AS: Unit 1 - Maximum and Minimum pricing, Zero Pricing

In this post we will learn:

1.  Maximum pricing / Price ceilings
2.  Minimum pricing / Price floors
3. Zero pricing

 

Maximum prices

 

Maximum prices may be defined as a price ceiling whereby price of a good or service is not allowed to exceed. It usually below the free market equilibrium price (Pe).

Suppliers therefore are no longer allowed to charge the market price and is forced to meet the maximum price ceiling set by the government.

However this contributes to excess demand (Q2 to Q1) as suggested by the Law of Demand, the lower the price, the higher the demand HOWEVER at 'Pmax' suppliers are not willing to supply what is demanded at 'Q1' and is only willing to supply at 'Q2' thus there is excess demand.

 

Maximum prices may be imposed by the government in an attempt to prevent the market price from rising above and beyond a given amount; for example to prevent the monopolistic exploitation of consumers.

 

Impact (evaluation)

• Can result in a underground market whereby maximum prices is evaded targeting those who are prepared to paid more (to satisfy excess demand) promoting illegal criminal activity. Higher prices therefore act as a device for rationing.
• May lead to corruption and bribery in regulation
• Maximum price above the equilibrium will contribute no effect thus may be considered as Government failure (as government administration costs will exceed the 'benefits')

Minimum pricing

 

Minimum prices may be defined as a price floor whereby price of a good or service is not allowed to go below. It usually above the free market equilibrium price (Pe).

Suppliers therefore are no longer allowed to charge the market price and is forced to meet the minimum price floor set by the government.

 However this contributes to excess supply (Q3 to Q1) as suggested by the Law of Supply, the higher the price, the higher the supply HOWEVER at 'Pmin' consumers are not willing to pay what is supplied at 'Q1' and is only willing to pay at 'Q3' thus there is excess supply.

 

Minimum prices may be imposed by the government I an attempt to prevent the market price from falling beyond a given amount; for example to prevent over consuming of  a demerit good. 

 

Impact (evaluation)

• Prevents the market from working efficiently therefore may lead to further misallocation of resources.
• Minimum price below the equilibrium will contribute no effect thus may be considered as Government failure (as government administration costs will exceed the 'benefits')

Zero Pricing

This illustrates the effect of the market when a  good is produce free at the point of use. This suggests a market price of 0. For example the NHS health care (though we 'pay' for it through taxation it is free at point of use). However demand for this service will most likely lead to excess demand (Q2 - Q1) thus disequilibrium resulting in waiting lists.

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AS: Unit 1 - Shifts in demand and supply

In this post we will learn:

1. How and why there are shifts in demand
2. How and why there are shifts in supply

Shifts in the demand curve

Analysing the diagram:

Given that the original equilibrium demand curve is 'D' at price 'P' and quantity 'Q'

• Reduction in demand
• The demand curve will shift left (D to D1)
• Price will reduce from 'P' to 'P1'
• Quantity demanded will reduce from 'Q' to 'Q1'
• Increase in demand
• The demand curve will shift right (D to D2)
• Price will increase from 'P' to 'P2'
• Quantity demanded will increase from 'Q' to 'Q2'

Causes:

• Change in prices or related goods
• Substitutes
• If price of a substitute increase then demand for this good will increase
• If price of a substitute decrease then demand for this good will decrease
• E.g. If the good is butter and the price of margarine increases, then the demand for butter will increase. Similarly if price of margarine decreases, then the demand for butter will decrease.
• Complements
• If price of complementary good increase then demand for this good will decrease
• If price of complementary good decrease then demand for this good will increase
• E.g. If this good is DVD players and the price of DVDs increases, the demand for DVD players will decrease. Similarly if price of DVDs decreases, the demand for DVD players will increase as they are consumed together.
• Change in income
• Normal goods
• If income increases then demand for normal goods will increase
• If income decreases then demand for normal goods will decrease
• Inferior goods
• If income increases then demand for inferior good will decrease
• If income decreases then demand for inferior good will increase
• E.g. Transportation, if income increases you are more likely to drive your car. If income decreases you are more likely to take the train. In this case car is the normal good and public transport is the inferior good.
• Change in taste
• Change in expectation

Shifts in the Supply curve 

 

 

Analysing the diagram:

Given that the original equilibrium demand curve is 'S' at price 'P' and quantity 'Q'

• Reduction in supply
• The supply curve will shift left (S to S2)
• Price will increase from 'P' to 'P2' 
• Quantity demanded will reduce from 'Q' to 'Q2'
• Increase in supply
• The supply curve will shift right (S to S1)
• Price will decrease from 'P' to 'P1'
• Quantity demanded will increase from 'Q' to 'Q1'

