This is slides of The Price System (Chapter 2 Core, A Level). It will help on revision time.

1. The Price System
CORE
Kalaiyarasi Danabalan
A’ Level

2. DEMAND
• defined as want or willingness of
consumers to buy goods and services.
• In economics willingness to buy goods and
services should be accompanied by the
ability to buy (purchasing power) and is
referred to as effective demand.
• Demand Extension - increase in demand
due to the fall in price, all other factors
remaining constant.
• Demand Contraction - the fall in demand
due to the rise in price, all other factors
remaining constant.

3. Factors affecting demand
• People’s income
• Population
• Fashion and taste
• Income Tax
• Substitute goods and Complementary goods
• Advertising
• Climate - Changes in climate affects the demand for certain goods
and services.
• Interest rates - A fall in Interest rate will see a rise in demand for
goods and services.

4. SUPPLY
• The amount of goods and services firms or
producers are willing and able to sell in the
market at a possible price, at a particular
point of time.
• The higher the price for the good or service
the more it will be supplied in the market.
The reason behind it is that more and more
suppliers will be interested in supplying those
good or service whose prices are rising.
• Supply Extension - the increase in supply of a
commodity with the rise in price, other
factors remaining unchanged.
• Supply Contraction - the fall in supply of a
commodity when its prices fall, other factors
remaining unchanged.

5. Factors affecting supply
Commodity price
A rise in price will result in more of the commodity being supplied to the
market and vice versa
Production cost
Increase in the cost of any factor of production may result in the decrease
in supply as reduced profits might see producers less willing to produce
that commodity
Technological advancement
Improvement in technology results in lowering of cost of production and
more profits for the producer and thus more supply of that commodity.
Climate
Climate and weather conditions affect the supply of commodities
(agricultural goods)

6. Market Equilibrium / Price Determination
• Equilibrium is a point of balance or a point of rest.
• a state in market where economic forces are balanced and in the
absence of external influences the (equilibrium) values of
economic variables will not change.
• quantity demanded and quantity supplied is equal
• The amount of goods or services sought by buyers is equal to the
amount of goods or services produced by sellers.

7. Equilibrium between DD and Supply

8. Effects of Change in Demand and Supply

9. Elasticity
• 4 categories
- Price Elasticity of Demand
- Income Elasticity of Demand
- Cross Price Elasticity of Demand
- Price Elasticity of Supply

10. Price Elasticity of Demand
• The responsiveness of quantity demanded, or how much quantity
demanded changes, given a change in the price of goods or
service.
*The mathematical value which is derived from the calculation is
negative. A negative value indicates an inverse relationship between
price and the quantity demanded. However, the negative sign is
ignored.
Price Elasticity of demand
(PED)=
% change in quantity demanded
% Change in price

11. 5 Types of PED Curve
• Elastic Demand (PED > 1)
• percentage change in price brings about a more than proportionate change in
quantity demanded.
• when the percentage change in quantity demanded is greater than the percentage
change in price, and the coefficient of the elasticity is greater than 1.
• Ex : Tesco bread, Aero chocolate bar, The Star newspaper.

12. Inelastic Demand
• when an increase in price causes a smaller % fall in
demand.
• when the percentage change in quantity demanded is
less than the percentage change in price, and the
coefficient of the elasticity is less than 1.
• Petrol – petrol has few alternatives because people with
a car, need to buy petrol. For many driving is a
necessity. There are weak substitutes, such as train,
walking and the bus. But, generally, if the price of petrol
goes up, demand proves very inelastic.
• Ex: Diamonds, Iphone, Cigarettes

13. Unitary Elastic Demand
When the percentage change in demand is equal to the
percentage change in price, the product is said to have
Unitary Elastic demand.
PED=1

14. Perfectly elastic
• a small percentage change in price brings
about a change in quantity demanded
from zero to infinity. The coefficient of
elasticity is equal to infinity.

15. Perfectly Inelastic
• In this case the PED =0 That means, any change
in price will not have any effect on the demand
of the product.
• The percentage change in demand will be equal
to zero.

16. POINT ELASTICITY
• The midpoint elasticity is less than 1. (Ed < 1). Price
reduction leads to reduction in the total revenue of
the firm.
• The demand curve is linear (straight line), it has a
unitary elasticity at the midpoint. The total revenue
is maximum at this point.
• Any point above the midpoint has elasticity greater
than 1, (Ed > 1).

