Chap 5-13 ( The allocation of resources )

Economy: an area where people and firms produce, trade and consume goods and
services. This can vary in size- from your local town to your country, or the globe itself.

Chap 5: Microeconomics and Macroeconomics

Microeconomics is the study of individual markets. For example: studying the effect of
a price change on the demand for a good. Microeconomic decision makers are
producers and consumers (who directly operate in markets)

Macroeconomics is the study of an entire economy, as a whole. Examples include

studying the total size of the economy or the unemployment rate, among other things.
Macroeconomic decisions are made by the government of the particular economy – a
town, state or country)

Chap 6: The Role of Markets in Allocating Resources

Resource allocation: the way in which economies decide what goods and services to
provide, how to produce them and who to produce them for.

These questions- what to produce, how to produce, and for whom to produce – are
termed ‘the basic economic questions’. In short, resource allocation is the way in which
economies solve the three basic economics questions.

Market is any set of arrangements that brings together all the producers and consumers
of a good or service, so they may engage in exchange. Example: a market for soft drinks.
Goods and services are bought and sold in a market at an equilibrium price where
demand and supply are equal. This is called the price mechanism. It helps answer the
three basic economic questions. Producers will produce the goods that consumers
demand the most, it will be produced in a way that is cost-efficient, and will be
produced for those who are willing and able to buy the product.

Chap 7: Demand
Demand is the want and willingness of consumers to buy a good or services at a given
price. Effective demand is where the willingness to buy is backed by the ability to pay.
For example, when you want a laptop but you don’t have the money, it is called demand.
When you do have the money to buy it, it is called effective demand. The effective
demand for a particular good or service is called quantity demanded.
(Individual demand is the demand from one consumer, while market demand for a
product is the total (aggregate) demand for the product, or the sum of all individual
demands of consumers).
The law of demand states that an increase in price leads to a decrease in demand, and
a decrease in price leads to an increase in demand (it’s an inverse relationship between
price and demand. However it’s worth noting that an increase in demand leads to an
increase in price and a decrease in demand leads to a decrease in price. The law of
demand is established with respect to changes in price, not demand, hence the
difference).

A fall in demand for a product due to the changes in other factors (excluding price)
causes the demand curve to shift to the left (from A to B).
Factors that cause shifts in a demand curve:
● Consumer incomes: a rise in consumers’ incomes increases demand, causing a
shift to the right. Similarly, a fall in incomes will shift the demand curve to the
left.
● Taxes on incomes: a rise in tax on incomes means less demand, causing a shift to
the left; and vice versa.
● Price of substitutes: Substitutes are goods that can be used instead of a
particular product. Example: tea and coffee are substitutes (they are used for
similar purposes). A rise in the price of a substitute causes a rise in the demand
for the product, causing the demand curve to shift to the right; and vice versa.
● Price of complements: Complements are goods that are used along with another
product. For example, printers and ink cartridges are complements. A rise in the
price of a complementary good will reduce the demand for the particular product,
causing the demand curve to shift to the left; and vice versa.
● Changes in consumer tastes and fashion: for example, the demand for DVDs
have fallen since the advent of streaming services like Netflix, which has caused
the demand curve for DVDs to shift to the left.
● Degree of Advertising: when a good is very effectively advertised (Coke and
Pepsi are good examples), its demand rises, causing a shift to the right. Lower
advertising shifts the demand curve to the left.
● Change in population: A rise in the population will raise demand, and vice versa.
 ● Other factors, such as weather, natural disasters, laws, interest rates etc. can also
shift the demand curve.

Chap 8: Supply
Supply is the want and willingness of producers to supply a good or services at a
given price. The amount of goods or services producers are willing to make and supply
is called quantity supplied. (Market supply refers to the amount of goods and services all
producers supplying that particular product are willing to supply or the sum of
individual supplies of all producers).

The law of supply states that an increase in price leads to an increase in supply, and a
decrease in price leads to an decrease in supply (there is a positive relationship
between price and supply. However it’s also worth noting that, an increase in supply
leads to a decrease in price and a decrease in supply leads to an increase in price. The
law of supply is established with respect to changes in price, not supply, hence the
difference).

