The Price Mechanism]

Microeconomics

Year 11 Bridging Work for Non-GCSE Students

Summer Term 2020

[THE PRICE MECHANISM]

Activity: Creating A Demand Curve

• The want or willingness of consumers to buy goods and services but consumers must have enough money to buy goods and services they demand

• Effective Demand- Desire for a good or service supported by the ability and willingness to pay

You are thinking about starting a business during lockdown delivering home made cupcakes. You have done some market research by asking 5 members of the neighbourhood how many loaves of bread they would purchase at each price in a week.

Calculate the total demand for your product (market demand) at each price level. (You need to add up all of the individual demand at each prive level)

Individual Demand

Price Lee Aneesh Sarah Samara Mindy Market Demand 5 +3+10+4+8 = 30 £0.50 5 3 10 4 8

£1 4 3 8 2 4

£1.50 3 2 6 1 2

£2 2 1 4 0 1

£2.50 1 0 2 0 0

Individual Demand Individual demand is the demand for a good or service by an individual consumer. Draw Sarah’s individual demand for your cupcakes here. You’ll need to put Quantity on the X axis and Price on the Y axis. You cannot do it another way in Economics.

Market Demand Market demand is total demand for a product created by adding together all the individual demands

Next, draw a demand curve for your product. This will need to include the total demand from ALL individuals added together.

Your demand curve must have the following:

• Title e.g. Market for Cupcakes • Labelled Axes • Prices written in • Quantities written in • Curve drawn showing the relationship between price and quantity

Watch this video to see if your demand curve looks the way it is supposed to and to give a bit of an introduction to demand

https://www.youtube.com/watch?v=LwLh6ax0zTE

Changes in Price Any change in price leads to a movement ALONG the demand curve

• Increases in price lead to a contraction of demand. Show this on the diagram below using the cupcakes data from previous pages and price £1 and £1.50. Remember to label the axis price and quantity and label the demand curve as D1.

At £1 you will sell ______cupcakes. At £1.50 there will be a contraction of demand along D1 as consumers demand less cupcakes at a higher price and will now only demand ______cupcakes.

• Decreases in price lead to an extension of demand. Show this on the diagram below using price of £1 to £0.50

Explain what has happened in this diagram (use the format from the example above)

Movement Along the Demand Curve

For most goods and services the quantity demanded will fall as the price rises. This shows an inverse relationship. This is called the law of demand and occurs for three reasons. Read this article and write a brief explanantion for each of the reasons below https://www.economicsonline.co.uk/Competitive_markets/Demand_curves.html

1. Substitution effect

2. Income effect

3. Law of diminishing marginal utility

Here is what a diagram showing a fall in price should look like when there are no specific values we use P1, P2, Q1, Q2.

The demand schedule for Yummy Bagels is as follows. Draw a properly labelled Demand Curve. The current price is $4.

Price Quantity Demanded per week $1 3500 $2 3000 $3 2500 $4 2000 $5 1500

Your demand curve must have the following

• Title • Labelled Axes • Prices written in • Quantities written in • Curve drawn showing the relationship between price and quantity

Show on the diagam above what would happen to the demand for bagels if Yummy Bagels drop their prices by 50%

Explain in words what will happen if Yummy Bagels increases the price. (HINT: You need to use the word “contraction” or “extension”) (HINT: You also need to use the word “inverse”)

Shifts in the Demand Curve

A shift of the demand curve is when the demand curve moves to the right or left. Anything that affects the demand for a product that is NOT the price (non-price factors) will shift the demand curve.

Market for Pumpkins Price Quantity Demanded in September Quantity Demanded in October $0.50 550 $0.60 500 $0.70 450 $0.80 400 $0.90 350 1. Draw the demand curve for pumpkins in September. Label this curve D1

2. In October, it is Halloween and at every price level, there is an increase in demand for pumpkins by 1000 pumpkins. Fill in the table to show this and then draw new demand curve for pumpkins in October. Label this curve D2.

3. https://www.khanacademy.org/economics-finance-domain/ap-macroeconomics/basic-economics-concepts- macro/demand/v/change-in-demand-versus-change-in-quantity-demanded-microeconomics-khan-academy Watch this video and explain the difference between change in demand and change in quantity demanded. THIS IS VERY IMPORTANT FOR YOU TO UNDERSTAND.

Increases in Demand If there is an increase in demand, the curve will shift to the right. This is shown on the diagram. Don’t forget to put in your lables. When we don’t have a value for price and quantity we will label those as P1 and P2 and Q1 and Q2. This shows that at price p1 consumers will purchase more of this good.

Decreases in Demand If there is a decrease in demand, the curve will shift to the left. Show this on a diagram

Factors that Shift the Demand Curve

Read the text and use it to summarise why each of the following factors will shift the demand curve.

1. Income- disposable income (income after tax has been deducted)

2. Taste and fashion

3. Marketing

4. Change in price of substitute goods

5. Change in price of complementary goods

6. Population size and demographic

7. Expectations of future price changes

8. Economic Situation

Activity: Shifts in Demand for Skateboards

Tony Eagle is a pro skater. He has started up his own skateboard shop, and would like you to do some analysis of factors than may affect demand for skateboards in Reading. Remember to show P1 to show the price and Q1 and Q2 to show the change in quantity demanded at the same price P1 once the curve has shifted. Don’t forget to label your axes Price and Quantity and label your demand curve D1 and D2.

1. Income- disposable income (income after tax has been deducted)

Coronavirus had lead to on average a decrese in incomes The UK government lowers the rate of income tax of £550 per month.

2. Taste and fashion

Skateboarding is added as an official Olympic sport and Kim Kardashian tweets about how she would never date receives a lot more television coverage. Everyone is a skater, because skateboarding is so last decade. loving it.

