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Microeconomics
Economics: a social science that studies the allocation of scarce resources to the
production of goods and services used to satisfy consumers unlimited wants.

Scarcity, Choice and Opportunity Cost:

Defi nitions:
Factors of Production:

Land all productive resources supplied by nature

Labour human effort, physical and mental, directed to the production of
goods and services
Capital man made resource used in the production of goods and services
Entrepreneurship organizes and manages factors of production,
innovation etc.

Opportunity Cost:
Refers to the real cost in terms of the next best alternative that has to be
forgone

Free Goods free goods incur no opportunity cost whatsoever

Economic Goods production that incurs an opportunity cost, but is not
charged to the consumer, or free of charge goods,

3 Main Questions:

What and how much to produce? Allocative efficiency

How to produce? Productive efficiency
For whom to produce? Distributive efficiency

3 Main Decision-Making Bodies:

Households aim to maximise satisfaction/utility from consuming a

combination of goods given their limited income
Firms aim to maximise profits from production of goods and services
subject to the costs of scarce factors of production
Government need to allocate tax revenue to fund projects and initiatives
that fulfil microeconomic and macroeconomic objectives, social welfare

Absolute Advantage: perform activity with less resources

Comparative Advantage: perform activity at lower opportunity cost

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Marginalist Principle
Undergirded by the assumption of Maximising Behaviour that all rational actors
will aim to maximise certain objectives, generally known as utils. The rational
decision for a self-interested actor would be the optimal combination of resource
allocation that maximises utility.

Production/Consumption makes sense if Marginal Benefit(MB) > Marginal

Cost (MC)/
Marginal Private Benefit(MPB) > Marginal Private Cost (MPC)
Firms - producing up to the point where Marginal Cost (MC) = Marginal
Revenue (MR)
Governments considering Marginal Social Benefit (MSB)> Marginal Social
Cost(MSC)

The Marginalist Principle is important because it allows us to find this optimal

choice whereby utility is maximised because we will always choose up to the
point that the benefits accrued is equal to the cost incurred.
Hence, most of our economic choices are made at the margin. We consider the
marginal cost or the cost of consuming just a bit more against the marginal
benefit, the benefit of consuming just a bit more.
This guarantees economic efficiency and ensures that scarce resources are
allocated optimally to produce the outcome that is optimal to society

Free Market Relies on:

Private Ownership of Property

Freedom of Choice and Enterprise
Pursuit of Self-Interest
Competition
Price Mechanism Price functions as both a signal and incentive. Decisions
of producers determine supply and buyers determine demand. The
interaction of demand and supply determines the price. Hence, the Price
Mechanism allows for allocative, productive and distributive efficiency.

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Production Possibility Curve:

a graph that shows the maximum
attainable combinations of output that can
be produced in an economy within a
specific period of time, when all available
resources are fully and efficiently
employed, at a given state of technology.

Any point on the curve is a

maximised efficient use of resources in a binary allocation between two
types of goods
Any point inside the curve is an attainable but inefficient combination
Any point outside the curve is an unattainable combination

Unemployment: the situation in which not all available resources are used in the
production of goods and services
Underemployment: the situation in which resources are engaged in production
but operating below their production capacity.
The PPC is concave to origin due to the increasing opportunity cost, as not all
resources are perfectly transferable to the production of both goods
1. Increase in the Quantity and/or Quality of
Resources
Shift in the PPC outwards, the shift may be skewed
according to the suitability of the resource increased to
the good produced.
2. Consumer Goods vs Capital Goods
The production of more capital goods in one period will find that it can produce
more output in the next period, productive capacity
increase,
however the opportunity cost of such a decision is a
reduction in present consumption.
3. Technological Improvement
If technological improvement favours either good, the PPC
curve may be skewed.
Unemployment not all the available resources are used in the production of
goods and services
Underemployment resources are engaged in production but are operating
below their production capacity.

