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Chapter 2A - Resource Allocation in Competitive Markets: Price Theory -…
Chapter 2A - Resource Allocation in Competitive Markets: Price Theory
Introduction + Price Mechanism (P2)
helps to ration available goods, resources and services for the most efficient use of these resources
describes the means by which various decisions are made by consumers and firms interacting to determine the allocation of scarce resources between competing uses
prices reflect what is relatively scarce and abundant, providing information to buyers and sellers about what should be bought and produced
What and how much to produce?
rise in demand signaled by rise in price, more resources diverted from goods with lower demand to goods with higher demand
For whom to produce?
based on purchasing power of consumers, more resources allocated to producing goods for consumers that can and will pay higher prices for the goods
How to produce?
achieving least cost combination of inputs by looking at costs of production methods
Key Features of the Free Market Economy (P4)
a. private ownership of property
b. freedom of choice and enterprise
c. pursuit of self interest
competition
Market Equilibrium
Consumer Surplus
The difference between how much consumers in the market are prepared to pay and how much they actually pay
Producer Surplus
The difference between the price that producers in the market are prepared to sell their good or service at and how much they actually receive
shortage causes an upward pressure on prices and movements along the demand and supply curves continue until a new market equilibrium is achieved where QD=QS
surplus causes a downward pressure on prices and movements along the demand and supply curves continue until a new market equilibrium is achieved where QD=QS
Theory of Supply (P19)
Individual Firm Supply vs. Market Supply
Individual Firm Supply: supply of one producer
Market Supply: sum of all the supplies of all the producers in the market
The Law of Supply
In a given time period, the quantity supplied of a product is
DIRECTLY RELATED
to its price, ceteris paribus
Change in Quantity Supplied vs. Change in Supply
Change in Quantity Supplied: change in the amount supplied of a good/service by producers due to a
change in price
of the good/service.
Change in Supply: change in the amount supplied of a good/service by producers due to
factors not relating to price
of the good/service
Non-Price Determinants of Supply
a. changes in the cost of relevant resources
b. changes in the price of related goods
c. nature, 'random shocks' and other unpredictable events
d. expectation of future price changes
e. changes in technology
f. number of sellers
g. government policy - indirect taxes and indirect subsidies
Supply: the quantity of a well-defined commodity that producers are both
WILLING
and
ABLE
to supply at a given price during a given period of time, ceteris paribus
Theory of Demand (P6)
Derived Demand
a market where a good is demanded not for its own sake but for the production of another good.
e.g. inputs used in production of another good
NOT
complements in consumption
Non-Price Determinants of Demand
a. changes in consumers' income
b. changes in the price of related goods
c. changes in consumers' expectation
d. changes in consumers' taste and preferences
e. changes in the number or composition of consumers
f. government policies
Change in Quantity Demanded vs. Change in Demand
Change in Quantity Demanded: change in the amount of good/service by consumers due to a
change in price
of the good/service
Change in Demand: change in the amount of good/service by consumers due to
factors not relating to price
of the good/service
Individual Demand vs. Market Demand
Individual Demand: demand of
one
consumer
Market Demand:
sum of all
the individual demand of all consumers in the market
The Law of Demand
In a given time period, the quantity demanded of a product is
INVERSELY RELATED
to its price, ceteris paribus
Law of Diminishing Marginal Utility
Beyond a certain point of consumption, as more and more units of a good/service are consumed, the additional utility a consumer derives from consuming successive units decreases
Demand: the quantity of a well-defined commodity that consumers are both
WILLING
and
ABLE
to buy at a given price during a given period of time, ceteris paribus.
Decision Making Example (P39)
key concepts: price mechanism, determinants of demand, determinants of supply
decision to be made (by consumer)
perspectives on the decision/issue
relevant information to support consumer's decision
constraints
benefits and costs (consumer's perspective)
decision made (based on weighing of benefits and costs)
intended consequences
unintended consequences
review of the decision made
