Unit 2 - The price system and the microeconomy
Chapter 1 - Demand and supply curves
1.1 The price mechanism and markets
In market economies, the price mechanism is essential to allocating resources as
this is what decides the price and quantity of a product. The price mechanism sends
out a message from the consumers to the producers. If there is a surplus, the
producer should allocate less resources to produce this good, and vice versa.
Price mechanism: System where the forces of supply and demand determine the
prices of goods or services and the changes therein. Sometimes the government
controls the price mechanism to make commodities affordable. It is the buyers and
sellers who determine the price.
Buyers affect demand and sellers affect supply.
1.2 Demand
Demand: The willingness and ability of consumers to consume a given quantity of a
good or service.
Quantity: Numerical amount of the product that is being demanded.
1.3 The demand curve
Demand curve: The graphical representation of the relationship between the
quantity demanded and the price of a product.
Demand schedule: A table of values or set of data from which the demand curve is
drawn.
Law of demand: The higher the price, the lower the quantity demanded.
Factors that affect demand
● price (willingness)
● income (ability)
● price of substitutes (willingness)
● price of complements (willingness)
, ● tastes and preferences (willingness)
● population (willingness)
Income
Generally, there is a positive relationship between income and demand. This is the
case with normal goods.
However, sometimes there is a negative relationship between income and demand.
This is the case for inferior goods, where demand decreases as income increases.
Substitutes
Substitute goods: Goods which satisfy a similar demand.
There is a positive relationship between the price of substitutes and the demand for
a good.
Complements
Complementary goods: Goods which have a joint demand as they add to the
satisfaction consumers get from another product.
1.4 Supply
Supply: Quantity of a product that suppliers are willing and able to produce and sell
at a given price.
Law of supply: The higher the price, the higher the quantity supplied.
Quantity supplied: The numerical amount of the product that is being supplied.
Supply curve: It represents the relationship between the quantity supplied and the
price. (Individual/aggregate supply)
Supply schedule: The data from which the supply curve is drawn.
1.6 Factors affecting supply
● Price: The higher the price, the higher the quantity supplied.
● Costs: Supply decisions by firms are always driven by the costs of producing
and distributing their product. In some firms labour is a large cost of
, production, in others low productivity while some firms replace labour with
capital to reduce costs.
● Size and nature of the industry: If an industry is growing in size, then more
products will be supplied.
● Price of other products (substitutes): If competitors lower their price, other
suppliers who do not lower their prices will not supply as many products.
● Government policy: Government regulation can affect supply in many ways.
A tax on a product would decrease supply as the costs of production for the
business would be higher. A subsidy would do the opposite.
● Weather conditions (agricultural products): Storms or droughts affect
different crops in different ways, increasing or decreasing supply.
1.7 Causes of a shift in the demand curve
S1
Price
P2
P1
P3
D2
D1
D3
0 Qd3 Qd1 Qd2
Quantity
Increase in demand (increase in P & Qd) may mean:
● increase in income (ability)
● increase in the price of substitutes (willingness)
● decrease in the price of complements (willingness)
● favourable change in tastes and preferences
Decrease in demand (decrease in P & Qd) may mean:
Chapter 1 - Demand and supply curves
1.1 The price mechanism and markets
In market economies, the price mechanism is essential to allocating resources as
this is what decides the price and quantity of a product. The price mechanism sends
out a message from the consumers to the producers. If there is a surplus, the
producer should allocate less resources to produce this good, and vice versa.
Price mechanism: System where the forces of supply and demand determine the
prices of goods or services and the changes therein. Sometimes the government
controls the price mechanism to make commodities affordable. It is the buyers and
sellers who determine the price.
Buyers affect demand and sellers affect supply.
1.2 Demand
Demand: The willingness and ability of consumers to consume a given quantity of a
good or service.
Quantity: Numerical amount of the product that is being demanded.
1.3 The demand curve
Demand curve: The graphical representation of the relationship between the
quantity demanded and the price of a product.
Demand schedule: A table of values or set of data from which the demand curve is
drawn.
Law of demand: The higher the price, the lower the quantity demanded.
Factors that affect demand
● price (willingness)
● income (ability)
● price of substitutes (willingness)
● price of complements (willingness)
, ● tastes and preferences (willingness)
● population (willingness)
Income
Generally, there is a positive relationship between income and demand. This is the
case with normal goods.
However, sometimes there is a negative relationship between income and demand.
This is the case for inferior goods, where demand decreases as income increases.
Substitutes
Substitute goods: Goods which satisfy a similar demand.
There is a positive relationship between the price of substitutes and the demand for
a good.
Complements
Complementary goods: Goods which have a joint demand as they add to the
satisfaction consumers get from another product.
1.4 Supply
Supply: Quantity of a product that suppliers are willing and able to produce and sell
at a given price.
Law of supply: The higher the price, the higher the quantity supplied.
Quantity supplied: The numerical amount of the product that is being supplied.
Supply curve: It represents the relationship between the quantity supplied and the
price. (Individual/aggregate supply)
Supply schedule: The data from which the supply curve is drawn.
1.6 Factors affecting supply
● Price: The higher the price, the higher the quantity supplied.
● Costs: Supply decisions by firms are always driven by the costs of producing
and distributing their product. In some firms labour is a large cost of
, production, in others low productivity while some firms replace labour with
capital to reduce costs.
● Size and nature of the industry: If an industry is growing in size, then more
products will be supplied.
● Price of other products (substitutes): If competitors lower their price, other
suppliers who do not lower their prices will not supply as many products.
● Government policy: Government regulation can affect supply in many ways.
A tax on a product would decrease supply as the costs of production for the
business would be higher. A subsidy would do the opposite.
● Weather conditions (agricultural products): Storms or droughts affect
different crops in different ways, increasing or decreasing supply.
1.7 Causes of a shift in the demand curve
S1
Price
P2
P1
P3
D2
D1
D3
0 Qd3 Qd1 Qd2
Quantity
Increase in demand (increase in P & Qd) may mean:
● increase in income (ability)
● increase in the price of substitutes (willingness)
● decrease in the price of complements (willingness)
● favourable change in tastes and preferences
Decrease in demand (decrease in P & Qd) may mean:
