Embedded Files
--THINK AHEAD--
"What does this image possibly tell us about whether or not the school fees are set 'too high' or 'too low'?"
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"That's right; the lack of applicants in the first image suggests there's a surplus (excess supply) of school places due to the price being set too high, while the abundance of applicants in the second image suggests there's a shortage (excess demand) of school places, as the price has been set too low."
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"What do you think will 'tend' to happen to tuition fees when there is a 'surplus' of places?" What about when there is a 'shortage' of places?"
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"That's right; when there is 'surplus', the price tends to 'decrease', and when there is a 'shortage', the price tends to 'increase'."
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"So how to determine the most suitable price?"
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--MARKET EQUILIBRIUM--
--MARKET EQUILIBRIUM--
--MARKET EQUILIBRIUM--
QUANTITY DEMANDED = QUANTITY SUPPLIED
"In other words, when the forces of supply and demand are in balance and there is NO TENDENCY FOR THE PRICE TO CHANGE."
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"Diagrammatically it is at the point where the DEMAND CURVE INTERSECTS THE SUPPLY CURVE.
The PRICE in market equilibrium is called the 'EQUILIBRIUM PRICE', and the QUANTITY is the 'EQUILIBRIUM QUANTITY'."
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"At the equilibrium price, the quantity consumers are willing and able to buy is exactly equal to the quantity firms are willing and able to sell. This price is also known as the MARKET-CLEARING PRICE or simply MARKET PRICE."
--THINK AHEAD--
"How do we know that Labubu dolls are in short supply?"
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"That's right, the long queue is a signal that supply can't keep up with demand at the current pricing, creating a shortage?" "What do you think happens to prices 'in general' when shortages exist?"
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"That's right, when the price is set below the true equilibrium; the price begins to be 'BID-UPWARDS' by CONSUMERS, like at an AUCTION, which in turn sends a price SIGNAL to producers that they can charge a higher price for the good.
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With the INCENTIVE of more profit, they will raise their price and REALLOCATE resources towards producing more of this good. IN ADDITION, NEW ENTRANTS WILL BE ATTRACTED BY THE HIGH POTENTIAL PROFITS and hence increase the quantity supplied to satisfy the extra demand, and the market will clear at a higher price and quantity."
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--TASK--
"With the help of the diagram below explain how market forces react to a shortage."
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--THINK AHEAD--
"How do we know that Man City ticket prices are too high?"
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"That's right, the empty seats suggest that the price is set too high and is a signal that demand can't keep up with supply at the current pricing, creating a surplus?" "What do you think happens to prices 'in general' when surpluses exist?"
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--TASK--
"With the help of the diagram below explain how market forces react to a surplus."
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"That's right, when the price is set ABOVE equilibrium, the PRICE TENDS DOWNWARDS as PRODUCERS will need to CUT THEIR LOSSES by offering price reductions or LEAVE THE MARKET ALTOGETHER. This lower price sends a SIGNAL to producers that they have an INCENTIVE to reduce output in this industry and REALLOCATE their resources towards producing a good with a rising price. The end result is a new lower equilibrium price and quantity."
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--SHIFTS--
--SHIFTS--
--SHIFTS IN DEMAND--
--TASK--
"Using the diagram below, explain how market forces react to an increase and decrease in demand."
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--SHIFTS IN SUPPLY--
--TASK--
"Using the diagram below, explain how market forces react to an increase and decrease in supply."
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--PRACTICE TIME!!--
"Test your understanding of 'shifts' in supply or demand!"
"Test your understanding of 'shifts' in supply AND demand!"
--TASK--
"Use a diagram to explain under what CONDITION an INCREASE IN DEMAND and an INCREASE IN SUPPLY will result in an INCREASE in both PRICE and QUANTITY TRANSACTED." (4)
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"Use a diagram to explain under what CONDITION an INCREASE IN DEMAND and a DECREASE IN SUPPLY will result in an INCREASE in PRICE and a DECREASE in QUANTITY TRANSACTED." (4)
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--THINK AHEAD--
"Read these quotes from the renowned economists Thomas Sowell and Friedrich Hayek, and try and extract what they are critiquing."
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"That's right; he is commenting on the workings of a planned/command economy, criticising centralised decision-makers who make all the economic decisions and usually do not personally bear the consequences."
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--FUNCTIONS OF THE PRICE MECHANISM--
--FUNCTIONS OF THE PRICE MECHANISM--
"Without using the word 'price' can you explain why modern Hong Kong's land is not used for agriculture?" "Did some supreme leader decide how it was to be used?"
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--THINK AHEAD--
"Imagine you are the central planner of a command economy, and you have been challenged by a free market economist to answer these questions."
