INTRODUCTION 4

What is Economics? 4
Needs and Wants: 4
Scarcity: 4
Choice: 4
Opportunity cost: 4
Free Goods and Economic Goods: 4
The basic economic Questions: 5
Resource Allocation: 5
The Four Factors of Production = Input = Productive Resources: 5
Rationing systems: Command/Free Market Economies 6
Disadvantages of Free Market 7
Disadvantages of Command Market 7
PPC/PPF 8
The shape of the PPC 9
Shifts of the PPC 10
Positive and Normative Concepts 11
Microeconomics and Macroeconomics 11
Model building 11
Ceteris Paribus 11
Rational Economic Decision making 11

UNIT 1 MICROECONOMICS 12
1.1 Competitive Markets: Demand and Supply 12
The nature of Markets 12
Competitive Markets 12
The law of demand + Demand Curve 12
Individual demand and Market Demand 14
Income 14
Related products 14
The non-price determinants of demand 15
Movements along and shifts of the demand curve 16
Movements along the curve 16
Shifts of the curve 16
Linear demand functions (equations), demand schedules and graphs (HL ONLY) 17
General Form of Linear Demand Functions 18
P=ab-1bQd 20
The Law of Supply + Supply Curve 20

1
 Individual supply and Market supply 21
The non-price determinant of supply 21
Movements along the curve 24
Shifts of the curve 24
Linear Supply Functions (HL only) 24
Equilibrium and changes to Equilibrium 25
Equilibrium: 26
Disequilibrium: 26
Market Equilibrium Graph 26
Changes in market equilibrium 27
Calculating and illustrating equilibrium using linear equations (HL ONLY) 28
Price Mechanism 29
what to produce question 31
Resource Allocation*help 32
Market Efficiency_ Consumer Surplus + Producer surplus 33
Social Surplus (community surplus) 33
Allocative Efficiency 35
Mostly wanted by society 36
1.2 Elasticity 37
Price Elasticity of Demand and its Determinants 37
Elasticity 37
Price Elasticity of Demand (PED) 37
Five categories of PED 38
Variable PED along the demand curve 40
At high P and Low Qd = elastic 41
At low P and High Qd = inelastic 41
The Slope of the Demand Curve 41
PED = Slope x P x Q 41
Why PED varies along a straight line demand curve 41
Determinants of PED 42
Applications of PED 43
PED and Total Revenue 43
Maximizing Total Revenue 43
Primary commodities 44
Indirect tax 44
Cross Price Elasticity of Demand and its Determinants 45
Cross Price Elasticity of Demand (XED) 45
Calculating XED 46
Applications of Cross Price Elasticity of Demand 47

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Income Elasticity of Demand and its Determinants 48
Income Elasticity of Demand 49
Applications of income Elasticity of Demand 50
Applications of YED 50
Economic Sectors: 52
Price Elasticity of Supply and its Determinants 52
Price Elasticity of Supply (PES) 52
Determinants of PES 55
Applications of Price Elasticity of Supply 56

3
INTRODUCTION
The foundations of Economics

What is Economics?
➔ It is social science on how to deal with scarcity
➔ It is a study of people in society and how they manage scarce resources
➔ Study of rationing system
➔ It is the study of ​how scarce resources are allocated to fulfill the infinitive wants of consumers

Needs and Wants:

➔ Needs: we must have to survive, such as food, shelter, and clothing
➔ Wants: things that we would like to have but which are not necessary for our immediate
physical survival
→ there is a conflict between the limited resources and unlimited needs and wants
➢ Need for rationing system (분배 시스템)

Scarcity:
➔ Is the ​condition which available resources are not enough to produce everything that human
beings need and want
- This economic problem forces people to make a choice

Choice:
➔ The ​condition of scarcity that forces people and society to make a choice between available
alternatives

Opportunity cost:
➔ Is the ​value of the next best alternative that must be sacrificed to obtain something else
- ex) my decision to read a book means that I have given up different activities. If my best or
favorite alternative to reading a book is watching TV, the TV time you have sacrificed is the
opportunity cost of reading a book.

Free Goods and Economic Goods:

➔ Free goods: any good that is not scarce

4
 -
Unlimited in supply
-
Has zero opportunity cost
ex) air, sea, water
➔ Economic goods: any good that is scarce
- Has a price
- Have an opportunity cost greater than zero

Scarcity → Choice → Opportunity Cost

Scarcity leads people having to choose and choices mean that something is given up

The basic economic Questions:

= Resource Allocation and Output/Income distribution
Scarcity forces every economy in the world, regardless of its form of organization to answer three
basic questions:
1. What to produce: ​(resource allocation)
a. Choices about what particular goods and services and what quantities of these they
wish to produce
2. How to produce: ​(resource allocation)
a. Choices on how to use their resources in order to produce goods and services
b. Use of different combinations of resources/technologies
3. For whom to produce: ​(distribution of output and income)
a. Choices about how the goods and services produced are to be distributed among the
population