3. Marketing 4. Seasons

Tony spends a lot of time on Reading High Steet The winter is viciously cold and it snows in Reading marketing his skateboards to young people. He also pays frequently. a bunch of Reading instagram influencers to post about his boards.

5. Substitute and complementary goods

Substitute goods: alternative goods that could be used for the same purpose

Complementary goods: products which are used together

The price of longboards decreases The price of kneepads and skateboard helmets decrease

6. Population size and demographic

If the number of people in a country increase or decrease this will change demand for goods and services simply by virtue of market size.

What would happen to the demand for Tony Eagle’s Change in the age or demographic of the population is skateboards if high cost of living in London pushes more also important. If a larger % of the population is older people to move to Reading? there will be increased demand for products used by older persons.

What would happen to the demand for skateboards as Britains population ages?

7. Expectations of future price changes

If consumers expect prices to rise, they are likely to demand more of the product now. This may be because they hope to sell the product and make a profit off it in the future. E.g. buying art, houses, shares

What would happen to demand for skateboards if people believed that exclusive Tony Eagle skateboards would be able to be sold for a profit in the future?

If consumers expect price rises, they may purchase goods and services now to save money in the future when prices rise.

In retailiation for Donald Trump’s steel tariffs, the UK has put an import tax on American timber, a crucial part of making skateboards. Tony Eagle has been very outspoken in the press about how this will increase the prices of his skateboards.

8. Economic Situation

If the economy is in a poor state and there is significant unemployment, this may mean that consumers purchase less of certain products as people are worried about becoming unemployed and begin to save instead of spend.

There are widespread reports that there will be another economic downturn in 2020 due to corona virus, and this will be far worse than the 2008 global financial crisis.

Consequences of Demand Curve Shifts

1. A change in price will lead to shift in demand for substitute and complement goods. Falling demand for petrol due to less travel due to corona virus has meant that the price of petrol has fallen. Show the effect of falling petrol prices in 2020 on the market for cars.

An increase in demand for Heinz baked beans has increased the price of Heinz baked beans. Show the effect of this on Sainsbury’s baked beans.

2. If there are no cheaper substitutes, consumers may have to purchase less goods and services if prices rise, leading to a lower standard of living 3. Increase in demand may allow producers to gain a greater economy of scale which may allow them to lower the price or have higher profits 4. Falling demand may lead to falling profits which can mean firms exit the market 5. Falling prices due to increase in supply may mean producers increase their market share, leading to higher profits and possibly forcing competitors out of the market 6. The change in price and quantity depends on price elasticity of supply Price Elasticity of Demand

Price elasticity of demand – shows the responsiveness in quantity demanded of a good or service in response to a change in price. The more responsive the demand of a good or service is to a change in price, the more elastic the demand curve.

• When demand is very responsive to changes in price it is said to be ‘price elastic’

• When demand is not very responsive to changes in price it is said to be ‘price inelastic’

Calculating PED PED = %change in Quantity Demanded / % change in price = (Actual change in Qd/Original Qd ) x 100 (Actual change in Price/Original Price) x 100 = [(Qd2 – Qd1)/Qd1] x 100 [(P2 – P1)/P1] x 100

When doing questions about PED it is important to write in what is P1 and P2 and Qd1 and Qd2. Otherwise you will make mistakes.

Complete the following examples

The price of saucepans rises from £20 to £24 and demand falls from 400 to 300

PED ======

Johanna sells coffee cups. She has changed the price to £4 from £5 and seen sales increase from 1000 to 1500

PED ======

Billy sells rugs and has increased his price from £100 per rug to £200 per rug. In this time rug sales went to 70 from 100 rugs sold per week.

PED ======

Answers for previous page:

Saucepans

PED = %change in Quantity Demanded / % change in price

= (Actual change in Qd/Original Qd ) x 100

(Actual change in Price/Original Price) x 100

= [(Qd2 – Qd1)/Qd1] x 100

[(P2 – P1)/P1] x 100

= ((-100/400) x 100)

((+4/20) x 100)

= -25%/20% ]

= -1.25

Joanna

• P1 = 5, P2 = 4

• Qd1 = 1000, Qd2 = 1500

• PED = -2.5

Billy

P1 = 100 p2 = 200

QD1 = 100, QD2 = 70

PED = -0.3

1. Draw a diagram to show the following: The price of milk rises from £1 to £1.50 and demand falls from 70 bottles to 65 bottles

PED ======

2. Draw a diagram to show the following: The price of soda rises from £1 to £1.50 and demand falls from 70 bottles to 30 bottles

PED ======

Compare the demand curve for milk and soda.

Which has a steeper curve?

Which sees demand be more responsive to changes in price?

https://www.youtube.com/watch?v=nOlOf_KEnrw Watch this video which gives an introduction to PED.

Answers:

1. PED = -0.1428

2. PED = -1.14 Drawing Different Price Elasticities https://www.tutor2u.net/economics/reference/price-elasticity-of-demand Read this article and then use this link to help you draw the diagams below.

Perfectly Inelastic PED = 0

Perfectly Elastic PED = -∞

Unitary Elastic PED = -1

Value Description of Response

Perfectly Inelastic 0 A change in ____ will have no effect on Quantity Demanded

Inelastic 0 to - 1 The %Δ in QD is _____ than the %Δ in P (i.e. demand is not very responsive to changes in P)

Unitary

Elastic

Perfectly Elastic

Practice Questions on Price Elasticity of Demand

Explain whether the diagram here is showing inelastic or elastic demand. Justify your answer (HINT: You need to discuss the %change in price relative to the % change in quantity demanded.

