the price mechanism in action
DESCRIPTION
Revision presentation on aspects of the price mechanism - for unit 1 microeconomicsTRANSCRIPT
AS Micro
The Price Mechanism in Action!
Geoff Riley, FRSA, Eton College & Tutor2u
Functions of the Price Mechanism
1. Allocation – allocating scarce resources among competing uses
2. Rationing – prices serve to ration scarce resources when demand outstrips supply
3. Signalling – prices adjust to demonstrate where resources are required, and where they are not
4. Incentives – when the price of a product rises, quantity supplied increased
Incentives matter!
Markets in Action – Crude Oil
Applying supply and demand analysis
Changing supply / demand conditions
Market Change Shift in Supply or Demand?
Rise or Fall in Market Price for Crude Oil?
• There is a steep slowdown in the Chinese economy
• OPEC agrees to an increase in output quotas for each of their members
• There is a fall in the number of active oil rigs in many of the world’s major oil producers
Changing supply / demand conditionsMarket Change Shift in Supply or
Demand?Rise or Fall in Market Price for Crude Oil?
• There is a steep slowdown in the Chinese economy Demand
Price of crude oil
Quantity of crude oil
D1D2
S1
Q1Q2
P2
P1
Changing supply / demand conditionsMarket Change Shift in Supply or
Demand?Rise or Fall in Market Price for Crude Oil?
• OPEC agrees to an increase in output quotas for each of their members Supply
Quantity of crude oil
Price of crude oil
Quantity of crude oil
D1
S1
Q1 Q2
P2
P1S2
Oil Rigs and Price IncentivesHigh oil prices increase the incentive to drill for oil
Deepwater oil rigs now cost between around $600m to build
Changing supply / demand conditionsMarket Change Shift in Supply or
Demand?Rise or Fall in Market Price for Crude Oil?
• There is a fall in the number of active oil rigs in many of the world’s major oil producers
Supply
Quantity of crude oil
Price of crude oil
D1
S1
Q1Q2
P2
P1
S2
Impact of changing oil prices
Oil Industry
• Exploration & Drilling
• Investment
People• Cost of living• Real incomes
Related sectors
• Oil substitutes• Oil supply
chain industries
Connections
Connections
StakeholdersGroups who benefit from high oil prices
Oil companies
Oil exporting nations
Government – oil taxes
Renewable energy industry
StakeholdersGroups who benefit from high oil prices
Groups who lose out from high oil prices
Oil companies Motorists
Oil exporting nations Transport businesses e.g. airlines, road haulage
Government – oil taxes Higher energy prices - consumers
Renewable energy industry Businesses hit by falling real incomes of households
The Global Market for Aluminium
Aluminium Prices
Shifts in supply & demandMarket Change Shift in Supply
or Demand?Rise or Fall in Market Price for Aluminium?
A fall in demand for new long-haul aircraft
Tighter fuel-efficiency standards for new vehicles in the USA
A persistent fall in the world price of steel
A rise in the price of bauxite (used in manufacturing aluminium)
P7
Shifts in supply & demandMarket Change Shift in Supply
or Demand?Rise or Fall in Market Price for Aluminium?
A fall in demand for new long-haul aircraft
DEMAND FALL
Tighter fuel-efficiency standards for new vehicles in the USA
A persistent fall in the world price of steel
A rise in the price of bauxite (used in manufacturing aluminium)
Please use BIG DIAGRAMS – large, clear diagrams are easier to mark and credit!
Shifts in supply & demandA fall in demand for new long-haul aircraft
DEMAND FALL
Price of Aluminium
Demand
Supply
P1
Q1 Quantity of Aluminium
Shifts in supply & demandA fall in demand for new long-haul aircraft
DEMAND FALL
Price of Aluminium
Demand
Supply
P1
Q1 Quantity of Aluminium
D2
Shifts in supply & demandA fall in demand for new long-haul aircraft
DEMAND FALL
Price of Aluminium
Demand
Supply
P1
Q1 Quantity of Aluminium
D2
P2
Q2
Shifts in supply & demandMarket Change Shift in Supply
or Demand?Rise or Fall in Market Price for Aluminium?
A fall in demand for new long-haul aircraft
DEMAND FALL
Tighter fuel-efficiency standards for new vehicles in the USA
DEMAND RISE
A persistent fall in the world price of steel
A rise in the price of bauxite (used in manufacturing aluminium)
Shifts in supply & demandMarket Change Shift in Supply
or Demand?Rise or Fall in Market Price for Aluminium?
