PRICE DETERMINATION
Lecture Chapter 6H1 Economics 2017
Recap
■ What are the (non-price) factors affecting Demand and Supply?
Typical DD/ SS Qn
■ Many airlines had recently announced that they would restructure their airfares given the falling oil prices. At the same time, the World Bank announced that the global economy would continue growing this year. [let’s say that this info is extracted from a case study]
■ Using economic analysis, explain how the above factors might affect the equilibrium price and quantity for air travel. [8]
Conceptual OutlinePrice
Determination
•Equilibrium price and quantity•Changes in equilibrium
Market Equilibrium
Shifts in demand Shifts in supply Simultaneous shifts in demand & supply
6.1
What determines the equilibrium price and quantity of a good in a
market?
Assuming free market economy (no govt intervention!)
■Equilibrium Price & Quantity of a good/ service is determined by demand and supply of the good/ service
Price of good X ($)
Quantity of good X
0 1 2 3 4 5
0.2
0.4
0.6
0.8
1.00
Demand
Supply
6.2
A
6.1 MARKET EQUILIBRIUM PRICE & QUANTITYEQUILIBRIUM PRICE
• The price level at which quantity demanded is equal to quantity supplied
Qd = Qs
6.2
Equilibrium Price & Quantity
• Market Clearing Price where Qd = Qs
• No shortage & no surplus
Price of good X ($)
Quantity of good X
0 2 4 6 8 10
0.2
0.4
0.6
0.8
1.00
Demand
Supply
In this market, the equilibrium price
is $0.60.
6.2
The equilibrium quantity
exchanged is 6.
The total consumer expenditure is
$0.60 x 6 = $3.60
6.2 MARKET EQUILIBRIUM
• Surplus of 20,000 units at price $125,000
• Surplus of 10,000 units at price $100,000
SURPLUSPrice ($’000)
Quantity (‘000)
Supply
0 8 14 24 28
25
50
75
100
125
Demand
20
6.3
A
CB
Equilibrium Price & Quantity
‘000 per Month
Price per Car
($’000)
Quantity Demanded
Quantity Supplied
Surplus or Shortage
Price Will
$125 8 28 Surplus of 20 Fall
$100 14 24 Surplus of 10 Fall
$75 20 20
$50 26 16
$25 32 12
6.3
At a price above equilibrium price
Qs > Qd (Surplus)
Downward Pressure on Price
6.3
When Price is below eqm Price
Shortage occurs as Qd > Qs
Upward Pressure on Price
6.3
• Shortage of 20,000 units at price of $25,000
• Shortage of 10,000 units at price of $50,000
• Price increases until $75,000 when Qd = Qs
SHORTAGE
Price ($’000)
Qty (‘000)
Supply
0 12 16 26 32
25
50
75
100
125
Demand
20
6.2 MARKET EQUILIBRIUM6.3
A
DE
Equilibrium Price & Quantity
‘000 per Month
Price per Car
($’000)
Quantity Demanded
Quantity Supplied
Surplus or Shortage
Price Will
$125 8 28 Surplus of 20 Fall
$100 14 24 Surplus of 10 Fall
$75 20 20 None
$50 26 16 Shortage of 10 Rise
$25 32 12 Shortage of 20 Rise
6.3
Qd = Qs
Equilibrium Price is reached
UPWARD pressure on price
Qs↑, Qd ↓
There is a SHORTAGE when
Qd > Qs
Qd = Qs
Equilibrium Price is reached
DOWNWARD pressure on price
Qd↑, Qs↓
There is a SURPLUS when
Qs > Qd
At equilibrium price,
where Qd = Qs,
there is no more pressure for price to change
6.2
When the market is said to be in equilibrium it meansprices will neither ________ nor ________further. It willremain there unless the equilibrium is ______________.At the equilibrium price, the quantity ________________is equal to the quantity _____________.
RISE FALLDISTURBED
DEMANDEDSUPPLIED
THINK: What will caused the
initial equilibrium to be disturbed?
Changes in Equilibrium
Shifts in demand
Shifts in Supply
Simultaneous shifts in demand and supply
6.3 CHANGES IN EQUILIBRIUM6.4
When asked to explain oranalyse impact on market,consider changes to thefollowing:■ equilibrium Price [P]
■ equilibrium Quantity [Q]
■ Price x Quantity [PxQ], i.e. Total Expenditure
Skill: Steps for analysing DD/SS Qn
1. Question Focus (what does the question want?)
2. Identify whether it is a DEMAND or SUPPLY factor
3. Identify the factor that affects Demand/ Supply (PTIDE or CPPSE)
4. Explain with reference to context
5. Paragraph Development (SEED)
6. Ensure that you have answered that question requirement (refer back to pt 1)
General Rubrics for marking (a tick each):
State (identify correct factor)
Elaborate with economic analysis
Exemplify (with reference to context)
Diagram (explained)
Explain correct direction of change in DD/SS
Brief Adjustment process Link to change in
equilibrium price Link to change in
equilibrium quantity
RECALL: Shifts in Demand• P rices of related goods• T astes & preferences• I ncome• D emographics• E xpectations
6.3.1 SHIFTS IN DEMAND6.4
Consider the impact of the following event on the market for cars.