Resource Allocation:
➔ Assigning available resources or factors of production, to specific uses chosen among many
possible alternatives

The Four Factors of Production = Input = Productive Resources:

❖ Land
➢ All natural resources such as minerals, oil reserves, underground water and forest
■ Payment to owner of land “​RENT​”
❖ Labour
➢ The physical and mental effort that people contribute to the production of g+s
➢ Human resources
■ Payment to those who provide labour “​WAGE​”
❖ Capital

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 ➢ Physical capital
➢ Man-made factor of production used to produce g+s, such as machinery, tools,
factories, and buildings
➢ 다른 g+s 를 produce 하기 위해 사는 또 다른 g+s
■ Payment to owners of capital “​INTEREST​”
❖ Management/Entrepreneurship
➢ Skill possessed by some people, involving the ability to:
■ Innovate
■ Take business risks
■ Seek opportunities for running a business
➢ Organizes the other tree factors and takes on the risks of success or failure of a
business
➢ 사실상 가장 중요한 역할, resources
■ Payment to owners of entrepreneurship “​PROFIT​”

Profit: 수익
Revenue: 총 번 돈
Total Revenue - Cost of Production = Profit

Rationing systems: Command/Free Market Economies

➔ The methods used to make the choices required by the what, how and for whom to produce
questions

1. Command Economies:
a. Decisions to the three basic questions are made by the government
b. Resources, Land & Capital, in particular, are owned by the government
c. Government bodies arrange
i. All production
ii. Set wages
iii. Set prices
1. Through ​CENTRAL PLANNING
2. Free Market Economies:
a. Resources are owned by private individuals
b. Mainly ​consumers​ and ​firms​ who make e​ conomic decisions​ by responding to the
prices that are determined in markets
➔ In reality, all economies are mixed economies
➔ Government involvement is essential since there are some dangers that will exist if the free
market is left to operate without interference

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Disadvantages of Free Market
1. Demerit goods will be over-provided
a. Goods that are socially undesirable
b. ex) cigarettes
2. Merit goods will be under-provided
a. Only be produced for those who can afford them
b. The poor can’t consume
c. ex) healthcare, education
3. Resources may be used up too quickly and the environment may be damaged by ​pollution​, as
firms seek to ​make high profits and to minimize costs
a. Resource depletion, degradation speeds up
b. 오직 돈만 추구함으로써
4. Some members of society will not be able to look after themselves
a. Orphans
b. Sick
c. Long-term unemployed
i. Will not survive
d. Income inequality ↑
i. Poor and the rich gap ↑
e. Transfer payment = income support by the government to economically wearable
households = 복지금 (welfare payment)
5. Large firms may grow and dominate industries
a. leading to high prices
b. Loss of efficiency and excessive power
c. Easy power abuse

Disadvantages of Command Market

1. The dominance of government may lead to a loss of personal liberty and freedom of choice
a. Lack of choice
2. Incentives​ tend to be distorted
a. Workers with guaranteed employment
b. Managers who gain no share of profits
i. Difficult to motivate
➔ Output/Quality will suffer
3. Total production, investment, trade, and consumption are too complicated to be planned
efficiently
a. Misallocation of resources
b. Shortages
c. Surpluses
4. No price system: lack of price mechanism
a. Resources will not be used efficiently

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 b. Arbitrary (random choice) decisions will not be able to make the best use of
resources
5. Governments may not the share the same aims as the majority of the population
a. By power, implement plans that are not popular or even corrupted

PPC/PPF
Production Possibilities Curve / Production Possibilities Frontier
➔ Represents the maximum combination of goods and services that can be produced by an
economy in a given time period
◆ Resources are being used fully
◆ Efficiently (productive efficiency is achieved
● Fewest resources 로 produce 하는 것
● Without any resource waste
◆ Full employment is assumed
◆ State of technology is fixed

❖ Opportunity cost: to move from point B to point D, the economy must sacrifice 7 guns in
order to gain 20 butters
➢ Involves reallocation of resources

❖ Points on the frontier

➢ Using its resources fully and efficiently
➢ All points along the frontier are equally productively efficient

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 ■ Output is produced by the use of the fewest possible resources
→ Point B, D, C

❖ Points inside the frontier

➢ Resources are not being used fully and efficiently
➢ Production of some goods could be increased without decreasing the production of
anything else
■ No opportunity cost
→ Point A

❖ Points outside the frontier

➢ Unattainable combination with the currently available resources
➢ Could be attained at some future date if the frontier shift outwards
→ Point X

An Economy’s actual output is always at a point inside the PPC!

