle of producing one more? Do I need a whole new factory, or do I

have

• Exercise: PEoS Handout

Market Failure & Role of Government Intervention (Year 10 Economics)References: ECONOMICS (Moynihan & Titley) Ch 7, Section 6: p131-134; Ch 21, Section 1-4: p 392-400


• What is the price of a packet of cigarettes? What does that price include?• Raw materials• Production costs (electricity, processing, labour)• Marketing & sales• What else??

• Externalities:• When there are 3rd party cost or benefits:

• 1st party = producer; 2nd party = consumer• 3rd party is external to the relationship as defined by the market• Give examples …

• What is the role of ‘price’ in the economy?• To convey information (a ‘signal’) to ALL traders in the market• To provide an ‘incentive’ to producers to supply a product

• What is ‘wrong’ with the market price of cigarettes?• Information problems exist.

Market Failure & Role of Government Intervention (Year 10 Economics)References: ECONOMICS (Moynihan & Titley) Ch 7, Section 6: p131-134


The effect of a SUBSIDY (extra cash to cover supplier’s costs)

If left to the market, Pm and Qm results.

But government wants more than Qm – so pays Po-Pm as a subsidy.

This shifts the So to Ss – more supply at every price – so consumers can afford to

demand more at the lower prices.

Governments use subsidies to incentivise investment in

‘green’ products & services.[BUT they can distort competition –

enable inefficient producers to stay in business]

So

Quantity

Price/ unit Ss

subsidy

Qty supplied increases

Po

Subsidy = P1-Po

Pm

Qm Qs

Market Failure & Role of Government Intervention (Year 10 Economics)References: ECONOMICS (Moynihan & Titley) Ch 7, Section 6: p131-134


The effect of a TAX on supplier’s costs & market price

Taxes are an additional cost of production (increase from Po to Pt). Therefore quantity supplied

will reduce from Qo to Qt

St

Quantity

Cost/ price per unit Sotax

Po

Pt

D

QoQt

The effect of a SALES TAX on market price

Quantity

So

StPrice/cost unit

Tax as a % of price

The position of the St curve shows a sales tax (i.e. % of value) effect on supply So – the effect of a %age is higher on larger absolute amounts, thus the St curve PIVOTS out from original So.The impact on reducing Qs (because tax cost is higher) will be greater at higher prices.

Po

Pt

QoSoQoSt

QoSt QtSo


• Sometimes a private producer or consumer fails to recognise their responsibility:• The free market fails to generate an ‘incentive’ for less pollution (who’s cost is it?)• The free market fails to ‘keep tabs’ on which consumers enjoy beautiful public parks• The ‘market price’ needs to take these externalities into account.

• Private costs Vs private benefits:• The firm’s own costs and revenues are PRIVATE costs and benefits:

• Raw materials, wages (labour), electricity, transportation, research & development• What about pollution into the river, noise pollution – who suffers and who pays?• The issue - If the private firm had to take into account ALL the costs would it still make

profit?

• External costs Vs external benefits:• The costs that result from private firm activity that are borne by society not the firm• And the benefits that result from private activity that give benefit to more people that

just the private firm & its customers (e.g. fireworks display)

Market Failure & Role of Government Intervention (Year 10 Economics) References: ECONOMICS (Moynihan & Titley) Ch 21, Section 1-4: p 392-400

Social costs & benefits



Exercise: What are the total social costs [private costs + external costs] and social benefits [private benefits + external benefits] of everyday actions/decisions? (Mini group work)

•Smoking inside buildings•Litter (rubbish/garbage) in the river•Loud music from a concert•Building a fast motorway•Building a factory on the coast•Giving pre-school children vaccinations•Building a school•Setting up a National Park (for an area of outstanding beauty)

Who is affected?Consumers

Bystanders/neighboursProducers

Wider societyGovernment



• Making ‘economic’ decisions – what do you have to consider?:• Profits – is there any unexpected risk to profits• Economic growth – short term or long term• Resource allocation – are resources scarce, could they be better used• Distribution of income – how many people/which people will benefit• Opportunity cost – what is the next best allocation of resources … consider all social

costs/benefits• Conflicts of interest – parties may disagree on the best (most ‘economic’) use of

resources .. Who is right?

• What can the government do when the market fails?• Taxation• Subsidies• Nationalisation - public provision of goods & services. When does this make sense?• Laws & regulations (see Kyoto protocol)• Government policy to overcome conflicts of interest

• Exercise: Pg 398, Ex 2 ‘Belt Up’



The Kyoto Protocol (1997):•The first attempt to provide a global framework to limit carbon based emissions by setting deadlines for developed countries to reduce emissions to 1990 levels.

•By 2009 187 states had signed and ratified the protocol•BUT the US refused to ratify … because it made no demands on China and other developing nations

•Copenhagen (2009) was another attempt to reach international agreement, but was disappointing. The eventual document signed agreed that:

•Climate change is one of the greatest challenge today•Must aim to keep to a maximum of 2% temperature increase•BUT nothing was legally binding

What is the problem?•Developing countries think it’s unfair to have to reduce their emissions because it may prevent them from reaching a more mature state, when the developed countries operated under no such constraints in the past. The developing nations argue that once they are equally developed, they wil reduce their emissions … what’s the problem with this?

Appendix: How markets work

Price Elasticity of Demand (Year 10 Economics)References: ECONOMICS (Moynihan & Titley) Ch 7, Section 4: p122-127


• Price Elasticity of Demand – what is changing? • What happens to consumer demand when prices rise?

• Price increase = less Qty D• What direction does quantity move when price moves?

• Opposite way (inverse relationship)• PeoD is negative sign (exceptions):

• Veblen goods are a group of commodities for which people's preference for buying them increases as a direct function of their price because a higher price confers greater status Conspicuous consumption .. Status goods

• Giffen goods - e.g. staple foods without a substitute. Substitute goods are not available, so if prices rise, consumers are forced to consumer more (they cannot substitute and cannot afford additional food stuffs as well, so end up consuming more of the more expensive staple on its own e.g. rice or bread). A theoretical construct, very little real-life evidence.

• What’s the formula for PEoD?% Change in Qty S% Change in Price

• Is PeoS likely to be a positive or negative number? • If price increases …. What usually happens to Supply?• A positive sign – If price increases, IF POSSIBLE, Supply increases (Why? More profits for the

supplier who sells more)

http://en.wikipedia.org/wiki/Good_(economics_and_accounting)

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Economics iGCSE The Allocation of Resources Price Elasticity of Demand Price Elasticity of Supply Market Failure Externalities