--IMPORTANT RULE--
⚠️You can't use the word 'PRICE' at all!"
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'QUESTION #1'
"How do you know that nobody wants Man City kits and that we should stop making them and use the resources to make Liverpool kits?"
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"Well, this is clearly a question related to the economic question of 'WHAT TO PRODUCE?' so we intend to conduct expensive surveys of everybody and ask them what they want, and do this daily, as we know that people's preferences are constantly changing. Though it would be really helpful to have some kind of SIGNAL that automatically tells our producers when consumers want more or less of something; can you think of one?"
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"I know! Why don't you use PRICES? Then you can see that goods with RISING PRICES due to RISING DEMAND are the ones people want, while goods with FALLING PRICES due to FALLING DEMAND are those that people want less of. So resources are 'automatically' reallocated towards the goods that people want away from those that they don't."
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'QUESTION #2'
"How do you ensure that copper is used instead of gold as the main conductive metal in circuit boards?"
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"Well, this is clearly a question related to the economic question of 'HOW TO PRODUCE?' so we intend to comprehensively determine the suitability of all resources by looking at each individually and calculating their abundance and highest value uses by surveying millions of producers so that they are not misallocated with huge opportunity costs."
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Though it would be really helpful to have some kind of SIGNAL that automatically indicates scarcity and highest value use without having to gather all this costly information.”
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"I know! If a resource is scarce and lots of firms want it (like quality economics teachers like me or gold), its PRICE tends to rise, and only those firms that believe they can use that resource most productively and get a higher reward from it will be willing and able to PAY that high a PRICE; hence, only your school and jewellers will use it."
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"So, automatically, the resources are allocated to their highest valued use, with the lowest opportunity cost (remember the expensive oil only being bought by the airlines); therefore, gold would never be used by the RC car company, which would use a cheaper, low-valued alternative like copper.”
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--TASK--
Now apply this thinking to explain why Mr Bounous didn't end up in the production of football and Messi in the production of education."
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"That's right, Messi's (Mr Bounous') skills are extremely rare, and therefore there is competition from the best teams (schools) in the world who can use his presence to make more money, which has made his price very high, so clearly he would not be employed in 7-11, which, as we know, would be a complete waste of his talent."
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'QUESTION #3'
"How do you ensure that only high-value consumers who love coffee are the ones that get rationed it first over those lower-value ones that prefer tea?"
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"Well, this is clearly a question related to the economic question of 'FOR WHOM TO PRODUCE?' Obviously we want to satisfy the most wants as possible, so we will do our best to try and choose products that suit the 'average' household, and our rationing system is simple: we know you are desperate, and we don't discriminate in any way, so if you want to get it, we use a FIRST COME FIRST SERVED BASIS."
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"Though it would be really helpful to have some kind of SIGNAL that automatically indicates whether we are giving the product to the people that get the most satisfaction from it and not to those that are only consuming it out of desperation.”
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"I know! What if we use PRICES? When something is scarce, competition between consumers pushes its PRICE upwards. This higher price RATIONS the limited supply because some consumers will decide that the product is not worth the price and switch to alternatives, and those consumers that really want the good are WILLING AND ABLE TO PAY."
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'QUESTION #4'
"How do you ensure that the most skilful and productive workers are identified and allocated efficiently?"
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"Well, this is similar to our answer to the 'HOW TO PRODUCE?' question, as obviously, we want the best performers in the most suitable role, so we have rigorous tests nationwide and then allocate the highest scorers accordingly. We have no doubt they will do their best for the party."
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"But I agree the incentive not to bother doing your best is high, as the job you will be assigned gives you no extra money and they receive exactly the same reward regardless of their effort, productivity or skills, so the incentive to excel in their best subjects is weakened."
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"I know why not allow WAGES to operate as another PRICE? Employers competing for scarce workers can offer HIGHER WAGES for skills and labour that are particularly productive or in high demand so workers have a FINANCIAL INCENTIVE to work, acquire skills, become more productive and move towards occupations where their labour is valued more highly."
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"Now that you have seen how the price mechanism answers these fundamental economic questions, we can go a step further and identify the FOUR specific 'FUNCTIONS' that price actually carries out."
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--THINK AHEAD--
"The scenario below highlights the 4 FUNCTIONS OF PRICE: 'SIGNALLING', 'INCENTIVISING', 'ALLOCATING', and 'RATIONING', following an INCREASE IN DEMAND. Can you identify them?"
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"The next step is to turn this into a set of paragraphs describing the process. Below is an answer builder for an increase/decrease in both demand and supply."
