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M.

5 Social Studies

TOPIC 4
UNIT 7 – HOW PRICES ARE
DETERMINED (P.104 – 134)
Unit Objectives

 Understand forces of supply and


demand.
 Market demand curve, supply
curve and equilibrium price.
 Price elasticity of demand and
price elasticity of supply.
 Effects of tax and subsidy.
What is
demand?
 Demand – want / willingness of
consumers to buy goods and
services.

 Quantity demanded – amount of
products consumers are willing to
buy.

Demand curve

 Shows amount of goods and services


people are willing to buy.
 Downward sloping.

Possible price of chocolate bar Your demand per month
(pence)

200p

150p

50p

30p

20p

10p

5p

1p

Now plot your
demand curve
in your
handout.
Demand curve is
downward
sloping.
Pr As price is high,
ic quantity demanded
e is low.

As price is low,
quantity demanded
is high.

Quanti
ty
Revenue
The revenue for
Pr producers is shown by
ic the white rectangle.
e 50 x 100 = 5000
50

100
Quanti
ty
Changes in demand curve

Movement along demand curve


 Changes in quantity because of
changes in price
 Ceteris Paribus – all other things
remain the same.
Changes
P,Q in
Pr quantity
ic demanded
e P1 , as price
Q1
changes .

P ,
Q
Quanti 
ty P ,
Q
Shifts in demand curve

 Demand curve shifts in or out


(Increase / decrease in demand)

What causes shift in
demand?
1. Changes in income
 When income rises, people
consume more goods.
 Normal goods – demand rises as
income rises.
 Inferior goods – demand falls as
income rises.
2. Changes in taxes on incomes.
 Lower tax = more disposable
income (money people have left
after spending or paying tax).

3. Complementary and substitute


goods
 Complementary goods – goods
used in combination with other
goods.
 Substitutes – goods which can
replace other goods.
4.Changes in tastes, habits
 Demands change as people’s
tastes and preferences change.

5.Population change

Possible Price of Original Demand per Increased demand per
Chocolate bars month month

50 100,000 200,000
40 150,000 250,000
30 200,000 300,000
20 260,000 360,000
10 330,000 430,000
5 400,000 500,000
Expansion
of quantity
Pr demanded as
ic income of
e consumers
increase .

D1
D

Quanti
ty
Shift in demand curve  S ame
priceS 
bigger quantitS
Pr
ic
e
P

D1
Q Q1 D

Quanti
ty
 Movement along demand curve is
due to changes in price only,
ceteris paribus.

 Extension or contraction of demand
curve is due to changes in other
factors (income, tastes and
preferences).
What is supply?
 Supply is want / willingness of
producers to sell goods and services.

 Quantity supplied – amount of


products, producers are willing to sell.
Possible price of Market supply per
tankards
20 month
1600
16 1100
12 700
8 300
4 100
As price rises,
quantity
supplied by
producers rises.
S

Pr
ic
e

Quanti
ty
Changes in supply curve

Movement along supply curve


 Changes in quantity because of
changes in price.

S

P1 ,
Q1

Pr
ic P, Q
e

Quanti
ty
Shifts in demand curve
S

Pr
ic S1
e

Quanti
ty
Shift in supply curve  Same
priceS bigger
quantitS
Pr S
ic
e S1
P

Quanti Q Q1
ty
What causes shift in
supply?
1.Changes in the cost of factors of
production.
2.Changes in price of other goods and
services.
3.Technological advances.
4.Business optimism and expectations.
5.Global factors.
 Exercise 6, P. 114
 Exercise 7, P. 116
Market Price
Reaching equilibrium

 Market price (equilibrium) is reached


when we combine supply and
demand curve.
 Equilibrium is the price and the
quantity of product that will be sold
and purchased.
S
Pr
ic
e
Equilibri
P um

D
Quantit Q
y
 In free market economy, the market
will determine the price and
quantity of goods / services.

 At equilibrium, the amount supplied


equals the amount demanded.
 Exercise 8, P.
118
Disequilibrium
Pr
ic Excess Supply S
e
30
0

20
0

10
0
Excess Demand
D
200 Quantit
y
 When we have disequilibrium, the
market forces will force the price
and quantity to the equilibrium
point again.
 Exercise 9, P. 120
 Exercise 10, P.

121
 Exercise 11, P.

122
Price Elasticity
Price Elasticity of Demand

 Responsiveness of quantity
demanded to changes in the price.
Formula

Elasticity < 1 = Inelastic demand


Elasticity = 1 = Unitary elastic
demand.
Elasticity > 1 = = Elastic demand.
Elasticity = 0 = Perfectly inelastic.
Elasticity = ∞ = Perfectly elastic.
Inelastic Demand
Small change
in quantity .
Big change in
price .
Elastic Demand
Big change in
quantity .
Small change
in price .
Factors that affect elasticity

1. Number of substitutes


 Demand is elastic if there are many
substitutes.
 Demand is inelastic if there are few
substitutes (e.g. Medicine)
2. Time Period
 When price rises, people search for
substitutes. The longer the time, the
more chance they have to find
substitute.

3. Proportion of income spent


 Cheap items (e.g. Newspaper) will
be inelastic.
 Expensive items (e.g. Cars) will be
elastic.
 Exercise 12 –
14, P.124 - 125
Price elasticity of supply

 Price elasticity of supply measures


the responsiveness of quantity
supplied to a change in price.
INELASTI
Pr C S
ic
e

P1

D D1

Q Q1 Quantit
y
ELASTIC
Pr
ic
e S

P1
P

D D1

Q Q1 Quantit
y
What affects elasticity of
supply?
1.Time
 Supply is price inelastic in the short
run.
 Supply is price elastic in the long
run.

 Producers have limited resources


and will have limited amount of
products to sell. It will take time to
produce more.
2.Availability of resources.
 If firms want to expand production,
they need more factors of production
(land, labour, capital).
 If all resources have been used up,
they cannot increase their
production, so supply is inelastic.
Taxes and Subsidies

 Governments often intervene in a


free market.
 Influences price and quantity of
products traded.

Taxes

 Taxes on goods and services are


called Indirect taxes
 Value added tax (VAT) – percentage
of price.
 Excise duties – fixed tax mark-up
(petrol, alcohol, cigarettes.)
Effects of tax on supply
S
P S1

S
P1
P

Q1 Q Q
Effects of subsidy on supply
S
P S

S1
P
P1

Q Q1 Q