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Demand-Supply Model:
Defi nitions:
Free Market Economy: an economy where all economic decisions are taken by
individual households and firms, with no government intervention, resources are
allocated according to market forces of demand and supply.
Characteristics:

Private ownership of property Land and capital are owned by individuals,

not collectively.
Economic freedom People are free to use their factors of production as
they see fit, producers are free to produce what they like, how they like,
etc. Consumers are free to buy what they please consumer sovereignty
Self interest everyone acts in own self interest. Producers seek to
maximise profit, consumers seek to maximise satisfaction, workers try to
maximise their incomes
Competition everyone competes in producing goods, offering labour and
buying goods.
Limited role for Government Government provides legal framework to
protect property rights, but beyond that keeps out of economy
Price Mechanism Prices act to coordinate the whole system, Changes in S
and D cause Ps to alter and consumers and producers respond accordingly
(prices convey information)
o Role of price in conveying information to buyers and sellers

Market Equilibrium a position from which there is no inherent tendency to

change, where buyers and sellers are on aggregate satisfied with the current
combination of price and quantity of a good bought or sold (Ceteris Paribus)
Equilibrium Price Price at which quantity demanded is equal to the quantity
supplied, i.e. the price at which equilibrium quantity is traded OR market
clearing price.
Market is said to be at disequilibrium where quantity demanded and supplied are
not the same. This results in shortages or surpluses.

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At prices above equilibrium,
will be a surplus in the market,
exerting downward pressure on
suppliers compete with each other
At prices below equilibrium, there
will be a shortage in the market,
exerting upward pressure on the
compete amongst each other and
Price levels tend toward
dynamic markets.

there
the price as
and lower prices.

price as consumers
offer higher prices
equilibrium in

Demand and Supply:

An increase in demand will raise the equilibrium price
and quantity, conversely a decrease in demand will
the equilibrium price and quantity. Ceteris Paribus.

lower

D1 moves to D2, resulting in an increase of price

from P1 to P2, and an increase in quantity from Q1 to
Q2

An increase in supply will lower the equilibrium price

equilibrium quantity, in contrast a decrease in
supply will result in a lower equilibrium quantity but a
higher equilibrium price.

but still increase the

S1 moves to S2, resulting in a decrease of price from

P1 to P2, and an increase in quantity from Q1 to Q2

Simultaneous increases in D and S will result in

quantity supplied but an uncertain price change

greater

Simultaneous decreases in D and S will result in a lesser quantity supplied but an

uncertain price change.
An increase in D but a decrease in S will result in a definite price increase but an
indeterminate equilibrium quantity.
A decrease in D but an increase in S will result in a definite price fall but an
indeterminate equilibrium quantity.

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Demand Theory:
Defi nition:
Demand: refers to the amount that consumers are willing and able to purchase
at any given price over a given period of time. (for demand to be effective,
willingness to pay must be supported by ability to pay)
Real income: Real purchasing power
Normal Good: demand for good varies proportionately

with income

Inferior Good: demand falls as income increases

The quantity demanded of a good and service is inversely
price, ceteris paribus.
Exceptions? Vablen and Giffen(inferior) goods

related to its

A movement along the demand curve is a

change in the quantity demanded
A movement of the demand curve is a change in
demand
o Any factor that influences buying plans other than the
price of a good.

Substitution Effect: the effect of a change in price on quantity demanded arising

from the consumer switching to or from alternative products
Income effect: the effect of a change in the price of a commodity on quantity
demanded arising from the consumer becoming better or worse off(change in
real income) as a result of the price change. An increase in price leads to a
decrease in Purchasing power.

Factors Infl uencing Market Demand (Non Price Determinants):

1. Taste and Preferences

The effect of advertisements, education, culture and age group

Temporary increases in demand due to fads
Permanent decreases in demand for old technology as a result of new
inventions
Seasonal Changes climactic conditions and/or festivals

2. Expectations of Future Prices

If people expect the price of the good to increase, they will increase
demand in current market even when prices have not increased yet,
ceteris paribus

3. Income in the case of normal goods

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An increase in income leads to a rightward shift in the demand curve,

and a decrease in income leads to a leftward shift
The converse is true for inferior goods as consumers switch to better
substitutes

4. Prices of Interrelated Goods

Changes in the price of substitutes or complements can also affect

demand.

Prices of Substitute Goods

A substitute is a commodity that can be used in place of another, it satisfies the
same want and are competitive in demand.
e.g. Coca-Cola and Pepsi, MRT and Taxi Services, Cadburys and Nestle
Chocolate, Milk and Yoghurt
Hence, an increase in the price of one good results in a rise in the demand for its
substitute, as consumers switch from one good to another
Prices of Complementary Goods
A complementary good is a good that is used in conjunction with another, they
are jointly demanded to satisfy the same want, and are thus in joint demand.
e.g. tea and sugar, cars and petrol, digital cameras and memory sticks, DVD and
DVD players, computers and computer software
A fall in the price of one good leads to an increase in demand for a complement
good, this is because a fall in the price of one good leads to a bigger quantity of
the quantity good and that good being purchased, which increases demand.