The increase in supply due to changes in price (without changes in other factors) is
called an extension in supply.

decrease in supply due to changes in price (without the changes in other factors) is
called a contraction in supply.

A rise in the supply for a product due to the changes in other factors (excluding price)
causes a shift to the right.

A fall in the supply for a product due to the changes in other factors (excluding price)
causes a shift to the left.

Factors that cause shifts in supply curve:

● Changes in cost of production: when the cost of factors to produce the goods
falls, producers can produce and supply more products cheaply, causing a shift in
the supply curve to the right. A subsidy*, which lowers the cost of production
also shifts the supply curve right. When the cost of production rises, supply falls,
causing the supply curve to shift to the left.
 ● Changes in the quantity of resources available: when the amount of resources
available rises, the supply rises; and vice versa.
● Technological changes: an introduction of new technology will increase the
ability to produce more products, causing a shift to the right in the supply curve.
● The profitability of other products: if a certain product is seen to be more
profitable than the one currently being produced, producers might shift to
producing the more profitable product, reducing supply of the initial product
(causing a shift to the left).
● Other factors: weather, natural disasters, wars etc. can shift the supply curve left.

Chap 9: Market Price

The market equilibrium price is the price at which the demand and supply curves in a
given market meet.

Disequilibrium price is the price at which market demand and supply curves do not
meet.

Chap 10: Price Changes

When the price is above the equilibrium price, a surplus is experienced. (Surplus
means ‘excess’).

When the price is below the equilibrium price, a shortage is experienced. (This
shortage and surplus is said in terms of the supply being short or excess respectively).

Chap 11: Price Elasticity of Demand (PED)

The PED of a product refers to the responsiveness of the quantity demanded for it to
changes in its price.

PED (of a product) = % change in quantity demanded / % change in price

For example, calculate the price elasticity of demand of Coca-Cola from this diagram.
PED= [(500-300/300)*100] / [(80-60/80)*100]
= 66.67 / 25 = 2.67
a change in price makes a higher change in quantity demanded. These products have
a price elastic demand. Their values are always above 1.
When the % change in quantity demanded is lesser than the % change in price, it is said
to have a price inelastic demand. Their values are always below 1. A change in price
makes a smaller change in demand.

When the % change in demand and price are equal, that is value is 1, it is called
unitary price elastic demand.

When the quantity demanded changes without any changes in price itself, it is said to
have an infinitely price elastic demand. Their values are infinite.

When the price changes have no effect on demand whatsoever, it is said to have a
perfect price inelastic demand. Their elasticity is 0.

What affects PED?

● No. of substitutes: if a product has many substitute products it will have an
elastic demand. For example, Coca-Cola has many substitutes such as Pepsi and
Mountain Dew. Thus a change in price will have a greater effect on its demand (If
price rises, consumers will quickly move to the substitutes and if price lowers,
more consumers will buy Coca-Cola).
● Time period: demand for a product is more likely to be elastic in the long run.
For example, if the price rises, consumers will search for cheaper substitutes. The
longer they have, the more likely they are to find one.
● Proportion of income spent on commodities: goods such as rice, water
(necessities) will have an inelastic demand as a change in price won’t have any
significant effect on its demand, as it will only take up a very small proportion of
their income. Luxury goods such as cars on the other hand, will have a high price
elastic demand as it takes up a huge proportion of consumers’ incomes.

Relationship between PED and revenue and how it is helpful to producers:

Producers can calculate the PED of their product and take a suitable action to make the
product more profitable.
Revenue is the amount of money a producer/firm generates from sales, i.e., the total
number of units sold multiplied by the price per unit. So, as the price or the quantity
sold changes, those changes have a direct effect on revenue.
If the product is found to have an elastic demand, the producer can lower prices to
increase revenue. The law of demand states that a price fall increases the demand. And
since it is an elastic product (change in demand is higher than change in price), the
demand of the product will increase highly. The producers get more revenue.

