Eco notes:

Demand: The willingness and financial ability to buy a product at different prices and different time
periods

Law of demand: Other things remaining constant (ceteris paribus) when the price increases, the quantity
demanded falls

Determinants of demand (ceteris paribus):

Price: when price increases quantity decreases, there is a movement of the demand curve

Non price determinants: there is a shift of the demand curve

1. Income-

2 parts to understand income, the types of goods which are normal goods and inferior goods

Normal goods: as the income rises, the demand for the product also increases since people can afford to
buy more of the good. For example, travel would increase with an increase in income.

Inferior goods (when income increases, and quantity demanded decreases its considered an inferior
good): As the income increases, people begin to purchase less of these goods. An example of inferior
goods is groceries.

2. Price of related goods

Under related goods there are two types of goods:

Substitute goods-

If products are substitutes for each other, then a change in the price of one of the products will lead to a
change in demand for the other product. If there is a fall in the price of tea, then there will be an
increase in the demand for tea and a decrease in the demand of coffee since tea and coffee are
substitutes for each other.

Complimentary goods-

Complimentary goods are goods that are often purchased together, for example milk and cereal. If there
is a fall in the price of milk, then there will be an increased quantity demanded of milk which will cause a
rise in the quantity demanded of cereal

3. Tastes and preference:

If tastes change in favor of a particular, then more will be demanded at every price
 4. Future price expectations:

If consumers expect the price of a good to increase in the future, then they will buy more of the product
currently, and if they expect the price of a good to decrease in the future they will buy more of the
product in the future and less currently.

5. Number of consumers

If there is an increase in the number of consumers of a product, then the demand curve shifts to the
right, and if number of consumers decreases then the demand curve shifts to the left

Relationship between individual consumer demand and market demand:

Market demand= summation of all individual consumer demand

Assumptions behind the law of demand:

1) All consumers are rational, which means they always make correct decisions which maximizes
their utility, hence known as homo economicus
2) Consumers have perfect knowledge of the market

Behavioral economics:

It was theorized by Richard thaler

Thaler theorized that econs (neo classical economists) don’t exist

Bual system model:

It said there are two

types of thinking,
automatic (short term)
and reflective (long term)
thinking

Neo classical consumers

always use reflective
thinking

How cognitive biases

affect decision making-

1) Availability bias: which is relying on recent examples rather than carefully examined data, for
example believing smoking is not bad for health because there is an old person smoking
 2) Anchoring bias: when a value for a product is taken as a reference point, for example if 20
dollars is the price of a calculator then when its increased to 25 consumers will be wary to buy it
and if its decreased to 15 dollars consumers will want to buy it more

3) Framing bias: the way that information is presented influences our choices, for example if a pack
of milk says it has 90 percent protein on the pack and another pack says it has 10 percent fat on
the carton rather than 90 percent protein more people tend to buy the former rather than the
latter

4) Social conformity/herd behavior: people tend to fit into the crowd hence buy products which
other people buy as well. For example, if white sneakers are popular then people will end up
buying white sneakers to “fit in”

5) Status quo/inertia bias: when consumers are faced with bewildering choices, they would prefer
to maintain status quo by not doing anything. For example, if a better phone is in the market
and a consumer wants to switch phones, they might not because they would have to conduct
extensive research hence, they might just choose to continue with their current phone.

6) Loss aversion bias: Humans feel that losses are more far more significant that gains hence
people may make poor choices out of the fear of suffering a loss.

7) Hyperbolic discounting: it refers to the tendency of humans to prefer short term gain over long
term benefit

How can behavioral economics be used to help consumers make better choices:

Due to the many cognitive biases behavioral economics helps through choice architecture

What is choice architecture:

Choice architecture is the theory that the decisions we make are heavily influenced by the way they are
presented to us

An example of this is organ donation, if in a country organ donation is an opt out situation people are
much more likely to donate their organs because they would have to opt out, however in places where
you are asked if you want to donate your organs and have to opt in people are less likely to donate their
organs.

The key to nudge theory is that consumers maintain their choice and they are just nudged in the right
direction. For example in a supermarket there is candy right next to the cashier and people are more
likely to but the candy since its right there, however if there were vegetables or fruits there people
would be nudged in the right direction and buy the fruits and vegetables.
Elasticity of demand:

Elasticity of demand is a measure of how much the demand for a product changes when there is a
change in one of the determinants of demand.

