The Allocation Of Resources In

Competitive Markets
 Content
• The determinants of demand for goods and services
• Price, income and cross elasticity's of demand
• The determinants of the supply of goods and services
• Price elasticity of supply
• The determination of market equilibrium prices
• Cause of changes in equilibrium price
• Demand and supply analysis in specific markets
• Interrelationships between markets
• How markets and prices allocate resources
The determinants of demand for goods and
services
• The demand curve shows the relationship between
price and quantity demanded
• Generally the higher the price of a product the
smaller the quantity demanded
• As price decreases quantity demanded increases
• Therefore the demand curve has a negative slope
Demand Curve
• The demand curve shows
an inverse relationship
between price and quantity
demanded
• If price changes then you
would move along the
demand curve to calculate
any change in quantity
demanded
 Shifts in the demand curve
• Changes the following factors causes a shift in the demand
curve:
– Prices of other goods – either substitutes or compliments
– Incomes
– Tastes and fashions
– Consumer expectations
– Advertising
– Population level and structure
• These factors can enable the demand curve to shift to the:
– Left (less demanded at each price)
– Right (more demanded at each price)
 Shifts in the demand curve
• These graphs show what would happen if
– Demand increased
– Demand decreased
 Price elasticity of demand
• Elasticity looks at the responsiveness of one
variable to a change in another
• Price elasticity:
– The responsiveness of demand to a change in price
– %change in quantity demanded / % change in price
– If PED > 1 it is elastic (flat demand curve)
– If PED < 1 it is inelastic (steep demand curve)
 Price elasticity of demand, revenue and
profit
• If a product is elastic to increase revenue you reduce price
• The reduction in price increases quantity demanded by a
greater amount therefore increasing revenue
• If a product is inelastic to increase revenue you increase
price
• The increase in price reduces quantity demanded by a
smaller amount therefore increasing revenue
• If costs stay the same then these actions will result in
greater levels of profit for the firm
 Income elasticity of demand
• Measures the responsiveness of demand to
changes in income
• % change in quantity demanded / % change in
income
• YED > 0 (positive sign) = Normal goods – as
income rises demand rises
• YED < 0 (negative sign) = Inferior goods – as
income rises demand falls
 Cross elasticity of demand
• Measures the responsiveness of demand of one
good to changes in the price of another good
• % change in quantity of good 1 / % change in price
of good 2
• Cross elasticity < 0 (negative sign) The goods are
compliments
• Cross elasticity < 0 (positive sign) The goods are
substitutes
Factors that influence elasticity of demand
• Number of substitutes – the greater the number of
substitutes the more elastic a product is
• The % of income spent on the product – the smaller
the % the more inelastic the good
• The time period – the longer this is the more elastic
the good is
• Luxury or necessity – Luxuries tend to be more
elastic and necessities more inelastic
 The determinants of the supply of goods
and services
• The supply curve shows the relationship between price and
quantity demanded
• The supply curve generally slopes upwards at higher prices
more is supplied
• There is a positive relationship between price and quantity
supplied
• As price increases revenues would increase for the supplier
• If revenues increase then profits would be likely to increase
encouraging producers to increase production levels
The Supply Curve
• If price changes the
quantity demanded will
change – this will indicate
a movement along the
supply curve
 Determinants of Supply
• The following factors influence supply:
– Profitability of other goods in production
– Technology
– Costs of production
– Natural shocks
– Social factors
– Expectations of producers
• Changes to any of these factors will cause the supply curve
to shift:
– Supply curve shifts to the left – less will be supplied at every price
– Supply curve shifts to the right – more will be supplied at every
price
 Shifts in the supply curve
• These graphs show the consequences of:
– An increase in supply
– A decrease in supply
 Price elasticity of supply
• This measures the responsiveness of supply to
changes in price
• % change in quantity supplied / % change in price
• If PES > 1 it is elastic – this means it is easy for
suppliers to respond quickly to price changes
• If PES < 1 it is inelastic – this means it is hard for
suppliers to respond quickly to changes in price
 Factors influencing Price Elasticity of
Supply
• Spare capacity – if there is lots of spare capacity the
business should be able to increase output quite quickly
therefore supply will be elastic
• Ease of factor substitution -If capital and labour resources
can easily be switched then the production process is more
flexible and elasticity of supply for a product is likely to be
higher
• Stocks – If stock levels are high then supply will be elastic
• Time period – the longer the time period the more likely
supply is likely to elastic as the firm has time to alter
production levels
 The determination of market equilibrium
prices
• The interaction of the demand
and supply curves sets the
equilibrium price in a market
• The equilibrium point is where
the supply and demand curves
cross
• Equilibrium price is p*
• Equilibrium quantity is q*
• Unless the demand or supply
curve shift p* and q* stay the
same
 Cause of changes in equilibrium price