TRIGGER: Rise in income
Figure 2: Market for Cars
■ Shortage at original Price of $75k
■ Upward pressure on price
Price ($’000)
Quantity (‘000)
SS
0 24 30
25
50
75
100
125
DD
20
New eqm is reached when Qd = Qs at a
HIGHER Price
DD1
6.4
AB
C
Step 4
Explanation of Figure 2:
■As income increases, increasing the purchasing power ofconsumers, demand for cars (normal good) will increase, thedemand curve will shift from DD to DD1
■Quantity demanded exceeds quantity supplied at the originalprice of $75,000 per car, resulting in a shortage.
■There is an upward pressure on price as competition for the carsamongst consumers will drive prices up (i.e. consumers who do notsucceed in purchasing all they want of the cars at the current pricewill offer higher prices).
■At the same time, producers would be willing to increase quantitysupplied at the higher prices (Law of Supply). I.e. as the price rises,quantity supplied increases along supply curve SS (from point A toC).
■As price rises, quantity demanded decreases (Law of Demand)along the demand curve DD1 (from point B to C).
■When the new equilibrium price of $100,000 is reached, thequantity demanded will once again equal the quantity supplied.
PRICE MECHANISM
Chapter 3.3.2
6.4
Good to have, but not requiredunless the focus is on price adjustment
Explanation of Figure 2:
■Both the final price and quantity exchanged are higher followingthe increase in demand.
■A rise in DD leads to an increase in eqm price from $75,000 to$100,000 & an increase in eqm qty from 20,000 units to 24,000units
Step 4
Explanation of Figure 2:
■Both the final price and quantity exchanged are higher followingthe increase in demand.
■A rise in DD leads to an increase in eqm price from $75,000 to$100,000 & an increase in eqm qty from 20,000 units to 24,000units
■Given that both equilibrium price and equilibrium quantityincrease, total expenditure on cars, which is given by multiplicationof price and quantity, will rise unambiguously.
Step 5
THINK: Why Do Prices of Old Model Electronics Fall?
You're Not Buying, That's Why…...
Decrease in Demand
• Surplus at original Price• Downward pressure on price• ↓Pe, ↓Qe
Price
Quantity
Supply
0 Q0
P1
P0
Demand1
Q1
Demand0
New eqm is reached when Qd = Qs at a
LOWER Price
Q2
6.6
RECALL: Shifts in Supply•Cost of production• Price of related good• Number of Producers• Supply shocks• Expectations
Increase in Supply (improvement in technology that lowers (unit) COP)
■ Shortage at original Price of $75k
■ Downward pressure on price
■ ↓Pe, ↑Qe, TE?
Price ($’000)
Quantity (‘000)
SS0
0 24 30
50
75
DD0
20
SS1
New eqm is reached when Qd = Qs at a
LOWER Price
6.5
A B
C
■ As more producers enter the market due to improvement intechnology that lowers cost of production, ………
■ Quantity supplied exceeds quantity demanded at the originalprice of $75,000 per car resulting in a surplus.
■ There is downward pressure on price. This is becauseproducers will find that they are unable to sell all their outputat the original price. Hence, they will begin to competeagainst one another to sell their excess supplies, thus askingfor lower prices.
■ As price falls, quantity supplied falls along the supply curveSS1 (from point B to C). i.e. Law of Supply
■ As the price falls, quantity demanded increases along thedemand curve DD (from point A to C), i.e. Law of Demand.This is because consumers will also recognize the excesssupply and begin to offer lower prices.
■ When the new equilibrium price of $50,000 per car isreached, the quantity supplied will once again equal thequantity demanded.
PRICE MECHANISM
Chapter 3.3.2
Good to have, but not required unless the focus is on price adjustment
Decrease in Supply
• Shortage at original Price of $75k• Upward pressure on price• ↑Pe, ↓Qe
Price ($’000)
Quantity (‘000)
Supply0
0 14
100
75
Demand0
20
Supply1New eqm is reached when Qd = Qs at a HIGHER Price
6.6
With the aid of a diagram, indicate whatwill happen to the equilibrium price andquantity exchanged in the following situations:
(a) Demand decreases, c.p. (b) Supply decreases, c.p.
6.6
Price increases, quantity decreases Price decreases, quantity decreases
Price
Quantity
DD
DD1
SS
0
P
Q
P1
Q1
Price
Quantity
DD
SS1
SS
0
P
Q
P1
Q1
6.3 SIMULTANEOUS SHIFTS IN DD AND SS
6.7
6.3.3 SIMULTANEOUS SHIFTS IN DEMAND AND SUPPLY
If both demand and supply curves shift, then either final price or quantity will be indeterminate.
