% CHANGE IN QS

% CHANGE IN QD
% CHANGE IN PRICE
% CHANGE IN PRICE
Price Elasticity
of Demand
Price Elasticity
of Supply Determinants
- Availability of substitutes
Determinants - If the good is a luxury or
necessity good.
- Level of spare capacity - If it’s an addictive good
- State of the economy - Time period = short run
- Ease of entry into
market Elasticity doesn’t really affect but in the
long run does.

% CHANGE IN QD

Cross Elasticity Income Elasticity % CHANGE IN INCOME

of Demand of Demand

% CHANGE IN QD FOR B
- Substitutes= rise in price in coffee,
- Normal good= when income
increased demand for tea
% CHANGE IN INCOME IN A increases, demand increase
- Complementary = fall in price of
- Inferior good = when income
fuel, increase demand for cars
increases, quantity decreases.
 Government Regulation Buffer Stock Schemes

Reduce price
Advantages of Regulations fluctuations of a
- Simple to understand. Eg age restrictions on
commodity.
alcohol.
- Its possible to fine companies who don’t apply to
the regulation
- Consumer protection laws may help reduce
asymmetric information

Disadvantages of Regulations How to correct

- Expensive to monitor firms actions
- Extras cost to firms – ie installing pollution market failure?
monitoring system.
- Hard to obtain a value for pollution emissions
- Regulations prevents the price mechanism from
working, it over rules it.
- If regulations fail it leads to government failure.

Advantages of Buffer Stock

- Reduce price fluctuations stabilize income.
- Greater certainty in the market, leads to more investment
- Helps ensure provision commodities even in poor harvest years

Disadvantages of Buffer Stock

- If several years of good harvest then puts pressure on government to
buy up stock – expensive
- Storage costs, security
- The good may be perishable so would not last in storage
- Years of bad harvest would lead it to low stock so price would
drastically increase.
 Grant provided by the Subsidies Tradable Pollution Permits
s
government to encourage
production and consumption.
- 2005 – European Commissions= this attempts to limit greenhouse gas
Goods that have high external emissions from heavy industry.
benefits - Each year they give out carbon dioxide permits. These permits are
tradable so firms can buy and sell them.

Advantages of Pollution Permits

- Specific market
- Pollution permits can reduce over time by cutting
emission allocations
- Firms have an incentive to invest in clean
technology
How to correct - Production costs will increase for firms who
exceed their permits.
market failure? - Governments can sell their permits for extra
cash.

Disadvantages of Pollution Permits

Advantages of Subsidies
- Reduce air pollution
- Uses more renewable energy to
promote sustained economic growth.
- Rate of consumption of non-renewable
resources is reduced.
Disadvantages of Subsidies
- Opportunity cost to government
subsidies = cut gov. spending
- Firms may become inefficient as
rely on subsidies
- Wind power may be less reliable
than fossil fuels.
- The commission may give too many credits thus
little incentive to reduce pollution.
- Disputes between companies as they think they
should receive larger permits.
- Firms may make higher costs to pay for buying
more permits.
- EU firms may avoid finding better technology
and get cheaper schemes in developing
countries.
- Just applies in the EU needs to be effective all
over the world.
 Taxes levied on the - Indirect taxation
Indirect taxation
expenditure of goods. The
- Subsidies
government imposes tax on
- Pollution permits
goods with big external
- Property rights
costs
- Regulation
- Buffer stocks
- Minimum pricing
- Free market equilibrium is Pe and Qe
- Socially optimum equilibrium is P1 and Q1
- ZY shows external cost
- By placing tax equal to external cost it
internalizes the pollution
- Consumer tax top = YP1PeT
- Producer tax bottom = PeTZW

Disadvantages of indirect tax
- Tax increases cost of production for firms so
make them less competitive.
- Firms may re locate to places with less tax
regulations
- Encourage development of illegal markets.
- The tax gained may not be used to help
environment or consumers.
- Difficult to put a price on pollution
How to correct
market failure?
Advantages of indirect tax
- Both producers and consumers pay
- They help internalize the external costs
while maintaining consumer choice.
- Level of pollution decreased as output has
decreased and price increased.
- Tax raised could help clean up
environment.
 Labour Immobility Imperfect Market Knowledge

Symmetric Information
Frictional Unemployment
- Normal – while people search for jobs and fill them. - Where consumers and producers have perfect and equal
market information on a good. This leads to an efficient
Structural Unemployment allocation of resources.
- Due to a mismatch of skills and location between job
seekers and providers Types of Market Asymmetric Information

Geographical Immobility Failure - Reality they both have imperfect and unequal
- Obstacles which prevent labour from moving from one knowledge upon which they make their decisions and
area to another:
(Knowledge, this could lead to inefficient allocation of resources
- Family, finance, knowledge Immobility) - Producers might know more about a good /service. E.g.
second hand salesman would know more about the
Occupational Immobility history of the car then the consumer.
- Prevent labour from changing type of occupation - The consumer if purchasing a insurance policy could hide
- Education, training, skills, work experience. information of a risky lifestyle.