• Shifts in the demand or supply curve will cause the

equilibrium price to change
• The extent to which the price changes is dependent
on the elasticity of demand / supply
 Demand and supply analysis in specific
markets
• Demand and supply may work differently in different
markets
• Governments may pay subsidies to producers in certain
markets
• These reduce producers costs of production and encourage
them to produce more therefore the firms supply curve
shifts to the right
• Subsidies are often common in agricultural markets, where
industries are struggling e.g. shipbuilding and where goods
are perceived as merit goods
 Consumer surplus
• A consumer surplus arises is where consumers are
willing to pay more for a good / service than they
actually do
• As the government provides health care free on the
NHS this represents a consumer surplus
 Different Markets
• In commodity markets such as coffee and oil
demand and supply interact to create an equilibrium
price
• In the housing market prices have risen as demand
has outstripped supply causing a shift in the
demand curve
 Interrelationships Between Markets
• Changes in one market are likely to influence other
markets
• Composite demand is the demand for a product
that has more than one use
• Derived demand is where demand for one good or
service is due to demand of another
• This may be due to the production process
• E.g. demand for trainers will increase demand for
rubber
 Joint demand
• Joint demand is where the demand of one product
is tied to the demand of another
• Joint demand occurs when products are
complements in production or consumption
• Because the products are used together the
demand for one good is tied to the demand for the
other good
• E.g. tea and milk – if there is no milk demand for
tea would decline
How markets and prices allocate resources

• Markets allocate resources as they allow all

consumers who are willing and able to purchase
goods at a set price to receive them
• Prices allow a good to be rationed – if the product is
in short supply the price of the good will increase so
only those willing to pay the highest prices will be
allocated the resources
How markets and prices allocate resources

• Incentives are any factor (financial or non-financial)

that provide a motive for a course of action
• Incentive pricing aims to encourage consumers to
purchase a particular product increasing its demand
• Prices can also be used as a signaling tool
• Often high prices are seen to reflect high quality
The effectiveness of the market system
• The allocation of resources in the market system is
not always efficient
• Governments may use taxes and subsidies to try
and correct market failure
• The market system only allocates resources to
those who are able to pay
 Summary
• Demand for goods and services is determined by price, tastes and fashions, income etc
• The demand curve has a negative slope more is demanded at lower prices
• Elasticity measures the responsiveness of one variable to a change in another
• PED looks at the responsiveness of quantity demanded to a change in price
• If a product is elastic quantity demanded is more responsive to a change in price
• The supply curve has a positive slope as price increases amount supplied also increases
• Price elasticity of supply looks at the responsiveness of quantity supplied to a change in price
• Where the supply curve and demand curve interact is market equilibrium
• Market equilibrium price changes if the demand or supply curves shift
• The extent of the change in market equilibrium price is dependent on elasticity's
• Demand and supply analysis can be used in many markets
• There are Interrelationships between demand and supply in different markets this is due to
composite demand, derived demand and joint demand
• Markets allocate resources to those that are able to pay at a certain price