Revision presentation on aspects of the price mechanism - for unit 1 microeconomics

1. AS Micro
The Price Mechanism in
Action!
Geoff Riley, FRSA, Eton College &
Tutor2u

2. Functions of the Price Mechanism
1. Allocation – allocating scarce resources
among competing uses
2. Rationing – prices serve to ration scarce
resources when demand outstrips supply
3. Signalling – prices adjust to demonstrate
where resources are required, and where
they are not
4. Incentives – when the price of a product
rises, quantity supplied increased

3. Incentives matter!

4. Markets in Action – Crude Oil
Applying supply and demand analysis

6. Changing supply / demand conditions
Market Change Shift in Supply or
Demand?
Rise or Fall in
Market Price for
Crude Oil?
• There is a steep slowdown in the
Chinese economy
• OPEC agrees to an increase in output
quotas for each of their members
• There is a fall in the number of active oil
rigs in many of the world’s major oil
producers

7. Changing supply / demand conditions
Market Change Shift in Supply or
Demand?
Rise or Fall in
Market Price for
Crude Oil?
• There is a steep slowdown in the
Chinese economy
Demand
Price of
crude oil
Quantity of
crude oil
D1D2
S1
Q1Q2
P2
P1

8. Changing supply / demand conditions
Market Change Shift in Supply or
Demand?
Rise or Fall in
Market Price for
Crude Oil?
• OPEC agrees to an increase in output
quotas for each of their members
Supply
Quantity of
crude oil
Price of
crude oil
Quantity of
crude oil
D1
S1
Q1 Q2
P2
P1
S2

9. Oil Rigs and Price Incentives
High oil prices
increase the
incentive to drill
for oil
Deepwater oil rigs now
cost between around
$600m to build

10. Changing supply / demand conditions
Market Change Shift in Supply or
Demand?
Rise or Fall in
Market Price for
Crude Oil?
• There is a fall in the number of active oil
rigs in many of the world’s major oil
producers
Supply
Quantity of
crude oil
Price of
crude oil
D1
S1
Q1Q2
P2
P1
S2

11. Impact of changing oil prices
Oil
Industry
• Exploration &
Drilling
• Investment
People
• Cost of living
• Real incomes
Related
sectors
• Oil substitutes
• Oil supply
chain industries
Connections
Connections

12. Stakeholders
Groups who benefit from high
oil prices
Oil companies
Oil exporting nations
Government – oil taxes
Renewable energy industry

14. Stakeholders
Groups who benefit from high
oil prices
Groups who lose out from high
oil prices
Oil companies Motorists
Oil exporting nations
Transport businesses e.g.
airlines, road haulage
Government – oil taxes
Higher energy prices -
consumers
Renewable energy industry
Businesses hit by falling real
incomes of households

15. The Global Market for Aluminium

16. Aluminium Prices

17. Shifts in supply & demand
Market Change Shift in Supply
or Demand?
Rise or Fall in
Market Price for
Aluminium?
A fall in demand for new long-haul
aircraft
Tighter fuel-efficiency standards for new
vehicles in the USA
A persistent fall in the world price of
steel
A rise in the price of bauxite (used in
manufacturing aluminium)
P7

18. Shifts in supply & demand
Market Change Shift in Supply
or Demand?
Rise or Fall in
Market Price for
Aluminium?
A fall in demand for new long-haul
aircraft
DEMAND FALL
Tighter fuel-efficiency standards for new
vehicles in the USA
A persistent fall in the world price of
steel
A rise in the price of bauxite (used in
manufacturing aluminium)

19. Please use BIG DIAGRAMS
– large, clear diagrams are
easier to mark and credit!

20. Shifts in supply & demand
A fall in demand for new long-haul
aircraft
DEMAND FALL
Price of
Aluminium
Demand
Supply
P1
Q1 Quantity of
Aluminium

21. Shifts in supply & demand
A fall in demand for new long-haul
aircraft
DEMAND FALL
Price of
Aluminium
Demand
Supply
P1
Q1 Quantity of
Aluminium
D2

22. Shifts in supply & demand
A fall in demand for new long-haul
aircraft
DEMAND FALL
Price of
Aluminium
Demand
Supply
P1
Q1 Quantity of
Aluminium
D2
P2
Q2

23. Shifts in supply & demand
Market Change Shift in Supply
or Demand?
Rise or Fall in
Market Price for
Aluminium?
A fall in demand for new long-haul
aircraft
DEMAND FALL
Tighter fuel-efficiency standards for new
vehicles in the USA
DEMAND RISE
A persistent fall in the world price of
steel
A rise in the price of bauxite (used in
manufacturing aluminium)

