Demand and Supply (1.2)

Revision cards for section 1.2 (chapter 2) in the International Baccalaureate economics course

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Markets

Markets will in economic terms be defined as where buyers and sellers carry out economic transactions. A market doesn't have to be a physical place, but it can also be online through transactions

There are three types of markets; the market for goods and services,  the labor market and the financial market

At a market for goods and services, it is possible to buy and sell goods and services. In a labor market it is possible to buy and sell factors of productions. In the financial market it is possible to trade, buy and sell international currencies and stocks.

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Demand

The quantity of a good or service that consumers are willing, and able, to purchase at a given time.

For example if McDonald's sells  200 cheeseburgers an afternoon for a price of $1, the demand of cheeseburgers at $1 would be 200 units an afternoon

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The law of demand

The law of demand states that 'as price of a product goes down, the quantity demanded will usually increase, ceteris paribus'. Ceteris paribus - everything is equal, meaning that there isn't a change in any other factors

Even though a price decrease usually leads to an increase in demand, it doesn't mean that there is an increase in revenue - for example, if McDonald's is selling 500 hamburgers at a price of $1.20 a day (they'll earn $600 in revenue), and they decrease the price to $0.80 and demand increases to 700 a day they'll be making $560 on the burgers, giving them a loss of $40 a day.

The book gives two reasons to why demand increases:

1. Income effect - as the price of a product falls, the consumers will experience an increase in 'real income', making consumers more likely to buy more of the product

2. Substitution effect - as the price falls on a products, it will become more attractive than some other products

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The non-price determinants of demand

The book describes 3 different factors of demand. These factors determine the demand and whether or not the demand curve moves to the right or left. It is important to assume the ceteris paribus assumption when looking at these factors. The factors are:

  • Income
  • The price of other products
  • Tastes/preferences 
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The non-price determinants of demand - income

There are two types of products to consider when looking at how income affects demand:

Normal goods -  when the income rises, so does the demand for the product, this is at least when it comes to normal goods. As income rises the demand curve will shift to the right

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The non-price determinants of demand - income

Inferior goods - as income rises, consumers will start to buy higher priced and higher quality products, rather than inferior goods. Examples of inferior goods could be store brand soda or cheap wine

This means that if the consumers income rises enough, the demand for inferior goods will become zero

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The non-price determinants of demand - the price o

There are three possible relationships between products:

  • Substitutes
  • Complements
  • Unrelated goods 
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The non-price determinants of demand - the price o

Substitutes - substituting products effects each other in both price and demand. For example, if the price of Pepsi declines, it will experience an increase in demand and then Coca Cola will experience a decrease in demand for their product

Another example is beef and chicken. If the price of chicken increases, people may buy the cheaper beef instead, leading to a decrease in demand in chicken and an increase in demand for beef

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The non-price determinants of demand - the price o

Complements - complementary goods are often bought together, for example a tennis racket is often bought with tennis balls, or DVD players and DVD's. These products influences each other in the way that if one of the products drops in price, the demand for the other increases. If the price of DVD players falls, the demand for DVD's will increase

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The non-price determinants of demand - the price o

Unrelated goods - some products does not affect other products, these are classified as unrelated goods. A price change in an unrelated good does not lead to increase/decrease in demand of another good

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The non-price determinants of demand - tastes/pref

Marketing of a product can lead to an increase in demand. In the graph D represents the sales of the product before marketing and D' represents the same product after marketing

 (http://i49.tinypic.com/34yur7m.png)

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The non-price determinants of demand - other facto

The book discusses a number of other factors:

The size of population - as populations grow larger, it can be assumed that demand for most products will increase

Changes in the age structure of population - if the percentage of a certain age group increases/decreases, the demand for products which targets that age group will increase/decrease

Change in income distribution - if the poorest of an economy gets richer or the richest of the economy gets poorer, there may be an increase in demand for basic necessity goods such as meat

Government policy changes - this includes taxation on both products and income. If a product gets a higher tax it becomes more expensive and may suffer from a decrease in demand and if consumers has to pay higher taxes, they are less likely to buy unnecessary goods

Seasonal changes - in the winter demand for ice cream will decrease whereas it will increase in the summer

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The distinction between a movement along a demand

Movement along a demand curve - when the price of a product increases or decreases, there will be a movement along the demand curve

Shift of the demand curve - when a change in one of the factors to demand occurs, the demand curve will be shifted either to the right or the left. For example, if there's new government regulations concerning bike helmets, the demand will increase whereas the price will remain the same, so the demand curve will be shifted to the right