➔ Condition of SCARCITY does not allow the economy to produce outside its PPC
◆ Resource scarcity
➔ Condition of SCARCITY forces the economy to make a CHOICE about what particular
combination of goods it wishes to produce
◆ Must decide at which particular point on the PPC it wishes to produce
➔ CHOICE gives rise to OPPORTUNITY COST
◆ Not possible to increase the production of one good without decreasing production
of the other good
★ The PPC only shows what can be produced, not what should be produced

The shape of the PPC

1. Concave PPC_Increasing Opportunity Cost

From point C to Point D

→ 4 cars = 3 pizza
= 1 cars = 0.75 pizza

From point D to Point B

→ 2 cars = 5 Pizza
= 1 cars = 2.5 Pizza

➔ Increase in Opportunity Cost

◆ This occurs because the resources​ are not
perfectly suited for both goods

9
 ◆ Works, land and the technology that is best suited for making Pizzas will ​remain​ in
the Pizza production but will take out resources that are not ideally suited for Pizza
production and ​re-allocate​ them towards the production of Cars
● ex) land that was not great for growing tomatoes will be better used for
mining first
● The resources that are best suited for car production will be reallocated
★ Cars were very cheap when they first produced cars because those resources were best suited
for car production whereas the resources best suited for pizza production remains in Pizza
production
★ As the economy, time proceeds, the resources best suited for car production becomes more
and more scarce
○ When the production reaches Point B, even the resources best suited for Pizzas will
be reallocated towards car production
■ Not going to be productive
■ Number of Pizzas that must be given up is very high
➔ Specialization of Resources
◆ The more you produce of a particular good the greater the cost of an additional unit
of that good due to the fact that the resources needed for its production become
increasingly scarce → more costly

2. Straight line PPC_Constant Opportunity Cost

→ 2 cars = 2 pizza
= 1 cars = 1 pizza

→ 4 cars = 4 pizza
= 1 cars = 1 pizza

➔ Constant Opportunity Cost

Shifts of the PPC

The PPC can shift inwards

- Natural Disaster

● Increase in PPC can result from: Outward Shift_ Production Potential ↑

○ Increase in the quantity of resources in the economy
○ Improvement in resource quality (ex. Education, Healthcare access)
○ New and improved technology

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 ● Decrease in PPC can result from: Inward Shift
○ Decrease in the quantity of resources

Positive and Normative Concepts

Positive Statement: a statement that can be proven to be right or wrong by looking at the facts
- Doesn’t necessarily have to be true
- Something that can be tested
Normative Statement: a matter of opinion that can’t be conclusively proven to be right or wrong

Microeconomics and Macroeconomics

Microeconomics:
- Examines the behavior of individual decision making units in the economy
Macroeconomics:
- Examines the economy as a whole, to obtain an overall picture, by use of aggregates, such as
the ​sum of consumer behavior​ and the ​sum of firm behaviors,​ and​ total income and output of
the entire economy​, as well as ​total employment and general price level

Model building
- Illustrated by use of diagrams showing the relationships between important variables

Assumption in model-building

Ceteris Paribus
➔ “Other things equal”
➔ All other variables are assumed to be constant or unchanging

Rational Economic Decision making

➔ Individuals are assumed to act in their ​best self-interest​, trying to ​maximise the satisfaction
they expect to receive from their economic decisions
◆ More benefits from consumption
◆ More profits from production
◆ Higher wages
◆ More income from selling resources

11
UNIT 1 MICROECONOMICS

1.1 Competitive Markets: Demand and Supply

The nature of Markets

● Outline the meaning of the term market.

➔ A market is any place where transactions (g+s trade) take place between buyers and sellers
◆ Shares: stock market
◆ Currencies: foreign exchange market
◆ G+S: product Markers
◆ Resources: resource markets
● No need of physical market
● At least one buyer and seller

Competitive Markets
➔ Market power: the control that a seller may have over the price of the product it sells
◆ The greater the degree of competition between sellers:
● Smaller their market power
● Weaker is their control over the price
◆ Determined by the level of competition
➔ Competitive market: a market where the price of a good, service or factors is determined
through the interaction of many small sellers and buyers, so that no one can influence the
price
◆ ↑ competition = ↑ No. of sellers
◆ No market power = No control over price
➔ There are so many buyers and many sellers that each has NO IMPACT on the MARKET
PRICE
◆ Assumed that the same products are for sale

The law of demand + Demand Curve

● Explain the negative causal relationship between price and quantity demanded.
● Describe the relationship between an individual consumer’s demand and market
demand.

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 ● Explain that a demand curve represents the relationship between the price and the
quantity demanded of a product, ceteris paribus.
● Draw a demand curve.

➔ Demand: the quantity of a good that buyers are ​willing​ and ​able​ to buy at various prices over
a time period
➔ Law of Demand: When the price goes up, ceteris paribus, quantity demanded goes down.
Therefore, a negative relationship exists between price and quantity demanded
= Downward sloping demand curve

As the price increases from P2 to P1, the quantity

demanded decreases from Q2 to Q1.