5. Government Policies
Direct Tax Policy

Direct tax is a tax on peoples incomes. Changes in direct tax rates

affect peoples disposable income (the income available for spending
after payment of income tax)
An increase in the income tax rate will reduce peoples disposable
income. This reduces purchasing power, leading to a decrease in a
demand for goods and services.

Direct Subsidy Policy

Direct subsidies are payments made by the government to the

consumers.
Direct subsidies increases purchasing power of consumers and hence
demand

6. Population

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Affects the number of potential consumers or the size of the market

Absolute increase or decrease in total population

Change in demographic/composition of the population

7. Interest Rates
Rate of interest is the price of borrowing or using money
Changes in the rate of interest affect the level of demand by consumers,
especially those than rely on loans or hire purchase

8. Exchange Rates
Changes in the rate of exchange will affect foreign demand for a countrys goods
and services. Strong currencies find it easier to import whereas weak currencies
find it easier to export.

Consumer Surplus:
Consumer Surplus: is the difference between
the maximum amount that consumers are
willing to pay for a given quantity of a good
what they actually pay
In a competitive market, the price is actually
the market and demand and supply forces, the
amount that consumers are willing to pay gives
indication of the value of benefit (satisfaction)
consumers derive from buying the good.
Consumer surplus is also the measure of consumer welfare,
the bigger the surplus the higher the level of consumer welfare.

and
determined by
maximum
an
that

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Supply Theory:
Defi nitions:
Supply: refers to the quantity of a good or service that
willing and able to offer for sale at each given price over a
time.

producers are
given period of

The quantity supplied is directly related to the price of a

product. The higher the price of a good, the greater the
quantity supplied and vice-versa, ceteris paribus.
The supply curve represents the minimum price at which
producers are willing and able to supply each good or
is upward sloping, the higher marginal cost of supplying the
additional unit can be covered by the marginal benefit.

service, it

A change in quantity supplied refers to a shift along the supply curve

A change in supply refers to a change of the supply curve due to non-price
determinants.

Factors Infl uencing Market Supply (Non Price Determinants):

1. Costs of Production/Prices of Factors of Production

Changes in price of factor inputs such as raw materials, fuel and power
and cost of labour and cost of capital changes cost of production, in
turn affects the supply of the good
Increase in factor price results in a decrease in supply and vice versa

2. Innovation/State of Technology

Technology determines how efficiently resources can be used to

produce goods, improvements in techniques of production will increase
productivity of factors of production, cost per unit output will be lower
Producers are willing to increase the supply of a good at a given price,
causing the curve to shift to the right

3. Natural Factors

Favourable Climatic Conditions such as abundant and reliable rainfall

as well as absence of pests increases the supply of agricultural
products
Occurrence of natural phenomena such as natural disasters will reduce
the supply of agricultural produce.

4. Number of Firms

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An increase in the number of firms producing the good increases

supply and gives a rightward shift in the supply curve and vice-versa
This follows from the fact that market supply is the sum of all individual
supplies

5. Government Policies

Government policies on indirect taxation and subsidies affect the cost

of production of firms and therefore the supply of a good
Indirect Taxes taxes imposed on expenditure of goods and services for
example GST, increases the cost of production for firms leading to fall
in supply and leftward shift in supply curve
o Ad Valorem Taxes = Percentage Taxes
o Unit Tax
Indirect Subsidy is a payment made to producers by the government
and is equivalent to a decrease in the cost of production. This leads to
a rise in supply and a rightward shift in the supply curve.

6. Prices of Related Goods: Joint Supply

Joint Supply: production of goods that are derived from a single

product, so that it is not possible to produce more of one without
producing more of the other.
E.g. Butter and skimmed milk, petrol and diesel, beef and leather.
Increase in the price of one leads to an increase in its quantity supplied
and also an increase in supply of the other joint product

7. Prices of Related Goods: Competitive Supply

Competitive Supply: production of one OR the other by the same firm,

the goods compete for the use of the same resources and producing
more means producing less of the other.
E.g. wheat or corn, farmer may choose to switch from one to the other
according to price fluctuations.

