FACULTY OF BUSINESS AND MANAGEMENT

BBEK1103PRINCIPLES OF MICROECONOMICS

SEMESTER JANUARY 2011

Market is a situation where potential buyers (consumers) and potential sellers (producers) of a goods or service come together for the purpose of exchange. Activities of both producers and consumers determine the level of demand and supply. The concept of demand and supply is the basic concept in market economy. The price system will determine how resources, goods and services are distributed. It is depends on anyone who has wants and willing to pay will obtain what is required. Demand is refer to total quantity of goods required and able to be purchased by consumers at various price levels in a particular period of time. Market demand refers to the total quantities of a product that all households would want to buy at each price level. Price elasticity of demand is a measurement on responsiveness of demand quantity towards a price change. Generally, elasticity can be pictured in the shape of demand curve. The range of price elasticity at different point on a downward sloping straight line demand curve is illustrated in Figure 1.

Price

P

0.5P

0.5QQQuantity

Figure 1: Ranges of price elasticity

Elasticity of demand price can be determined by the followings factors.i) The number of substitute goodsii) Budget ratioiii) Timeiv) The number of uses of goodsNowadays fuel is one of the main materials (input) in many sectors. It is almost become a necessity of our life. In general, demand for fuel is inelastic since there are almost no other substitute goods can be replaced it. When demand is inelastic, an increase in price will still result in a fall in quantity demanded, but in total expenditure will rise. Figure 2 illustrate area X (expenditure gained) is greater than area Y (expenditure lost). Therefore, price change gives a more significant effect compared to quantity change.

Expenditure rises when price risesPrice

B

APBPAY X

QBQAQuantity

Figure 2: Inelastic demand for fuel marketWhen a war breaks out in a country which is main fuel producer in the world, it will result fuel supply disruption in the world and fuel price increase. In economic analysis, demand does not solely mean for quantity. It is also refers to relationship between quantity and price which can be shown graphically as a demand curve and demand table. See illustration below, Figure 3 and Table 1. When price increase, demand quantity decrease, and when price decreases, demand quantity increases. This inverse relationship we call it as Law of Demand. A demand curve show quantity demanded will change in response to a change in price. Movement along demand curve indicates the changes of demanded quantity caused by the goods price change.There are several factors influence the total market demand for a goods. The determinants of demand includesi) Price of the goodsii) Consumer incomeiii) Price of related goodsiv) Taste and fashionv) Expectationvi) The distribution of income amongst buyers or households

Table 1: Demand tablePrice (RM)Demanded Quantity (Litre)

10600

20500

30400

40300

50200

60100

Price

D

60

50

3040

20

10Quantity

100200300400500600

Figure 3: Demand curve

A supply curve is show quantity of a goods that existing supplier (existing producers) are willing to produce for the market at a given price. It is upward sloping curve from left to right, the greater the quantities will be supplied at higher price. Figure 4 is the supply curve derived from Table 2. Table 2 shows the quantity of goods that willing to produce by the producer at different price level.Table 2: Supply TablePrice (RM)Quantity Supplied (Litre)

10100

20200

30300

40400

50500

60600

6050PriceS

40

30

20

10

200500400400300400 600100Quantity

Figure 4: Supply Curve

What is market equilibrium?Market equilibrium is where the point of intersection between demand and supply curve. At the point of market equilibrium, we will able to know the particular quantity (known as equilibrium quantity, Qe) and price (equilibrium price, Pe) where buyer and seller are willing to pay and sell. With understanding of demand and supply, we can show how the decisions of buyers of goods or services interact with the decisions of sellers to determine the equilibrium (McConnell, Brue& Flynn, 2009).According to McConnell, the market equilibrium is the base point in which the supply and demand of the product quantity (McConnell, 2009). This can be illustrated by drawing demand curve and supply curve on the same graph (Figure 5). Market equilibrium will achieve when there is no surplus and shortages. Figures 5 illustrates the condition when market equilibrium, surplus and shortages.