--TASK (SUPER HARD)--
"Using the concepts, ideas, functions, answer builder, etc. laid out above, explain how the price mechanism is responsible for Mr. Bounous (a UK citizen), standing in front of you (a person that really desires an IB education), teaching in a brand-new IBDP international high school in Hong Kong."
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Sentence starter:
"It was observed that applications for international schools in Hong Kong were frequently over-subscribed, and fees were gradually rising, this sent a signal to..."
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--THINK AHEAD--
"Why do you think it is considered efficient that this person got to purchase the new i-phone?", "Why would this outcome be desirable in terms of the rationing function of the free market?"
"Why do you think it is considered efficient that coke got to supply Coke Cola?", "Why would this outcome be desirable in terms of the allocating function of the free market?"
--ECONOMIC EFFICIENCY [HL]--
--ECONOMIC EFFICIENCY [HL]--
--TASK--
"The two videos below feature ideas that are fundamental to what is considered economic efficiency in a free market price system. Watch them and answer these important questions."
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(Video#1)
"What do you notice about the consumers at high prices in terms of their perceived benefit?", "What can we conclude about the relationship between consumers' willingness to pay and their benefit?"
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"That's right, @ higher prices, the first units are bought by those consumers who value the good the highest and are thus willing and able to pay the most (value them the most = 'high-value consumers' = e.g., the airline companies), and when prices fall, consumers who value the good less are also willing to join in (e.g., the rubber duck manufacturers)."
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(Video#2)
"What do you notice about the producers at low prices in terms of their costs of production and opportunity cost?"
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"That's right, @ lower prices, the first units of a good are always supplied by those producers who can produce most cheaply ('low-cost producers of oil = e.g., Saudi Arabia'), and as the price increases, producers with higher costs are willing to join in (e.g., oil-rig producers)."
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"Move the slider on the diagram below to see how in a free market the price system ensures that the equilibrium quantity is produced by the lower-cost, least wasteful producers and is consumed by those consumers who derive the greater levels of satisfaction."
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...now if we define economic efficiency as follows...
"Economic (or Allocative) efficiency occurs when the greatest possible consumer benefit (measured in $) is achieved at the lowest overall economic cost, including opportunity cost."
"What can we conclude about economic efficiency and equilibrium quantity?"
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"That's right; equilibrium quantity = the most allocatively efficient level of output for that particular market, hence we can 'rebrand' Qe, to Qso (Socially, optimal quantity)."
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"Can we actually measure efficiency?"
--CONSUMER/PRODUCER SURPLUS--
--CONSUMER/PRODUCER SURPLUS--
"Look at the image below. Can you identify the amount of $-benefit enjoyed by both consumer and producer, thanks to the use of a price mechanism?"
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"That's right! Thanks to the forces of demand and supply, the free-market-determined price resulted in both parties receiving a benefit or a monetary 'surplus of benefit' equal to the difference between what they were willing to pay/receive and what they actually paid/received. (£10 gain for the buyer, and £9 for the seller)"
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--CONSUMER SURPLUS--
--CONSUMER SURPLUS--
"Let's look at the buyer-side first: the difference between what the consumer above was willing to pay (his 'demand curve') and the price they actually paid is referred to as 'CONSUMER SURPLUS', and if we looked at a demand curve, it would be represented by the area below the demand curve and above the actual price."
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--TASK--
"Look at the individual demand diagram below and explain why @ a price of $2, consumer surplus totals $12. Also comment on the relationship between price and consumer surplus."
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"Let's also look at a market demand curve example."
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"So, that's one price for all right? Wouldn't it be great if we could extract as much 'consumer suplus' as possible?"
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--PRODUCER SURPLUS--
--PRODUCER SURPLUS--
"Now let's look at the seller-side: the difference between what the producer is willing to receive (his 'supply curve') and the price they actually received is referred to as PRODUCER SURPLUS, and if we looked at a supply curve, it would be the area above the supply curve and below the actual price."
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--TASK--
"Look at the individual firm's diagram below and explain (using a diagram) why at a price of $2 producer surplus totals $12. Also comment on the relationship between price and producer surplus."
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"Let's also look at a market demand curve example."
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--TOTAL SOCIAL SURPLUS--
--TOTAL SOCIAL SURPLUS--
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"If CS expresses the total benefits enjoyed by the highest valued consumers, and PS the total benefits enjoyed by the lower-cost producers, then..."
"If CS expresses the total benefits enjoyed by the highest valued consumers, and PS the total benefits enjoyed by the lower-cost producers, then..."
'CS + PS = TOTAL SOCIAL SURPLUS'
'CS + PS = TOTAL SOCIAL SURPLUS'
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--TASK--
"Look at the diagram below. What do you notice about the TTS and the equilibrium quantity of output?"