8. Expectations of Future Price Changes

If the price is expected to rise, producers may temporarily reduce the

amount they sell in the market, building up stocks and only releasing
them when the price rises.
At current prices, producers are willing to supply less than they
otherwise would, this is represented by a leftward shift in the supply
curve.

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The opposite would be true if producers

expect prices to fall.

Producer Surplus:
The difference in the amount received by
producers for selling their good and the
minimum amount that they are willing and able to
accept to produce the good (does not refer to profits
= total revenue total cost)

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Role of Price Mechanism in Resource Allocation:

Free Market Economy: an economy where all economic decisions are taken by
individual households and firms, with no government intervention, resources are
allocated according to market forces of demand and supply.
Characteristics:

Private ownership of property Land and capital are owned by individuals,

not collectively.
Economic freedom People are free to use their factors of production as
they see fit, producers are free to produce what they like, how they like,
etc. Consumers are free to buy what they please consumer sovereignty
Self interest everyone acts in own self interest. Producers seek to
maximise profit, consumers seek to maximise satisfaction, workers try to
maximise their incomes
Competition everyone competes in producing goods, offering labour and
buying goods.
Limited role for Government Government provides legal framework to
protect property rights, but beyond that keeps out of economy
Price Mechanism Prices act to coordinate the whole system, Changes in S
and D cause Ps to alter and consumers and producers respond accordingly
(prices convey information)
o Role of price in conveying information to buyers and sellers

Price Mechanism:
Price as Signal prices communicate information to decision makers
Price as Incentive prices motivate decision makers to respond to the
information
Product Market vs Factor/Resource Market

factor resources are allocated according to the forces of demand and

supply in both the factor resource markets and the final product markets.
Changes in the final product markets can have effects on the factor
resource markets. Resource movements.
Demand for factors of production is a derived demand; refers to demand
for one good or service that occurs as a result of the demand for another
intermediate/final good or service.
An increase in demand for a product will result in an increase in a demand
for the factor good.

Economic Effi ciency in Competitive Markets

Efficiency: best possible use of resources; allocative and productive efficiency

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Allocative Efficiency: society produces and consumes a combination of goods
and services that maximises welfare. Right goods in right quantities
This is achieved when Price = Marginal Cost, valuation of last unit of good
consumed is equal to the opportunity cost in producing that last unit of good.
Marginal Social Cost = Marginal Social Benefit, when the additional
Productive Efficiency: situation where firms produces goods by using the fewest
possible resources. Alternatively it could be interpreted at given output at lowest
possible cost
This is achieved when: Firms produce at the lowest point on the long run average
cost curve from Societys point of view, or when Firms produce at any point on
the long run average cost curve from firms point of view.

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Elasticities of Demand and Supply:

Defi nitions:
Elasticity: is a measure of the responsiveness of a variable to changes in price or
any of the variables determinants.
Price Elasticity of Demand (PED): is a measure of the responsiveness of the
quantity demanded of a good to a change in its price, Ceteris Paribus.
Income Elasticity of Demand (YED): is a measure of the responsiveness of
demand of a good to a change in consumers income, ceteris paribus.
Cross Elasticity of Demand (XED): is a measure of the responsiveness of demand
of a good to a change in price of another good, ceteris paribus.
Price Elasticity of Supply (PES): is a measure of the responsiveness of the
quantity supplied of a good to a change in its price, Ceteris Paribus

Price Elasticity of Demand:

Formula:
PED

= Percentage Change in Qd/Percentage change in P

= Q/Q0 + P/P0
=Q/P x P0/Q0

The coefficient of PED is normally negative because of the inverse relationship

between price and quantity demanded. The negative sign is thus ignored and the
absolute value is considered.

Note: Elasticity of Demand is always considered in relation to a change in supply,

and vice versa.

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Coefficient
PED > 1

Interpretation
Price Elastic Demand
- A change in price leads to a
greater than proportionate
change in quantity demanded

PED < 1

Price Inelastic Demand

- A change in price leads to a
less than proportionate
change in quantity
demanded.

