Section 2 - The Market

• Drawing supply and demand diagrams

  1. Plot quantity on x-axis

  2. Plot price on y-axis

  3. Draw demand curve sloping downwards

  4. Draw supply curve sloping upwards

  5. Identify equilibrium price and quantity where demand and supply curves intersect
• Demand


  The quantity of a product that consumers want and are able to buy at a particular price and time
• Supply


  The quantity of a product that suppliers are willing and able to supply to the market at a particular price and time
• The demand curve (D) usually slopes downwards, showing that as the price of a product increases, the demand decreases
• The supply curve (S) usually slopes upwards, showing that as the price of a product increases, the quantity supplied increases
• Equilibrium price


  The price at which the quantity demanded matches the quantity supplied
• A surplus occurs when the price increases, causing quantity demanded to decrease and quantity supplied to increase
• A shortage occurs when the price decreases, causing quantity demanded to increase and quantity supplied to decrease
• Factors that influence demand

  • Substitutes
  • Complementary products
  • Consumer income
  • Fashion, consumer tastes and preferences
  • Advertising and branding
  • Demographics
  • Seasonal changes
  • External shocks
• Factors that influence supply


  • Costs of production
  • Indirect taxes
  • Subsidies
  • New technology
  • Weather conditions
  • External shocks
• A rise in demand


  Shifts the demand curve to the right, increasing equilibrium price and quantity
• A fall in demand


  Shifts the demand curve to the left, decreasing equilibrium price and quantity
• A rise in supply


  Shifts the supply curve to the right, decreasing equilibrium price and increasing quantity
• A fall in supply

  Shifts the supply curve to the left, increasing equilibrium price and decreasing quantity
• Price elasticity of demand


  Measures how responsive the quantity demanded is to a change in price
• Price elasticity of demand is always negative, as a decrease in price leads to an increase in quantity demanded
• Price elastic demand


  When the % change in quantity demanded is greater than the % change in price
• Price inelastic demand


  When the % change in quantity demanded is less than the % change in price
• Factors affecting price elasticity of demand


  • Necessity or luxury product
  • Availability of substitutes
  • Proportion of income spent on product
  • Time period considered
• Price Elasticity of Demand


  Shows how Demand Changes with Price
• Calculating Price Elasticity of Demand

  % change in quantity demanded / % change in price
• Price Elasticity of Demand

  • Always a negative number
  • A negative change in price can cause a positive change in demand
• Price Elastic


  Price elasticity of demand is greater than 1
• Price Inelastic


  Price elasticity of demand is less than 1
• Price Elasticity of Demand


  • A price rise of 20% results in a 30% reduction in demand
  • A price reduction of 20% results in a 3% increase in demand
• For price elastic products, the % change in demand is greater than the % change in price
• For price inelastic products, the % change in demand is less than the % change in price
• Factors affecting Price Elasticity of Demand


  • Necessity or luxury products
  • Ability to switch to substitutes
  • Brand loyalty
  • Time to find alternatives
  • Product type
  • Proportion of income spent
  • Frequency of purchase
• Demand curve shape


  • Shallow curve = price elastic
  • Steep curve = price inelastic
• Sales Revenue


  • Price elastic - revenue decreases with price increase
  • Price inelastic - revenue increases with price increase
• Income Elasticity of Demand


  Shows how Demand Changes with Income
• Calculating Income Elasticity of Demand


  % change in quantity demanded / % change in income
• Normal Product


  Positive income elasticity of demand, less than 1
• Luxury Product


  Positive income elasticity of demand, greater than 1
• Inferior Product


  Negative income elasticity of demand
• Elasticity helps businesses make marketing decisions on pricing and promotion
• Businesses may focus on different products based on income elasticity during economic growth or recession