Ped= percentage change in quantity demanded/percentage change in price of product

Range of values for ped:

Ped= infinity- perfectly elastic

Ped=0 perfectly inelastic

Ped=1- unitary elastic demand- this means if price is raised by x amount, then the quantity demanded
will fall by x amount

Ped= between 0 and 1- relatively inelastic demand- change in price leads to a smaller change in quantity
demanded so it looks like there is no change in the graph

Ped= greater than 1- relatively elastic demand- percentage change in price leads to larger change in
demand hence graph is more steep

Determinants of price elasticity of demand:

1) Number and closeness of substitutes: more the number of substitutes leads to greater elasticity

2) Necessity of product and how widely the product is defined: if the product is necessary the
demand is inelastic however if the product does not have as much necessity, it is elastic

3) Proportion of income spent on good: if a lesser amount of income is spent out of a person’s
budget, then the demand is inelastic

4) Time period: Ped is inelastic in short term and elastic in the long term

Variables which decide short term and long term:

Land, entrepreneur, capital, labor

Why knowledge of price elasticity of demand is important for decision making by governments and
firms:

For firms the main use is for predicting the effects of their pricing decisions on quantity demanded and
on total revenue
For governments it helps them for the imposition of taxes as when the demand is relatively elastic there
would be lesser tax, however with relatively inelastic demand there is higher tax

Difference between price elasticity of demand for primary commodities and manufactured products:

For primary commodities demand is inelastic however for manufactured products the demand is elastic

Income elasticity of demand:

Necessity goods: relatively inelastic (low elasticity) since necessities no matter increase or decrease in
income will be bought at same quantity

Inferior goods: relatively elastic since demand decreases when income increases

Luxury goods or superior goods: high elasticity since with increase in income there will be proportionate
increase in demand of luxury goods

Primary commodities have relatively inelastic demand whilst manufactured goods have relatively elastic
demand

Law of supply:

The law of supply states ceteris paribus as price increases amount of quantity supplied also increases

Determinants of supply:

Price: As price increases amount of quantity supplied also increases and as price decreases amount of
quantity supplied decreases (law of supply)

Cost of factors of production: as the cost of the factors of production increases the quantity supplied
decreases and graph shifts leftwards, and if there is a decrease in the cost of the factors of production
there is an increase in the quantity supplied and graph shifts rightwards

Price of related goods: competitive and joint supply

Competitive supply- Producers have to choose the best allocation of resources from the given factors of
production. What this means is, for example if a producer is creating roller skates and there is a rise in
the price of skateboards. If it would take minimal change in the factors of production for producing
skateboards, they would shift to producing skateboards. Due to this there will be a movement along the
supply curve of skateboards and a leftwards shift of the supply curve of the rollerblades

Joint supply: joint supply refers to a product that can yield 2 or more products. For example, sugar which
can be used on its own but can also be refined to create molasses or cows which can be used to create
milk or a meat source. When the demand for one of the products in joint supply increases, the supply
for both products increases hence a shift to the right of the supply curve.

Government intervention: indirect taxes and subsidiaries

Indirect taxes: they are taxes on goods and services that are added to the price of a product, producers
have to pay this tax and when this is added the supply at each price goes down

Subsidies:

they are payments made by the government to firms that will reduce the cost of production for
suppliers. When subsidies are added there is a rightwards shift of the supply curve since there is a lower
cost of production.

Future price expectations:

If producers expect the demand to increase in the future, they will supply more for the future and will
produce the same amount currently however will store the excess for the future to meet the demand.
Producers who expect the demand to go down producers will try to lower their production.

Changes in technology:

Improvement in technology increases the supply and the supply curve shifts to the right

Weather or natural disasters:

Due to natural disasters, there can be huge impacts on supply since land labor capital and entrepreneur
would all take impact, and there will be a leftward shift of the supply curve. If the weather is good, for
the agricultural industry that is a huge benefit since they can have bumper crop, basically more supply of
the product and a rightwards shift of the supply curve.

How do economists explain the law of supply:

The short run:

Economists consider two periods while considering supply, the short run and the long run
These two are measured through the factors of production, in the short run only one factor can be
variable whilst in the long run all factors can be variable

Most production occurs in the short run

Increasing production in the short run is difficult because only one factor varies, which is labor since
capital entrepreneur and land are difficult to change in a small period of time

The time period is determined by the amount of time it takes for all factors to become variable

Law of diminishing marginal utility:

The more you use a product the lesser utility gained from it, for example if I’m thirsty the first sip of
water will bring me more utility than the second sip

Average product: total product (tp)/number of units of variable force employed (v)

Marginal producto: delta tp/ delta v

Price elasticity of supply:

PES formula: percentage change in quantity supplied/percentage change in price of product

If pes=0, then change in price of a product will have no effect on the quantity supplied

If pes greater than 1, elastic supply

If pes between 0 and 1, inelastic supply

If pes=1 unitary elastic supply

Determinants of elasticity of supply:

How much costs raise as output increases: If totals costs rise significantly as a producer tries to increase
supply, it is more likely that the producer won’t raise the supply since its proving to be too expensive
and hence the supply at a higher price is inelastic

Factors that assist in preventing significant rise in cost:

Existence of unused capacity: if the resources are not being allocated correctly (basically if there are
resources which are not being used) then the correct allocation of resources helps decrease the cost of
production and the production is relatively elastic, if the resources are correctly allocated then the
production is relatively inelastic
Mobility of factors of production:

If the factors of production are mobile, then the supply is relatively elastic and if factors are immobile
then supply is relatively inelastic

Time period: longer time means relatively elastic because factors of production can be variable in a
longer amount of time, in shorter period the factors are fixed so its relatively inelastic

Ability to store stock: if company is able to store more stock, then supply is relatively elastic and if they
are able to store minimum stock then supply is relatively inelastic

Elasticity of primary vs manufactured commodities:

