Resource allocation in the market

1
Resource allocation in the market

• A market is the meeting of buyers and sellers.
  You do not have to physically meet. Bu there must
  be both buyers an sellers.
• The forces of demand and supply are two forces in
  a market. The buyers demand things and the
  sellers supply things.

2
Demand

• A demand curve shows the quantity that consumers
  are willing and able to purchase at each and
  every price. The demand curve represents the
  relationship between price and the quantity
  demanded. (P and QD). It is the amount bought.
  Demand is not a wish or desire or need.

3
Supply

• Supply differs from demand in that most supply
  decisions have to be made ahead of the market
  transaction. Suppliers have to guess what will be
  demanded.
• Supply is the quantity of a good or service which
  a seller is willing to provide a t a particular
  price over a particular period of time. Supply
  represents the relationship between QS and P.

4
The demand function

• What determines QD over a particular period of
  time?
• PRICE!
• So the QD of good x is a function of its own
  price QDxfPx.
• In fact, price is the most important thing that
  determines how quantity demanded there is

5
The law of demand

• A higher quantity will be demanded (ceteris
  paribus-all else equal) at a lower price. By the
  same token the quantity demanded will fall as
  prices rise
• QD? as P? and P? QD?
• (Graphs page 4 of Gillespie showing that a change
  in price?P will lead to a change in QD, shown by
  a movement along the curve)

6
The demand function (again)

• Price is not the only thing that determines the
  quantity demanded.
• The prices of close substitutes to x and
  complementary goods to x are also important. A
  substitute good is one that acts as a close
  alternative for the original good
  (beef/pork/fish,butter margarine) Complementary
  goods usually go together(cars/gasoline, golf
  clubs/golf balls). Again, in economics it is not
  what a good is, but how it is acting in a given
  situation. Therefore QdxfPxPsPc

7
The demand function

• How much we earn as a household is another
  important determinant of demand.
• More income (Y) usually means more demand (D).
  Demand for countries is also closely associated
  with their ability to buy i.e. their income (GDP-
  gross domestic product amount produced by a
  country in a given year). Deamd for goods and
  services in very high in Japan compared to
  Malawi. Y is the symbol for income. Therefore
• QdxfPxPsPcY

8
Income and substitution effects

• Y and D are positively correlated as Y? so D?.
  If income increases demand increases, if income
  decreases, so demand decreases (ceteris paribus).
  This is when we are dealing with normal goods.
• There are goods that correlate inversely with
  income. When Y falls demand for these goods
  increases. These are known a s inferior goods (it
  does not mean that there is something wrong with
  the good. It can vary from time to time. (e.g.
  rice and buses, bicycles in China-inferior versus
  mountain bikes in US-normal)

9
Income and substitution effects

• If P falls QD will increase. Why
• 1.substitution effect- good A falls in price, A
  become relatively cheaper than other alternative
  goodsconsumers buy more of A
• 2. Income effect-fall in P of good Amore real
  income. If the same amount of goods were bought
  as before then money may be left overpurchasing
  power has increasedconsumers will buy more
  normal goods. Of the two the substitution is the
  larger effect (usually.)

10
Giffen Goods and Veblen Goods

• These are exceptions to the substitution effect
  being dominant.
• Giffen goods- Qd falls when P falls so the demand
  curve is upward sloping. E.g potatoes in the
  famine. When P? for an inferior good (potatoes)
  is so large it will outweigh the sub effect and
  people will buy more potatoes.
• Veblen goods-ostentatious goods. As P? so QD?
  because they are more expensive.

11
Shift in demand

• A change in the price of x leads to a change in
  the OD of x which results in movements along the
  demand curve. (see graph)
• A change in any of the other determinants of
  demand cause shifts in the actual demand curve.
  At each and every price there is an increase or a
  decrease in the QD (see graph)

12
Shifts in demand

• The demand curve can shift outward when more is
  demanded at each and every price. Because
• Real income has risen (assuming normal goods)/
  the price of a substitute has gone up/ the price
  of a complement good has gone down/more effective
  advertising/population growth/ change in tastes/
  more credit is available so people can borrow
  more etc.( i.e. Interest rates have fallen the
  cost of borrowing money)

13
Why do demand curves slope downward?

• In a nutshell, because of the law of diminishing
  marginal utility. Each extra unit of a good or
  service will eventually give less
  satisfaction(utility) therefore consumers will
  only be willing to pay less for more goods.
• NB-although the consumer gets less extra
  satisfaction from each additional unit his or her
  total satisfaction will continue to rise to a
  point.

14
A word about Ceteris paribus

• It literally means other things being equal.
  Think in scientific terms if you want to see the
  effect of one variable on another you need to
  isolate it from all other variables. T
• This is impossible to do in reality, but it is
  assumed in economics to take place to simplify
  our understanding.

15
Other factors that determine demand

• Consumer taste these are lumped together to
  include all psychological factors such
• I like the taste of x x is healthy for you
  this is a healthy activity
• Size of population is another determinant of
  demand
• Weather could also be a factor
• Advertising could also be a determinant