DHS Y5 H2 Economics Content Clinic 1 - Price Mechanism (with answers)

1 H2 Economics – Content Clinic 1 (Price Mechanism) 1. Demand, Supply & Elas�ci�es a. Key Defini�ons: i. Demand is defined as the quan�ty of a good (or service) that a consumer is both willing and able to buy at each possible price during a given period of �me, ceteris paribus. ii. Supply is defined as the quan�ty of a good or service that a producer is both willing and able to sell at each possible price during a given period of �me, ceteris paribus. iii. Price elas�city of demand (PED) is a measure of the degree of responsiveness of the quan�ty demanded for a good to a change in the price of the good itself, ceteris paribus. iv. P rice elas�city of supply (PES) is a measure of the responsiveness of the quan�ty supplied of a good to changes in its price, ceteris paribus. v. Income elas�city of demand (YED) is a measure of the degree of responsiveness of the demand for a good to a change in the income, ceteris paribus. vi. Cross elas�city of demand (XED or CED) is a measure of the degree of responsiveness of the demand for one good to a change in the price of another good, ceteris paribus.

2 b. Key Concepts i. Demand & Supply Demand Quan�ty Demanded Graphical Representa�on Refers to the en�re demand curve Refers to a point on the demand curve Shi� vs Movement • A change in non-price factors will cause a shi� in the demand curve. • When demand ↑/↓ (shi�s right/le�), it means that qty dd has ↑/↓ at all prices. A change in the price of the good will cause a movement along the demand curve. Factors • Expecta�ons of future price change • Govt policies • Y - income • P - Price of related goods (subs�tutes/Complements), Popula�on size • T – Tastes and Preferences • Price of the good itself Supply Quan�ty Supplied Graphical Representa�on Refers to the en�re supply curve Refers to a point on the supply curve Shi� vs Movement • A change in non-price factors will cause a shi� in the supply curve. • When supply ↑/↓ (shi�s right/le�), it means that qty ss has ↑/↓ at all prices. A change in the price of the good will cause a movement along the supply curve. Factors • Number of sellers • Marginal cost of produc�on • Unpredicted Events/ Supply shocks • Qty of goods in joint supply or compe��ve supply • Expecta�ons of future price change • Govt policies • Price of the good itself Note: When explaining shifts in demand or supply, do the following: • Based on the event, identify and explain the non-price factor (include assumptions, if any) • State whether there is an ↑/↓ in demand/supply Example: Given the global economic recovery  economies are experiencing econ growth  ↑income by households  ↑purchasing power  assume the good is a normal good  ↑qty dd at all prices  ↑demand

3 Prac�ce 1: Iden�fy the impact on demand or supply, and the direc�on of change. Market Event Explain impact on demand and/or supply Cars There have been increasing occurrences of disrup�ons in the public transport system Favourable change in preferences towards cars  ↑qty dd at all prices  ↑demand for cars Cigaretes Government has raised the tobacco tax ↑indirect tax  ↑marginal COP for producers  ↓qty ss at all prices  ↓supply for cigaretes Housing Singapore has a high na�onal income No change in demand as there is no change in income. Surgical Masks Public and firms expects prices to rise in future due to dwindling stocks Expecta�on of future price increase  consumers buy more now to avoid higher prices in future  ↑qty dd at all prices  ↑demand for masks in current period (This event also causes ↓supply) ii. PED and PES PED PES Formula 𝑃𝑃𝑃𝑃𝑃𝑃 = % 𝑐𝑐ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑎𝑎 𝑞𝑞𝑞𝑞𝑞𝑞 𝑑𝑑𝑑𝑑 𝑓𝑓𝑓𝑓𝑓𝑓 𝑎𝑎 𝑎𝑎𝑓𝑓𝑓𝑓𝑑𝑑 % 𝑐𝑐ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑎𝑎 𝑝𝑝𝑓𝑓 𝑖𝑖𝑐𝑐𝑎𝑎 𝑓𝑓 𝑓𝑓 𝑞𝑞ℎ𝑎𝑎 𝑎𝑎 𝑓𝑓𝑓𝑓𝑑𝑑 𝑖𝑖𝑞𝑞𝑖𝑖𝑎𝑎𝑖𝑖 𝑓𝑓 𝑃𝑃𝑃𝑃𝑃𝑃 = % 𝑐𝑐ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑎𝑎 𝑞𝑞𝑞𝑞𝑞𝑞 𝑖𝑖𝑖𝑖 𝑓𝑓𝑓𝑓 𝑎𝑎 𝑎𝑎𝑓𝑓𝑓𝑓𝑑𝑑 % 𝑐𝑐ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑎𝑎 𝑝𝑝𝑓𝑓 𝑖𝑖𝑐𝑐𝑎𝑎 𝑓𝑓 𝑓𝑓 𝑞𝑞ℎ𝑎𝑎 𝑎𝑎 𝑓𝑓𝑓𝑓𝑑𝑑 𝑖𝑖𝑞𝑞𝑖𝑖𝑎𝑎𝑖𝑖 𝑓𝑓 Factors • Subs�tutability (avail of close subs�tutes) • Propor�on of income spent on the good • Luxury or necessity (Degree of necessity) • Addic�on • Time • Mobility of FOPs • Existence of spare capacity • Availability of stocks • Time Note: When explaining the value of PED/PES: • Based on the context, identify and explain the PED/PES factor • Explain the link to the magnitude Example: As vegetables are perishable, it cannot be stored for long periods and thus there is likely to be low availability of stocks. The supply is likely to be price inelastic as any increase in price of vegetables will only lead to a less than proportionate ↑qty ss, ceteris paribus, as the producers have little stock to draw upon to raise qty ss.

