EJC H2Econs Topic2

1 © Eunoia Junior College Economics Department Topic 2: Demand & Supply Theme 2.1 Price Mechanism and its Applications How to use this set of lecture notes? 1) BEFORE LECTURES – UNDERSTANDING CONTENT - Reference your notes against your H2 syllabus. Mark out the key concepts so that you know what you MUST know - Read your notes ahead so that you can focus on listening and capturing additional notes during lectures 2) During lectures – APPLYING CONTENT - Bring your hard copy notes along, and use your PLDs to refer to the lecture slides concurrently - Capture additional notes, especially the real-world examples where you can note down how concepts are applied and how economic analysis are developed in varying contexts - You should make use of a notetaking/consolidation tool to take notes during lessons and to consolidate your learning at timely junctures. Examples are MIRO, Notion, Good Notes, Notability, Microsoft One Note, KAMI, and etc. The choice is yours! 3) After Lectures – TUTORIAL PREPARATION to use content flexibly to show application, analysis and evaluation skills - Revise concepts relevant for the case study and essay questions - Refer to the notes and use it flexibly to prepare your answers to meet question requirements. Pure memorisation will not work as it does not involve deep understanding. - Do share your notes with your friends to multiply learning!

2 © Eunoia Junior College Economics Department Introduction to Price Mechanism and its Applications CONTENTS 1. Price Mechanism and its Functions 1.1 The role of price mechanism in resource allocation 2. Demand and Supply Model 2.1 Rationale for the use of models in Economics 2.2 Features of the demand and supply model 2.3 Assumptions of the demand and supply model 3. Demand Theory 3.1 Definition of demand 3.2 Law of Demand 3.3 Demand curve 3.4 Explaining the downward-sloping shape of the demand curve 3.5 Individual demand schedule 3.6 Market demand schedule 3.7 Market demand curve 3.8 Change in quantity demanded vs. Change in demand 4. Supply Theory 4.1 Definition of supply 4.2 Law of supply 4.3 Supply curve 4.4 Explaining the upward-sloping shape of the supply curve 4.5 Individual supply schedule 4.6 Market supply schedule 4.7 Market supply curve 4.8 Change in quantity supplied vs. change in supply 5. Market Equilibrium 5.1 Definition 5.2 Price adjustment process 6. Factors Affecting Demand 7. Factors Affecting Supply 8. 9. Impact on Market due to Simultaneous Shifts in Demand and Supply Inter-Market Relationships Summary Essential Questions: 1. How do consumers and producers make choices about the use of limited resources amongst unlimited wants? 2. How does the market system assist in the allocation of limited resources and distribution of goods and services? 3. What are the factors that affect the market, and what are the impact on market prices and quantities of goods and services?

3 © Eunoia Junior College Economics Department Introduction to Price Mechanism and its Applications To recap, we learnt why the central economic problem of scarcity arises. This is because resources are limited in meeting unlimited human wants. As such, price serves to influence the allocation of limited resources and hence goods and services, in a free market. Have you ever wondered why the price of property in Singapore has been increasing? 10 years ago, a 1,400 square ft private condominium could be as low as $650,000; today, that same condominium would cost a few million dollars! That is a more than 100% increase in price. Could it have been because of higher raw material prices or due to an increasing population? Even so, the increase in price does not seem to deter many people from investing or speculating in it. Is there a way to explain this apparently irrational behaviour? On a global scale, we have seen sharp spikes and plunges in oil price. What are the possible reasons for the volatility in the prices of oil? What were the key determinants? How would changes in oil prices affect other markets such as electricity or even the market for cars? In this topic, you will be equipped with the relevant economic tools in unraveling these complex questions. One such tool is the demand and supply model. We start by understanding the factors that affect demand and supply. After establishing the basic set up of the model, we will introduce various scenarios and consider their impacts on the consumers and producers. Let’s begin!

4 © Eunoia Junior College Economics Department 1. Price Mechanism and its Functions 1.1 The role of price mechanism in resource allocation The central economic problem , scarcity, forces economic agents to make decisions on how they are going to allocate their scarce resources to meet competing wants. How do societies allocate scarce resources? In his publication of An Inquiry into the Nature and Causes of the Wealth of Nations in 1776, Adam Smith argued that markets guide production and consumption of goods and services like an “invisible hand”. Even though everyone is looking after their own private self-interest, their interaction in the market will lead to social good. This is achieved by the price mechanism that allocate scarce resources in producing the optimal amount of goods and services that society desires. Prices facilitate resource allocation as they fulfil the different functions of signalling, incentivising, and rationing. These functions would help economists answer the following questions: i) What goods and services to produce? (Signalling) ii) How much to produce and how to produce? (Incentivising) iii) Who should receive the goods and services? (Rationing) Connect, Extend, Challenge What is the “invisible hand”? It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their self -interest. We address ourselves not to their humanity but their self-love, and never talk to them of our own necessities, but of their advantages. Every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it… he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other eases, led by an invisible hand to promote an end which was no part of his intention. By pursuing his interest, he frequently promotes that of the society more effectually than when he really intends to promote it. Source: Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, Volume 1

5 © Eunoia Junior College Economics Department 1.1.1 Signalling function One role of prices is a signal from consumers to producers to answer ̈What to produce? ̈ when allocating scarce resources amongst unlimited wants to address the fundamental problem of economics. Recall under Topic 1 on Rational Decision Making, where consumers use the marginalist principle, specifically marginal private benefit and marginal private cost to decide how much to consume a good or service? In terms of marginal private benefit, for example, the marginal private benefit of consuming education services can be the personal satisfaction of learning new knowledge and skills. The level of personal satisfaction will determine the price that consumers are willing to pay for education, and that is the quantitative measure of marginal private benefit. So, consumers use price as a signal to inform producers what goods and services they are able and willing to buy, which allows the producers to know what to produce and allocate the nec