Competitive markets & how they work

OCR Economics AS Level F581Microeconomics

Lesson 1 Objectives

• To be able to explain what exactly we mean by a market

• To be able to explain the difference between notional and effective demand

• To be able to explain the relationship between price and quantity demanded, using a graph to display a demand curve

To begin

• You have 5 minutes to come up with as many uses of the word ‘market’ as you can (in relation to the world of Business, Commerce & Economics)

Definition of ‘Market’

Market: where or when buyers and sellers meet to trade or exchange products & services

Examples include the stock market, housing market, local high streets, e-bay, the labour (jobs) market

Within markets the level of demand and supply fluctuate and as a result so do prices

Who would like one of these?

Who can afford to buy one of these?

Definitions of Notional & Effective Demand

Notional Demand : the desire for a product

Effective Demand : desire for a product backed up by a willingness and ability to pay

Demand : the quantity of a product that consumers are able & willing to purchase at various prices over a period of time

An example of a lack of effective demand

Relationship between price & quantity demanded

• We assume ceterus paribus (that all other factors remain equal)

• We focus on a period of time (e.g. a day, a week, a month, a year)

• We assume that consumers are rational, seeking the cheapest purchase

• There is an inverse relationship between price and quantity demanded – as prices rise, demand falls

Task:

• Look at table 2.1 and Fig 2.1 on Page 25• Turn over to Page 26 and complete the

Benidorm holiday activity

Definitions of Demand Curve & Demand Schedule

Demand curve : this shows the relationship between the quantity demanded and the price of a product

Demand schedule : the data that is used to draw up a demand curve

Movements along the demand curve : a change in quantity demanded in response to a change in price

Pass the BuckWhat can you recall from Lesson

1?

Lesson 2 Objectives

• To be able to define and explain what we mean by consumer surplus

• To recognise how price and quantity demanded can be used to calculate total revenue/total expenditure

• To be able to describe the range of factors other than price that influence demand

How much would you pay to use Facebook or Twitter?

Globally, it’s estimated that we get €100 billion more in value from use of the internet than we pay for (click on the image

below to read live on line)

Definition of Consumer Surplus

• Consumer Surplus : the extra amount a consumer would be willing to pay for a product and service over and above the amount that actually is paid

Consumer Surplus

Price

Quantity

P

Q

How have the following affected consumer surplus?

• The introduction of a congestion charge in London• The arrival of Amazon and others in to the market

for books• Price discrimination by low-cost airlines who

charge different prices depending upon how far in advance customers book

We’ll return to this concept later to see how consumer surplus is affected by market

developments

Calculating Total Revenue/Total Expenditure

• A demand curve is plotted against two axis– Price– Quantity

• By multiplying price per unit by the number of units sold, we can determine the total revenue earned by firms which is also the total expenditure by consumers, at a given price

• E.g. 200 units x £1.50 per unit = £300

Why is this important?

• We will discover in future lessons how different products/services have demand that is more or less sensitive to price changes

• Total revenue/expenditure can vary quite dramatically if demand and or prices fall

• There may be an increase in revenue even if prices are cut, or a decrease in revenue even if prices are increased

Other factors that influence demand

Key income definitions• Disposable income : Income after taxes on income have been

deducted and state benefits have been added• Real disposable income : As per disposable income but further

adjusted to take account of changes in price level (inflation)• Normal goods : goods for which an increase in income leads

to an increase in demand e.g. Plasma TV• Inferior goods : goods for which an increase in income leads

to a fall in demand e.g. ‘Basics’/’Value’ branded foods• Substitutes : competing goods e.g. i-tunes vs CDs• Complements : goods for which there is joint demand e.g.

houses and mortgages

The effect on the demand curveChange in demand due to

Effect on the demand curve

An increase in consumer income

Demand at the same price is HIGHER than before, and the curve shifts to the RIGHT

A rise in the price of substitutes

A fall in the price of complements

A positive change in tastes & fashion

A fall in consumer income

Demand at the same price is LOWER than before, and the courve shifts to the LEFT

A fall in price of substitutes

A rise in price of complements

A negative change in tastes & fashion

DD1

D2

Real Life Examples

• What examples of these factors in action do you recall from the commodity presentations you did last term?

Talkabout

• I’d like a volunteer to talk about factors other than price that influence demand

• They have to talk for a minute and hopefully hit 6 key words

Lesson 3 objectives

• To be able to understand how a supply curve is drawn from a supply schedule

• To be able to explain what is meant by the producer surplus

• To be able to describe the main influences on supply levels other than price

A supply curvePrice Per Person (£)

Quantity Supplied

500 1200

450 1150

400 1100

350 1050

300 1000

250 950

200 900

150 850

Price P

Quantity

S

Definition of supply curves/schedules

• Supply curve : this shows graphically the relationship between the quantity supplied and the price of a product

• Supply schedule : the data from which a supply curve is drawn

The Producer Surplus

Watch this video for an explanation of the producer surpluspajholden is a channel on YouTube worth looking at to support your studies (jodiecongirl is a better looking alternative!)

•Producer surplus : the difference between the price a producer is willing to accept and the actual price

What effects supply levels other than price?

