Economics - Resource Allocation

c. d.

Resource Allocation http://education.helixated.com An Open Source Education Project Free market economy – Decisions about production and consumption are left to those who are willing and able to participate in the market place 1. Private ownership of economic resources 2. Profit maximisation for consumers, maximum satisfaction for consumers 3. Price mechanism determines demand and supply

Perfect information Perfect competition

Consumer surplus – The excess of what a consumer is willing to pay over what he actually pays Producer surplus – The excess of what a producer is actually paid over what he is willing to be paid

What to produce: Consumer sovereignty – Consumers have the purchasing power to dictate what goods are produced How to produce: Cheapest method of production For whom to produce: Consumers with purchasing power gets the goods that have been produced Demand – Willingness and ability of consumers to purchase Law of Demand – The quantity demanded of a good is inversely related to its price Change in quantity demanded – Movement along the demand curve Change in demand – Shift of demand curve Factors Affecting Demand 1.

2. 3.

4. 5. 6. 7.

Household income a. Normal goods b. Inferior goods Taste and preferences Prices of related goods a. Substitutes b. Complements Speculations Population structure and size Government policies Climate and weather

Elasticity of Demand 1. 2. 3.

Price elasticity of demand – degree of responsiveness of quantity demanded to a change in price of the good Income elasticity of demand – degree of responsiveness of quantity demanded to a change in income Degree of responsiveness of quantity demanded of a good to a change in price of another good

Price Elasticity of Demand

Types of Demand 1. 2. 3. 4. 5. 6.

Individual demand Market demand Complimentary demand (compliments) Competitive demand (substitutes) Derived demand (factors of production) Composite demand

Supply – Willingness and ability of producers to produce goods Law of Supply – The quantity supplied of a good is proportional to the price of a good

1. 2.

3.

4.

5.

Change in quantity supplied – Movement along the supply curve Change in supply – Shift of supply curve

6.

Factors Affecting Supply 1. 2. 3. 4. 5. 6. 7. 8.

Costs of production Goals of firm Technological improvements Government policies Speculations Climate and weather Number of producers Prices of related goods a. Competitive supply (substitutes in production) b. Complementary supply (complements in production)

Types of Supply 1. 2. 3. 4.

Usually a negative value due to the law of demand Price elastic demand – Elasticity < -1 a. A change in price of the good brings about a more than proportionate change in quantity demanded Price inelastic demand – Elasticity > -1 a. A change in price of the good brings about a less than proportionate change in quantity demanded Unit elastic demand a. A change in the price of the good brings about a proportionate change in quantity demanded Perfectly elastic demand a. A change in the price of the good will bring about an infinite change in quantity demanded b. Horizontal demand curve Perfectly inelastic demand a. A change in the price of the good will not bring about any change in the quantity demanded b. Vertical demand curve

Factors Affecting Price Inelasticity of Demand 1. 2.

Availability of substitutes Proportion of income spent on good

3.

Necessities vs luxury goods

4.

Time period

Price Elasticity of Demand Affecting Total Revenue 1.

Elastic

2.

Inelastic

Individual supply Market supply Competitive supply Complementary supply

Market Equilibrium 1. 2.

Interaction of demand and supply Neither surplus nor shortage arises

3.

Conditions a. No external benefits b. No external costs

1. 2. 3. 4.

Productivity (MPP changes) Price of good (MR changes) Demand for goods and services using skills offered by labour market Market value of product

Elasticity of Demand for Labour 1. 2.

Degree of responsiveness of the level of employment to a change in wage levels Effect of wage increase on the employment level

Factors Affecting Elasticity of Demand for Labour 3.

Unit elastic a. Loss = gain

Income Elasticity of Demand

1. 2. 3. 4. 5.

Time period Proportion of wages to total cost Price elasticity of demand of products Supply of substitute factors Strength of economy

6.

Ease of substitution of resources (eg. labour and capital)

Supply of Labour 1.

