How to determine what and how much to produce ?
it depends on the interaction of ss
& dd
- if dd increases/ dd decreases
- the prices will act as a signal to the producers on how much to allocate sources to production
- producers respond by increasing ss/ decreasing ss
*more resources are diverted from goods with lower demand to goods with higher demand
How to determine how much to produce?
The price mechanism helps producers in determining the method of production based on the prices of inputs.
- competition forces firms to use the least cost combination of inputs(prices of labour/ capital) to produce a given level of output.
How to determine for whom to produce?
- the distribution of finished products to consumers is based on consumers’ ability and willingness to pay for the market price for the product
- determined by the purchasing power of the consumers
How the price mechanism allocates scarce resources in the free market? (3 functions)
- Signalling function: changes in prices provide information to producers and consumers about changes in market conditions
- Incentive function: changes in prices provide incentives for producers to reallocate their scarce resources
- Rationing function: changes in prices enable scarce resources to be rationed to the parties who are most willing and able to pay.
What are the key features of the free market economy?
- private ownership of property (individuals have the right to own, control and dispose of land, capital and natural resources)
- freedom of choice and enterprise (households and firms undertake all decisions)
- pursuit of self interest (each unit in the economy attempts to do what is best for itself)
- competition (price competition, no single buyer or seller is influential enough to control a market and exploit other sellers or buyers)
Definition of demand
Demand is defined as the quantity of a well-defined commodity that consumers are both willing and able to buy at each and every price during a given period of time, ceteris paribus.
Definition of demand curve.
The demand curve shows the relationship between the price and quantity demanded of a well-defined commodity. It shows us the quantity demanded of a well-defined commodity that consumers are both willing and able to buy at each possible price during a given period of time, ceteris paribus.
What is the Law of Diminishing Marginal Utility (LDMU)?
Marginal utility(MU) = change in total utility (TU)/ change in quantity (Q)
- LDMU states that beyond a certain point of consumption, as more and more units of a good or service are consumed, the additional utility a consumer derives from consuming successive units decreases
Definition of the law of demand.
The law of demand states that in a given time period, the quantity demanded of a product is inversely related to its price, ceteris paribus.
When there is a change in the amount of a good/ service purchased by consumers due to a change in price of the good/ service, economists say that there has been a change in ___ of the good/ service, which is illustrated by a ___.
quantity demanded, movement along the demand curve
When there is a change in the amount of a good/ service by consumers due to factors not relating to the price of the good/ service, economists say that there has been a change in ___, which is illustrated by a ___.
demand, shift in the demand curve
The 6 non-price determinants of demand are:
- changes in consumers’ income (normal good/ inferior good)
- changes in the price of related goods (substitutes/ complements in consumption)
- changes in consumers’ expectation (future income of consumers, future price of the good)
- changes in consumers’ taste and preferences (advertising/ latest fashion trends)
- changes in the number or composition of consumers (size and composition of the population)
- government policies (influence the purchasing power of consumers and T&P)
Definition of substitutes in consumption.
Substitutes in consumption are goods that can be used in place of one another for the satisfaction of a particular purpose.
Definition of complements in consumptions.
Complements in consumption are goods used in conjunction with one another in the satisfaction of a particular purpose.
What is derived demand?
- a good is demanded not for its own sake but for the purpose of producing another good.
- derived demand applies to inputs used in the production of another good
(different from complements)
Definition of supply.
Supply is defined as the quantity of a well-defined commodity that producers are both willing and able to supply at each and every price during a given period of time, ceteris paribus.
Definition of supply curve.
The supply curve shows the relationship between the price and quantity supplied of a well-defined commodity. It shows us the quantity supplied of a well-defined commodity that producers are both willing and able to sell at each possible price during a given period of time, ceteris paribus.
Definition of the law of supply.
The law is supply states that in a given time period, the quantity supplied of a product is directly related to its price, ceteris paribus.
When there is a change in the amount supplied of a good/service by
producers due to a change in price of the good/service, economists say
that there has been a change in ___of the good/service, which is illustrated by a ___.
quantity supplied, movement along the supply curve.
When there is a change in the amount supplied of a good/service by
producers due to factors not relating to the price of the good/service,
economists say that there has been a change in ___, which is illustrated by a ___.
supply, shift in the supply curve
What are the 7 non-price determinants of supply?
- changes in the costs of relevant resources (wages of labour, prices of raw material, fuel & power)
- changes in the price of related goods (substitutes (competitive supply)/ complements (joint supply) in production)
- nature, ‘random shocks’ and other unpredictable events (weather, diseases, war, flood)
- expectation of future price changes
- changes in technology
- number of sellers
- government policy (indirect taxes and indirect subsidies)
Market equilibrium occurs at a price at which ___.
QD=QS
What will happen when the demand for a good increases?
When the quantity demanded exceeds the quantity supplied, a shortage occurs. Consumers are thus willing to offer a higher price. However, with the higher price, QD falls as the goods are no longer affordable/ may not be worthwhile to purchase as it is higher than the marginal utility (MU) they derive from it. This is indicated by the upward movement along the demand curve until a new market equilibrium is achieved where QD=QS. This process is known as price mechanism.
I the demand for goods fall, this will lead to a ___ in the market as the ___ is greater than the ___. There will be a ___ on prices till the ___ is achieved whereby =.
surplus, quantity supplied, quantity demanded, downward pressure, market equilibrium, QD=QS
