SHIFT IN SUPPLY /OR/ DEMAND

SHIFTS IN BOTH SUPPLY AND DEMAND

--4-MARKET QUESTIONS: (DIAGRAM 2, EXPLANATION 2)--

• Use a diagram to explain under what CONDITION an INCREASE IN DEMAND and an INCREASE IN SUPPLY will result in an INCREASE in both PRICE and QUANTITY TRANSACTED. (4)

• Use a diagram to explain under what CONDITION an INCREASE IN DEMAND and a DECREASE IN SUPPLY will result in an INCREASE in PRICE and a DECREASE in QUANTITY TRANSACTED. (4)

• The price mechanism incorporates a 'SIGNALING FUNCTION' which refers to how changes in prices ACT AS SIGNALS to both PRODUCERS and CONSUMERS.

• • • SIGNALS FOR PRODUCERS:

• If DEMAND RISES => SHORTAGE OCCURS at initial price => the PRICE starts to RISE => SIGNAL to PRODUCERS that CONSUMERS WANT MORE of this product.

• If DEMAND FALLS => SURPLUS OCCURS at initial price => the PRICE starts to FALL => SIGNAL to PRODUCERS that CONSUMERS WANT LESS of this product.

• If SUPPLY RISES => SURPLUS OCCURS at initial price => the PRICE starts to FALL => SIGNAL to PRODUCERS that CONSUMERS WANT LESS of this product..

• If SUPPLY FALLS => SHORTAGE OCCURS at initial price => the PRICE starts to RISE => SIGNAL to PRODUCERS that CONSUMERS WANT MORE of this product.

• SIGNALS FOR CONSUMERS:

• If DEMAND RISES => SHORTAGE OCCUIRS => the PRICE starts to RISE => SIGNALS to CONSUMERS that the OPPORTUNITY COST of consuming this product has INCREASED, so consumers WANT LESS.

• If DEMAND FALLS => SURPLUS OCCURS => the PRICE starts to FALL => SIGNALS to CONSUMERS that the OPPORTUNITY COST of consuming this product has DECREASED so consumers WANT MORE.

• If SUPPLY RISES => SURPLUS OCCURS => the PRICE starts to FALL => SIGNALS to CONSUMERS that the OPPORTUNITY COST of consuming this product has DECREASED so consumers WANT MORE.

• If SUPPLY FALLS => SHORTAGE OCCURS => the PRICE starts to RISE => SIGNALS to CONSUMERS that the OPPORTUNITY COST of consuming this product has INCREASED, so consumers WANT LESS.

--How did the founders of TES actually know that there was a demand for IN INTERNATIONAL EDUCATION in Singapore?--

• The 'INCENTIVE FUNCTION' of price refers to how PRODUCERS are INCENTIVIZED TO LISTEN TO THE CONSUMER and provide them the goods and services they wish for, as they have the INCENTIVE (REWARD) of GREATER PROFIT as price and quantity increase, which in a market economy, they can keep the majority of for themselves (Unlike in a planned economy). Hence a good with a rising price will motivate them to supply more, whereas a falling price will INCENTIVISE PRODUCERS to CUT THEIR LOSSES and SUPPLY LESS.

• The 'INCENTIVE FUNCTION' of price also refers to how CONSUMERS are INCENTIVIZED TO MAXIMISE THEIR SATISFACTION by BUYING MORE when the price FALLS, or BUYING LESS when the price RISES.

• • • INCENTIVES FOR PRODUCERS:

• If DEMAND RISES => SHORTAGE OCCURS at initial price => the PRICE starts to RISE => SIGNAL to PRODUCERS that CONSUMERS WANT MORE of this product => INCENTIVISES PRODUCERS to supply more as they make MORE PROFIT.