17. Applications of Price Elasticiy of Demand

18. Income elasticity of demand
• Relationship between a change in quantity demanded for a good
and a change in real income.
• YED =
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑑𝑒𝑚𝑎𝑛𝑑
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑖𝑛𝑐𝑜𝑚𝑒

19. Normal Goods
• positive income elasticity of demand so as consumers’ income rises
more is demanded at each price.
• demand shifts to the right. Thus YED is positive for normal goods.
Inferior Goods
• negative for inferior goods, the demand curve shifts left as income rises.
• As income rises, the proportion spent on cheap goods will reduce as now
they can afford to buy more expensive goods.
• Ex : demand for cheap/generic electronic goods will fall as people
income rises and they will switch to expensive branded electronic goods.

20. • Different types of economies,
the demand for goods and
services are determined by the
income elasticity.
• As economies grow, firms will
want to avoid producing
inferior goods.
• The reason being as income
increases more and more
people will switch from
inferior goods to superior
goods.

21. Cross price elasticity of demand (XED)
• The effect on the change in demand of one good as a result of a
change in price of related to another product.
• XED =
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑 𝑜𝑓 𝑔𝑜𝑜𝑑 𝑋
% 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑔𝑜𝑜𝑑 𝑌
• It is important to have the positive/negative sign in front of the
value.
• If the value of XED is positive - substitute goods
• If the value of XED is negative – complements goods
• If the value of XED is zero - two goods are unrelated

22. The price of Good X rises by 20 %. As a result, the demand for a
substitute Good Y rises by 10 %. What is the cross-elasticity of
demand for Good Y with respect to Good X?
A + 2 B + 0.5 C - 0.5 D - 2

23. Price Elasticity of Supply
• measure of the responsiveness of quantity to a change in price.
• the percentage change in supply as compared to the percentage
change in price of a commodity.
• PES =
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑆𝑢𝑝𝑝𝑙𝑖𝑒𝑑
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒
• If supply is elastic, producers can increase output without a rise in
cost or a time delay.
• If supply is inelastic, firms find it hard to change production in a
given time period.
Pes > 1 = supply is price elastic
Pes < 1= supply is price inelastic
Pes = 0 = supply is perfectly inelastic
Pes = infinity, supply is perfectly elastic following a change in
demand

24. Supply Curve
PES is more than 1 PES is less than 1.

25. PES = INFINITY PES = 0

26. When the supply of a good decreases, equilibrium price stays the
same. What is the price elasticity of demand of the good?
• A –1
• B zero
• C +1
• D infinite

27. Factors affecting Price Elasticity of Supply
• Spare production capacity
Can increase output without a rise in costs and supply will be elastic
in response to a change in demand. The supply of goods and services
is most elastic during a recession, when there is plenty of spare
labour and capital resources.
• Stocks of finished products and components
In industries where there are high inventories/stocks of finished
goods, the suppliers can easily supply more as the price rises. Thus,
the PES for these goods will be elastic

28. Number of producers
Improvement in Technology
Time
Availability of resources
Ease of storing stocks
If goods can be stocked with ease and have a long shelf life, the
supply will be elastic, otherwise inelastic.
Ex : fresh flowers, vegetables have comparatively inelastic supply
because it is difficult to store them for longer periods.

29. Consumer and Producer Surplus
• Consumer Surplus
The difference between the maximum total price a consumer would
be willing to pay (reservation price) for the amount he buys and the
actual total price.
CS show their benefit in a transaction is how much they saved when
they didn't pay that price.
• Producer Surplus
The difference between the amount that a producer of a good
receives and the minimum amount that he or she would be willing to
accept for the good.
Producers' surplus exists when actual price exceeds the minimum
price sellers will accept.

30. Consumer Plus Producer Surplus

31. Community Surplus
(the welfare of society and it is made up of a consumer surplus plus a producer surplus. It exists
when it is impossible to make someone better off without making someone else worse off )
• When the consumer surplus is
equal to producer surplus
• It exists when the market is in
equilibrium, with no external
influences and no external
effects.
• Market is said to be socially
efficient and community surplus
is at its maximum.
• Q :- What happen to consumer
surplus if Market Demand shift
upward?

32. Question
Definition
1.) Inferior goods
2.) Giffen goods
3.) Consumer surplus
Draw graph
4.) Perfectly elastic of demand
5.) Perfectly Inelastic of Demand