Download Market fundamentals

Market Fundamentals
Frederick University
2012
Main Economic Problems
Questions
Problems

What and how much


How


For Whom

Efficiency in
allocation
Efficiency in
motivation
Efficiency in
distribution
Types of Economic Systems



Traditional economy
Market Economy
Command Economy
Market Functions



Allocation of scarce resources
Motivation for efficiency
Distribution of goods and services
The Demand for chocolates
“Milka”
The Demand schedule
A
B
C
D
E
F
G
H
I
P (€)
2,5
2
1,6
1,5
1,4
1,3
1,2
1,1
1
Q
5
8
12
15
22
28
36
50
100
The Demand for chocolates
“Milka”
P
The demand schedule
A
B
C
D
E
F
G
H
P (€)
2,5
2
1,6
1,5
1,4
1,3
1,2
1,1
Q
5
8
12
15
22
28
36
50
A
B
C
D
E
The demand curve
Q
Demand
Demand – buyers’ behavior
The Demand for a good – the quantities
buyers are willing and able to buy at
every different price
The law of Demand – the decrease in the
price of the good raises the quantity of
the good demanded, other factors
held equal
FACTORS DETERMINING DEMAND





Buyers’ income
Prices of the other
goods
Buyers’ expectations
Buyers’ taste and
preferences
Market size
Institutions
P
D
Q
Demand rises = the demand
curve shifts rightwards
Demand falls = the demand
curve shifts leftwards
Supply of Chocolate “Milka”
The Supply Schedule
A
B
C
D
E
F
G
H
I
P (€)
2,5
2
1,6
1,5
1,4
1,3
1,2
1,1
1
Q
120
100
70
60
50
42
36
15
2
S
P
S
Q
100
50
0
1st
Qt
r
Supply
Supply – sellers’ behavior
The Supply of a good – quantities of the
good that sellers are willing to sell at
different price levels
The Law of Supply – as the price of the
good rises, sellers are willing to sell
greater quantities of the good, ceteris
paribus.
FACTORS DETERMINING SUPPLY





Sellers’ expectations
Cost of production
Technological
changes
Market size
Institutions
P
S
Supply rises – the supply curve Q
shifts rightwards
Supply falls – the supply curve shifts
leftwards
Market Equilibrium
The demand schedule
A
B
C
D
E
F
G
H
I
P (€)
2,5
2
1,6
1,5
1,4
1,3
1,2
1,1
1
D
Q
5
8
12
15
22
28
36
50
100
S
P
E
Pe
The Supply Schedule
A
B
C
D
E
F
G
H
I
P (€)
2,5
2
1,6
1,5
1,4
1,3
1,2
1,1
1
Q
120
100
70
60
50
42
36
15
2
Qe
The market is in equilibrium when the quantity supplied equals
the quantity demanded at the same price
Q
Market Equilibrium
P

S
D

E
Pe


Q
Qe
Market equilibrium
quantity supplied
equals
quantity
demanded
Pe – equilibrium
price
Qe – equilibrium
quantity
The Dynamics of Market
Equilibrium
D’
P
Qd > Q s
Qd – Qs = shortage
D
E’
P’
P rises and Qs increases
E
Pe
P rises and Qd falls
S
Qe
Q’
Qd
The Equilibrium is restored at E’
Q
The Dynamics of Market
Equilibrium
P
S
D
S’
E
Qd < Qs
Qs – Qd = surplus
P falls and Qd increases
Pe
P falls and Qs decreases
E’
Qe
The Equilibrium is restored at E’
Qs
Q
The equilibrium price clears all shortages and surpluses
Pe = market clearing price
Price Ceiling
P
Shortage = (Qd-Qs) x Pc
D
Pb.m.
Profits of the blackmarketeers =
(Pb.m. – Pc) x Qs
Pe
Pc
S
shortage
Qs
Qe
Qd
Q
Arbitrage and speculation
P
POz
Oz widget market
P
Zo widget market
S
PZo
D
S
QOz
Q
Demand shifts to Zo market
imports
Q
QZo
Supply shifts to Oz market
exports
Shifts in Supply and Demand until price differences are eliminated
Arbitrage and speculation


Arbitrage – the process by which
individuals seek to make a profit by
taking advantage of discrepancies
among prices prevailing simultaneously
in different markets
Speculation – a way to make a profit by
taking a deliberately risky position
Quantifying Market Responses
Elasticity



TR = P x Q
Price Elasticity of Demand – buyers’
responsiveness to the price changes
Ep = % change in Quantity Demanded : %
change in Price
Classifying Price Elasticity of
Demand
|Е|
|E|
|E|
|E|
|E|
< 1 inelastic demand
> 1 elastic demand
= 1 unit elastic demand
= 0 perfectly inelastic demand
=∞ perfectly elastic demand
Calculating Price Elasticity of
Demand
Ep = % change in Quantity Demanded :
% change in Price
% change in Quantity Demanded =
= (Q2 – Q1) : (Q2 + Q1)/2
% change in Price =
= (P2 – P1) : (P2 + P1)/2
Price Elasticity of Demand and
Total Revenue