Calculate the following to 2 decimal places and state whether demand is elastic or inelastic. (Show the full method in all of your calculations.)

1. A fall in price from £10 to £6 causes demand to extend from 100 to 150

2. A rise in price from 90p to £1.20 results in a contraction in demand from 300 to 200

3. The price of a product increases from $8 to $9 which causes demand to contract from 800 to 200

4. Demand extends from 2,580 to 3,120 when price falls from £12 to £9

5. Using a diagram, explain price elastic demand

Answers

150 − 100 ( ) × 100 100 1. PED = 6−10 = -1.25 (Elastic) ( )× 100 10

200 −300 ( ) × 100 300 2. PED = 120 −90 = -1 (Unitary) ( )× 100 90

200−800 ( ) × 100 800 3. PED = 9−8 = -6 (Elastic) ( )× 100 8

3120−2580 ( ) × 100 2580 4.PED = 9−12 = -0.8373 (Inelastic ( )× 100 12 Factors that affect elasticity of demand:

Watch this video and use it to explain 5 fators which affect price elasticity of demand. 1. 2. 3. 4. 5.

Decide why demand for the below might be elastic or inelastic and give a reason:

Explain whether you think the demand for the following products would be more elastic or inelastic and why you think this

1. Bread

2. Home saunas

3. Petrol

Significance of Price Elasticity of Demand https://www.youtube.com/watch?v=HHcblIxiAAk Watch this video and then explain the relationship between revenue and price elasticity of demand

Inelastic demand and revenue

Elastic demand and revenue

Effect on Producers TR = Total Revenue

Total revnue is the income earned by producers. It is calculated by multiplying the number of products sold by the price

TR = Price x Quantity

Calculate Total Revenue and PED for the following. Explain whether each company should lower or raise their price.

Company A

Company B

Evaluating the effect of price rises for producers Whether a price rise will benefit a producer by creating more revenue will depend on ______

When demand is inelastic, price and revenue move in the ______direction. A rise in price will cause a ______in revenue and a ______in price will cause a fall in revenue. When demand is elastic, price and revenue move in ______directions. A rise in price will cause a ______in revenue and a _____ in price will cause a rise in revenue Effect on Consumers • If demand is inelastic, governments may choose to tax this product as they know they will receive significant tax revenue. • Consumers may find their elasticity changes at different times, and prices may reflect this. e.g. peak train times • Consumers may have different PED at different times of the year e.g. coats in summer, ice cream in winter.

1. Read the following. How does PED affect consumers of Uber?

In general, most customers are price sensitive, looking for the best deal possible for the greatest value. Unfortunately, this experience is not that straightforward for all markets. Some price changes – even the smallest of increases – can have an immediate, dramatic impact on sales revenue, while others seem to have no effect at all. Take beef, for example. When the price dramatically rises, demand wanes because people can easily substitute chicken or pork. However, for bread and cereals, the U.S. Department of Agriculture revealed that it takes a 25% price increase to induce a 1% fall in consumption.

While these examples reflect pricing that is typically stable for a time period of a week or so, what happens when pricing fluctuates hourly or at any moment when demand spikes? How do customers react then?

“Just like traditional economics would predict, as you raise the price, surge-pricing starts to dampen demand. When you go from a surge of 1x, meaning no surge, to 1.2x, you actually see a very, very large drop in demand,” said Chen. “And when we first started surge pricing at Uber, going from 1x to 1.2x would result in 27 percentage points drop in people who would request our services.”

As time passes and people get used to such fluctuations, the dynamic pricing model doesn’t affect demand as much. They may not love it, but it’s no longer such a shock anymore. And then the price increases incrementally, leading to another drop in demand. However, there is one surprising behavior that is defying this fundamental rule – consumer respect for the perceived use of algorithms.

Chen observed, “there is a very, very strong round number effect [when it comes to pricing]. When you go from 1.9 to 2.0, you see six times larger of a drop in demand than you saw from going from 1.8 to 1.9. So the amount more that you’re paying for the trip is the same between those two steps, but 2.0 just feels viscerally larger to people. Everyone understands they’re paying twice as much for this trip as I would have.”

However, something happens once the multiplier moves from 2.0 to 2.1: People take more rides. But it’s not that a customer would rather pay 2.1 times versus just double the rate. According to Chen, “when you tell someone that their trip is going to be two times more than it normally costs, they think, ‘Wow, that’s capricious and unfair.’ Like, Uber must have seen it was raining and just decided to mess with the customer.” But if the price of the trip is set at 2.1x more than the standard rate, customers tend to believe that there must be a smart algorithm in the background at work. It doesn’t seem quite as unfair.

Although customers can always refer to their mobile device to find another business to get the same service at a lower price, real life can set in and lessen the options available. For example, people are more likely to accept a surge price if their smartphone’s battery is low. Plus, if they are stuck in a location with nowhere else to go, they are likely to enlist the service that will pick them up the fastest – regardless of price

2. Read the following on cigarette taxes a. If the government’s aim is to increase tax revenue, explain a benefit of choosing to tax cigarettes.

b. If the government’s aim is to reduce smoking, explain one disadvantage of taxing cigarettes.

Because smoking is a habit so hard to kick, demand for cigarettes is highly inelastic - meaning that large price changes induce only small changes in the quantity demanded. Equivalently, only large price increases (decreases) will shrink (stretch) demand because the demand is inelastic to price changes. Social factors and education are often significant determinants of which people start smoking, but for those who do smoke the number of cigarettes smoked is not highly sensitive to price.

Evaluating The Importance of PED

Another command word used in exams is evaluate.