• If DEMAND FALLS => SURPLUS OCCURS at initial price => the PRICE starts to FALL => SIGNAL to PRODUCERS that CONSUMERS WANT LESS of this product => INCENTIVISES PRODUCERS to supply less as they make LESS PROFIT (or LOSSES)

• If SUPPLY RISES => SURPLUS OCCURS at initial price => the PRICE starts to FALL => SIGNAL to PRODUCERS that CONSUMERS WANT LESS of this product. => INCENTIVISES PRODUCERS to supply less as they make LESS PROFIT (or LOSSES)

• If SUPPLY FALLS => SHORTAGE OCCURS at initial price => the PRICE starts to RISE => SIGNAL to PRODUCERS that CONSUMERS WANT MORE of this product INCENTIVISES PRODUCERS to supply more as they make MORE PROFIT.

• INCENTIVES FOR CONSUMERS:

• If DEMAND RISES => SHORTAGE OCCUIRS => the PRICE starts to RISE => SIGNALS to CONSUMERS that the OPPORTUNITY COST of consuming this product has INCREASED => INCENTIVISES SOME CONSUMERS to REDUCE THEIR CONSUMPTION and enjoy ALTERNATIVE CHEAPER SUBSTITUTES. 

• If DEMAND FALLS => SURPLUS OCCURS => the PRICE starts to FALL => SIGNALS to CONSUMERS that the OPPORTUNITY COST of consuming this product has DECREASED => INCENTIVISES SOME CONSUMERS that the OPPORTUNITY COST of consuming this good has DECREASED so they should INCREASE THEIR CONSUMPTION and enjoy LESS MORE EXPENSIVE SUBSTITUTES. 

• If SUPPLY RISES => SURPLUS OCCURS => the PRICE starts to FALL => SIGNALS to CONSUMERS that the OPPORTUNITY COST of consuming this product has DECREASED => INCENTIVISES SOME CONSUMERS that the OPPORTUNITY COST of consuming this good has DECREASED so they should INCREASE THEIR CONSUMPTION and enjoy LESS MORE EXPENSIVE SUBSTITUTES. .

• If SUPPLY FALLS => SHORTAGE OCCURS => the PRICE starts to RISE => SIGNALS to CONSUMERS that the OPPORTUNITY COST of consuming this product has INCREASED => INCENTIVISES SOME CONSUMERS to REDUCE THEIR CONSUMPTION and enjoy ALTERNATIVE CHEAPER SUBSTITUTES. 

--Do you think any entrepreneur would risk starting a business without the incentive of making profits? Would this school have opened if the founders were not incentivised by the prospect of profit? Do you think this school would exist in a socialist state? Do you think the X-BOX or the i-phone would have been invented in the first place? why not?--

• -WHAT IS THE 'REALLOCATION FUNCTIION' OF THE PRICE SYSTEM? When the signals occur and with the incentive of profit and/or loss reduction, producers will REALLOCATE their productive resources accordingly. 

• If the PRICE of a good is RISING, the producer will ALLOCATE MORE RESOURCES TO THIS PRODUCT and the quantity supplied will rise, similarly, 

• if the PRICE of the good is FALLING, the producer will ALLOCATE LESS RESOURCES TO THIS PRODUCT and reduce the quantity supplied, and in turn reallocate these resources to the market for the good, which is rising in price.

--Over the past few years have you noticed any SUBJECT areas becoming MORE POPULAR while others are becoming LESS POPULAR? How has the school reacted, in terms of ALLOCATION OF THEIR RESOURCES?--

• Explain using the 'FUNCTIONS OF THE PRICE MECHANISM' mentioned above how and why the owner of a Coffee shop made the decision to close down, refurbish, and open a bubble tea shop at the local mall. 

• WATCH THE VIDEO BELOW RELATED TO HOW THE PRICE MECHANISM WORKS TO REALLOCATE RESOURCES FOLLOWING AN 'INCREASE IN DEMAND', THEN CREATE YOUR OWN VIDEO SCRIPT AND VIDEO, EXPLAINING HOW THE PRICE MECHANISM REACTS FOLLOWING EITHER:

  • • • • • 1) 'DECREASE IN DEMAND'

          • 2) 'DECREASE IN SUPPLY

          • 3) INCREASE IN SUPPLY

  • *REMEMBER TO INCLUDE BOTH THE PRODUCER AND CONSUMER SIDES*

    • • • • • HOW?:

            • If you have a stylus and tablet, then this is easily accomplished using a free screen recorder such as ScreenRec, as you sketch simply narrate your script

            • If you have a mobile phone, film yourself sketching the diagram on a sheet of paper and narrate as you draw.

