Allocation of Resources

Microeconomics and Macroeconomics

Microeconomics

 It is the study of particular markets, and segments of the economy. It looks at issues

such as consumer behaviour, individual labour markets, and the theory of firms.

 It involves supply and demand in individual markets, Individual consumer behaviour,

and individual labour markets

 Example - A consumer considering his options while buying a production

Macroeconomics

 Study of the whole economy. It looks at ‘aggregate’ variables, such as aggregate

demand, national output and inflation.

 Involves decisions made by the government regarding, for example, policies

 Example - Governments deciding on the tax rates

The role of markets in allocating resources

The Market System

 A market economy is an economic system in which economic decisions and the

pricing of goods and services are guided by the interactions of supply and

demand- the market mechanism

Key Resources Allocation Decisions

The basic economic problem of scarcity creates three key questions

 What to produce?

 How to produce?
 For whom to produce?

Introduction to the Price mechanism

 It aids the resource allocation decision making process. The decision is made at the

equilibrium point where supply and demand meet

Features of Price Mechanism

 Private Economic Agents can allocate resources without any intervention from the

government

 Goods and Services are allocated based on price (Higher Price means more supply and

lower price means more demand)

 Allocation of Factors of Production is based on financial returns

 Competition creates choices and opportunities for firms, private individuals and

consumers.

Demand
 Demand refers to the willingness and the ability of customers to buy a good or service

at a given price level.

 Higher price of good = less people demand that good, hence, demand is inversely

related to price

Price∝1DemandPrice∝Demand1

 Factors that affect demand

o Price

o Advertising

o Government Policies

o Consumer tastes/preferences

o Consumer Income

o Prices of substitute/ complementary goods

o Interest rates (price of borrowing money)

o Consumer population (population increase = demand increase)

o Weather

 The individual demand is the demand of one individual or firm

 The market demand represents the aggregate of all individual demands

Movement along the Curve Shift of the Curve

A Change in the price of the
Changes in Non-Price factors cause the demand
good or service will cause
curve to shift. These factors include tastes, prices
movement along the curve.
of substitute goods, consumer incomes and many
The movement can be either
more.
contraction or extension.
Movement along the Curve Shift of the Curve

Contraction is caused when

the demand falls due to an
increase in price, This causes
the point to go upwards. An increase in demand causes the demand curve
Extention is caused when the to shift rightwards and a decrease in demand
demand increases because of shifts the curve towards the left.
a decrease in price, This
causes the point to go
downwards
 Supply
 Supply refers to the ability and the willingness of suppliers to provides goods and

services at a given price.

Higher price of good = higher quantity

supplied, hence quantity is directly proportional to price

Price∝Quantity suppliedPrice∝Quantity supplied

 Factors that affect supply

o Cost of factors of production

o Prices of other goods/services

o Global factors

o Technology advances

o Business optimism/expectations

 The individual supply is the supply of an individual producer

 The market supply is the aggregate of the supply of all firms in the market

Price Determination

Market Equilibrium

 When supply & demand are equal the economy is said to be at equilibrium
 At this point, the allocation of goods is at its most efficient because amount of goods

being supplied is the same as amount of goods being demanded & everyone is satisfied

Market Disequilibrium

Excess Supply Excess Demand

If the price is set too high, excess

When price is set below the equilibrium
supply will be created within the
price. Creates demand that exceeds
economy and there will be allocative
production due to the low price.
inefficiency
Price Changes

Causes of Price Changes

 A change in supply

 A change in demand
 Consequences of Price Changes

 An inward shift of the supply curve will increase prices and vice versa

 An inward shift of the demand curve will decrease prices and vice versa

Price Elasticity of Demand

 Definition: The responsiveness of demand to a change in price

Inelastic Demand Elastic Demand

PED lower than 1 PED greater than 1
The necessity of the product is high – it The necessity of the product is
is either essential or habitual relatively low
A change in price has little effect on the Demand would respond quickly and
change in demand more drastically

PED=% change in price% /change in quantity demanded

 When demand is price inelastic:

o An increase in price would raise revenue

 When demand is price elastic:

o A decrease in price would raise revenue

 Factors that affect PED:

o The number of substitutes

o The period of time

o The proportion of income spent on the commodity

o The necessity of the product

Special Situation with PED

Perfectly Price
Perfectly Price Elastic Unitary Price Elastic
Inelastic
Any changes in the The percentage change in price
Changes in price do
price will lead to is proportional to the
not affect the
quantity demanded percentage change in quantity
quantity demanded
being zero demanded

Price Elasticity of Supply

 Definition: The responsiveness of quantity supplied to a change in price

Inelastic Supply Elastic Supply

It has a PES less than 1 It has a PES more than 1
A large price change will A large price change will have
have little effect on the amount supplied a large effect on the amount supplied

PES=% change in price% /change in quantity supplied

 Factors that affect PES:

o Time

o Availability of resources
o Supply available to meet demand

o Spare production capacity available

o Factor substitution available