Causes:

•  Change in technology
• Better technology will increase efficiency / productivity
• E.g. new machine which can produce 5 times more goods will lead decrease average costs
•  Change in supplies
• Cheaper supplies
• E.g. cheaper source of oil will decrease average costs (therefore shift S to S1). Conversely natural disaster may increase price of oil thus increase average costs (therefore shift S to S2)

 

AS: Unit 1 - Demand and Supply curves in a market and the equilibrium

In this post we will learn:

1. The basics of the demand and supply curve
2. How the price mechanism establishes an equilibrium in a market

So this post will mainly be about the very basic demand and supply diagram.

*ASSUMING CETERUS PARABUS*

Firstly the Demand curve (on the right) is downwards sloping. Why?

This because of the Law of Demand which suggests there is an inverse relationship between the price and demand of a good (hence the axes on the diagram)! This basically means as prices fall (P1 to P2) there will be a increase in quantity demanded (Q1 to Q2), similarly as prices rises (P2 to P1) there will be a decrease in quantity demanded (Q2 to Q1).

 

Secondly the Supply curve (on the left) is upwards sloping. Why?

Well surprise; this is because of the Law of Supply! Similarly to the relationship of the demand curve, as prices increase (P1 to P2) there will be an increase in the quantity supplied (Q1 to Q2) and as prices decrease (P2 to P1) there will be a decrease in the quantity supplied (Q2 to Q1).

 

It is actually quite logical, if you think about it. If the price of  a good decreases of course you're more likely to buy it! Similarly if you sold a good and the price of the good increased of course you'd supply more!  

 

The Equilibrium

 

When demand meets supply the equilibrium is established and there is no tendency for change. Price is at 'P1' and quantity is at 'Q1'.

 

 

However when we're not at equilibrium we are at market disequilibrium and supply does not equal demand.

• If price is at 'Ps'
• Suppliers are willing to supply quantity 'Qy'
• However demand is only at 'Qx'
• Thus there is excess supply (more supply than demand) from points 'A' to 'B' (Qx to Qy)
• If price is at 'Pd'
• Suppliers are only willing to supply at 'Qx'
• However demand is at 'Qy'
• Thus there is excess demand (more demand than supply) from points 'C' to 'D' (Qy to Qx)
• If price is at 'P1'
• There is market equilibrium

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AS: Unit 1 - The economic problem and the PPF

In this post we will answer 2 questions.

1. What is the economic problem?
2. What is the production possibility frontier?

What is the economic problem?

Right so lets get straight to it!

The economic problem is scarcity

Yep that is pretty much the economic problem; not so difficult right? But lets go in a bit more detail. 

Scarcity means there is only a limited amount of resources available to produce the unlimited demands of goods and services people desire. So basically in the world we live in, there are infinite 'needs' (necessities) and 'wants' (desires) and we cannot satisfy all of them, therefore we have the economic problem of scarcity.

 

SO! Basically there are 3 fundamental questions

• WHAT should we produce?
• HOW should we produce it?
• For WHOM should it be produced?

The purpose of economic activity is to increase economic welfare. Increasing production will enable economic welfare to increase (assuming production actually consumed and not just sitting around).

Here are some quick terms you'll need to know (most is probably common sense)

• Depletion - Using up scarce resources
• Degradation - e.g. Pollution and destruction of natural environment
• Consumer goods - Goods brought for consumption, e.g. food
• Capital goods - Goods brought by firms to produce other goods, e.g. machinery

The production possibility frontier (PPF)

This diagram illustrates possible combinations of product X and product Y an economy can produce when all the available economic resources are being used.

Say initially economy is producing at point A; this means at X1 output of product X, there will be Y1 output of product Y. However say the economy wants to increase output of product Y to level Y2, they cannot achieve this without decreasing the level of output of product X to X2. 

This is because the economy is operating at productive capacity, it cannot increase production of one product without decreasing production of another. This is called an opportunity cost where the loss of other alternatives when one alternative is chosen.

There are opportunity costs everywhere and you encounter them everyday. For example, you have £1 and you want to buy bottle of coke and a notebook; however you cannot afford both. You will then use a value judgement to decide which to get. Say you chose the notebook, the opportunity cost of the notebook was the bottle of coke.

The 'Guns vs Butter' model is a good example of the PPF applied.

This diagram is a fairly simple diagram, however as the course is synoptic - we can still use this diagram in A2 economics as well (as a low level diagram) so it is good to remember!

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