➔ This is because consumers will want to buy less of a good when its price has risen
➔ The HEIGHT of the demand curve = the highest price consumers are willing to pay for a
product
◆ Willingness to pay
◆ Value to the consumer
◆ MB = Marginal Benefit (additional benefit/satisfaction from consuming one more
unit of a product)

Why the demand curve Slopes Downward

❖ Income effect
➢ As price falls the real income (the amount of goods and services that incomes will
buy) of customers rises.
■ They are able to buy more products at lower prices
■ 가격이 떨어질수록 소비 가능 수량이 증가한다
❖ Substitution effect
➢ When the price of a product falls, then the product will be relatively more attractive
to people than other products, whose prices have stayed unchanged
■ 가격의 감소로 다른 제품에 비해 낮은 가격으로 사람들의 소비를 유인한다
❖ Diminishing marginal utility

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 ➢ As people consume more of a particular good, the utility (benefit or satisfaction/MB)
gained from the marginal unit declines so consumers will only purchase more at a
lower price
■ 그 물건이 흔해 질 수록 그 제품에 대한 값어치가 내려가서 소비자가 내려는
가격 또한 감소한다

Individual demand and Market Demand

➔ Individual Demand: the demand of a single buyer
➔ Market Demand: the demands of all buyers in a market
◆ Adding up all the individual demands for each price

Income
➔ Normal good: a good for which, other things are equal, and​ increase in income​ leads to an
increase in demand
Ex. 외제차
➔ Inferior good: a good for which, other things are equal, and ​increase in income​ leads to a
decrease in demand
Ex. 중고차

Related products
➔ Substitutes: substitutes are products that can be used instead of each other
◆ two goods for which an increase in the price of one goods leads to an increase in the
demand for the other
● Competitive consumption
● Choosing A not B
● 하나의 가격이 오르게 되면 다른 하나의 가격이 더 낮아보이기 때문에 다른
제품의 Demand 수요량은 증가한다
Ex. Pepsi and Coca Cola

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 ➔ Complements: two goods are complements if they tend to be used together. Goods that are
consumed together
◆ two goods for which an increase in the price of one good leads to a decrease in the
demand for the other
● Joint consumption
● Impossible to use A without B
● Having higher satisfaction on A with B
● 하나의 가격이 오르게되면 다른 제품을 사도 그만큼의 시너지를 발휘하지
못하기 때문에 satisfaction 이 내려가기 때문에 그 다른 제품의 Demand
수요량은 감소한다.

The non-price determinants of demand

= factors that change demand or shift the demand curve

● Explain how factors including changes in income (in the case of normal and inferior
goods), preferences, prices of related goods (in the case of substitutes and complements)
and demographic changes may change demand.

Changes in ​Income ● When income increases consumers will have more money to
spend. So their demand will increase. This will shift the demand
curve to the right
● When income decreases consumers will have less money to spend.
So their demand will decrease. This will shift the demand curve to
the left
● Normal​ goods: demand increases with increased income
● Inferior​ goods: demand decreases with increased income

Preferences​ and Tastes ● When this change, so will the demand for certain goods
● Ex. fashion

Demographic​ changes ● When the population increases, there will be more people to
demand the good. This will increase demand, shifting the demand
curve to the right
● When the population decreases, there will be less people to
demand the good. This will decrease demand, shifting the demand
curve to the left
● If there is an increase in the number of buyers, demand increases
● Study of population

Prices of ● A fall in the price of one leads to an increase in the demand for the

15
 Complementary​ goods other
● Ex. when the price of a DVD player decrease, people would tend
to buy more DVDs which are used well together

Prices of ​Substitute ● A fall in the price of one results in a fall in the demand for the
goods other
● Ex. when the price of Mcdonalds fall, the price is ​relatively
cheap/low so people will consume less Lotteria, decrease in the
demand of Lotteria

Seasonal changes ● Changes in seasons may lead to changes in the pattern of demand
in the economy
● Ex. increased demand for warm coats in the winter

Movements along and shifts of the demand curve

● Distinguish between movements along the demand curve and shifts of the demand
curve.
● Draw diagrams to show the difference between movements along the demand
curve and shifts of the demand curve.

Movements along the curve

➔ Any ​change in price​ produces a change in quantity demanded

➔ When the ​CAUSE is PRICE​, only the ​points on the curve
moves
➔ x = f (y)
◆ If price (y) changes, Qd (x) changes

Shifts of the curve

➔ Any change in a ​non price determinants​ of demand leads to a

change in demand

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 ➔ When the ​CAUSE is NON-PRICE DETERMINANTS​, the ​whole curve shifts
➔ Increased (right) shift = increased quantity demanded at ALL PRICE

Linear demand functions (equations), demand schedules and graphs (HL ONLY)

● Explain a demand function (equation) of the form Qd = a – bP.