• Economics studies how scarce resources are allocated, but how do we determine if the allocation is right or wrong? How do we measure successful allocation? What metric is used to determine whether the allocation is efficient or not? 

• Generally speaking, the allocation is said to be 'OPTIMISED' or 'ALLOCATIVELY EFFICIENT' when "THE GREATEST AMOUNT OF BENEFIT IS SATISFIED, USING THE LEAST AMOUNT OF RESOURCES", which incidentally occurs at the equilibrium price and quantity

• But how does the interaction between demand and supply make this happen? 

• Let's use an example to illustrate this: Imagine two people are able to pay for a new pair of Jordan’s, yet the first person is willing to pay $500 whilst the other is only willing to pay $100, we can say that the expected benefit of owning the Jordan’s will be far greater for the first person given that they are willing to give up $500 right?

• As such, a well-functioning economic system should ensure that this first person gets to consume this good ahead of the second guy, as this way we are satisfying the most wants and maximising the level of total benefit.

• This may sound obvious but again if we compared this system to that of a planned economy without a price mechanism, then there would be no way for the first person to indicate their stronger desire.

• If we take this a step further, we can realise that an individual's demand curve not only represents the price they are willing to pay at each quantity, but also the amount of benefit they expect to receive. This is in accordance with the law of diminishing marginal utility we studied earlier in the 'DEMAND' unit. As such, the area below the market demand curve represent an accumulaton of society's benefit (aka 'Total benefit'), which gets progressively smaller as price falls.

• To understand this, we need to review our understanding of the link between 'PRODUCTIVITY' and 'OPPORTUNITY COST'. 

• PRODUCTIVITY refers to the output per unit of resource, whereas OPPORTUNITY COST refers to the highest value alternative use of those resources forgone.

• Do you remember the concept of 'INCREASING OPPORTUNITY COST?' when we explained why the PPC curved. It was related to the fact that the opportunity cost to unsuitable resources was higher than for more suitable resources. 

• In other words, a firm that employs resources that are highly suitable for a particular product's production will not only be MORE PRODUCTIVE but, also have a LOWER OPPORTUNITY COST, than a firm that employs resources that are suited to other industries. Think about why China is better at producing labor-intensive textile products, compared to Singapore, or why a Judge does not become a 7-11 clerk.

• As such a firm is only likely to enter an industry if the price it receives compensates them for the opportunity cost forgone. e.g Singapore silicone wafer business owners would only consider entering the garment market if the price of garments was high enough to compensate them for not using their resources to produce silicone wafers.

• This implies that At LOW PRICES only THE MOST (SUITABLE) PRODUCTIVE and LOW-COST FIRMS will be WILLING TO SUPPLY, whilst at HIGHER PRICES the LESS PRODUCTIVE and HIGHER-COST FIRMS will enter, as such THE AREA UNDER THE SUPPLY CURVE REPRESENT TOTAL COST.

• This may sound obvious but again if we compared this system to that of a planned economy without a price mechanism, then there would be no way for the first firm to indicate their suitableness and ability to produce the good at a low opportunity cost.

• Thus a well-functioning and efficient economic system should ensure that this producer with the lowest cost gets to produce the good ahead of the higher cost producers. 

  • • Let's look at an example: Imagine a spike in demand increased the price of bubble-tea, and earned bubble tea sellers a revenue, twice that of Judges, four times that of lowly economics teachers, and ten times that of juice sellers. What do you think would happen? What is likely to happen is they will all be willing to enter the bubble tea market, and the quantity supplied will increase (in accordance with the law of supply). 

    • However, a recent news report claims bubble tea makes you impotent, and a fall in demand inevitably follows. As the price falls to a level at which the revenue is below that of the judge's salary (His opp. cost), he is likely to leave the industry and return to his judging, and as the price and revenue fall below that of a teacher's salary (His meagre opp. cost), he will also leave. However, the juice seller, who has a very low opportunity cost to start with will remain. 