‘evaluate’ encompasses the ability to ‘explain’ and to ’analyse’ and refers to the ability to weigh up both sides of the argument, or to compare alternatives, and to come to a supported judgement

You specification will tell you what time of questions you need to “evaluate”. In section 2.2 Demand you will need to be able to “evaluate the importance of price elasticity of demand for consumers and producers”

Read the exercpt below from the World Bank:

The recent crisis in food prices, which has affected thousands of families throughout the developing world, has once again underscored the urgent need for governments to strengthen their safety net systems to ensure that the rise in the price of basic commodities does not trigger an increase in poverty rates.

According to the World Bank study High Food Prices: Latin America and the Caribbean Responses to the New Normal, the region is “well positioned to benefit from high prices and increase food production.” While the region as a whole is a net food exporter, increased food prices negatively affect income, nutrition and health of poor consumers.

1. Latin America is a net exporter of food, meaning there are many food producers in the region. Explain why they will benefit from higher prices?

2. If producers benefit from higher food prices, what does this suggest about the price elasticity of demand for agricultural products?

3. What effect will higher food prices have on consumers in Latin America?

4. What does this suggest about price elasticity of demand for food?

5. Why do you think demand for food is elastic/inelastic?

6. What does the World Bank suggest governments should do to product consumers against higher food prices?

When answering an evaluate question, you will need to do A04: Evaluation (To what extent). Fill in the gaps

The extent to which a producer will benefit from a rise in prices will depend on ______. If demand is ______a rise in price will lead to a fall in revenue. If demand is ______a rise in price will lead to an increase in revenue.

The extent to which a consumer will be disadvantaged by a rise in prices will depend on whether the good or service is a necessity and whether there are many alternatives. If it is a necessity with few alternatives, demand will be ______. This means that as price rises, consumers will have to accept the higher price and this will lead to a ______in the amout of goods and services they can afford which may ______poverty. If the good is not a necessity or has many alternatives, demand will be ______. This means that consumers can switch to alternatives, or choose not to purchase the product.

It will also depend on the size of the rise in food prices. A ______in prices will lead to more revenue for producers, since demand for food is likely to be inelastic. Higher prices will also lead to ______poverty for consumers, since they food is a ______.

Using a diagram, evaluate whether or the UAE will benefit from falling oil prices

The command word here is evaluate. This means you should consider costs and benefits to the UAE, and what it will depend on.

Answer

Demand is the willingness and ability to purchase a good or service at a given price level in a given period of time.

As prices for oil fall in the UAE, this will lead to a movement along the demand curve from Q1 to Q2, showing an increase in the quantity demanded of oil in the UK. Since the UAE is a country which produces oil, and also receives tax revenue from oil, this will affect producers, consumers and the government of the UAE.

Consumers will benefit from a fall in oil prices since this will cause petrol prices to fall. This means that consumers will either be able to purchase more petrol and drive more, or they will be able to have more income left over after purchasing petrol to buy other goods and services. This leads to higher standard of living for consumers.

A fall in oil prices may lead to higher revenue for producers, if demand is elastic and consumers increase the amount of petrol they are buying. This means that firms will make more profit which can be reinvested into new oil wells.

However, demand for oil is likely to be inelastic since it is a necessity with few alternatives. Therefore, oil companies will see their revenues and profits fall. This means that they may need to make workers redundant, and cannot invest in new oil wells.

Since the UAE government makes significant tax revenue from oil, this loss of revenue will also affect the government budget. This means that they have had to reduce spending by 10% from the previous quarter. This means that there may be less government services provided to households such as health and education and infrastructure.

The extent to which a fall in oil prices will affect producers, consumers and governments will depend on the size of the fall. It will also depend on the price elasticity of demand for oil.

In this case, demand for oil is inelastic and the price fall has been large ($110 a barrel to $30 a barrel). Therefore, producers have lost revenue and governments have lost tax revenue. Therefore despite some benefits to consumers from falling oil prices, this is outweighed by the significant losses to producers and governments, which may result in many households losing jobs or government support. Thus the fall in oil prices will not benefit the UAE.

Activity: Creating a Supply Curve

We will look at the supply curve for cupcakes delivered during lockdown. There are a number of sellers of cupcakes in neighbourhood. This shows how many cupcakes each seller would be willing and able to make in a week at each price.

Calculate the total number of cupcakes that will be supplied at each price level.

Individual Supply

Price Fred Adit Rashida Chamelee Jonny Market Supply

£0.50 1 2 0 0 1

£1 2 4 1 0 2

6£1.50 3 5 2 1 3

£2 4 6 5 5 6

£2.50 5 7 10 6 8

Individual Supply Individualsupply is the supply of a good or service by an individual producer. Draw Rashida’s individual supply curve using price on the Y axis and quantity on the X axis.

Market Supply Market supply is total supply of a product created by adding together all the individual producers supply curves

Next, draw a market supply curve for cupcakes. Your supply curve must have the following:

• Title e.g. Market for Cupcakes • Labelled Axes • Prices written in • Quantities written in • Curve drawn showing the relationship between price and quantity

https://www.youtube.com/watch?v=nKvrbOq1OfI Watch this video to check if your supply curve is drawn correctly and learn about the law of supply

Movement Along the Supply Curve

There is a positive relationship between price and quantity supplied. As the price of a product rises, producers (firms / businesses / sellers) expand their supply onto the market.

Read this article https://www.tutor2u.net/economics/reference/theory-of-supply Use it to explain why the supply curve slopes upwards.

1. The profit motive

2. Production and cost

3. New Firms

Changes in Price Any change in price leads to a movement along the supply curve

• Increases in price lead to a extension of supply. Show this on the diagram below using £1 to £1.50 for cupcakes.

At Price £1 suppliers will provide ______quantity of cupcakes. At price £1.50 there will be a ______of supply as producers supply more cupcakes at a higher price and there will now be ______quantity of cupcakes supplied.