● Plot a demand curve from a linear function (eg. Qd = 60 – 5P).
● Identify the slope of the demand curve as the slope of the demand function Qd = a –
bP, that is –b (the coefficient of P).
● Outline why, if the “a” term changes, there will be a shift of the demand curve.
● Outline how a change in “b” affects the steepness of the demand curve.

Demand Schedule: Demand Graphs:

Usually, if
f (x) = a + bx
→ dependent variable which is on the x axis is going to be the determinant of the y value which is on
the y axis

But for the demand curve, the ​y axis is the independent variable ​and the values on the x is
determined by the y axis, making the ​Quantity demanded (x axis) the dependent variable
f (x) = Qd = a + bP
→ Quantity demanded depends on the Price

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General Form of Linear Demand Functions

Qd = a​ ​ -​b​P

Qd: Quantity Demanded

P: Price

a​ : x-intercept/Q intercept. If a​ ​ change, the demand curve will

shift left (​a↓
​ ) and shift right (​a​↑)
→ quantity demanded when price = 0
→ Autonomous Demand

b​: inverse of a slope. The higher the b

​ ​, the steeper the slope
→ always negative because of the negative relationship between price and quantity
demanded
→ why inverse?
Bec. we measure the change in quantity resulting from a particular change in price
ΔQd
→ ΔP
- Normally it would be the other way around
Δy
→ Δx

In order to find out the values of a and b

b : we need two Qs and two Ps

always negative. bec. There will always be an inverse relationship between the price and quantity
demanded

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a : plug in/substitute one of the Qs and one of the Ps in

➔ When ‘a’ changes, holding ‘b’ constant, shift in the demand curve

➔ When ‘b’ changes, holding ‘a’ constant, the slope of the demand curve will change

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 ★ If the question is given like:
○ P = ba − b1 Qd
○ You have to change it so that the dependent variable is P
○ Qd에 관한 방정식으로 바꾸어 풀어야함!!!

The Law of Supply + Supply Curve

● Explain the positive causal relationship between price and quantity supplied.
● Describe the relationship between an individual producer’s supply and market
supply
● Explain that a supply curve represents the relationship between the price and the
quantity supplied of a product, ceteris paribus.
● Draw a supply curve.
➔ Supply: the quantity of a good that sellers are ​willing​ and ​able​ to produce and sell at various
prices over a time period, ceteris paribus.
➔ Law of Supply: higher prices will, ceteris paribus, increase quantity supplied.
Therefore, a positive relationship exists between price and quantity supplied
= upward - sloping supply curve

As the price increases from P to P1, the quantity

supplied rises from Q to Q1

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 ➔ This is because the producers will want to make and sell more products when the price on
the market for these products has increased in order to make more profit
➔ The HEIGHT of supply curve = the lowest price the producers will accept for the product
◆ Willingness to accept
◆ Cost to the producers
◆ MC = Marginal Cost (additional cost)

Why the demand curve Slopes Downward

❖ Higher prices​ generally means that the​ firm’s profit increases​, and so the firm faces an
incentive to produce more output

Individual supply and Market supply

➔ Individual Supply: the supply of a single seller
➔ Market Supply: the supply of all sellers in a market
◆ Adding up all the individual supplies for each price

The non-price determinant of supply

= ​factors that change supply or shift the supply curve

● Explain how factors including changes in costs of factors of production (land,

labour, capital and entrepreneurship), technology, prices of related goods
(joint/competitive supply), expectations, indirect taxes and subsidies and the
number of firms in the market can change supply.

Costs of factors of ● Rent, wages, interest

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production ● If a factor price rises, production costs increases, production
became less profitable and the firm produce less
● When the factors of production become more expensive, the
production cost for producers will increase. This means they will
probably produce less and the supply curve will shift to the left
● When the factors of production become less expensive, the
production cost for producers will decrease. This means they will
probably produce more and the supply curve will shift to the right

Technological changes ● A new improved technology lowers cost of Price, thus making
production more profitable and therefore increasing the supply

Price of Joint supply ● When two or more goods are derived from a single product, it is
impossible to produce more of one, without production more of
Ex. other
cows for beef and hide ● Ex. when butter and Skim milk are derived from ‘whole milk’,
when you produce butter, you will eventually also get Skim milk
1. 소가죽 가격 ★ Although the price of skim milk hasn’t changed, the
올라감 supply of skim milk increased/decreased
2. 소가죽 생산 ● One input 에서 두개의 output 이 produce 되는 것
올라감 ● When the prices of related goods increases, producers will feel less
3. 소 더 많이 잡음 confident about selling their goods along with the related good.
4. 소고기 생산도 Therefore they will produce less goods, shifting the demand curve
같이 올라감 to the left
● When the price of related goods decreases, producers will feel
more confident about selling their goods along with the related
good. Therefore they will produce more goods, shifting the
demand curve to the right