The effect on the supply curveChange in supply due to Effect on the supply

curve

A fall in raw material costs

Supply at the same price is HIGHER than before, and the curve shifts to the RIGHT

An improvement in labour efficiency

A reduction in indirect taxation

A positive technological advance

An increase in raw materials

Supply at the same price is LOWER than before, and the curve shifts to the LEFT

An increase in labour costs

An increase in indirect taxation

A failure in technological advances

S

S1

S2

Next week…

• Some practice paper questions to take stock• How demand & supply interact to create a

market equilibrium price

Lesson 4 Objectives• To understand how to draw supply and

demand charts that ‘commentate’ on changes in markets

• To do this by watching a segment of ‘Trading Places’ together and drawing supply and demand charts that describe what happened

• To be able to define and use the terms market equilibrium and market disequilibrium

Watch the section of Trading Places and note what’s happening

• What are the key moments when– demand rises?– demand falls?– supply rises?

As we watch it again, draw a supply and demand diagram to comment on what is happening

‘Trading Places’ in Supply & Demand Graphs• The market opens, with price set at the

level previous close (market equilibrium)

• Duke & Duke start buying frozen OJ contracts and others follow suit believing the know something about the impending crop report (creating market disequilibrium)

• The real crop report is released and proves to be a good one with a healthy crop. Buyers realise there won’t be a shortage of OJ afterall and want to get rid of frozen OJ contracts rather than be left with them. They start selling, flooding the market and resulting in demand falling (new market disequilibrium)

Key definitions

Market equilibrium Market equilibrium : the price and quantity at which supply and demand are level (also known as the ‘clearing price’)Market disequilibrium Market disequilibrium : any position in the market where demand and supply are not equalSurplus Surplus : an excess of supply over demandShortage Shortage : an excess of demand over supply

Homework• In October 2007, on the day of the World Cup Final, it was

reported that English rubgy fans were prepared to pay as much as £1000 for a ticket for the match. The actual price was £60. Use demand & supply concepts/diagrams to explain the situation

• By contrast, earlier in the year it was reported that local cricket fans in Barbados were being offered tickets to watch World Cup matches for as little as $10. The actual price was $80. Again, use supply & demand concepts and diagrams to explain the situation

• Due in on Friday Day5

Lesson Objectives

• To understand the term elasticity in an Economics context

• To consider how variables have relationships with each other

• To understand that some of these variables will react with each other in more dramatic or less dramatic ways

Match these in to pairs that may be responsive to each other

Eating hamburgers Getting a snog!

Money spent on a date

Time spent in the gym

The shape & tone of your body

Time spent at the driving range

Golf handicap

Working outdoors

Getting Skin CancerAmount of sleep

Level of productivity at work

Becoming obese

What Economic ‘relationships’ can you think of?

Key Definition

Elasticity : the extent to which buyers and sellers respond to a change in market conditions

Plot these demand schedules on the same demand curve diagram

Price Quantity demanded

£1.00 100

£1.10 90

£1.20 80

£1.30 70

£1.40 60

Price Quantity demanded

£1.00 140

£1.10 120

£1.20 100

£1.30 80

£1.40 60

Price Quantity demanded

£1.00 80

£1.10 75

£1.20 70

£1.30 65

£1.40 60

Describe how each differs

Demand/Supply Curves and Elasticity

• The steeper the curve the less sensitive the quantity of demand or supply is to a change in price: price inelastic

• The shallower the curve the more sensitive the quantity of demand or supply is to a change in price : price elastic

Key definition

Price Elasticity of Demand (PED) : the responsiveness of quantity demanded to a change in the price of the product

Formula:% change in quantity% change in price

Ignore whether it’s a negative or positive change

ExampleQuantity demanded changes from 1000 units to 1400 units = 40% changeThis happens as a result of a price change from £20 to £15 = 25% change

40/25 = 1.6

Elasticity =% change in Q% change in P

Remember!Remember!

You QUEUE before you PEE

Calculate the price elasticity of demand

Price Quantity demanded

£1.00 100

£1.10 90

£1.20 80

£1.30 70

£1.40 60

Price Quantity demanded

£1.00 140

£1.10 120

£1.20 100

£1.30 80

£1.40 60

Price Quantity demanded

£1.00 80

£1.10 75

£1.20 70

£1.30 65

£1.40 60

Outcome of 1 = unit elasticityOutcome of >1 = demand is ‘price elastic’Outcome of <1 = demand is ‘price inelastic

1.4251

0.625

Key Definitions

Price elastic : where the percentage change in quantity demanded is sensitive to a change in price

Price inelastic : where the percentage change in quantity demanded is insensitive to a change in price

Why might quantity demanded be more price sensitive for some

products than others?

vs

vs

Match each picture to the elasticity outcome

Price Quantity demanded

£1.00 140

£1.10 120

£1.20 100

£1.30 80

£1.40 60

Price Quantity demanded

£1.00 80

£1.10 75

£1.20 70

£1.30 65

£1.40 60

1.425

0.625

Put the items in order, in terms of sensitivity of demand to a change in

price

Lesson Objectives

• To understand the term income elasticity of demand

• To be able to calculate income elasticity of demand

• To be able to describe the link between income elasticity and normal goods and inferior goods

July 7, 2010Consumer Demand Rising Among Urban and

Rural ChineseNearly one in five rural Chinese plan to buy a computer in the

next two yearsby Tao Wu and Steve Crabtree

BEIJING -- Economists and Chinese leaders for years have worried that China's

predominantly export-driven growth is unsustainable, with poverty, the isolation of its rural citizens, and a culture of thriftiness

hampering domestic demand. A Gallup survey of Chinese consumers conducted in

2009 suggests this mindset is changing. Chinese intent to buy several items

previously considered luxury goods -- including computers, digital cameras, and cell phones -- has increased significantly

since 2004.