PED =
infinity

Infinitely price elastic demand

- A change in price leads to an
infinitely large change in
quantity demanded. An
infinitely small increase in
price will cause quantity
demanded to fall infinitely to
zero.
Perfectly price inelastic demand
- No change in quantity
demanded in response to a
change in price. Same
quantity is demanded
regardless of the price of the
good
- For example, heroin

PED = 0

Diagram

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PED = 1

Unit price elastic demand

- A change in price leads to a
proportional change in
quantity demanded.
- The curve is a rectangular
hyperbola
Determinants of Price Elasticity:

THIS
1. Availability of Substitutes
The more substitutes there are for a good, and the closer they are, the more
likely consumers are to switch to these alternatives when the price of the good
increases. The greater number of substitutes available for a good and the greater
the substitutability among these goods, the more price elastic is the demand.
The availability of substitutes is dependent on how the good is defined

2. Habitual Consumption
Demand tends to be price inelastic if the good is considered a necessity or
bought habitually. For e.g. petrol, medicine, food.
It may depend on habits, such as a consumers addiction to the good.

3. Proportion of Income Spent on the Good

The higher the proportion of income spent on a good, the more people will be
forced to reduce their consumption when price increases; hence the more price
elastic will be the demand. This is because small increases in price will take up
more of the consumers available income. For example, price increases in cars
and luxury goods.

4. Time Period
When the price of a good rises, the consumer will take time to respond to price
changes, adjust their consumption pattern and find alternatives, the longer the
time period the more price elastic demand will be.

Usefulness of PED
PED is able to analyse the effects of a price change arising from a change in
government policy or firms pricing policy, (Ceteris Paribus).

PED and Firms Pricing Decisions

Relationship between PED and Total Revenue: Price x Quantity

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If demand for product is price inelastic, ceteris paribus, then firms should
raise price to maximise total revenue.
If demand for product is price elastic, ceteris paribus, then firms should
lower its price so as to increase total revenue.

If demand is price elastic, then price and Total Revenue move in opposite
directions, an increase in price leads to a decrease in total revenue and vice
versa
If demand is price inelastic, then price and Total Revenue move in the same
direction, an increase in price leads to an increase in total revenue and vice
versa

Primary commodities: goods arising directly from the use of natural resources,
have a lower PED compared to PED of manufactured products
Low Price elasticity of demand, together with fluctuations in supply over short
periods of time creates serious problems for primary commodity producers due
to large fluctuations in prices which affect incomes

PED and Marketing Strategies

Firm may seek to make demand for good less price elastic, it can do so through

Reducing the substitutability by other products, creating real or perceived

differences between his product and the substitutes

Timing of Pricing and Marketing Decisions

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Short run demand relatively price inelastic, firm can adopt price adjustment
strategy
Long run demand being more price elastic, focus on product innovation and
promotional and marketing strategies.

PED and Indirect Taxes

Lower the price elasticity, the greater government revenue. Price Inelastic Goods
usually taxed

Income Elasticity of Demand

Income Elasticity of Demand (YED) measures the responsiveness of demand of a
good to a change in consumers income, ceteris paribus.
YED helps us predict how much the demand curve will shift for a given change in
income, ceteris paribus.
Formula:
YED

= (% in quantity demanded/% in income)

=Q/Qo divided by Y/Yo
=Q/Y x Yo/Qo

Coefficient of YED can either be positive, negative or zero.

If YED is negative (YED <0), the good is an inferior good, an increase in income
will lead to a fall in demand for the good
If YED is positive (YED>0), the good is a normal good, an increase in income will
lead to an increase in demand for that good.

If it is positive but less than one (0 < YED < 1), demand for good is income
inelastic, a percentage increase in income produces a smaller percentage
increase in quantity demanded. E.g. necessities.
If it is positive and greater than one (YED > 1), the demand for that good
is income-elastic, a percentage increase in income produces a larger
percentage increase in quantity demanded. E.g. Luxury goods.

Determinants of Income Elasticity of Demand:

Mostly determined by the degree of necessity of the good. The more basic an
item is in the consumption pattern of households, the lower is its income
elasticity of demand.
The nature of a good is dependent on the level of income of the consumer, a
good can be a luxury good at low income levels, a necessity at middle income
levels and an inferior good at very high income levels.