Price of competitive ● When two goods uses the same resources, it is not possible to
supply produce more of one without producing less of the other
● Ex. when onion and potatoes are grown on the same agricultural
Ex. land, it is not possible to produce more onion without producing
A carpenter producing less potatoes
chairs and tables ● When the price of competitive goods increases, producers will feel
more confident about ‘winning’ the competition. They will
1. 의자가 가격 increase production, shifting the supply curve to the right
올라감 ● When the prices of competitive goods decreases, producers will
2. 의자 생산 feel less confident about ‘winning’ the competition. They will
올라감 decrease production shifting the supply curve to the left
3. 책상 생산
내려감

Producers expectations ● If firms expect the future price of their product to increase, they
supply less in the market in the present so they can sell more in
the future at a higher price

22

Govt interventions:
changes in indirect taxes
or ​taxes​ on profit
Govt interventions:
changes in ​subsidies
No. of firms /
competitors on the
market
Increase in production cost = decrease in supply
○ Supply decreases
● When the expectations change so does the production of
producers. If a producer for example, expects an economic crisis to
occur, he will probably decrease supply in order to be prepared for
a sudden loss in demand
● The imposition of a new tax or the increase of an existing tax
represents an increase in the cost of production
○ Supply decreases
● Indirect taxes 로 돈 뜯어감 = increase in production cost
● Direct tax = business tax = corporate tax
● When the indirect taxes increases the price of goods will increase.
This will make producers feel less confident on selling their goods
so they will decrease their production and supply. Consequently,
the supply curve will shift to the left
● When the indirect taxes decrease the price of goods will decrease.
This will make producers feel more confident on selling their
goods so they will increase their production and supply.
Consequently, the supply curve will shift to the right
● The introduction of a subsidy or an increase in an existing subsidy
is equivalent to a fall in cost of production
○ Supply increase
● Subsidies: financial assistance to firms
● Subsidies, 지원금으로 돈을 줌 = decrease in production cost
● When subsidies increase, produces will decide to produce more of
the good. This will shift the supply curve to the right
● When subsidies decrease, producers will decide to produce less of
the good. This will shift the supply curve to the left.
● Increase in number of firms producing the good
○ Supply increase
● When there are more competitors on the market, the producers
will face increased competition, decreasing their market shares.
This causes them to produce less, shifting the supply curve to the
left
● When there are less competitors on the market, the producers will
face decreased competition, increasing their market shares. This
causes them to produce more, shifting the supply curve to the
right
23
Movements along the curve

➔ Any ​change in price​ produces a change in quantity

supplied

➔ When the ​CAUSE is PRICE​, only the ​points on the

curve moves
➔ x = f (y)
◆ If price (y) changes, Qs (x) changes

Shifts of the curve

➔ Any change in a ​non price determinants​ of supply

leads to a change in demand
➔ When the ​CAUSE is NON-PRICE
DETERMINANTS​, the ​whole curve shifts
➔ Increased (right) shift = increased quantity
supplied at ALL PRICE

Linear Supply Functions (HL only)

Qs = c + dP
Qs = quantity supplied
P = price
c = quantity that would be supplied if the price was 0
d = sets the slope of the curve

−c Qs
P = d + d
→ change this equation

24
If ‘c’ changes,

→ shift in supply curve

Causes a shift in supply to the left or the
right. A decrease causes a leftward shift, an
increase causes a rightward shift
Any of the determinants of supply can
cause the change

ex. Cost of cattle feed decreases. Supply of beef

increases

If ‘d’ changes,

→ changes in slope in supply curve

A change in the responsiveness of
producers to price changes will cause the ‘d’
variable to change. If producers become more
responsive, ‘d’ will increase. If producers are less
responsible, ‘d’ will decrease.
Steeper of flatter

ex. New tech allows producers to become more

responsive to price changes, and the supply
increases

Equilibrium and changes to Equilibrium

● Explain, using diagrams, how demand and supply interact to produce market
equilibrium.
● Analyse, using diagrams and with reference to excess demand or excess supply, how
changes in the determinants of demand and/or supply result in a new market
equilibrium.

25
Equilibrium:
➔ When a market is in equilibrium, Qd equals to Qs, and there is no tendency for the price to
change

Disequilibrium:
➔ In a market disequilibrium, there is excess demand (shortage) or excess supply (surplus), and
the forces of demand and supply cause the price to change until the market reaches
equilibrium

All other price except equilibrium price = disequilibrium price

● If there is surplus, there is a tendency for price to fall to remove the excess supply
● If there is a shortage in the market, the price will tend to rise to remove the excess demand
● Self-righting ability: tendency to achieve equilibrium when in disequilibrium
○ In a free market, a market disequilibrium cannot last, as demand and supply force the
price to change until it reaches its equilibrium level.