• Decreases in price lead to a contraction of supply . Show this on the diagram below for the market for cupcakes using the price of £1 to £0.50

Explain what has happened in this diagram (use the format from the example above)

The supply schedule for Yummy Bagels is as follows. Draw a properly labelled supply Curve.

Price Quantity Demanded per week $1 1500 $2 2000 $3 2500 $4 3000 $5 3500

Your supply curve must have the following

• Title • Quantities written in • Labelled Axes • Curve drawn showing the relationship between • Prices written in price and quantity

Show what would happen to the supply for bagels if Yummy Bagels drop their price from £3 to £1.

Consequences of Movements Along the Supply Curve

• Quantity supplied will move in the same direction as price. This is a positive relationship • Expansion of Supply o greater profits (due to higher output and higher prices) o More firms may enter the market which may shift supply to the right (which then leads to a fall in price) • Contraction of Supply o Fall in profits o Less efficient firms may be pushed out of the market, while efficient firms may have to reduce their production

Shifts in the Supply Curve

If the supply curve itself shifts this is called an INCREASE or DECREASE in supply. It is caused by a change in a factor OTHER THAN price.

Increases in Supply If there is an increase in supply, the curve will shift to the right. It is very important you think about this as a shift RIGHT and NOT a shift up or down.

Decreases in Supply If there is a decrease in supply, the curve will shift to the left. Show this on a diagram

Factors which shift the Supply Curve

Below are factors that may shift the supply curve. Use the information to create a summary of why each factor will shift supply.

1. Changes in the availability of factors of production

2. Changes in the cost of the factors production

3. New firms entering the market

4. Natural disasters/Seasons

5. Taxes/Subsidies which make the good more or less expensive (note that taxes and subsidies will ONLY shift supply NEVER the demand curve)

6. Technological Improvement (making it cheaper to produce goods and services)

7. Increase in the size of existing firms E.g. if existing firms build a new factory or devote more land to growing a certain crop this would increase the supply

8. Government regulations E.g. governments can intervene in the market through health and safety regulations, consumer protection or minimum wage. This will all lead to increases in costs for firms.

Activity: Shifts in Supply for Burgers Tony’s Burgers would like you to do some analysis which may affect the supply of burgers in Reading. Remember to label your axes Price and Quantity, label the supply curves S1 and S2, and show the shift from Q1 to Q2 at P1 using dotted lines

1. Changes in the availability of factors of production Due to cow flu, there is less beef available to make Due to Brexit, meat can now be imported from the USA burger patties which previously was not allowed due to health and safety regulations

2. Changes in the costs of factors of production

The company which the plastic burger wrappers is Most workers who flip burgers are on minimum wage. offering discounts The UK government raises minimum wage.

3. New Firms entering the market

Honest burger are closing all of their Reading stores Due to the profitability of burger joints, new shops are opening all over Reading

4. Natural Disasters/Seasons It is a great year for lettuce growers. There is flooding in tomato growing regions of the UK

5. Taxes/Subsidies The UK government decides to subsidise all small The UK government introduces a fat tax paid on the % of businesses to help with the stresses of Brexit fat in a food product

6. New Technology There is a burger maker 3000 machine invented which can double burger production daily

Consequences of Supply Curve Shifts

1. Economies of scale – the ability of a firm to produce more at every price level should lead to a fall in average costs and the gaining of greater economies of scale. Watch https://www.youtube.com/watch?v=JdCgu1sOPDo to understand what an economy of scale is. Write a definition of economy of scale

2. Efficiency – being able to produce more with the same resources leads to greater efficiency which may include greater productivity

3. Sales – being able to supply more at a lower price may lead to greater sales

4. Exports – all of the above would make a firm more competitive and increase its ability to export successfully

5. Monopoly – if a firm becomes more competitive than its rivals it made be able to drive them out of the market leading to the establishment of a monopoly

Practice Supply Curve Questions

Price Elasticity of Supply

Price Elasticity of Supply measures the responsiveness of quantity supplied to changes in price. The more responsive the supply of a good or service is to a change in price, the more elastic the supply curve.

Calculating PES PEs = %change in Quantity Supplied / % change in price = (Actual change in Qs/Original Qs ) x 100 (Actual change in Price/Original Price) x 100 = [(Qs2 – Qs1)/Qs1] x 100 [(P2 – P1)/P1] x 100

When doing questions about PES it is important to write in what is P1 and P2 and Qs1 and Qs2. Otherwise you will make mistakes.

Complete the following examples

Barbara farms almonds and produces 3000kg. The price of almonds has increased from £3 per Kg to £5 per Kg thanks to increased demand for almond milk during Veganuary. Barbara increases her supply to 3500kg.

PES ======

Kenny is a wine grower. The price of wine has falled from £20 a bottle to £10 a bottle. Luckily, Kenny can simply store his wine so instead of supplying 5000 bottles he is only going to supply 1000 while the price is so low.

PES ======

Kendrick runs a factory making yoyos. He previously has only had to run all the machines at half their capacity because there wasn’t much demand for yoyos and the price was only £1 per yoyo. Kendrick only made 4000 yoyos per year. This year yoyos have been the on trend Christmas toy and prices have skyrocketed to £4 per yoyo. Kendrick has turned the machines up to full and produced 10000 yoyos. PES ======Draw a diagram to show the following: The price of milk rises from £1 to £1.50 and supply increases from 65 bottles to 70 bottles because cows can only produce so much milk and it is difficult to quickly gain more dairy cows

PES ======

Draw a diagram to show the following: The price of soda rises from £1 to £1.50 and supply increases from 30 bottles to 70 bottles since the factories just start operating their machinery faster to produce more soda.