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An increase in income will produce a small rightward shift in the demand curve
for necessities, and a large rightward shift for luxuries, in the case of an inferior
good, an increase in income results in a leftward shift
Applications of Income Elasticity of Demand:
YED is important to firms when incomes are changing in a country. Firms can
ascertain the nature of their product and plan the future output accordingly.
Income elasticity of demand also helps firms in planning the future size of the
market for their product
Responding to changes in income, if household incomes are rising, firms could

Produce goods which are income elastic (luxury goods)

Make products more income elastic by making it more prestigious or
luxurious
Stock up more of the normal and luxury goods in anticipation of the rise in
demand
Plan to expand the number of retail outlets it has

If household incomes are falling or expected to fall, firms could

Stock up or switch to goods which are more income inelastic in demand

e.g. necessities
Focus marketing efforts on groups that view the good as essential
Promote the good as value for money to the budget conscious

Targeting different consumer groups

YED and the Government

Can help the government predict demand patterns and allow government to
project changes in government policies.

Cross Price Elasticity of Demand (XED)

Cross price elasticity of demand (XED) measures the responsiveness of demand
of a good to a change in price of another good, ceteris paribus.
XED predicts how much the demand curve for a particular good will shift in
response to a given change in the price of another good, ceteris paribus.
Formula:
XED (of good A)

=%in quantity demanded of good A/% in price of good B

=Qa/Qa divided by Pb/Pb

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=Qa/Pb x Pb/Qa
Interpretation of Sign and Coefficient
If XED is negative (XED <0), the two goods are complements. An increase in the
price of one good leads to a fall in the demand for the other good. The larger the
absolute value of the negative XED, the greater is the complementarity between
the two goods.
If XED is zero (XED = 0), the two goods are unrelated.
If XED is positive, (XED > 0), the two goods are substitutes. An increase in the
price of one good will lead to an increase in the demand for the other good.
If XED is positive but less than one ( 0 < XED < 1) the two goods are not very
close substitutes since the demand for one does not respond very much to a
change in price of the other
If XED is greater than one (XED>1) then the two goods are close substitutes,
hence the value of XED shows the degree of substitutability between the two
goods, the larger the value of XED the greater is the substitutability between the
two goods.
Determinants of XED:
The determinants of XED are the relationship between the two goods and the
closeness of the substitute and complement.

Applications of XED:
XED and Firms:

Pricing Policies: a firm may have a product that has a high positive XED in
relation to his rivals product (close substitutes), in such a case the firm will
have to respond to changes in the price of the rivals product (price cuts,
price raise?)
Should the competitor lower the price of his good, firm has to respond by
lowering price of his good to prevent loss striving to be as cost efficient
as possible
Marketing Sales Strategies:
o Making good less substitutable so that it is less affected by the
pricing policies of the rival firms. Advertising or improving product
o Complementary goods, linking marketing plans to pricing policy of
other firms, collaborations or packaging.

Price Elasticity of Supply (PES)

Price Elasticity of Supply (PES) is defined as a measure of the responsiveness of
quantity supplied to a change in the commoditys own price, ceteris paribus.

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PES gives us an indication of the ease at which a firms production can be
expanded when price changes.
Formula
PES

= (%in quantity supplied)/(% in price)

=Q/Qo divided by P/Po
=Q/P x Po/Qo

Interpretation of Coefficient
Coefficien

Interpretation

t
PES > 1

Price Elastic Supply

A given percentage change in

the price of a good will lead to
a greater percentage change
in quantity supplied

PES < 1

Price Inelastic Supply

A given percentage change in

the price of a good will lead to
a smaller percentage change
in quantity supplied. All
straight line supply curves
passing through negative y-

PES =
infinity

axis are price inelastic

Perfectly Price Elastic Supply

Producers are willing to

produce any quantity at the
prevailing price. Any infinitely
small decrease in price will
cause quantity supplied to fall
infinitely to zero (free good?)

Diagram

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PES = 0

Perfectly Price Inelastic Supply

No change in quantity
supplied in response to a
change in price. Same
quantity is supplied
regardless of the price of

PES = 1

good
Unit Price Elastic Supply

A given percentage change in

the price of the good will
bring about an equal
percentage change in
quantity supplied. All straight
line supply curves from the
origin are unitary price
elastic.