Market Equilibrium Graph

If the price lies above the market price, the
quantity supplied will be higher than the quantity
demanded (Qs > Qd).
➔ Excess supply
➔ Surplus
If the price is below the market price, the quantity
demanded will be higher than the quantity
supplied (Qd > Qs).
➔ Excess demand
➔ Shortage

★ Surplus = Price ↓
★ Shortage = Price ↑
○ Qd = Qs 일때까지 movement along the curves

26
Changes in market equilibrium
1. Increase in demand
a. Demand shifts to the right

E​0​= initial equilibrium

E​1​= final equilibrium
(A - E​o​) = excess demand

→ disequilibrium (Qd > Qs)

➢ Upward pressure on price to increase to point E​1

= excess demand is eliminated, according to the law
of demand & supply

❖ Higher price equilibrium + greater/longer Quantity equilibrium

2. Decrease in demand
a. Demand shifts to the left

E​0​= initial equilibrium

E​2​= final equilibrium
(E​o​ - B) = excess supply

→ disequilibrium (Qs > Qd)

➢ Downward pressure on price to decrease to point E​2

= excess supply is eliminated

❖ Lower price equilibrium + smaller/shorter Quantity

equilibrium

3. Increase in supply

27
 a. Supply shifts to the right

E= initial equilibrium
E​1​= final equilibrium
(E​o​ - H) = excess supply

→ disequilibrium (Qs > Qd)

➢ Downward pressure on the price to fall to point E​1

= excess supply is eliminated

❖ Lower Price equilibrium + Greater Quantity equilibrium

4. Decrease in supply
a. Supply shifts to the left

E= initial equilibrium
E​2​= final equilibrium
(E - a) = excess demand

→ disequilibrium (Qd > Qs)

➢ Upward pressure on price to rise to point E​2

= excess demand is eliminated

❖ Higher price equilibrium + Lower quantity

equilibrium

Calculating and illustrating equilibrium using linear equations (HL ONLY)

● Calculate the equilibrium price and equilibrium quantity from linear demand and
supply functions.
● Plot demand and supply curves from linear functions, and identify the
equilibrium price and equilibrium quantity.
● State the quantity of excess demand or excess supply in the above diagrams

Ex.

28
 - Demand curve: Qd = 60 - 5p
- Supply curve: Qs = -40 + 20p

➔ Finding the equilibrium price and equilibrium quantity

◆ Qd = Qs at the market equilibrium

60 - 5p = -40 +20p
100 = 25p
p=4
Q = 60 - 20 = -40 + 80
Q = 40

p = 60/5 -1/5Qd
p = 12 -0.20Qd

If p = a → substitute this number into the equations

Price Mechanism
● In a free market price determined by the forces of supply and demand play a crucial role in
allocating resources to the production of specific goods.

29
● Price as signals and incentives
○ Price as signals:
■ The ability of prices to communicate information to consumers and
producers, on the basis of which they make economic decisions
● surplus가 있는지 shortage가 있는지 scarcity의 레벨을 얼마인지
■ A high price is a signal to producers that consumers want to buy the good
○ Price as incentives (동기부여)
■ The ability of prices to convey information to consumers and producers that
motivates them to respond by offering them incentives to behave in their best
self-interest.
● Consumer 들의 behavior을 바꾸는 reason이 price 가 된다
■ A higher price is an incentive for producers to produce more to increase
profit

30
what to produce question

1. Demand for strawberries increases because of their health benefits

2. At the initial price, P1, this results in a shortage equal to the difference between Q2 and Q1
(Qd > Qs)
3. Due to the shortage in the market, the price of strawberries begins to rise - excessive demand
elimination
4. The new, higher price signalled to producers that a shortage in the market has emerged. The
increase in price is also an incentive for producers to increase the Qs. (because of a higher
profitability) → producers move along the supply curve from A to C, increasing Qs from Q1
to Q3 (respond to increasing price by producing more supply)
5. The new, higher price signals that strawberries are now more expensive, and is an incentive
for consumers to buy fewer strawberries → consumers move along the demand curve from B
to C, decreasing Qd from Q2 to Q3

31
 6. The increase in price resulted in a reallocation of resources → more resources are now
allocated to strawberry production. (this affects the answers to the ​what to produce question
of resource allocation)

Resource Allocation*help
● Explain why scarcity necessitates choices that answer the “What to produce?”
question.
● Explain why choice results in an opportunity cost.
● Explain, using diagrams, that price has a signalling function and an incentive
function, which result in a reallocation of resources when prices change as a result
of a change in demand or supply conditions.

32
Market Efficiency_ Consumer Surplus + Producer surplus
● Explain the concept of consumer surplus.
● Identify consumer surplus on a demand and supply diagram.
● Explain the concept of producer surplus.
● Identify producer surplus on a demand and supply diagram.