4 iii. YED and XED YED XED Formula 𝑌𝑌𝑃𝑃𝑃𝑃 = % 𝑐𝑐ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑎𝑎 𝑞𝑞𝑞𝑞𝑞𝑞 𝑑𝑑𝑑𝑑 (𝑓𝑓𝑓𝑓 𝑑𝑑𝑎𝑎𝑑𝑑𝑎𝑎𝑎𝑎𝑑𝑑) 𝑓𝑓𝑓𝑓𝑓𝑓 𝑎𝑎 𝑎𝑎𝑓𝑓𝑓𝑓𝑑𝑑 % 𝑐𝑐ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑎𝑎 𝑖𝑖𝑎𝑎 𝑐𝑐𝑓𝑓𝑑𝑑𝑎𝑎 𝑋𝑋𝑃𝑃𝑃𝑃 = % 𝑐𝑐ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑎𝑎 𝑞𝑞𝑞𝑞𝑞𝑞 𝑑𝑑𝑑𝑑 (𝑓𝑓𝑓𝑓 𝑑𝑑𝑎𝑎𝑑𝑑𝑎𝑎𝑎𝑎𝑑𝑑)𝑓𝑓𝑓𝑓 𝑎𝑎𝑓𝑓𝑓𝑓𝑑𝑑𝑔𝑔 % 𝑐𝑐ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑎𝑎 𝑝𝑝𝑓𝑓 𝑖𝑖𝑐𝑐𝑎𝑎 𝑓𝑓 𝑓𝑓 𝑎𝑎 𝑓𝑓𝑓𝑓𝑑𝑑 𝐵𝐵 Factors Nature of good: Sign • Normal good: YED>0 • Inferior good: YED<0 Magnitude For normal goods, • Necessity: 0<YED<1 • Luxury: YED>1 Nature of rela�onship: Sign • Subs�tutes: XED>0 • Complements: XED<0 Closeness of rela�onship: Magnitude • Weak: 0<XED<1 • Strong: XED>1 Note: When explaining the value of YED/XED: • Explain the reason for the sign (positive or negative) • Explain the reason for the magniture (>1 or <1) Example: As rice is considered a normal good which has a YED that is positive i.e., a rise in income would result in a rise in demand for rice. Specifically, rice is considered a necessity. This means that the magnitude of YED is less than one. A rise in income would lead to a less than proportionate increase in demand, ceteris paribus.

5 iv. Single and double shi� analysis to determine P & Q Single Shi� Analysis on P & Q ↑Demand ↑Supply • Ini�al Eqm: Market is ini�ally at equilibrium, producing Q0 units at Price, P0. (don’t write P0Q0!) • Shi�: Explain the shi� in demand • Shortage/Surplus: At the original equilibrium price P0, quan�ty demanded increases to Q2 while the quan�ty supplied remains at Q0, crea�ng a shortage of Q0Q2. • Upward/Downward Pressure on Price: Buyers, compe�ng for the good, bid up prices. As the price rises, two things happen: o U�lity-maximising consumers, constrained by their budget, reduce the quan�ty demanded. o The units of output that can only be produced at higher marginal cost now become profitable at higher prices, incen�vising firms to increase the quan�ty supplied. • Equilibrium: The process will con�nue un�l the price eventually reaches P1 where quan�ty demanded exactly balances quan�ty supplied and the shortage is removed, removing further pressure on the market to adjust. The new equilibrium quan�ty rises from the original Q0 to a higher Q1. • Ini�al Eqm: Market is ini�ally at equilibrium, producing Q0 units at Price, P0 • Shi�: Explain the shi� in supply • Shortage/Surplus: At the original equilibrium price P0, quan�ty supplied increases to Q2 while the quan�ty demanded remains at Q0, crea�ng a surplus of Q0Q2. • Upward/Downward Pressure on Price: To remove the surplus, firms cut prices. As the price falls, two things happen: o Q uan�ty demanded rises as u�lity - maximising consumers, constrained by their budget, are now willing and able to buy larger quan��es. o The units of output that are produced at higher marginal cost become unprofitable at lower prices. Profit- maximising firms cut back output to avoid the marginal losses, reducing quan�ty supplied. • Equilibrium: The process will con�nue un�l the price eventually reaches P1 where quan�ty demanded exactly balances quan�ty supplied and the surplus is removed, removing further pressure on the market to adjust. The new equilibrium quan�ty rises from the original Q0 to a higher Q1.

6 Double Shi� Analysis on P & Q Context: ↑Dem