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"That's right, the 'TSS IS MAXIMISED @ EQUILIBRIUM', and any output level below Qe will result in LOST BENEFIT, which is referred to as a 'DEADWEIGHT LOSS'."
--TASK--
--CALCULATIONS (HL)--
--CALCULATIONS (HL)--
"In paper 3, you will likely be asked to work out the size of ΔTSS, ΔPS or ΔCS, following some shift in demand and supply."
..If PRICE is FIXED ABOVE Pe
..If PRICE is FIXED BELOW Pe
--END--
--THINK AHEAD--
"You have a final exam in 5 days. Your goal is to get the best possible grade. The first hour of studying: You're reviewing easy concepts. The marginal benefit (the likely increase in your exam score) is very high. The marginal cost (one hour of your time, not watching Netflix) is relatively low. MB > MC. Should you study or give up?"
"By the tenth hour of studying: You're drilling obscure details. The marginal benefit is much lower (this might only bump your score up from a 94% to a 95%). The marginal cost is now very high (lost sleep, stress, missed social time). MB < MC. Should you study or give up?"
"What can we conclude about how decisions about the value of a unit (in this case an extra hour of study) are made?", "What is it that we compare for each unit?", "When do we decide something is/isn't worthwhile doing?" and "How can this help us answer whether the production of a unit of a good or service is beneficial to society?"
--MARGINAL ANALYSIS--
--YES ANOTHER METHOD!!!!--
--MB MINUS THE LEAST RESOURCES--
As an individual consumer, the price you are willing to pay for each unit reflects your MARGINAL BENEFIT from consuming that unit, right? so that must mean the area below your demand curve is also your TOTAL BENEFIT
As an individual producer, the price you are willing to accept reflects your MARGINAL COST from producing that unit, right? So that must mean the area below your supply curve is also your TOTAL COST.
So if we combine the total benefit and total costs of all the customers and producers in the market, we arrive at SOCIETY'S TOTAL BENEFIT and SOCIETY'S TOTAL COST, and we can see that at the equilibrium quantity, the level of BENEFIT MINUS COST is at its maximum. Therefore, another way to express why the equilibrium quantity is the most efficient is to say that at this output level...
At equilibrium, the sum of consumer surplus + total producer surplus is maximised. That’s why economists say the market is allocatively efficient — all the units where benefit was higher than cost have been produced and bought. No more, no less.
"the greatest possible consumer benefit is attained at the lowest overall economic cost."
--WHY IS THIS IMPORTANT?--
--WHY IS THIS IMPORTANT?--
ECONOMICS is ultimately about how economies ALLOCATE THEIR SCARCE RESOURCES in order to SATISFY THE MOST WANTS.
As we know, with a PLANNED ECONOMY the WHAT TO PRODUCE? and the HOW TO PRODUCE? questions are ANSWERED BY THE GOVERNMENT, hence we have NO WAY OF KNOWING whether the CONSUMERS GET THEIR WANTS SATISFIED, nor whether the PRODUCERS ARE DOING THEIR BEST TO BE AS LOW-COST & EFFICIENT as possible.
However in a MARKET SYSTEM that utilises a PRICE MECHANISM the WHAT TO PRODUCE is guided by CONSUMER DESIRES, and the HOW TO PRODUCE is guided by producers being as efficient as possible in order to MAKE HIGHER PROFITS.
Therefore if we look at how the SUPPLY CURVE works, AT LOW PRICES, ONLY THE MOST COST-EFFECTIVE FIRMS ARE ABLE TO TURN A PROFIT, and as price rises, other higher cost and less efficient producers will progressively enter, and so on, with more and more higher-cost producers entering as price rises.
Similarly, if we look at the DEMAND CURVE AT HIGH PRICES ONLY THOSE CONSUMERS WHO RECIEVE THE MOST UTILITY WILL OFFER TO PAY THE HIGH PRICES however as the price falls, other consumers with progressively lower utilities will enter the market, and so on.
Given this, we can say that the EQUILIBRIUM QUANTITY produced, SATISFIES THE MOST WANTS at the LEAST COST.
This level of output is also referred to as the ALLOCATIVE EFFICIENT LEVEL OF OUTPUT.
--RELATED PAST PAPER QUESTIONS & MS--
--RELATED PAST PAPER QUESTIONS & MS--
--RELATED PAST PAPER QUESTIONS & MS--
--RELATED PAST PAPER QUESTIONS & MS--
Explain one supply factor and one demand factor that might lead to a rise in the price of rented housing. Demand refers to.... supply refers to.... A rise in the price of rented housing can occur as a result of either an increase in demand or a decrease in supply. An increase in demand for rented housing could be caused by increases in the population or a rise in incomes allowing young people to move out of their familiy homes. We can illustrate how this will result in a rise in price by looking at figure 1.