24. Shifts in supply & demand
Market Change Shift in Supply
or Demand?
Rise or Fall in
Market Price for
Aluminium?
A fall in demand for new long-haul
aircraft
DEMAND FALL
Tighter fuel-efficiency standards for new
vehicles in the USA
DEMAND RISE
A persistent fall in the world price of
steel
DEMAND FALL
A rise in the price of bauxite (used in
manufacturing aluminium)

25. Shifts in supply & demand
Market Change Shift in Supply
or Demand?
Rise or Fall in
Market Price for
Aluminium?
A fall in demand for new long-haul
aircraft
DEMAND FALL
Tighter fuel-efficiency standards for new
vehicles in the USA
DEMAND RISE
A persistent fall in the world price of
steel
DEMAND FALL
A rise in the price of bauxite (used in
manufacturing aluminium)
SUPPLY RISE

26. Shifts in supply & demand
Price of
Aluminium
Demand
Supply
P1
Q1 Quantity of
Aluminium
D2
P2
Q2
A rise in the price of bauxite (used in
manufacturing aluminium)
SUPPLY RISE
S2

27. Shifts in supply & demand
Price of
Aluminium
Demand
Supply
P1
Q1 Quantity of
Aluminium
D2
P2
Q2
A rise in the price of bauxite (used in
manufacturing aluminium)
SUPPLY RISE
S2
P3
Q3

28. Price of
Aluminium
D1
S1
P1
Q1Quantity of
Aluminium
Price of
Pepsi Max
Di
Si
Pi
Qi
Inter-related markets
Quantity of
Pepsi Max

29. Price of
Aluminium
D1
S1
P1
Q1Quantity of
Aluminium
Price of
Pepsi Max
Di
Si
Pi
Qi
Inter-related markets
D2
P2
Q2 Quantity of
Pepsi Max

30. Price of
Aluminium
D1
S1
P1
Q1Quantity of
Aluminium
Price of
Pepsi Max
Di
Si
Pi
Qi Quantity of
Pepsi Max
Inter-related markets
D2
P2
Q2
Sii
Pii
Qii

31. Analysis
Evaluation
Application
Good application opens the door to
good analysis and good evaluation

32. ”A new norm of
high prices seems to
be consolidating,
and the world
cannot afford to be
complacent to this
trend while 870
million people still
live in hunger and
millions of children
die every year from
preventable
diseases caused by
malnutrition.”

33. Why are prices volatile in the markets
for many commodities?
Low
Ped
(<1)
Low
Pes
(<1)
Volatile
Supply
Shocks
Market
Specula
-tors

34. Double diagrams can be a
handy way of analysing
changing elasticity of
demand and supply

35. Using analysis diagrams
Price
Quantity
Price
Quantity

36. Using analysis diagrams
Price
Quantity
Price
Quantity
S1
D1

37. Using analysis diagrams
Price
Quantity
Price
Quantity
S1
D1 D2
P1
P2

38. Using analysis diagrams
Price
Quantity
Price
Quantity
S1
D1 D2
P1
P2
S1
D1

39. Using analysis diagrams
Price
Quantity
Price
Quantity
S1
D1 D2
P1
P2
S1
D1
S2
P1
P2

40. Problems arising from price volatilityRisk and Uncertainty
• Uncertain incomes and profits for farmers
• May limit capital investment / productivity
Extreme poverty and unemployment
• Millions of smaller farmers in the world
• Many do not gain when world prices rise
• Monopsony power of commodity buyers
Macroeconomic effects
• Volatile export revenues affects trade balance
• Causes inflation and extreme food poverty

41. Problems arising from price volatilityRisk and Uncertainty
• Uncertain incomes and profits for farmers
• May limit capital investment / productivity
Extreme poverty and unemployment
• Millions of smaller farmers in the world
• Many do not gain when world prices rise
• Monopsony power of commodity buyers
Macroeconomic effects
• Volatile export revenues affects trade balance
• Causes inflation and extreme food poverty

42. Problems arising from price volatilityRisk and Uncertainty
• Uncertain incomes and profits for farmers
• May limit capital investment / productivity
Extreme poverty and unemployment
• Millions of smaller farmers in the world
• Many do not gain when world prices rise
• Monopsony power of commodity buyers
Macroeconomic effects
• Volatile export revenues affects trade balance
• Causes inflation and extreme food poverty

43. Get help from fellow
students, teachers and
tutor2u on Twitter:
#econ1
@tutor2u_econ