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Linear demand functions (HL)

The IB economics course focuses on a function which shows the relationship between market demand and determinants for other factors than price:

Qd = a - bP

Where Qd is quantity demanded, a is the demand if cost for the product was zero, P is the price of the product and b sets the slope of the equation

The factors of a and b are affected by a change in a non-price determinant of demand

An example of an equation could be for ice cream during the summer and the winter. The equation for demand of ice cream in the summer could be Qd = 1000 - 100P - this means that at a producer would sell a thousand ice creams at a price of zerio, but if he were to set the price for ice cream at $5 the equation would change - Qd = 1000 - 100*5 = 500, which means that at a price $5, the producer would be able to sell 500 ice creams in the summer time

In the winter time the equation could be different, it may look like this Qd = 450 - 120P, as the demand for ice cream may shrink during the winter. This could make the producer consider a stop in production in this period

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Supply

Supply is defined as the willingness and ability to produce a certain quantity of a good or service at a given time period

an example of supply could be if a banana farmer is able to pick 10.000 bananas at a price of $1 each per week, his supply of bananas at a price of $1 would be 10.000 units a week

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The law of supply

The law of supply states that 'as the price of a product rises, the quantity supplied of the product will usually increase ceteris paribus'

This means that as the producers will produce more of a given product as the price increases. In a graph, the supply curve will usually get steeper as the price rises, however, it is usually drawn as a straight line

In other words, the price determines the production

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The non-price determinants of supply

The book describes five factors of supply that doesn't regard price. These factors determine whether the supply curve moves to the right or to the left. When considering these factors, it is important to make the ceteris paribus assumption. The factors are:

  • The cost of production
  • The price of other products, which the producer could produce instead of the existing product
  • The state of technology
  • Expectations
  • Government intervention 
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The non-price determinants of supply - the cost of

The factors of production includes wages, and machinery, these factors determine the supply of a producer.

For example, if a ball producer increases its wages, the producer will have to cut some of its costs on production itself. This decreases the overall supply of the producer and will move the supply curve to the left

(http://i46.tinypic.com/9i76ll.png)

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The non-price determinants of supply - The price o

As producers are able to produce more than just one product, they'll likely focus their production on the product they believe can sell the most. If these two products are very similar, they would be able to change production without any major changes

For example if a producer is producing two kinds of bread (we'll call it bread A and B) and bread A rises in price due to an increased demand, the producer may choose to focus production on bread A, hence decreasing production of bread B

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The non-price determinants of supply - The state o

If a producer is able to improve the technology of the factors of production, the producer is able to increase their supply - moving the supply curve to the right

It is also possible for a producer to experience a backwards step in technology, the supply curve would be moved to the left as the producer will not be able to supply the same levels as before. Even though this is quite unlikely it is still possible through natural disasters such as earthquakes

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The non-price determinants of supply - Expectation

The producers base their supply on their expectations of future prices

Producers that expect the price of a certain product to rise, may assume that demand will also increase, making them consider storing products in order to prepare for a higher supply of the product at a later time

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The non-price determinants of supply - Government

The government can impose on supply of a product through different method, the two most common ones are indirect taxes and subsidies

Indirect taxes - these are added to the price of the good or service, these taxes leads to an upwards movement on the supply curve. An example of indirect taxes could be taxes on cigarettes, making them more expensive

Subsidies - the government can also subsidize a product, meaning that the government is paying some of the production costs of the producer, this makes the product cheaper to produce and will usually be sold at a cheaper price - moving the supply curve downwards. An example of subsidies could be government subsidies to farmers, in order to make the product cheaper to the general public

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The distinction between a movement along a supply

Movement along the supply curve - a change in the price of the good will lead to a movement along the supply curve as it raises supply to a point that is still on the curve at the given price

Shift of the supply curve - when the supply directly changes without price changing, there will be a shift of the supply curve as the new point of supply at  the given price would not be found on the previous supply curve

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Linear supply functions

The IB economic course focuses on an equation which determines the relationship between supply and price of the product:

Qs = c + dP

Where Qs refers to quantity supplied, c shows the quantity supplied at a price of zero, P is the price and d sets the slope

An example of an equation could be for a company that produces tables, at a price of zero they would produce 100 tables, Qs = 100 + 500*0 = 100, if the price of tables were to increase to one they would produce Qs = 100 + 500*1 = 600 tables and so on

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