An increase in demand for rented housing could be caused by increases in the population or a rise in incomes allowing young people to move out of their familiy homes. We can illustrate how this will result in a rise in price by looking at figure 1.
Explain how changes in price work to reallocate resources in a market. Changes in price send signals to producers that goods are either desired via a rise in price following an increase in demand, or undesired via a fall in price following a decrease in demand. When goods are desired, producers have the incentive of more profit, to supply more, hence they will allocate more resources towards the production of this good, similarly, when goods are no longer desired, producers have an incentive to reallocate resources away from the production of this good and towards the production of goods with rising prices, hence we can say that the prices have sent signals to the producers about 'What to produce'
Explain how the price mechanism allocates resources in an economy.
With reference to demand and supply in competitive markets, explain how the economic question “what to produce” is answered.: Changes in price send signals to producers that goods are either desired via a rise in price following an increase in demand, or undesired via a fall in price following a decrease in DEMAND. When goods are desired, producers have the incentive of more profit, to SUPPLY more, hence they will allocate more resources towards the production of this good, similarly, when goods are no longer desired, producers have an incentive to reallocate resources away from the production of this good and towards the production of goods with rising prices, hence we can say that the prices have sent signals to the producers about 'What to produce?'
Explain how an increase in the price of air travel might affect the demand for its complements and substitutes: An increase in the price of air travel, should result in a fall in demand for complementary goods such as long-haul holidays, hotels and luggage, whereas it should result in a rise in demand for its substitutes such as domestic holidays, and other forms of transport such as trains and ferries.
Explain two reasons why a government might impose an indirect tax on a good.
Explain three factors that could led to an increase in the demand for cigarettes.
Explain two factors that would lead to an increase in the demand for a product.
Discuss the view that competitive markets will always achieve allocative efficiency.
Using diagram(s), explain the signaling and incentive functions of price.
Explain two factors which could shift a firm's supply to the left
--HIGH-EQUITY CONSUMERS CONSUME--
--HIGH-EQUITY CONSUMERS CONSUME--
As PRICE FALLS, the QUANITY DEMANDED RISES as more consumers enter the market attracted by the falling price. When they enter, they are expressing their willingness to pay the price, which in turn reflects their personal expected satisfaction.
Clearly, those who enter at higher prices believe the product will give them a greater level of satisfaction than those who enter at lower prices.
Hence once an actual single price is determined, the people that pay it are all those consumers who were willing to pay more for it, while those that valued it below that price don't actually get to consume it.
--LOWEST-COST PRODUCER PRODUCE--
--LOWEST-COST PRODUCER PRODUCE--
LOWEST-COST PRODUCERS SUPPLY THE PRODUCT: As price rises, the quantity supplied increases as more and more producers enter the market attracted by the rising price. When they enter, they are expressing their willingness to receive that price for each unit of their output, which in turn reflects the fact that they are sufficiently productive to ensure that their costs are low enough for them to make a profit (Or else why would they enter in the first place).
Clearly, those who enter at lower prices are able to do so because they have lower unit costs and are more productive than those producers who enter at higher prices. Hence once an actual single price is determined, the firms that accept it are all those producers who were willing to accept less, while those that required a higher price above the equilibrium price don't actually get to supply it.
--HOW DO YOU DETERMINE THE ALLOCATIVELY EFFICIENT LEVEL OF OUTPUT?--
--HOW DO YOU DETERMINE THE ALLOCATIVELY EFFICIENT LEVEL OF OUTPUT?--
Ok, so far we have learned that the free market forces of demand and supply, determine the equilibrium price and quantity, we have also learned that at the equilibrium output total social surplus is maximized, and the system has allowed for the consumers with the most desire to consume the goods, whilst the producers with the lowest costs produce the goods. Now, just to add to the confusion, another few terms are frequently used to refer to this equilibrium-social surplus maximizing level of output, and that is 'THE ALLOCATIVELY EFFICIENT LEVEL OF OUTPUT', or 'THE SOCIALLY OPTIMAL LEVEL OF OUTPUT'.
--TASK--
--TASK--
Using the individual consumers and producer cards, CONSTRUCT the market demand and supply curves and DERIVE the following:
Equilibrium Price.
Equilibrium Quantity.
Consumer Surplus.
Producer Surplus.
Which producer earns the greatest PS?
Which consumer earns the greatest CS?
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