2023 ACJC H2 Price Mechanism Lecture Notes

©ACJC Econs Dept/2023/JC1/H2 Economics 1 ANGLO-CHINESE JUNIOR COLLEGE JC1 Economics 2023 H2 PRICE MECHANISM & ITS APPLICATIONS Section Content Page 1 Theory of Demand 5 1.1 Consumer’s behavior 5 1.2 Concept of demand 5 1.3 Types of demand 5 1.4 Law of diminishing marginal utility 6 1.5 Law of demand 6 1.6 Demand curve 7 1.7 Factors affecting the demand curve 8 2 Theory of Supply 12 2.1 Producer’s behavior 12 2.2 Concept of supply 12 2.3 Types of supply 12 2.4 Law of supply 12 2.5 Supply curve 12 2.6 Factors affecting the supply curve 14 3 The Market: Interaction of Demand and Supply 17 3.1 Market equilibrium 18 3.2 Movement to a new equilibrium 19 3.3 Equilibrium quantity and society’s welfare 21 4 Price as a Mechanism in Resource Allocation 24 4.1 The price mechanism 24 5 Elasticity of Demand 27 5.1 Price elasticity of demand (PED) 27 5.2 Factors influencing price elasticity of demand 30 5.3 Price elasticity of demand and change in producer revenue and consumer expenditure 32 5.4 Cross elasticity of demand (XED) 34 5.5 Income elasticity of demand (YED) 36 6 Price Elasticity of Supply 37

©ACJC Econs Dept/2023/JC1/H2 Economics 2 6.1 Price elasticity of supply (PES) 37 6.2 Factors influencing price elasticity of supply 40 7 Application of Price Elasticity of Demand and Supply to Determine New Equilibrium Price and Quantity 42 7.1 Price elastic vs price inelastic demand when supply changes 42 7.2 Price elastic vs price inelastic supply when demand changes 44 8 Relevance of Elasticity Concepts to Producers in Raising Total Revenue 46 8.1 Relevance of price elasticity of demand for producers 46 8.2 Relevance of cross elasticity of demand for producers 47 8.3 Relevance of income elasticity of demand for producers 47 8.4 Relevance of price elasticity of supply for producers 48 8.5 Limitations of elasticity concepts to producers 48 9 Government Intervention in Competitive Markets 49 9.1 Why government intervenes in markets 49 9.2 Indirect tax 50 9.3 Subsidy 51 9.4 Price controls – maximum & minimum prices 53 9.5 Quantity control - quota 57 10 Applications to Real World Markets 57 Reference Text (Optional): 1. Karl Case, Ray Fair, Sharon Oster. Principles of Economics, 11th Edition, Pearson, Chapters 3-5

©ACJC Econs Dept/2023/JC1/H2 Economics 3 WHAT IS THIS TOPIC ABOUT? Why are the prices of the latest smartphones like the iPhone 14 and Samsung Galaxy S22 so high when they are first introduced in the market? Why are air tickets much more expensive during school holidays? How has the entry of Grab and Gojek affected the revenue of traditional taxi companies like ComfortDelGro? These are some of the questions which will be dealt with in this topic. In the previous topic, you learned about the Central Economic Problem of scarcity: a situation where there are unlimited wants but limited resources. In this topic, you will learn about how markets deal with this problem, by allocating resources efficiently. You will also learn how economic agents make decisions to pursue their self-interest in markets. LEARNING OUTCOMES Enduring Understanding: [for students to understand and remember] • Market prices and outputs tend to adjust towards a new equilibrium when there are changes in factors affecting consumers and producers’ decisions. • Elasticity concepts explain the magnitude of change in equilibrium price and quantity , arising from changes in demand and supply conditions. • Elasticity concepts have practical applications for producers’ business decisions and governments’ policy decisions. Essential Questions: 1 How do markets allocate scarce resources efficiently? 2 How may elasticity concepts help economic agents in their decision making process? Note: Essential questions are meant to help students thoroughly understand the whole topic. Their aim is to stimulate thinking, provoke inquiry, and spark discussion by students. By answering essential questions, students will be engaged in uncovering the depth and richness of the topic.

©ACJC Econs Dept/2023/JC1/H2 Economics 4 Article: Bicycle sales get boost from Covid-19 pandemic, as more turn to cycling for leisure and transport (Adapted from The Straits Times, 10 August 2020) Thanks partly to the Covid-19 pandemic, cycling is fast gaining popularity - not only as a l eisure activity, but also as a mode of transport. This is so much so that bicycle shops are running out of stock and prices of popular brands have shot up. Secondhand Brompton bicycles for instance, are advertised for as much as $5,000 to $8,000 a piece because new ones - which cost around $2,500 - are in short supply. Brand new Dahon bikes are also sold for as much as 40 per cent more than before. Mr William Loo, 69, who imports the KHS range of bicycles, said sales had grown by 30 per cent this ye ar. "Because of Covid- 19, people are exercising a lot more ”, he said. "I have never sold so many bicycles before. Mr Paul Fam, 55, who owns a bicycle shop in Paya Lebar, said his inventory is also running low, but added that the growing popularity of bicyc les has spawned several new sellers. "Even durian sellers and phone cover sellers are now selling bicycles," he said. "Consumers are shifting spending away from traditional leisure activities towards what we call solitary leisure activities... and cycling would be one." The growing interest in cycling is in line with the trend in other parts of the world as commuters turn to cycling to avoid crowded public transport. The cycling boom amid COVID -19 has resulted in shortages for bicycle components due to production stoppages, plant shutdowns, port and border closures and longer shipping times. Questions: 1) How would you explain the basis of the decision a consumer makes to buy a new bicycle when the price of bicycles has shot up? 2) How would you explain the basis of the decision made by a durian seller or a phone cover seller to start selling bicycles? Note: Do revisit the above questions after you have completed the lectures on the Interaction of Demand and Supply.

©ACJC Econs Dept/2023/JC1/H2 Economics 5 1. THEORY OF DEMAND 1.1 Consumer’s Behaviour • The consumer aims to maximise his utility ( i.e. satisfaction) whenever he decides to consume a good. • With this objective in mind, the consumer needs to decide which good to consume and if applicable, how many units of that good to consume. • However, the consumer is constrained by his limited resources ( i.e. disposable income) and thus faces a budget constraint to spend on the goods and services he wants to consume. 1.2 Concept of Demand • Demand refers to the quantity of a product that buyers are willing and able to buy at various prices in a period of time, ceteris paribus. o Ceteris paribus is a Latin phrase that generally means “holding other things constant”. In Economics, we include this assumption when analyzing how one variable affects another. Hence, the need to include ceteris paribus when defining what demand is as we are assuming that price is the only factor that changes. o The willingness to purchase depen ds on the taste and preference of the consumer i.e. whether the consumer wants the good. o The ability to purchase depends on one’s disposable income i.e. the income the consumer earns after deduction of taxes, as well as his wealth (value of assets owned). o Demand is effective when consumers are both willing and able to pay for the goods and services.