Determinants of Price Elasticity of Supply

1. Time Period
The amount of time firms have to adjust their inputs (resources) and the quantity
supplied in response to changes in price. Over a very short time, firms are unable
to increase or decrease inputs to change the quantity it produces, in this case
supply is highly inelastic, may even be perfectly inelastic
The larger amount of time firms have to adjust their inputs increases, the larger
the PES
2. Factor mobility
Factor mobility refers to the ease and speed at which firms can shift resources
from one industry to another. The more easily and quickly resources can be
shifted, the greater responsiveness of quantity supplied to changes in price and
hence the higher the value of PES
3. Stocks and Spare Capacity
If the good can be stored with ease, supply will be more price elastic. Likewise if
the firm has spare capacity, production can be increased readily in response to
price increases. If capacity is maxed, it will be more difficult. Hence the greater
the spare capacity, the higher the PES
4. Length of production period
The shorter the time period for producers to convert inputs into outputs, the
more price elastic is the supply of the good. Supply of agricultural goods tends to

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be price inelastic, in contrast manufacturing goods are more price elastic
because the time taken is relatively short
Applications:
In general, primary commodities usually have a lower PES than manufactured
products. Hence there are greater price fluctuations in relatively price inelastic
goods.

Limitations: (Specific limitations to each Elasticity Concept)

Factors affecting supply
CRINGE

Cost of production
Inter-related goods (competitive supply- chicken and eggs and joint
supply- beef and leather)
Innovation- new technology etc
Natural Factors- drought flood etc
Government Policies- subsidies and taxes (when drawing the graph, use
the specific tax/ ad valorem tax graphs if taxes
Consumer expectations (consumer irrationality etc "my bike is outside")

Difficulties in computing exact elasticity values due to income differences/sociocultural differences

Ceteris Paribus assumption does not hold true in the real world.
PED
Factors affecting demand can range from Income, change in prices of other
Goods, etc

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Limitations: different changing factors like income (recession) or changes in
prices of complements or substitutes will render PED expectations less accurate.
YED
Which income group do you pick as a representative? To different groups (rich
and poor) there will be fairly different attitudes that exist towards the product.
Defining a target group is difficult, understanding income differences.
XED
Is useful when
(A) Substitute good: tries to either make good more competitive by lowering
price or make it less substitutable. However- cost of making it less substitutable
may not be feasible (overall increase of revenue may not be substantial)
(B) Complement good: tries to joint market the good: however this may not be
possible due to difficulty of working with another company and/or associated
cost. Company may not be able to increase profit or revenue by intended amount
due to amount spent on making themselves more competitive/attractive
Question types:
-how will this market/industry be able to use this information
-how useful will this be to firms (maximise profit maximise revenue minimise
cost)

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Government Intervention and Impacts on Market

Outcomes:
Indirect Taxes
Indirect taxes are compulsory payments levied by the government on
expenditure/spending, they can be classified into 3 types: general expenditure
taxes, excise duties and customs duties. These taxes are paid to government by
the producers. Producers may pass some if not all of the tax burden onto
consumers, depending on the relative price elasticity of demand and supply of
the good.
Indirect taxes lead to a leftward shift in the supply curve, lead to lower quantity
and higher prices, however the price will not ruse by full amount of tax because
demand curve is downward sloping.
An indirect tax can either be a specific tax or an ad valorem tax. A specific tax or
a per unit tax is a constant sum levied on each unit of the good sold and will shift
the supply curve vertically upwards (parallel).
An ad valorem or percentage tax is a tax pegged at a certain percentage price of
the good, hence the curve pivots upwards anti-clockwise.
Incidence of Tax: distribution of the burden of taxation between consumers and
sellers.
Price Elasticity of Demand and Supply and Tax Incidence
In the case of a relatively inelastic demand, the producers will bear less of the
burden than the consumers. Vice versa

Indirect Subsidy
A negative tax or payment to the producers by the government, the effect of an
indirect subsidy is to lower the cost of production, thereby shifting the supply
curve downwards by the amount of the subsidy.
Hence the benefit of an indirect subsidy is shared between consumers and
producers as well depending on the price elasticity of demand and supply.
If Supply is Elastic but Demand is Inelastic, consumers receive a greater share of
the subsidy when demand is relatively less price-elastic than supply.
Conversely, if demand is more price elastic than subsidy, producers receive a
greater share of the subsidy.

Price Controls

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Price Floors: legally established minimum price to prevent prices from falling
below a certain level, to be effective the price floor must be set above the
market equilibrium price
Reasons:

To provide income support for farmers by offering them prices for their
produce that are above market determined prices
To protect low-skilled, low-wage workers by offering them a wage that is
above the level determined by the market.

