2.1 Demand and supply curves

2.1.1 effective demand

2.1.2 individual and market demand and supply

2.1.3 determinants of demand

Determinants of demand includes price and other non-price factors (see 2.1.5).

The demand curve is downward sloping due to

• Income effect: the effect of price change on real income.
• Substitution effect: a price increase will encourage consumers to switch to a cheaper alternative.
• Law of demand: diminishing marginal utility.

2.1.4 determinants of supply

Determinants of supply includes price and other non-price factors (see 2.1.6).

The supply curve is upward sloping due to

• Profit incentive: the higher the price, the higher the profit. Hence higher quantity is supplied.
• Marginal cost: when quantity supplied increases, the marginal cost increases.

2.1.5 causes of a shift in the demand curve (D)

• Disposable income (normal / inferior goods)
• Price of other goods (substitutes / complements)
• Taste, fashion and advertising
• Age / gender distribution of the population
• Expectation of prices in the future
• Expectation of incomes in the future
• Interest rates
• Weather
• Distribution of income

2.1.6 causes of a shift in the supply curve (S)

• Cost of production
  • input costs
  • productivity changes
  • technological changes
  • organizational changes
  • government policy changes
• Price of other goods the producer could supply
  • profitability of alternate products
  • profitability in joint supply
• Taxes and subsidies
• Aims of producers
• Expectation of price changes
• Producer cartel
• Number of suppliers
• Weather

2.2 Price elasticity, income elasticity and cross elasticity of demand

2.2.1 definition of PED, YED, and XED

2.2.2 formulae for and calculation of PED, YED, and XED

$$\text{PED}=\frac{\Delta Q/Q}{\Delta P/P}=\frac{\text{Proportionate change in quantity demanded}}{\text{Proportionate change in price}}$$ $$\text{YED}=\frac{\Delta Q/Q}{\Delta Y/Y}=\frac{\text{Proportionate change in quantity demanded}}{\text{Proportionate change in income}}$$ $$\text{XED}=\frac{\Delta Q_A/Q_A}{\Delta P_B/P_B}=\frac{\text{Proportionate change in quantity demanded of good A}}{\text{Proportionate change in price of good B}}$$

2.2.3 significance of relative percentage changes, the size and sign of the coefficient of PED, YED, and XED
2.2.4 descriptions of elasticity values

PED (absolute value)	$\text{PED}=0$	$0<\text{PED}<1$	$\mathrm{PED}=1$	$1<\mathrm{PED}$	$\mathrm{PED}=\infty$
Demand type	Perfectly inelastic	Inelastic	Unitary elastic	Elastic	Perfectly elastic

YED	$\mathrm{YED}>0$	$\mathrm{YED}<0$	$0<\mathrm{YED}<1$	$\mathrm{YED}>1$
Good type	Normal good	Inferior good	Necessity	Luxury

XED	$\mathrm{XED}>0$	$\mathrm{XED}<0$	$\mid \mathrm{XED}\mid >1$	$\mid \mathrm{XED}\mid <1$	$\mathrm{XED}=0$
Good type	Substitute	Complement	Close relationship	Distant relationship	No relationship

2.2.5 variation in price elasticity of demand along the length of a straight-line demand curve

2.2.6 factors affecting PED, YED, and XED

Factors affecting PED

• Habit forming (addictiveness)
• Number of substitutes
• Price as a percentage of income
• Domain of definition (consider bread v.s. food)
• Length of time
• Degree of necessity

Factors affecting YED

• Habit forming (addictiveness)
• Domain of definition (consider bread v.s. food)
• Degree of necessity

Factor affecting XED

• The degree of substitution or complement of a good to another good

2.2.7 relationship between price elasticity of demand and total expenditure on a product

• If $|\mathrm{PED}|>1$, then a rise in price causes a fall in TR.
• If $|\mathrm{PED}|=1$, then TR is constant.
• If $|\mathrm{PED}|<1$, then a fall in price causes a rise in TR.

2.2.8 implications for decision-making of PED, YED, and XED

PED

consumers

• elastic demand is preferred

firms

• assess the effect of price changes on TR
• advertising to make PED less elastic

governments

• measure the responsiveness of QD due to subsidies or taxes

YED

firms

• repositioning a product
• changing conceptions of a product
• production focus on inferior/normal goods in recession/boom

government

• predict impact on regions that specialize in good and services that are sensitive to income changes
• assess impact of changes of income tax

XED

firms

• strategies to make a product less cross-price elastic
• change the effects of competitors' pricing strategy
• merge with firms producing close substitutes
• collaborate with firms producing complements

government

• encourage consumption of merit goods by lowering the price of its complement

2.3 Price elasticity of supply

2.3.1 definition of PES

2.3.2 formula for and calculation of PES

$$\mathrm{PES}=\frac{\Delta Q/Q}{\Delta P/P}=\frac{\text{Proportionate change in quantity supplied}}{\text{Proportionate change in price}}$$

2.3.3 significance of relative percentage changes, the size and sign of the coefficient of PES

PES	$\text{PES}=0$	$0<\text{PES}<1$	$\mathrm{PED}=1$	$1<\mathrm{PES}$	$\mathrm{PES}=\infty$
Demand type	Perfectly inelastic	Inelastic	Unitary elastic	Elastic	Perfectly elastic

2.3.4 factors affecting PES

• Factor substitution and mobility
• Time period
• Availability of FoP
• Extent of spare capacity in a firm
• Availability of stocks
• Number of firms in the market
• Ease of entry and exit from the market

2.3.5 implications for speed and ease with which firms react to changed market conditions

A high PES indicates that firms are quick and easy to react to changing market conditions, and vice versa.

2.4 The interaction of demand and supply

2.4.1 definition of market equilibrium and disequilibrium

2.4.2 effects of shifts in demand and supply curves on equilibrium price and quantity

This part should be pretty obvious by graph.

2.4.3 relationships between different markets

2.4.4 functions of price in resource allocation

• Rationing function: when prices serve to ration scarce resources when the demand in the market exceed supply.
• Signaling function: when a change in demand from consumers leads to a change in price and this price change acts as a signal to producers to change output.
• Incentivizing function: when the price mechanism encourages producers to supply more when price rises because of the possibility of greater profit.

2.5 Consumer and producer surplus

2.5.1 meaning and significance of consumer surplus
2.5.2 meaning and significance of producer surplus

The net benefit to the society is the sum of consumer surplus and producer surplus.

2.5.3 causes of changes in consumer and producer surplus
2.5.4 significance of price elasticity of demand and of supply in determining the extent of these changes

Draw to a graph to observe the effects on consumer and producer surplus.