• Note later in the course you will see that this concept in action when we discuss SPECIALISATION and the THEORY OF COMPARATIVE ADVANTAGE.

• So far we have shown that AT HIGH PRICES, ONLY CONSUMERS WITH THE MOST PERCEIVED BENEFIT ARE WILLING TO PAY, and at LOW PRICES ONLY THE MOST PRODUCTIVE FIRMS WILL BE WILLING TO PRODUCE THE GOOD.

• So given this we can also say that AS OUTPUT INCREASES the LEVEL OF ADDITIONAL BENEFIT (AKA 'MARGINAL BENEFIT (MB)') STARTS TO FALL (Accounting for the DOWNWARD slope of the DEMAND curve), hence the DEMAND CURVE = MB CURVE.

• Furthermore we can also say that AS OUTPUT INCREASES the LEVEL OF ADDITIONAL COSTS (AKA 'MARGINAL COST (MC)') STARTS TO FALL (Accounting for the UPWARD slope of the SUPPLY curve), hence the SUPPLY CURVE = MC CURVE.

• Clearly the market only determines a SINGLE EQUILIBRIUM PRICE ('Pe'), therefore there will inevitably be:

• • • 1) Some CONSUMERS who were WILLING TO PAY MORE FOR THE GOOD BUT ENDED UP ACTUALLY PAYING LESS (In other words their MB > Pe), and...

    • 2) Some PRODUCERS that were WILLING TO ACCEPT LESS FOR THE GOOD BUT ENDED UP ACTUALLY RECEIVING MORE (in other words their MC < Pe).

• As such both consumers and producers sides shared a form of SURPLUS benefit, which is termed CONSUMER SURPLUS for the consumer and PRODUCER SURPLUS for the producer, which are MAXIMISED AT EQUILIBRIUM.

• ECONOMICS is ultimately about how economies ALLOCATE THEIR SCARCE RESOURCES in order to SATISFY THE MOST WANTS.

• As we know, with a PLANNED ECONOMY the WHAT TO PRODUCE? and the HOW TO PRODUCE? questions are ANSWERED BY THE GOVERNMENT, hence we have NO WAY OF KNOWING whether the CONSUMERS GET THEIR WANTS SATISFIED, nor whether the PRODUCERS ARE DOING THEIR BEST TO BE AS LOW-COST & EFFICIENT as possible.

• However in a MARKET SYSTEM that utilises a PRICE MECHANISM the WHAT TO PRODUCE is guided by CONSUMER DESIRES, and the HOW TO PRODUCE is guided by producers being as efficient as possible in order to MAKE HIGHER PROFITS. 

• Therefore if we look at how the SUPPLY CURVE works, AT LOW PRICES, ONLY THE MOST COST-EFFECTIVE FIRMS ARE ABLE TO TURN A PROFIT, and as price rises, other higher cost and less efficient producers will progressively enter, and so on, with more and more higher-cost producers entering as price rises.

• Similarly, if we look at the DEMAND CURVE AT HIGH PRICES ONLY THOSE CONSUMERS WHO RECIEVE THE MOST UTILITY WILL OFFER TO PAY THE HIGH PRICES however as the price falls, other consumers with progressively lower utilities will enter the market, and so on.

• Given this, we can say that the EQUILIBRIUM QUANTITY produced, SATISFIES THE MOST WANTS at the LEAST COST.

• This level of output is also referred to as the ALLOCATIVE EFFICIENT LEVEL OF OUTPUT.

• Explain one supply factor and one demand factor that might lead to a rise in the price of rented housing. Demand refers to.... supply refers to.... A rise in the price of rented housing can occur as a result of either an increase in demand or a decrease in supply. An increase in demand for rented housing could be caused by increases in the population or a rise in incomes allowing young people to move out of their familiy homes. We can illustrate how this will result in a rise in price by looking at figure 1.   

• An increase in demand for rented housing could be caused by increases in the population or a rise in incomes allowing young people to move out of their familiy homes. We can illustrate how this will result in a rise in price by looking at figure 1.

