DEMAND The basic law of demand states that as the price of a good falls people will buy more of it....

DEMAND

• The basic law of demand states that as the price of a good falls people will buy more of it. (Certainly Michael O’Leary of RyanAir believes in this law with his persistent emphasis on low air fares as the means to boost consumer demand!)

• Alternatively when the price rises the quantity demanded will fall Therefore we can see that the Government in its attempt to reduce cigarette smoking keeps increasing the price in the budget!

• The demand curve shows the relationship between price and quantity of the good in question (assuming all other factors affecting demand remain unchanged)

• It slopes down from left to right showing that as the price falls more will

be demanded

• Alternatively as the price rises typically less will be demanded of a good

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Market demand(tonnes 000s)

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Demand

Market demand for potatoes (monthly)Market demand for potatoes (monthly)

OTHER FACTORS AFFECTING DEMAND

• Income is very important. When income goes up people will generally buy more of a good e.g. motor cars. Exceptions are inferior and Giffen goods

• The prices of substitute (and complementary) goods are also significant. If

the price of coffee was to rise sharply it would help tea sales (substitutes). If the price of petrol was to rise it could damage car sales (complementary)

• Tastes are important. Goods - not just clothes - can come in and go out of

fashion (e.g. the recordings of various pop stars) • Advertising can influence demand. One of the reasons why Coca Cola

remains so much in demand is due to successful advertising • Also the weather can be a factor. For instance a long hot Summer would

help beer sales!

• In economics these other factors are shown through shifts in the demand curve (either left or right). Changes in price are represented by movements along the same demand curve

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An increase in demandAn increase in demand

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SUPPLY

Similar dynamics work on the supply side as with demand.

• The supply curve is based solely on the relationship between price and quantity supplied (assuming other factors remain unchanged)

• Thus when the price rises firms will be willing to produce more (due to the prospect of higher profit margins)

The supply curve thus slopes up from left to right

Thus a change in the price of a product produced is associated with

a movement along the supply curve

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Market supply of potatoes (monthly)Market supply of potatoes (monthly)

OTHER FACTORS AFFECTING SUPPLY

• As with demand other factors however can affect supply • For example costs of production are often critical. Thus

if a firm can reduce costs it will be willing to supply more (as with RyanAir) at the given price. This causes the supply curve to shift to the right

• Improvements in technology are also important (as they

affect costs) • Weather conditions are very important especially in

agriculture • Also the government can affect supply through

measures such as subsidies and taxation.

• Thus a change in some factor other that price causes a shift in the supply curve

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Shifts in the supply curveShifts in the supply curve

DETERMINATION OF PRICE

• The price in an market is determined by the intersection of demand and supply.

• The market comes into equilibrium at the price where supply = demand.

• If the demand initially exceeds supply then this will lead to a shortage in the market with consumers willing to pay more. This will cause prices to rise!

• If however supply exceeds demand this will lead to a surplus thus causing prices to fall

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The determination of market equilibrium (potatoes: monthly)



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SHORTAGE

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SHORTAGES

• Due to market price being artificially low which creates situation of excess demand

• Examples- tickets for a big match- Government controlled prices e.g. food and currency rates

Manner of dealing with situation

• Rationing- without any formal system of control this leads to queueing; when controlled e.g.

through ration coupons it can be more orderly through expensive to administer- rationing usually leads to the formation of an underground market, where free market forces operate with respect to sale of some of the product e.g. ticket touts selling at inflated prices

• Increase price to free market level- in economic terms this is the best solution (though can be socially inequitable)

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SURPLUSES

• Due to market price being artificially high, which creates situation of excess supply

• Examples- Common Agricultural Policy- Unemployment

Manner of dealing with situation

• Maintain price supports- by providing appropriate level of subsidies to producers prices can be maintained at high level

• Take surplus off market- this enables consumers to buy a smaller amount at artificially high price;

however it requires authorities to destroy, store or get rid of surpluses in alternative markets

• Reduce price to free market level- the most satisfactory economic way of dealing with problem

EFFECTS OF SHIFTS IN DEMAND AND SUPPLY CURVES

• If the demand curve moves outwards to the right e.g. through an increase in income, the price will rise (ceteribus paribus)

• If the demand curve moves inwards to the left e.g. through a fall in price of a substitute good, then price will fall (ceteribus paribus)

• If the supply curve moves outwards to the right e.g. through a fall in costs of production, then price will fall (ceteribus paribus)

• If the supply curve moves inwards to the left e.g. through adverse weather conditions),then price will rise (ceteribus paribus)

• In reality however several factors may be working simultaneously on both demand and supply sides (as in housing market)

Therefore the real task is to estimate the likely effects of shifts in demand and supply - in both directions - so as to estimate likely effects on price

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Effect of a shift in the demand curveEffect of a shift in the demand curve

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Effect of a shift in the supply curveEffect of a shift in the supply curve

FREE-MARKET ECONOMY

Advantages

• It functions automatically (without the need for bureaucratic control)

• Markets respond quickly to changes in demand and supply (and all the

factors responsible for these changes)

• When markets are competitive no one has great power; competition keeps

prices low; firms are more responsive to consumers and have an incentive

to become more efficient

The more efficient firms tend to make higher profits; more efficient

workers generate higher earnings and careful consumers get better value

for money

Thus people pursuing their own self-interest minimise the central problem

of scarcity

FREE-MARKET ECONOMY (con)

Problems

• In practice competition between firms is often limited with a few giant firms dominating most industries; in the case of services though there may be many firms, local accessibility can reduce competition

• Lack of competition may then remove incentive to be more efficient which is a major problem in Irish economy at present

• Power and property may be unequally distributed

• The adverse environmental consequences of industrial actions may be ignored

• Socially desirable goods may not be produced by private sector in sufficient numbers

• May lead to macroeconomic instability

• Can be ethically objectionable in rewarding greed and encouraging a philosophy of materialism

MIXED ECONOMY

Because of problems of both free-market and command economies, all real-

world economies are a mixture of both systems

In mixed market economies, the government may control the following:

• Relative prices of goods and inputs through taxes, subsidies or price controls

• Relative incomes by the use of income taxes, welfare payments or direct controls over wages, profits, rents etc.

• The pattern of production and consumption through legislation or direct provision of certain goods and services

• The use of fiscal (tax and government expenditure) and monetary (money supply and interest rates) to control the overall macroeconomy

DEMAND The basic law of demand states that as the price of a good falls people will buy more of it....

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