PES ======

Compare the supply curve for milk and soda.

Which sees supply be more responsive to changes in price?

Which axis do each curve come out of?

Fill in the gaps

If the supply curve meets the price axis supply is ______responsive to changes in price. If the supply curve meets the quantity axis supply is ______responsive to changes in price. Answers

P1 = 3, P2 = 5, Qs1 = 3000, Qs2 = 3500 PES = ([Qs2-Qs1]/Qs1)/ ([P2-P1]/P1) = ([3500-3000]/3000)/ ([5-3]/3) = 0.25

Kenny is a wine grower. The price of wine has fallen from £20 a bottle to £10 a bottle. Luckily, Kenny can simply store his wine so instead of supplying 5000 bottles he is only going to supply 1000 while the price is so low.

P1 = 20, P2 = 10, Qs1 = 5000, Qs2 = 1000 PES = ([Qs2-Qs1]/Qs1)/ ([P2-P1]/P1) = ([1000-5000]/5000)/ ([10-20]/20) = 1.6

Kendrick runs a factory making yoyos. He previously has only had to run all the machines at half their capacity because there wasn’t much demand for yoyos and the price was only £1 per yoyo. Kendrick only made 4000 yoyos per year. This year yoyos have been the on trend Christmas toy and prices have skyrocketed to £4 per yoyo. Kendrick has turned the machines up to full and produced 10000 yoyos. P1 = 1, P2 = 4, Qs1 = 4000, Qs2 = 10000 PES = ([Qs2-Qs1]/Qs1)/ ([P2-P1]/P1) = ([10000-4000]/4000)/ ([4-1]/1) = 0.5 Draw a diagram to show the following: The price of milk rises from £1 to £1.50 and supply increases from 65 bottles to 70 bottles because cows can only produce so much milk and it is difficult to quickly gain more dairy cows

P1 = 1, P2 = 1.50, Qs1 = 65, Qs2 = 70 PES = ([Qs2-Qs1]/Qs1)/ ([P2-P1]/P1) = ([70-65]/65)/ ([1.50-1]/1) = 0.154

P1 = 1, P2 = 1.50, Qs1 = 30, Qs2 = 70 PES = ([Qs2-Qs1]/Qs1)/ ([P2-P1]/P1) = ([70-30]/30)/ ([1.50-1]/1) = 2.67

Drawing Different Price Elasticities https://www.economicshelp.org/microessays/equilibrium/elasticity-supply/ use this link to draw diagrams for supply curves with different elasticities.

Perfectly Inelastic PES = 0

Perfectly Elastic PES = ∞

Unitary Elastic PES = 1

Value Description of Response

Perfectly Inelastic

Inelastic 0-1 % Δ in quantity supplied is ______than % Δ in price

Unitary

Elastic

Perfectly Elastic

Practice Questions on Price Elasticity of Supply

Which supply curve shows inelastic supply?

Which supply curve shows elastic supply?

Numerical value of Elastic, inelastic the PES or unitary? 1

0.5

1 If the price of a good rises by 25% and the quantity supplied increases by 10%, is the supply price elastic, price inelastic or perfectly elastic? Justify your answer.

………………………………………………………………………………………………

2 The price of the good falls by 8% and this leads to a fall in the quantity supplied in the region of 10%. Calculate the PES and comment on whether supply is price elastic or inelastic.

………………………………………………………………………………………………

3 The price of product A falls by 80p. It was originally £1.99. This leads to a fall in the volume supplied from 325,000 to 140,000 units. Calculate the PES. Show all your working out.

………………………………………………………………………………………………

4 The price of product B increases from £1.79 to £2.09 per unit. The volume supplied increases from 80,000 to 95,000 units. Calculate the PES. Comment on the size of the co-efficient.

………………………………………………………………………………………………

……………………………………………………………………………………………… Answers

1. Supply is inelastic because % change in price is larger than % change in quantity supplied

2. 1.25 elastic

3. 1.4 elastic

4. 1.125 elastic

Factors that affect price elasticity of supply

1. Producer substitutes • Goods which a producer can easily produce as alternatives e.g. one model of car for another model in the same range 2. Time • The shorter the time period, the more difficult firms find it to switch from making one product to another, SUPPLY will tend to be INELASTIC. • In the long run SUPPLY will tend to be ELASTIC.(Firms can buy more equipment, hire and train more staff) 3. Spare capacity • The more spare capacity there is, the easier it is to increase output if price rises, SUPPLY will tend to be ELASTIC. 4. Number of producers • The more producers there are, the easier it should be for the industry to raise output, SUPPLY will tend to be ELASTIC. 5. Nature of product • If a product can be stored SUPPLY will tend to be ELASTIC. e.g. supply of fresh food is more inelastic because it is perishable

Decide why supply for the below might be elastic or inelastic and give a reason:

Explain whether you think the supply for the following products would be more elastic or inelastic and why you think this (Go back and check the notes for what affects elasticity).

1. Petrol

2. Wine

3. Tickets to the Football

4. Heart surgery (remember to think about supply here,not demand)

Significance of Price Elasticity of Supply

Consumers • If PES is inelastic it may be difficult for a consumer to get more of the product without paying a much higher price • In some cases even an ability to pay a higher price may not yield more product e.g. tickets to a stadium • If PES is elastic it is easy to gain more of a product

Producers In most cases it is better for firms to have an elastic PES. Firms can increase their elasticity by

o Adopting or upgrading to the latest technology o Creating spare capacity o Improving storage methods o Keeping large amounts of stock o Training employees so they can perform a range of jobs as required.