Key Definition

Income Elasticity of Demand (YED) : the responsiveness of quantity demanded to a change in price

Formula:% change in quantity% change in price

Ignore whether it’s a negative or positive change

ExampleQuantity demanded changes from 1000 units to 1400 units = 40% changeThis happens as a result of an increase to average household income of 15%40/15 = 2.67

Key definition

Normal Goods: An increase in income leads to an increase in quantity demanded. A fall in income leads to a fall in quantity demanded.

Outcome of formula is positive>1 = Income elastic (more sensitive to income change)<1 = Income inelastic (less sensitive to income change, but demand still increases with income)

Plot these data on a chartQuantity Demanded (index)

Income (index)

100 100

110 110

120 120

130 130

Quantity Demanded (index)

Income (index)

100 100

110 120

120 140

130 160

Quantity Demanded (index)

Income (index)

100 100

110 105

120 110

135 115

Key Definition

Inferior goods : A fall in income leads to an increase in quantity demanded. An increase in income leads to a fall in quantity demanded.

Outcome of formula is negative

Plot this data on a chart

Quantity Demanded (index)

Price (Index)

100 100

110 90

120 80

130 70

Caution!

• YED is relative, depending upon current level of income

• One person’s normal good is another person’s inferior good

Lesson Objectives

• Be able to define the term Cross Elasticity of Demand (XED)

• Be able to explain and identify examples of substitute and complement goods

• Be able to interpret XED calculations to identify the nature and strength of relationship between two goods

Watch the video (we’ll replay it if necessary)

Key Definitions• Cross elasticity of demand : the responsiveness of

quantity demanded of one product to a change in price of another product

%Change P ProductA%Change P Product B

• Substitute Good : competing goods (will have a positive XED, the higher the more they compete)

• Complement Good : goods which have joint demand (will have a negative XED, the lower the number the closer the relationship)

Using this knowledge, answer the following questions

• Product A has a XED of -1.6 in respect of Product B. Is it a complement or a substitute?

• Product C has a XED of 2.5 in respect of the same Product B as in the previous question.

– Is it a complement or a substitute?– Is the strength of this relationship between Product A and C stronger or weaker than the

relationship between A & B?• Using the data below, calculate the XED of Product D in respect of Product E

– Product E changes in price from £1.50 to £1.75– Product D quantity demanded changes from 1000 units to 1200 units

• Comment on the relationship that would appear to exist between the two products D & E

• If the calculation led to an outcome of zero, what does this tell you about the extent of any relationship between two products?

• Come up with your own examples of complement and substitute goods. Be as inventive as you like. I will consider offering a prize for the most novel suggestion.

The relevance of XED

• Especially important in competitive markets where there are many substitute goods

• Firms can both anticipate how their own prices cuts/rises might affect demand, & how competitors actions may impact upon them

• Not as obvious with complements, but a change in price may lead to a change in demand for a complement. Firms will need to be ready to meet new supply levels if possible

Lesson Objectives

Objectives

• To be able define the term price elasticity of supply

• To be able to carry out a price elasticity of supply calculation and interpret it

• To be able to explain the relevance of this estimate to business/industry

• To be able to define the term allocative efficiency

What effects supply levels other than price?

Key Definition

• Price Elasticity of Supply (PES) : the responsiveness of quantity supplied to a change in price level

% change in Q supplied% change in P level(As with PED ignore negative values)

• Inelastic = 0 to 1 : supply is not very responsive to a change in price

• Elastic = above 1 : supply is responsive to a change in price

How steep will the curves be?

Short term vs Long term

Service businesses like airlines need to sell seats in short term or they will make a loss. Over the medium/long term they can reduce capacity if necessary

Farmers cannot change their supply levels in short term as they are committed to certain types of crop

Influences on elasticity of demand

• Availability of stocks – can a firm add new supply to the market quickly?

• Availability of factors of production – does a firm have labour, land, capital available as required to increase supply? Can it easily decrease supply by reducing these inputs?

• Time period – what time period are we discussing?

Relevance

• PES always positive reflecting that as price increases supply will be more attractive to firms

• Reflects the availability of factors of production in short term and long term in order to respond to price changes with a change in supply levels

• Firms will try and make their supply as elastic as possible so they can react quickly. This means holding stock but this can be risky

Key Definition

Allocative Efficiency : where resources are used to produce goods and services that maximise consumer satisfaction