If the product is found to have an inelastic demand, the producer can raise prices to
increase revenue. Since quantity demanded wouldn’t fall much as it is inelastic, the
high prices will make way for higher revenue and thus higher profits.

Chap 12: Price Elasticity of Supply (PES)

The PES of a product refers to the responsiveness of its quantity supplied to changes
in its price.

PES of a product= %change in quantity supplied / %change in price

Similar to PED, PES too can be categorized into price elastic supply, price inelastic
supply, perfectly price inelastic supply, infinitely price elastic supply and unitary price
elastic supply. (See if you can figure out what each supply elasticity means using the
demand elasticities above as reference, and draw the diagrams as well!)

What affects PES?

● Time of production: If the product can be quickly produced, it will have a price
elastic supply as the product can be quickly supplied at any price. For example,
juice at a restaurant. But products which take a longer time to produce, such as
cars, will have a price inelastic supply as it will take a longer time for supply to
adjust to price.

● Availability of resources: More resources (land, labour, capital) will make way for
an elastic supply. If there are not enough resources, producers will find it difficult
to adjust to the price changes, and supply will become price inelastic.
Chap 13: Market Economic System
In a market economic system or free market economic system, all resources are
allocated by the market – private producers and consumers; that is, there is no or very
little government intervention in resource allocation. (There are virtually no economies
in the world that follow this system – there is government control everywhere, although
Hong Kong and Singapore do come close – check out the Index of Economic Freedom to
see the ranking of economies on the basis of how market-friendly they are

Features:
● All resources are owned and allocated by private individuals.
● Government refrains from regulating markets. It instead tries to create very
business-friendly environments and any intervention is mostly limited to
protecting private property. The demand and supply fixes the price of products.
This is called the price mechanism.
● What to produce is solved by producing the most-demanded goods for which
people spend a lot, as their only motive is to generate a high profit.
● How to produce is solved by using the cheapest yet efficient combination of
resources – capital or labour- in order to maximise profits.
● For whom to produce is solved by producing for people who are willing and
able to pay for goods at a high price.

Advantages:
● A wide variety of quality goods and services will be produced as different firms
will compete to satisfy consumer wants and make profits. Quality is ensured to
make sure that consumers buy from them. There is consumer sovereignty.
● Firms will respond quickly to consumer changes in demand. When there is a
change in demand, they will quickly allocate resources to satisfying that demand,
so as to maintain profits.
● High efficiency will exist. Since producers want to maximise profits, they will
use resources very efficiently (producing more with less resources).
● Since there is hardly any government intervention (in the form of regulations,
extra fees and fines etc. for example), firms will find it easy and inexpensive to
start and run businesses.

Disadvantages:
 ● Only profitable goods and services are produced. Public goods* and some merit
goods* for which there is no demand may not be produced, which is a drawback
and affects the economic development.
● Firms will only produce for consumers who can pay for them. Poor people who
cannot spend much won’t be produced for, as it would be non-profitable.
● Only profitable resources will be employed. Some resources will be left unused.
In a market economy, capital-intensive production is favoured over labour-
intensive production (because it’s more cost-efficient). This can lead to
unemployment.
● Harmful (demerit) goods may be produced if it is profitable to do so.
● Negative impacts on society (externalities) may be ignored by producers, as their
sole motive is to keep consumers satisfied and generate a high profit.
● A firm that is able to dominate or control the market supply of a product is called
a monopoly. They may use their power to restrict supply from other producers,
and even charge consumers a high price since they are the only producer of the
product and consumers have no choice but to buy from them.
● Due to high competition between firms, duplication of products may take place,
which is a waste of resources.

*Public goods: goods that can be used by the general public, from which they will
benefit. Their consumption can’t be measured, and thus cannot be charged a price for
(this is why a market economy doesn’t produce them). Examples are street lights and
roads.

*Merit goods: goods which create a positive effect on the community and ought to be
consumed more. Examples are schools, hospitals, and food. The opposite is called
demerit goods which includes alcohol and cigarettes

*Subsidies: financial grants made to firms to lower their cost of production in order to
lower prices for their products.