Article: Quinoa in Peru

In the ten years leading up to 2013, quinoa prices nearly tripled, on the back of skyrocketing international demand for the latest ‘superfood’. The grain had traditionally been cultivated in the high Andean plateau, principally for household consumption.. Consequently, the price shot up – it has tripled since 2006.

Just five years ago, Mr Cisneros had a small plot of land, growing food mainly for his own family's consumption. Today, thanks to the global popularity of quinoa as a "super-food", Mr Cisneros, together with his two brothers, owns more than 20 hectares of land and employs 15 farm workers.

Earnings from quinoa have paid for his daughter to study at university in Lima. He has also bought a solar panel and has electricity for the first time. In the evenings, he watches football on television or uses the light to read books on self- improvement.

But there is an unpalatable truth to face for those of us with a bag of quinoa in the larder. The appetite of countries such as ours for this grain has pushed up prices to such an extent that poorer people in Peru and Bolivia, for whom it was once a nourishing staple food, can no longer afford to eat it. Imported junk food is cheaper. In Lima, quinoa now costs more than chicken.

Peru is the world's largest producer of quinoa accounting for just over half of the global supply. Neighbouring Bolivia is the second-largest producer, accounting for just over a third.

The plant thrives in the high altitudes of the Andes mountains. Three years ago, the pioneering Fife Diet, Europe's biggest local food-eating project, sowed an experimental crop of quinoa. It failed, and the experiment has not been repeated. But in 2017, the genome of quinoa was mapped and experiments with different varieties of the plant that can grow in different climates and habitats are under way in Africa, Asia and Europe.

As is so often the case for agricultural commodities, the quinoa boom contained - quite literally - the seeds of its own decline. As prices rose, farmers’ incentive to sell it as a cash crop grew. High prices encouraged new production, less in the traditional mountain regions of Cusco and Puno than in coastal Arequipa. Lowland yields are many times higher, possibly because of irrigation and pesticide use. The price of quinoa has fallen by 75% since 2014.

A clear trend emerged: as global prices fell 40% throughout the year, local quinoa consumption fell, as did quinoa sales and purchases. Consumption of potatoes, which contain less protein, filled the gap. Even after the harvest, consumption remained low, suggesting that farmers were storing quinoa in the hope that prices would go back up. Unfortunately, the sacks in which farmers typically store quinoa are vulnerable to rodents and other pests.

The survey found that farmers would be willing to pay for more effective metal silos, albeit less than their cost of production. This suggests that well-targeted subsidies could incentivize the uptake of metal silos by quinoa cooperatives.

1. What does the increase in price leading up to 2013 suggest about the price elasticity of supply for quinoa?

2. What might cause the supply of quinoa to initially be inelastic?

3. What have been the effects on Peruvian producers of quinoa from the increase in price?

4. What have been the impacts on Peruvian consumers of increases in price?

5. How has the price elasticity of supply of Quinoa become more elastic over time?

6. What are the effects of increasing price elasticity of supply on consumers and producers?

7. How could the Peruvian government intervene to further increase price elasticity of supply to benefit quinoa producers?

Activity: Finding the equilibirum price

The following table below indicates supply and demand schedule for home made cupcakes shops in Reading.

Please use the table below to draw a demand curve and supply curve on the graph.

Note: Provide a title for the market for cupcakes Label both demand and supply curves and the axis. Price goes on the Y axis and Quantity on the X axis. Put both Supply and Demand curves onto the same diagram. You should see the point where they intersect (price £5 where quantity demanded is 80 cupcakes and so is quantity supplied).

Price Quantity Demanded Quantity Supplied

£0.25 100 40

£1 90 60

£5 80 80

£15 70 100

£30 60 120

Questions 1.) At what price does demand and supply meet? Quantiy: ______, Price: ______2.) At what quantity are firms likely to produce at? Quantity: ______3.) What is the equilibrium price? ______

4.) Label the equilibrium Qe and Pe.

This is the equilibrium point. A state of rest when there is no movement in demand or supply. Where price reflects a product’s worth and its role in determining an efficient distribution of resources. Drawing Supply and Demand

1. Draw the axes and label them Price and Quantity 2. Draw a demand curve and label it D 3. Draw a supply curve and lable it S 4. Label the initial equilibrium point with dotted lines to p1 and q1 5. Decide if this is a change which affects consumers and thus the demand curve, or producers and thus the supply curve 6. Draw and label the new curve 7. Label the new equilibrium with dotted lines to q2 and p2 e.g. The following diagram shows the market for fruit in Reading. There has been a huge advertising campaign to eat more fruit for your health.

Fill in the following chain of reasoning:

The increase in advertising has lead to an ______in demand from ______to ______because there has been a changes a consumers tastes in favour of fruit. This leads to a ______in price from ______to ______and an increase in the ______and the quantity supplied from ______to ______. The increase in marketing means that consumers are willing to buy more fruit but have to pay a ______price.

Drawing demand and supply practice questions

Jane’s salad bar would like you to do some analysis about the effects on the market for takeaway salad in Reading.

Due to Brexit there are shortages of lettuce and . The UK economy falls into a recession and incomes tomatoes being imported from Europe lower for everyone.

There are anti-obsesity marketing campaigns which The price of salad dressing decreases emphasize eating more salad.

There are 5 new takeaway salad shops opening in Jane purchases a giant sign to put on the high street Reading. directing customers to her Salad shop.

Takeaway healthy soups are discounted The government decides to subsidise healthy foods

Fill in the following analysis for takeaway healthy soups

The discounting of healthy soups has lead to an ______in demand from ______to ______because it has lowered the price of a substitute good. This leads to a ______in price from ______to ______and an ______in the ______and the quantity supplied from ______to ______. This means that consumers are willing to buy ______but have to pay a ______price.

Now write your analysis for an increase in the price of salad dressing using the same format.