6.7
Let’s look at an example…
Consider the smartphone market. How have the quantity andprice of smartphones changed in recent years over a decade?Explain the changes using demand and supply analysis.Think of both demand and supply factors.
6.8
Change in Eqm P
Change in EqmQ
DD __________
SS __________
Final Impact
Identify and explain the demand factor as well as the supply factor in this context
Draw a diagram (simultaneous shift).
6.8
DEMAND
SUPPLY
Consider the smartphone market. How have the quantity andprice of smartphones changed in recent years over a decade?Explain the changes using demand and supply analysis.Think of both demand and supply factors.
Demand & Supply
6.7
Increase in demand and supply Eqm Qty increases from Q to Q1, Eqm Price indeterminate
Price
Quantity
SS
0 Q
P1 ???
Q1
DD
DD1
E1E
SS1
P
6.7
D
Step 4: Compare initial & new Pe & Qe
The combined shifts reinforce each other in terms oftheir effect on quantity as shown by the increase in eqmqty from Q0 to Q1.HOWEVER, the change in price is indeterminate.
6.7
Demand has increased: ↑DD → P↑ , Q↑Supply has also increased: ↑SS → P↓ , Q↑
P ? , Q↑
Step 5: Make a judgementSince it is observed that price of smartphones has fallenover time. So we can conclude it is likely that the ↑SS>↑DD, eqm price will fall from P to P1
Note: Question only ask for eqm P & Q no need tocomment on TE
6.7
Consider the poultry market. How do thequantity and price of poultry changewhenever the H5N1 Bird Flu pandemicstrikes? Explain the changes using demandand supply analysis.
6.9
Consider the poultry market. How do the quantityand price of poultry change whenever the H5N1 Bird Flupandemic strikes? Explain the changes using demandand supply analysis.
6.9
DEMAND SUPPLY
Fear DD falls
Culling SS falls
Consider the poultry market. How do the quantityand price of poultry change whenever the H5N1 Bird Flupandemic strikes? Explain the changes using demandand supply analysis.
6.9
↓DD P↓ , Q↓
↓SS P↑ , Q↓
P? , Q↓
Qe↓ but Pe is indeterminate
If DD↓ > SS↓, then P↓
If SS↓ > DD↓, then P↑
Δ price??
SS1Price
Quantity
DD
DD1
SS
0
P
Q
P1
Q1
Market for poultry
Consider the tuna market. How will the quantityand price of tuna change given that there hasbeen over-fishing and pollution while tunasushi devotees get richer? Explain the changesusing demand and supply analysis.
6.10
Demand & Supply
6.9
Increase in demand and decrease in supply Eqm Price increases Eqm Qty indeterminate
Price
Quantity0
P1
P
Q ???
SS1
DD
DD1E
E1 SSD
6.9
No end in sight for US property slump as prices fall at record rateThe Guardian 2008
6.10
Using demand & supply analysis, explain the reasons for the falling price of US property.
falling demand due to recession
+
More homes confiscated and released on open market due to default in payment
Demand & Supply
6.10
Decrease in demand and increase in supply Eqm Price decreases, Eqm Qty indeterminate
Price
Quantity
SS
0
P
P1
Q ???
DD
E
E1
DD1
SS1
6.10
D
in demand
in supply
equilibrium
price
equilibrium quantity
1 Rise ‐‐2 Fall ‐‐3 ‐‐ Rise4 ‐‐ Fall5 Rise Rise6 Fall Fall7 Rise Fall8 Fall Rise
6.11
6.4 SUMMARY• Market equilibrium: a point at which the quantity
demanded = quantity supplied.
• Surplus occurs where quantity supplied > quantity demanded, at initial equilibrium.
• Shortage occurs where quantity supplied < quantity demanded, at initial equilibrium.
6.11
Additional Exercises
Market Equilibrium Exercise
“Wet weather and rising consumption for CNY have pushed up vegetable prices in Singapore & Malaysia”
Price of Vegetables
Quantity of Vegetables
S0
D0
P0
Q0
S1
D1
Qe
PeWill equilibrium quantity rise or fall?
Market Equilibrium Exercise
Price of Vegetables
Quantity of Vegetables
S0
D0
P0
Q0
S1
D1
Qe
Pe
“Wet weather and rising consumption for CNY have pushed up vegetable prices in Singapore & Malaysia”
Price of Bak‐Kua increases by 40% during CNY
“Price of Bak kua – a popular barbecued meat has increasedto $50 per kilogram during CNY despite an increase insellers.”
Price of Bak Kua
Quantity of Bak Kua
S0
D0
P0 = $30
Q0
S1
Q1
P1 = $20 D1
Pe = $50
Qe
Market Equilibrium Exercise
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