TR = P x Q
The Law of Demand - If P rises, Q falls
If the percentage change in price is greater
than the percentage change in quantity, the
demand is inelastic
If the price falls, the change in quantity
demanded does not compensate for the price
reduction and TR falls
If the price rises, TR will increase
Price Elasticity of Demand and
Total Revenue
P
Q
|E| < 1
|E| > 1
If |E| = 1, TR does not change
TR
If the price
rises, TR
increases
If the price
rises, TR
falls
E = % change in Q : % change in P
% change in Quantity Demanded =
= (Q2 – Q1) : (Q2 + Q1)/2
P
10
9
8
Q
1
2
3
A
B
C
7
4
D
6
5
F
5
6
G
4
7
H
2
3
8
I
1
2
9
J
1
10
K
% change in Price =
= (P2 – P1) : (P2 + P1)/2
% change in Q =
=(10-9) : (9+10)/2 = 0.10
% change in P =
= (1-2) : (2+1)/2 = - 0.67
E =- 0.14
|- 0.14| < 1
|E| < 1
J
K
9
10
% change in Q = (6-5) : (6+5)/2 =
= 1.18
P
10
9
8
Q
1
2
3
A
B
C
7
4
D
6
5
F
5
6
G
4
7
H
3
8
I
2
9
J
1
10
K
% change in P = (5-6) : (5+6)/2
= - 1.18
|E|>1
F
|E|= 1
6
5
G
|E| < 1
5
6
E = 1.18 : - 1.18 = -1
|- 1| = 1
P
A
|E|>1
10
9
P
10
9
8
Q
1
2
3
B
% change in Q =
= (2-1) : (2+1)/2 = 0.67
A
B
C
% change in P =
=(9-10) : (9+10)/2 = - 0.10
E = 0.67 : - 0.10 = - 670
|-670| > 1
E = % change in Q : % change in P
% change in Quantity Demanded =
= (Q2 – Q1) : (Q2 + Q1)/2
% change in Price =
= (P2 – P1) : (P2 + P1)/2
1
2
Q
FACTORS AFFECTING PRICE
ELASTICITY OF DEMAND




Availability of substitutes/Definition of
market
Time horizon
Income
Traditions
Price Elasticity of Supply


Price elasticity of supply – sellers’
responsiveness to the price changes
Ep = % change in Quantity Supplied :
% change in Price
Price Elasticity of Supply
P
E<1
E=1
E>1
Q
Price Elasticity of Supply
P
E=0
E=∞
Q
FACTORS AFFECTING PRICE
ELASTICITY OF SUPPLY






Time horizon
Availability of production factors
Mobility of production factors
Inventory levels
Competitiveness of the market structure
Institutions
Applications of Price Elasticity
Economics of Agriculture
P
S2
S1
P1
% change in P > % change in Q
E<1
P falls and TR falls
Farmers have lower income
P2
D
Q1
Q2
Q
Applications of Price Elasticity
Economics of Agriculture
P
Solution 1: government pays the
difference P1 – P0 to the farmers
S
P1
Government will lose (P1 – P0) x Q
P0
D
Q
Q
Applications of Price Elasticity
Economics of Agriculture
P
Solution 2: government buys all
Q from farmers at P1 and sells it.
However, buyers will buy less at P1
S
P1
Government cannot sell Q – Q1 and will
lose (Q – Q1) x P1
The loss under solution 1 is (P1 – P0) x Q
The loss under solution 2 is (Q – Q1) x P1
P0
D
Q1
Q
Since demand is inelastic,
(P1 – P0) x Q > (Q – Q1) x P1
Q
Solution 2 is preferable because the loss is smaller.
The Tax Incidence
Case 1: perfectly inelastic demand
P
D
S2
Government imposes an excise tax = t
S1
P2 = P1 + t
t
P1
Sellers will be willing to sell the same
Q if only someone else would pay the tax
Supply shifts to S2
Since demand is perfectly inelastic,
buyers will not change the quantity
demanded
Buyers pay the tax
Q
Q
The Tax Incidence
P
Case 2: inelastic demand and
elastic supply
D
Government imposes an excise tax = t
S2
P3
S1
P2
t
Sellers will be willing to sell
the same Q if only someone
else would pay the tax
Supply shifts to S2
Demand is not perfectly inelastic
And buyers will not want to buy
Q1 at the higher price P2
P1
Buyers are willing to buy Q2 < Q1
Q2
Q1
Q
The shortage Q2 – Q1 will push the
Price down to a new equilibrium
Q3
Tax = P2 – P1. Buyers pay (P3 – P1) - this is the greater part of the tax.
The Tax Incidence
S2
P
Case 2: elastic demand and
inelastic supply
D
Government imposes an excise tax = t
P2
S1
t
P3
Sellers will be willing to sell
the same Q if only someone
else would pay the tax
Supply shifts to S2
Demand is elastic
And buyers will not want to buy
Q1 at the higher price P2
P1
Q2
Buyers are willing to buy Q2 < Q1
The shortage Q2 – Q1 will push the
Price down to a new equilibrium
Q3 Q
Q
1
Tax = P2 – P1. Buyers pay (P3 – P1) - this is the smaller part of the tax.
The rest (P2 – P3) is paid by sellers