Price

SurplusMarket supply

Pe

ShortageMarket demand

QeQuantity

Figure 5: Market equilibrium, surplus and shortagesIf the quantity produce at a given price exceeds the quantity that consumers demand, there will be an excess of supply. When change in the price of goods relates to a commodity will shift the position of demand curve. A change in the price of one goods will not necessarily change the demand for another goods. For example we would not expect an increase in the price of bread to affect the demand for car. However, if both of the goods in the market demand are inter-connected and there are no other substitute goods, then the demand sensitivity of cars towards the price change of fuel is high. Substitute goods are goods that are alternative to each other. Meaning to say an increase in the demand for one is likely to cause a decrease in the demand for another. Consumers may switch demand from one goods to another rival goods. Example of substitute goods and services are:-i) Rival brands of the same commodity, likes Coca-cola and Pepsi-colaii) Butter or margarineiii) Bus rides and train ridesComplementary goods are goods that can be consume together, so that an increase in the demand for one is likely to cause an increase in the demand for the other and vice versa. Examples of complements are:-i) Fuel with carsii) Cups with saucersiii) Pen with inkFor instance, an example of complementary goods likes fuel and car. The fuel price increase in the market due to supply disruption in the world. Lets say the price of fuel increase from P1 to P2. This will cause quantity demand for petrol decrease. Refer demand curve for fuel which illustrated in Figure 6(a). Consequences after the increase of fuel price, it will have direct impact towards car market. Consumers will reduce demand for cars; see Figure 6 (b) illustrated below. In other words, the change in fuel price will cause consumers make changes to the fuel consumption they willing to be purchased. Demand for cars decrease as consumers have a mindset that fuel price too high, given that fuel and car are complementary goods. In car market demand will shift left due to reason expensive fuel price discourage people from buying car (Figure 6b). Therefore demand quantity for car market will decrease. When increase fuel prices, it is not only will affect car market. It will also cause other sectors increase in cost of production. Hence, costs of living such as foods and clothing also rise due to increase fuel price. This will then push inflation upwards, and later is interest rate rise!

D1DoPricePriceD

BABP2

P1DoAP1

D1D

QuantityQuantity

Q2Q1Q1Q2

(b) Demand curve for car(a) Demand curve for fuel

Figure 6: Change in the price of complementary goods

On the other hand, demand for public transport and bikes market will increase as there is not much other alternative to substitute fuel. The effect of one form of government intervention in market is indirect tax imposed on certain goods. When government tax imposed on cars, this will increase cost to seller, hence the tax will shift the supply curve to the left. Consumer has to pay the price includes the tax. For example in Figure 7:(a) S0 is the supply curve before impose tax(b) S1 is the supply curve including the cost of tax(c) Q0 is the demand quantity before impose tax(d) Q1 is the demand quantity after impose tax

Price

S1

S0

BP2

P0AC

P1ED

Figure 7: the effect of tax towards market equilibriumQuantityQ1Q0

From graph above (Figure 7) we can see when supply curve from S0 to S1, the market equilibrium from A move to B. Quantity demand has fall from Q0 to Q1 and price pay by consumer has increase from P0 to P2. The amount of tax collected by government is depicted by area P1P2BE and amount borne by consumer is the area P0P2BC. The amount of tax borne by the seller is P1P0CE. In general, the greater the elasticity of the demand and supply, the greater will be the effect of a tax in reducing the quantity sold in and the produced for the market. It can be appreciated from Figures 8 that the consumer bears greater proportion of the tax burden when the demand curve be more elastic.

PricePrice

DDS1S1S0

BTaxCBS0

AEHCHE

TaxA

FGF

GQ1Q2Q2Q1QuantityQuantity

(b) Elasticity demand(a) Inelasticity demand

Figure 8: Elasticity of demand curve after government imposed tax Point A in both diagrams is the initial equilibrium point and point B is the market equilibrium after tax is imposed. From Figure 8(a) we can see when the demand is inelasticity, the bigger the tax burden that has to be borne by consumers in area CHBE. Refer to Figure 8 (b) where the elasticity demand for car is elastic, the seller has to bear more taxes imposed (area EFGH) as we compare with consumer (area CHBE).In summary, when elasticity of demand or supply becomes lesser, the quantity will get decrease from Q2 to Q1. This may lead to significant rises in the unit costs of production when companies reduce quantities in production after government imposed tax. In view of fuel is an important resources to many sectors, government should not impose tax to burden both supplier and consumers. The impacts of increase price in fuel and follow by adverse consequences on the car market; this will make the country produce goods and services in an uncompetitive situation when compete with oversea market with foreign firm which are not subject to the same tax. ReferenceMunzarina Ahmad Samidi, Norehan Abdullah, Jamal Ali and Zalina Mohd Mohaideen (2009). Principles of Microeconomics. Meteor Doc. Sdn Bhd.British Library Cataloguing-in-Publication Data (1998). The Organisational Framework. BPP Publishing Limited.Ivan Png and Dale Lehman (2007). Managerial Economics. Blackwell Publishing.Hairun. Supply and Demand: How Market Work. 5/3/2011. http://www.ukm.my/hairun/Ecn3100/DD,%20SS,%20elasticity.pdfSparkNotes. Equilibrium. 5/3/2011. http://www.sparknotes.com/economics/micro/supplydemand/equilibrium/section1.rhtmlWikipedia. Supply and Demand. 6/3/2011. http://en.wikipedia.org/wiki/Supply_and_demandRobert Schenk. Price Elasticity. 7/3/2011. http://ingrimayne.com/econ/elasticity/Elastic1.htmlMohsensaberi (7/4/2010). Market Equilibrium. 7/3/2011http://www.oppapers.com/essays/Market-Equilibrium/350643

Note: 1,789 words excluding references. 8