Primary goods have inelastic supply because it is impossible to speed up the production of the goods
without ideal weather conditions where bumper crop is possible, manufactured commodities have
elastic supply because their production can be sped up by making the factors of production variable

Price equilibrium:

Equilibrium is defined as a state of rest, self-perpetuating in the absence of any outside disturbance

Excess demand: a price at which there is more demand than supply

Excess supply: a price at which there is more supply than demand

There is a shift in the equilibrium point of the graph when the determinants of demand or supply come
in effect

Price mechanism: forces of demand and supply

Functions of price in a market:

To signal information to consumers and producers- prices of a good are set by actions of consumers and
producers in a market, so they reflect the changing circumstances of a market hence they act as signals
to those in the market.
To ration scarce resources: resources are scarce and wants are unlimited and price helps to allocate and
ration scarce resources. If demand for a good is significantly higher than supply then the price of the
good will be higher, and the supply will be rationed to the consumers willing to pay the higher price.

to give incentive to consumers and producers: lower prices gives an incentive to consumers to buy more
of the good because they will receive greater utility from the good for their money spent and a higher
price would be a disincentive since it provides lower utility. When price increases due to increase in
demand it is an incentive for producers to create more. Hence producers allocate their resources
according to the change in the market (i.e., demand of a product)

Producer, consumer surplus:

Consumer surplus- extra utility gained by consumers from paying a price lower than what they are
prepared to pay

Producer surplus- excess of the actual earnings that a producer makes from a given quantity of output,
over and above the amount the producer would be prepared to accept for that amount

If consumer surplus is more than producer surplus its relatively elastic demand

When consumer and producer surplus is the same it is unitary elastic

When producer surplus is more than consumer surplus it is relatively inelastic demand

Government intervention:

Indirect tax: imposed upon expenditure

Direct taxes: imposed upon income

Reasons for imposing taxes:

For government to gain revenue

Government may put higher indirect taxes on goods such as cigarettes to disincentive consumption

Types of indirect taxes:

Specific and ad valorem

Specific tax: a fixed amount of tax imposed on a product, for example a tax of 1$ per unit on a
commodity, the diagram moves vertically upwards and parallel upwards

Ad valorem tax: a percentage tax on a good, such as gst, the supply curve moves vertically upwards but
not necessarily parallel
Who pays what share of indirect taxes:

When ped is relatively inelastic the consumer bears more tax

When ped is relatively elastic the producer bears more tax

When ped is unitary elastic the burden of tax is equally shared between producer and consumer

Subsidy:

A subsidy is an amount of money paid by the government to a firm, per unit of output

Causes of a subsidy:

To lower the price of essential goods such as rice the government hopes to increase the consumption of
the product since the public might be encouraged by lower prices

To guarantee the supply of products that are essential, when the government provides subsidiaries it
provides incentive to the producers to keep producing even when the demand is lower

To enable producers to compete with overseas trade thus protecting the home industry

Effect of the subsidy on graph:

If a subsidy is placed the graph shifts vertically downwards

Just like taxes there is specific subsidies which means a certain amount of subsidy per unit

Why do government impose price controls:

The free market doesn’t always bring out the perfect outcome and sometimes the government has to
impose

Price ceilings:

Maximum prices which a government sets below the equilibrium price

They are usually set to help the consumers if prices are too high for merit goods (necessities)

With imposition of price ceilings, the problem arises of excess demand and now a black market situation
may arise where the producers try to sell at the highest prices illegally

To curb this the government can do 2 things, shift the demand curve to the left or shift the supply curve
to the right

To increase the supply the government can do 3 things:

Provide subsidies to firms to encourage them to produce more

Start producing some of the good themselves and it becomes direct supply, this is known as direct
provision

If the government had stored stock previously, they could release some of it now so that there is
sufficient supply

Through this the government is able to shift the supply curve to the right but they incur a cost known as
opportunity cost

Price floors:

These are minimum prices set above the equilibrium price to help the producers

Causes for price floors:

To raise the income for producers of goods and services that the government thinks are important such
as agricultural products

To protect workers by setting a minimum price known as minimum wage to ensure that workers earn
enough to lead a reasonable existence

Effect of price floors:

Excess supply

Stuff to reduce excess supply:

The government intervenes further and solves this issue by buying the excess supply and this
incentivizes producers to keep producing but this brings about an opportunity cost for the government
since they have to buy up stock and can’t store nor destroy or dump in foreign nations

Another thing they can do to reduce excess supply is to limit the production of the good, but it would
mean that only a limited number of producers would receive the new price

Another thing that the government tries to do is increase the demand by advertising the product more

To reduce production the government restricts the supply of the raw materials of the good

Why do governments intervene:

To help consumers make better choices

Indirect taxes can disincentivize consumers from buying a product

Minimum prices to increase price of goods harmful for consumption and subsidies on healthy products
to make them more affordable

To promote sustainability:

Indirect taxes can be imposed on products that threaten sustainability

Subsidies can be put on products that promote sustainability

To promote equity and economic well-being:

Minimum wage to ensure that workers earn a fair payment for their labor hence minimum prices or
price floors

Maximum prices are set on necessities and rental accommodations