Role of price in determining an efficient distribution of resources

Use the textbook above to summaraise the role prices play in determining an efficient distribution of resources

1. Signalling

2. Transmission of preferences

3. Rationing The role of markets in the determination of price

The determination of price is the interaction of the free market forces of demand and supply to establish the general level of price for a good or service. Watch this video https://www.youtube.com/watch?v=sKCOvstA9c0 to help understand.

If the market is not in equilibrium then there will be either excess supply or excess demand. This means that there is an incentive for the seller to change the price until it reaches equilibrium. The market only clears at the equilibrium price.

If the sellers sells at price p2 then this causes ____ supply because supply ______demand so some of the goods and services are left unsold. The market only clears at price ______when both supply and demand are ______. This means the seller has an incentive to ______the price until the market returns to ____.

At a price lower than equilibrium price there will be ______demand because many sellers will be unwilling or unable to supply at that price. At price p2 demand ______supply so some buyers are unable to purchase the product. The market only clears at ______where both supply and demand are ______. This means that the seller has an incentive to ______the price until the market returns to ______.

Case Study Mobile Phones

Practice Questions https://www.youtube.com/watch?v=tm1R2Bns8c4 Watch this video before trying out your own practice questions.

1. Yummy Bagel is a normal good that is produced and sold by the Yummy Bagel Bakery. Explain what will happen to the equilibrium price and quantity of Yummy Bagels in each of the following scenarios and draw a correctly labelled supply and demand curve.

a) Draw a correctly labelled demand and supply diagram which clearly shows what will happen if Yummy Bagel buys new, high technology dough preparation equipment and new computer controlled ovens for its bakeries.

b) Explain what will happen if Yummy Bagel Bakery buys new, high technology dough preparation equipment and new computer controlled ovens for its bakeries. Use proper chains of reasoning

c) Draw a correctly labelled demand and supply diagram which clearly shows what will happen if a local health expert in a health conscious community that Yummy Bagels contain higher nutritional value than competing bagels. d) Explain what would happen to supply and demand if a local health expert in a health conscious community that Yummy Bagels contain higher nutritional value than competing bagels.

e) Draw a correctly labelled demand and supply diagram which clearly shows what will happen if Good Morning Bakery, a local competitor, drops the price of their bagels.

f) Explain what will happen to supply and demand if Good Morning Bakery, a local competitor, drops the price of their bagels.

g) Draw a correctly labelled demand and supply diagram which clearly shows what will happen if the local automobile assembly plant which hires many of Yummy Bagel’s customers lays off some employees due to a mild recession and the community’s average income decreases.

h) Explain what will happen to supply and demand if the local automobile assembly plant which hires many of Yummy Bagel’s customers lays off some employees due to a mild recession and the community’s average income decreases.

i) Draw a correctly labelled demand and supply diagram which clearly shows what will happen if the cost of flour used in Yummy Bagels increases significantly.

J) Explain what will happen to supply and demand if the cost of flour used in Yummy Bagels increases significantly.

2. Marco Manitti sells pizza by the slice at a popular ski resort. He completes with other vendors at that site who sell other prepared food and snack food items. How will each of the following scenario changes affect the demand and supply for Marco’s pizza slices? a) Draw a correctly labelled demand and supply diagram which clearly shows what will happen if the cost of natural gas for his pizza ovens increases dramatically.

B) Explain what will happen to supply and demand if the cost of natural gas for his pizza ovens increases dramatically.

C) Draw a correctly labelled demand and supply diagram for Marco which clearly shows what will happen if Taco vendors, Marco’s competitors, dramatically drop the cost of their tacos.

D) Explain what will happen to supply and demand if Taco vendors, Marco’s competitors, dramatically drop the cost of their tacos.

E) Draw a correctly labelled demand and supply diagram which clearly shows what will happen if heavy snows attract record numbers of skiers to the ski resort.

F) Explain what will happen to supply and demand if heavy snows attract record numbers of skiers to the ski resort.

https://www.youtube.com/watch?v=9QSWLmyGpYc Complete the practice questions in this video.

Shift in Demand Effect on Demand Effect on Equilibrium Price Effect on Equilibrium Quantity Right Increases Increases Increases Left Shift in Supply Effect on Supply Effect on Equilibrium Price Effect on Equilibrium Quantity Right Left

Read the textbook above and then answer the Activity questions and the Case Study questions.

Activity

Case Study

Price Elasticity of Demand and Supply

The effect of a shift in demand or supply curves on price and quantity will depend on price elasticity.

The government is considering putting a tax on fast food. Below are two diagrams showing the effect of a tax, one in which demand is elastic and one in which demand is inelastic. Label which one is elastic demand and which on is inelastic demand.

Which curve has the greater change in equilibrium price, elastic or inelastic?

Which curve has the great change in equilibrium quantity?

A gym decides to undertake a new membership advertising drive. Show the effect of this advertising drive on two diagrams, one showing elastic supply and the other inelastic supply. You should use the diagram above as a guide.

Which curve has the greater change in equilibrium price, elastic or inelastic?

Which curve has the great change in equilibrium quantity?

Do the questions in this video: https://www.youtube.com/watch?v=nAT_shQGlIk Definitions

These are key terms learners should be familiar with and learners should be able to explain their meaning.

Use https://s3-eu-west-1.amazonaws.com/tutor2u-media/subjects/economics/pdfs/AS-Micro-Key-Term- Glossary.pdf?mtime=20150503114109 to help you learn these definitions.

Key Term Definition

Demand

Demand Curve

Price Elasticity of Demand

Supply

Supply Curve

Price Elasticity of Supply

Market Price

Equilibrium Price

Excess Supply

Excess Demand

Economies of Scale