There will be a surplus as a result of the imposition of a minimum price

(22-20), there will be a direct effect of a

surplus
and
continuous
accumulation
of stocks
as the

quantity
supplied exceeds the quantity demanded each week.
To deal with surpluses, governments will have to buy up surplus and store
it or sell it abroad in other markets, storage costs vs exporting surplus at a
subsidized price to make it competitive.
Firm Inefficiency inefficient firms do not face incentives to cut costs by
using more efficient means of production as they have a minimum
guaranteed price.
Over allocation of resources new producers may be attracted, creating
even greater surpluses, too many resources may be allocated and thus
resulting in allocative inefficiency, missing the social optimum
Negative welfare impacts Changes in consumers and producers surplus,
a deadweight welfare loss is experienced, represents welfare benefits that
are lost to society because resources are not allocated efficiently.

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Labour surpluses and unemployment

Illegal workers at wages below the minimum wage.

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Maximum Price (Price Ceilings)

Legally established maximum price to prevent prices from rising above a certain
level, must be set below market equilibrium price.

Maximum price is usually imposed with the aim of achieving some form of
equity, for example rent controls make housing more affordable to low-income
earners or food price controls to make necessities more affordable.
Consequences:
Shortage:
When a price ceiling is established below equilibrium price, it results in shortages
as quantity demanded exceeds the quantity supplied. Prices are not allowed to
rise to eliminate the shortages
Non-Price Rationing:
Rationing refers to a method of dividing something among possible users, this no
longer functions and hence will result in queues, distribution of coupons or
restrictions of sales to favoured customers
Underground or Black Markets:
The emergence of a black market results in producers selling goods illegally at
prices above the maximum price.

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To minimise these problems, the government can encourage supply through
drawing on past surpluses, direct production or giving subsidies or tax relief,
alternatively it can reduce demand by controlling income or producing more
alternatives
Under production relative to social optimum quantity, society is worse off to
underallocation of resources, leading to allocative inefficiency.

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Labour Market:
The market for labour is a market for a factor of production. It is similar to any
other market, in the labour market, buyers and sellers transact labour for wages
Demand for Labour:
Is a derived demand, therefore demand for labour is intrinsically linked to the
monetary value of the additional goods and services that additional unit of
labour producers
Demand for labour is downward sloping in a competitive market.
Supply of Labour:
Made up of individuals who are willing and able to work for a given wage
Supply curve for labour is upward sloping.

Non Wage Determinants of Demand and Supply of Labour

Changes in price of the final product it produces, the demand for labour is
dependent upon the demand of the goods and services that it produces
Changes in the physical output each unit of labour is able to produce
(productivity of labour)
o May be due to advancements in technology or education
o The higher output per worker encourages firms to employ more
workers, hence demand curve for labour shifts to the right
Changes in prices of other factors of production used in production
o Capital can be seen as a substitute for labour in certain production
processes, better capital shifts demand to the left
o Resources may be complementary to labour, the increase or
decrease in one of them employed in production results in the same
increase or decrease in labour.

Long Term Supply of Labour:

Changes in Size of Population, foreign labour policy, birth rates/death rates

Labour Force Participation Rate, retirement age, demographic
Changes in tax and benefits levels

Supply of Labour to a Particular Industry

Changes in Educational Attainments, Number of people Qualified to hold

the job
Changes in job scope/job conditions
o E.g. job satisfaction, working environment, job security, status,
power, holidays
Changes in wage rate and non-wage benefits in other industries

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Wage Differentials

Non-Competing Groups labour market is made out of many sub

groups
Compensating Differentials jobs differ in attractiveness and are
influenced greatly by non-pecuniary aspects of the job
Labour Market Imperfections (trade unions) and Government
Intervention
Non Economic Factors Such as Discrimination

Wage Determination in Singapore Govt Intervention

National Wages Council (NWC) consisting of:

o Ministry of Manpower (MOM)
o National Trade Union Congress (NTUC)
o Singapore National Employers Federation (SNEF)

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Essay Writing:
1. Definitions
2. Diagrams
3. Discuss Relevant Economic Theory
4. Distinguish between that which is important and that which
is not important
5. Discern between relatively more and relatively less
important
6. Draw appropriate conclusions

Step 1: What is the question asking for?

Step 2: What terms need to be defined?
Step 3: What diagrams need to be drawn (which concepts am I explaining?)
Step 4: What are 2 3 important points I must explain?
Step 5: What are the conclusions I must draw specific to the question?
Step 6: How can I evaluate these points? (which is more important, bring in other concepts)