Determinants and Elasticity Notes PDF

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DETERMINANTS AND ELASTICITY UNI OF LIVERPOOL ECON 123...

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Faye Henaghan

Determinants and Elasticity Determinants of Demand  Disposable income  money used for consumption purposes.  Prices of related goods  complements & substitutes.  Tastes & preferences.  Expectations  future confidence about income, security and the economy as a whole.  Total population.  Individual v aggregate demand- here we can consider the demand of a single agent or that of all agents.  Position- not the slope- of the demand curve  determinants of demand only affect the position of the demand curve, not the slope  any change in determinants is a shock in demand  the demand curve parallel shifts. Disposable Income  There is typically a direct relation between income and consumption- more income = more consumption (higher demand)  normal goods.  Inferior goods are an exception- more income means less consumption of these goods (lower demand). Prices of related goods  Complements- demand of a good is inversely related to the price of complements  coffee & sugar, flights and holidays  if the price of flights rises, the demand for holidays falls.  Substitutes- demand of a good is directly related to the price of substitutes  coffee & tea, Coke & Pepsi  when the price of Coke rises, demand for Pepsi rises. Tastes & Preferences  Demand is dependent upon our tastes and preferences, as well as trends.  For example, some people prefer tea over coffee. Expectations  Our views on the future and certain variables can affect how much we demand of a good.  Job security may lead us to consume more as we feel confident in our current position.  If the economy is in a poor state, we may expect to be made redundant and therefore demand less. Population  The larger a population, the larger demand is.

Faye Henaghan

The diagrams show a shock in demand determinants, leading to a parallel shift. Determinants of Supply  The technology available to produce the good.  The cost of the factors of production (raw materials, etc.)  Future expectations- state of the economy, investment prospects, interest rates.  The supply side mirrors the demand side in that supply determinants affect the position of the supply curve  if they change, the supply curve shifts.

The diagrams show a supply shock, causing a shift in supply.

Equilibrium  Equilibrium- where demand meets supply  market clears.

Faye Henaghan   

This is always the case unless there are inefficiencies/frictions  taxes. When there is a shock in either demand or supply, the equilibrium has been perturbed, and thus the economy shifts to a new equilibrium. Adjustment- the speed of adjustment is dependent upon frictions. Where there are no frictions, adjustment is instantaneous.

Price Elasticity of Supply  PES- the percentage change in supply due to a 1% increase in the price of a good: Δ QS Q PES= S ΔP P  The elasticity of supply tends to be positive- producers make more of a good as the price of the good increases in order to make more profit.  PES is between 0 and   the higher the PES, the higher the sensitivity of supply with changes in price.  Low PES- typically in markets where inputs are scarce and are producing at full capacity  short-term production, planning restrictions reduce how many more buildings can be built in response to an increase in property prices.  High PES- typically in competitive markets where inputs are available and there is extra production capacity to be ‘tapped into’  there is a steady supply of food, and suppliers can react quickly to changes in prices.  In theory, there is a vertical supply curve (where PES=0, i.e. producers cannot react at all to price changes, and the supplied quantity is fixed) and a horizontal supply curve (where PES=, i.e. producers can adjust their supply immediately with no constraints).  The vertical supply curve is known as perfectly inelastic supply, the horizontal supply curve is known as perfectly elastic supply.

Government Interventions  Minimum and maximum pricing  price floors and ceilings.

Faye Henaghan  

Tax  increases price, causing fall in demand/consumption. Subsidies  reduces production costs, reducing overall cost, increasing consumption.

Taxation  In an economy without tax, the equilibrium price is PE.  When a production tax is introduced, the producers have to pay the government T for each unit of a good they produce.  This causes a wedge between the price consumers are paying (P C) and the price produces receive (PP).  The tax is the difference between these prices  T = PC – PP.  When there is no tax  PC = PP = T.  The tax burden is shared between consumers and producers.  Who is worse off? This depends on the PES and PED: o Higher PES- flat supply curve with a steep demand curve leads to consumers being worse off  consumer surplus falls. o Lower PES- steeper supply curve with a flatter demand curve leads to producer surplus falling.

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The diagrams show the effect of a tax when PES varies. Diagram A shows a low (relatively inelastic) PES, while diagram B shows a high (relatively elastic) PES....