• Explain how changes in price work to reallocate resources in a market. Changes in price send signals to producers that goods are either desired via a rise in price following an increase in demand, or undesired via a fall in price following a decrease in demand. When goods are desired, producers have the incentive of more profit, to supply more, hence they will allocate more resources towards the production of this good, similarly, when goods are no longer desired, producers have an incentive to reallocate resources away from the production of this good and towards the production of goods with rising prices, hence we can say that the prices have sent signals to the producers about 'What to produce'

• Explain how the price mechanism allocates resources in an economy. 

• Explain that when consumer surplus and producer surplus are maximized, allocative efficiency is achieved. 

• With reference to demand and supply in competitive markets, explain how the economic question “what to produce” is answered.: Changes in price send signals to producers that goods are either desired via a rise in price following an increase in demand, or undesired via a fall in price following a decrease in DEMAND. When goods are desired, producers have the incentive of more profit, to SUPPLY more, hence they will allocate more resources towards the production of this good, similarly, when goods are no longer desired, producers have an incentive to reallocate resources away from the production of this good and towards the production of goods with rising prices, hence we can say that the prices have sent signals to the producers about 'What to produce?'

• Explain how an increase in the price of air travel might affect the demand for its complements and substitutes: An increase in the price of air travel, should result in a fall in demand for complementary goods such as long-haul holidays, hotels and luggage, whereas it should result in a rise in demand for its substitutes such as domestic holidays, and other forms of transport such as trains and ferries. 

• Explain how the price mechanism reallocates resources when there is an increase in demand for a good or service

• Explain two reasons why a government might impose an indirect tax on a good.

• Explain how an increase in the costs of factors of production would affect the market price and output of a good.

• With reference to the concept of excess demand, explain how a decrease in supply of a good would lead to a new market equilibrium.

• Explain three factors that could led to an increase in the demand for cigarettes. 

• Explain the view that an increase in price will lead to a decrease in the quantity demanded while an increase in demand will lead to an increase in price. 

• Explain why an increase in incomes over time may lead to an increase in demand for some goods but a decrease in demand for other goods.

• Explain two factors that would lead to an increase in the demand for a product.

• Discuss the view that competitive markets will always achieve allocative efficiency.

• Using diagram(s), explain the signaling and incentive functions of price.

• Using diagrams, explain how a change in one of the determinants of demand might increase the price of rice and how a change in one of the determinants of supply might decrease the price of rice.  

• Explain two factors which could shift a firm's supply to the left

• As PRICE FALLS, the QUANITY DEMANDED RISES as more consumers enter the market attracted by the falling price. When they enter, they are expressing their willingness to pay the price, which in turn reflects their personal expected satisfaction. 

• Clearly, those who enter at higher prices believe the product will give them a greater level of satisfaction than those who enter at lower prices. 

• Hence once an actual single price is determined, the people that pay it are all those consumers who were willing to pay more for it, while those that valued it below that price don't actually get to consume it.

• LOWEST-COST PRODUCERS SUPPLY THE PRODUCT: As price rises, the quantity supplied increases as more and more producers enter the market attracted by the rising price. When they enter, they are expressing their willingness to receive that price for each unit of their output, which in turn reflects the fact that they are sufficiently productive to ensure that their costs are low enough for them to make a profit (Or else why would they enter in the first place). 

• Clearly, those who enter at lower prices are able to do so because they have lower unit costs and are more productive than those producers who enter at higher prices. Hence once an actual single price is determined, the firms that accept it are all those producers who were willing to accept less, while those that required a higher price above the equilibrium price don't actually get to supply it.

• Ok, so far we have learned that the free market forces of demand and supply, determine the equilibrium price and quantity, we have also learned that at the equilibrium output total social surplus is maximized, and the system has allowed for the consumers with the most desire to consume the goods, whilst the producers with the lowest costs produce the goods. Now, just to add to the confusion, another few terms are frequently used to refer to this equilibrium-social surplus maximizing level of output, and that is 'THE ALLOCATIVELY EFFICIENT LEVEL OF OUTPUT', or 'THE SOCIALLY OPTIMAL LEVEL OF OUTPUT'.