Bad Harvest Unstable Commodity Markets Good Harvest

Commodities = Raw materials used in the
production of goods

- Good weather increases supply to S1,

cause prices to fall.
- Supply in inelastic
- Total revenue falls
- A necessity good

- Bad weather decreases supply and

so prices rise
- Total revenue increases
 Triangle of Welfare Loss Negative Externalities
- External Costs = occurs in production or consumption of a good/service.
- Eg chemical firm polluting a river. This is an external cost to water suppliers as
they would have to purify the water.
- Private Costs = costs internal to the firm. Cost of workers, rent, raw materials,
and machinery costs.
- Social Costs = is external and private costs added together:

Types of Market
Failure
(Externalities)

Positive Externalities
Triangle of Welfare Gain
- External benefits = recycling waste materials reduces amount of waste disposal
at landfill sites as well as re-using materials for production.
- Private Benefits= ie the revenue that a firms receive from selling a good/service
- Social Benefits = adding private and external benefits together
 Public Goods

Market Failure - Externalities

- Non Excludable
When the price mechanism causes - Public goods
- Non Rivalry inefficient allocation of resources - Imperfect market
- Once a public good has been provided, the cost of and leads to net welfare loss
knowledge
supplying it to an extra consumer is zero
- National defense, street lighting. - Labour immobility
- Unstable commodity
The Under Provision of Public Goods markets
- The free rider problem = It is not possible for
firms to withhold the good from those customers
who refused to pay for it. E.g. street lighting –
people refuse to pay as they know someone else
will. Why do some
- The valuation problem = It’s difficult to
measure the value obtained by consumers of Markets Fail?
public goods so hard to put on a market price.

Government Provision of Public Goods

- In a mixed economy governments provide public
goods to try and correct market failure.
Government Failure Poor Information, Political interference
- Raises funds from general taxation
- Merit good – vaccine less than the social This occurs when government politicians may have e.g. politicians may take
optimum position intervention to overcome market poor information the short term new long
failure fails. about the type of term effects
service to provide

Lack Of incentives:
There is no profit motive
Reasons Why? working in the public
sector this can lead to
inefficiency.
 Balance in market, with no tendency
Consumer Surplus
Extra amount of money for output or price to change
consumers are willing to pay
above what they actually pay.
Equilibriu
Consumer +
Producer

Producer Surplus Way price responds to

Extra amount of money paid to changes in demand or
producers above what they are supply for a product so
willing to accept. What Determines
new equilibrium is
the Price of a Good
reached
in a Market?

Price
Mechanism Functions

Rationing Device Incentive Device

If resources are scarce, the Rising prices
price mechanism allocates encourages firms to
them to those who are produce more. They can
prepared to pay the most also cover the extra
for them. costs as well.

Signalling Device
Price mechanism indicates changes in conditions of demand or supply.
Eg demand increase so firm supplies more. So more resources are
allocated to production
 Supply for Labour Demand for Labour

Derived Demand = where demand for one good or

Quality, quantity of labour hours offered
service occurs as a result of demand for another.
for work over a given time period

Revetments at Easington Determinants for demand for labour

Determinants for supply for labour
o Protect the gas terminal - Demand for final labour = An increase in
- Net migration = UK received boost in economy
o Large granite boulders stacked up demand for good/service is likely to cause a increase
from immigration mainly from Eastern Europe.
o Absorbs energy in demand for labour. Profit incentive, as prices
- The wage rate = increase in wage rate will increase because of demand.
o Very
encourage expensive
more people to over themselves for work.
- The wage rate = a fall in wage rate means
o Sometimes
Encourages people tounacctractive
work for longer.
labour becomes more affordable so firms will demand
- Income tax = reduction in income tax means more labour.
people have more disposable income and have an
incentive to work. Many people will substitute leisure
What Determines - Price of other factor inputs = increase price
of capital encourage firms to employ more labour and
for work. Wage Rate? cut back on machinery. This is because labour and
- Trade unions = trade unions act to increase wage capital may be substitutes in the production process.
rate and improve working conditions. This may
- Productivity of labour = an increase in output
encourage increase in supply of labour.
per worker may lead to higher revenue and profits,
- Government regulations = national minimum encouraging firms to employ more people.
wage help increase supply. However can reduce
- Government employment regulations =
labour by putting limits on max hours working time.
the fewer the regulations, the greater demand for
labour. Eg national minimum wage decreases labour
 Levied directly on
an individual or Grant usually
organisation provided by the
Levied on purchase Fall in price
of goods / services government to
increase supply.
Direct Tax

Subsidy is often paid

Indirect Tax
directly to producers, but

Tax Subsidie also reaches consumers as

output has increased

Ad Valorem tax: Specific tax:

Charged as a % of Fixed amount per
the price of a unit of good. How a Change in
good.
Price is Explained

Consumer tax on top!

 .
Maximum potential level of
Positive = Facts,
output for 2 goods/services Shift Outward
value free. Scientific
that an economy can achieve
approach. Due to:
when all resources are fully Quality/quantity or
Normative = Value employed. resources

judgements. Education/grants
New Technology
Should, ought,
better, fair Positive / Normative
Production Possibility Shift Inward
Statements
Frontiers Due to:

Nature of War
Natural disasters

Opportunity Cost Economics

Division of Labour
The value of the next Advantages:
best alternative - Be highly skilled in that
forgone. area
Form of specialisation - No time wasted
= individuals - Less time is required to
Free-market Free-market / concentrate on train workers
- More choice of jobs for
Malaysia Mixed Economies production of a
workers
particular good.
Decided by the Thailand - Higher output per worker
price mechanism: Disadvantages
- Reduces cost of output
Centrally Mixed - Repetition = boredom, high turnover of
- What
Planned staff
- How
- Who Decisions are - Structural unemployment, easy to
Government UK made partly by replace worker with robots.
makes all France private sector, - Specialization creates interdependence
in production. If one section goes on