2.

3.

Positive income elasticity a. Rightward shift of demand curve b. Normal and luxury goods (inelastic) Negative income elasticity a. Leftward shift of demand curve b. Inferior goods Zero income elasticity a. Basic necessities

1.

Upward sloping as more labour supply at higher wage rates

Factors Affecting Supply of Labour 1. 2. 3.

Ease of entry of new labour Population structure Wages and working conditions in alternative industries

Elasticity of Supply of Labour Cross Price Elasticity of Demand 1.

Degree of responsiveness of quantity of labour supplied to a change in wage levels

Determination of Equilibrium Wage Rate 1. 2. 3.

Positive cross price elasticity a. Substitutes Negative cross price elasticity a. Complements Zero cross price elasticity a. Unrelated goods

Price Elasticity of Supply

1.

Wages paid to workers will depend on their contribution to employers’ revenue

Other Determinants of Wages 1. 2. 3. 4.

Minimum wage laws Racial/gender discrimination Influence of trade unions Imperfect information

Money Market (Loanable Funds)

• 1.

a. 2.

4. 5.

Eg. Manufactured goods

Price inelastic supply

a. 3.

Demand for Loanable Funds 1.

Eg. Agricultural goods

Unit elastic supply a. Straight line from origin Perfectly elastic supply a. Horizontal supply curve Perfectly inelastic supply a. Vertical supply curve

Factors Affecting Elasticity of Supply 1. 2.

Time period Existence of spare capacity (short run)

3.

Storage and perishability

4. 5.

Availability and mobility of factors of productions Number of firms

Diagrams plotted with Wages vs Number of workers employed

1.

3. 4.

Graphically, Demand = Marginal Revenue Product Marginal Revenue Product = Marginal Physical Product x Marginal Revenue (MRP = MPP x MR) MRP – Increase in total revenue contributed by the employment of an additional worker MPP falls, MR constant

Factors Affecting Demand for Labour

Upward sloping a. More savings as higher interest rate → Higher rate of returns

Currencies Market (Foreign Exchange)

•

Diagrams plotted with (eg.) Price of S$ in US$ vs Quantity of S$

Demand for Currencies 1.

Downward sloping

a.

2.

Demand for Labour 1. 2.

Downward sloping a. More demand as lower interest rate → Lower cost of borrowing

Supply of Loanable Funds

Labour Market

•

Diagrams plotted with Interest Rate vs Quantity of Loanable Funds

Price elastic supply

Lower exchange rate causes greater demand of the country’s currency to purchase goods and services Generated by: a. Exports b. Foreign direct investments c. Capital inflows

Supply of Currencies 1.

2.

Upward sloping a. Lower exchange rate causes dearer foreign goods and hence lower supply of domestic currency to import the goods Generated by: a. Imports b. Investment overseas

c.

Capital outflows

1. 2.

Prevent overcharging and allow equitable distribution of scarce product Release more resources for urgent needs

Purpose of Indirect Taxes 1. 2.

Improve resource allocation and achieve social efficiency Government revenue

Effects of Price Ceiling 1. 2.

Shortage of good Black market may result

Price floor → price set above the equilibrium price

Graphically, tax will cause a leftward shift of the supply curve Burden of Tax Supply is elastic → Burden of the tax falls more on the consumers Supply is inelastic → Burden of the tax falls more on the producers Purpose of Subsidies 1.

Encourage consumption and production (of goods which generates positive externalities)

Graphically, subsidy will cause a rightward shift of the supply curve Price controls → market at disequilibrium level → persistent shortages or surpluses Price ceiling → price below equilibrium price

Purpose of Price Ceiling

Purpose of Price Floor 1. 2.

Protect workers’ wages Stabilise prices

Effects of Price Floor 1. 2. 3. 4.

Surplus of good produced Guaranteed higher wage for employed Inflated production costs and consumption prices For agricultural products, surplus is bought by the government, and is an inefficient allocation of resources