A fall in demand for new long-haul aircraft
DEMAND FALL
Tighter fuel-efficiency standards for new vehicles in the USA
DEMAND RISE
A persistent fall in the world price of steel
DEMAND FALL
A rise in the price of bauxite (used in manufacturing aluminium)
Shifts in supply & demandMarket Change Shift in Supply
or Demand?Rise or Fall in Market Price for Aluminium?
A fall in demand for new long-haul aircraft
DEMAND FALL
Tighter fuel-efficiency standards for new vehicles in the USA
DEMAND RISE
A persistent fall in the world price of steel
DEMAND FALL
A rise in the price of bauxite (used in manufacturing aluminium)
SUPPLY RISE
Shifts in supply & demand
Price of Aluminium
Demand
Supply
P1
Q1 Quantity of Aluminium
D2
P2
Q2
A rise in the price of bauxite (used in manufacturing aluminium)
SUPPLY RISE
S2
Shifts in supply & demand
Price of Aluminium
Demand
Supply
P1
Q1 Quantity of Aluminium
D2
P2
Q2
A rise in the price of bauxite (used in manufacturing aluminium)
SUPPLY RISE
S2
P3
Q3
Price of Aluminium
D1
S1
P1
Q1Quantity of Aluminium
Price of Pepsi Max
Di
Si
Pi
Qi
Inter-related markets
Quantity of Pepsi Max
Price of Aluminium
D1
S1
P1
Q1Quantity of Aluminium
Price of Pepsi Max
Di
Si
Pi
Qi
Inter-related markets
D2
P2
Q2 Quantity of Pepsi Max
Price of Aluminium
D1
S1
P1
Q1Quantity of Aluminium
Price of Pepsi Max
Di
Si
Pi
Qi Quantity of Pepsi Max
Inter-related markets
D2
P2
Q2
Sii
Pii
Qii
Analysis
Evaluation
Application
Good application opens the door to good analysis and good evaluation
”A new norm of high prices seems to
be consolidating, and the world
cannot afford to be complacent to this
trend while 870 million people still live in hunger and
millions of children die every year from
preventable diseases caused by
malnutrition.”
Why are prices volatile in the markets for many commodities?
Low Ped (<1)
Low Pes (<1)
Volatile Supply Shocks
Market Specula
-tors
Double diagrams can be a handy way of analysing
changing elasticity of demand and supply
Using analysis diagramsPrice
Quantity
Price
Quantity
Using analysis diagramsPrice
Quantity
Price
Quantity
S1
D1
RISE IN MARKET DEMAND
Using analysis diagramsPrice
Quantity
Price
Quantity
S1
D1 D2
P1
P2
RISE IN MARKET DEMAND
Using analysis diagramsPrice
Quantity
Price
Quantity
S1
D1 D2
P1
P2S1
D1
RISE IN MARKET DEMAND RISE IN MARKET SUPPLY
Using analysis diagramsPrice
Quantity
Price
Quantity
S1
D1 D2
P1
P2S1
D1
S2
P1
P2
RISE IN MARKET SUPPLYRISE IN MARKET DEMAND
Problems arising from price volatilityRisk and Uncertainty• Uncertain incomes and profits for farmers• May limit capital investment / productivity
Extreme poverty and unemployment• Millions of smaller farmers in the world• Many do not gain when world prices rise• Monopsony power of commodity buyers
Macroeconomic effects• Volatile export revenues affects trade balance• Causes inflation and extreme food poverty
Problems arising from price volatilityRisk and Uncertainty• Uncertain incomes and profits for farmers• May limit capital investment / productivity
Extreme poverty and unemployment• Millions of smaller farmers in the world• Many do not gain when world prices rise• Monopsony power of commodity buyers
Macroeconomic effects• Volatile export revenues affects trade balance• Causes inflation and extreme food poverty
Problems arising from price volatilityRisk and Uncertainty• Uncertain incomes and profits for farmers• May limit capital investment / productivity
Extreme poverty and unemployment• Millions of smaller farmers in the world• Many do not gain when world prices rise• Monopsony power of commodity buyers
Macroeconomic effects• Volatile export revenues affects trade balance• Causes inflation and extreme food poverty
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