Social Surplus (community surplus)

❖ Consumer surplus
➢ The benefit received by consumers who buy a good at a lower price than the price
they are willing to pay (MB)
■ MB: The highest price consumers are willing to pay for a good
➢ The extra satisfaction gained by consumers from paying a price that is lower than the
price they were prepared to pay
■ Total welfare gained from being able to consume
Measured by calculating the size of the area locked inside the demand curve; the horizontal line from
P* and the vertical line from Q*

❖ Producer surplus
➢ The benefit received by producers who sell a good at a higher price that the price
they are willing to receive (MC)
■ MC: the firm’s cost of producing an extra unit of the good, the lowest price
producers are willing to accept
➢ The excess of actual earnings that a producers makes from a given quantity of output
above the amount a producer would be willing to accept for that output
■ Total welfare gained from being able to produce; equal to producer profits
Measured by calculating the size of the area locked inside the supply curve; the horzontal line from
P* and the vertical line from Q*

❖ Social surplus
➢ Sum of consumer and producer surplus

33
34
 ❖ The market equilibrium occurs where MB = MC, which is also where social surplus is
maximum
➢ society has allocated the ‘right’ amount of resources to the production of the good,
and is producing the quantity of the good that is mostly wanted by society
➢ markets are achieving market efficiency
➢ Efficiency that is acheived on a market can be measured by adding up the consumer
and producer surplus = total welfare
➔ To see that this true, let’s look at a situation where price is not equal to the market price
➔ You can see that consumer surplus + producer surplus is smaller than at the equilibrium, the
loss in producer and consumer surplus is marked in the figure

Allocative Efficiency
● Explain that the best allocation of resources from society’s point of view is at
competitive market equilibrium, where social (community) surplus (consumer surplus
and producer surplus) is maximized (marginal benefit = marginal cost).

➔ Best allocation of resources from society’s point of view is at competitive market equilibrium
◆ Where social surplus is maximized
◆ MB = MC
➔ An allocation of resources that results in producing and consuming to combination of goods
and servies
◆ Mostly wanted by society
➔ 사회가 가장 원하는 goods and services의 combination을 생산 + 소비

35
Mostly wanted by society
= 만족감이 제일 높아지는 것
= Social Surplus is Maximized

Efficiency in the allocation of resources

= economic efficiency
= allocative efficiency
= socially optimal quantity
- The most efficient allocation of resources
- The best allocation of resources from society (producer + consumer)’s point of view

요약:
- Competitive market: so many buyers + sellers = no market power
- Marginal benefit: the additional satisfaction or utility that a buyer receives from consuming
an additional unit of good or service
- Value to the consumer
- WTP
- Height of demand curve
- Buyer 사이의 경쟁으로 인해 결국 내가 느끼는 가치 = 내가 내려고하는 최대 가치
- Marginal cost: the additional cost that a seller pays for producing an additional unit of a good
or service
- Cost to the producer
- WTA
- Height of supply curve
- Seller 간의 경쟁으로 가격이 낮아져 marginal cost : 최저가격

36
1.2 Elasticity

Price Elasticity of Demand and its Determinants

● Explain the concept of price elasticity of demand, understanding that it involves
responsiveness of quantity demanded to a change in price, along a given demand curve.
● Calculate PED using the following equation. PED percentage change in quantity
demanded percentage change in price
● State that the PED value is treated as if it were positive although its mathematical value is
usually negative.
● Explain, using diagrams and PED values, the concepts of price elastic demand, price
inelastic demand, unit elastic demand, perfectly elastic demand and perfectly inelastic
demand.
● Explain the determinants of PED, including the number and closeness of substitutes, the
degree of necessity, time and the proportion of income spent on the good.
● Calculate PED between two designated points on a demand curve using the PED
equation above.
● Explain why PED varies along a straight line demand curve and is not represented by the
slope of the demand curve.

Elasticity
➔ Used to measure the effect a change in some factor (income, the price of a good, the price of
another good etc.) has on supply and demand of a good

Price Elasticity of Demand (PED)

➔ Measure of the responsiveness of the quantity of a good demanded to changes in its price
➔ A measure of how much the quantity demanded of a product responds to a change in the
price of the product
➔ Consumer 가 price에 얼마나 responsive 한지 보여주는 것 = PED
➔ 얼마나 price change 에 민감한지

★ Elasticity of Demand against Price = P가 변했을 때 Qd 에게 영향을 얼마나 주는지

○ When there is a movement along the demand curve, we can calculate the PED
■ Movement along the demand curve = change in price
○ A shift in the supply curve = movement on demand curve

37
 PED = || % change in P ||
% change in Qd

❖ Outcome is negative because there is a negative relationship between price and quantity
demanded but in economics, we do not write the minus symbol of the PED
➢ Outcome: if price increase by a certain percentage, quantity demanded will decrease
by PED x that percentage
➢ ex. PED = 2 Price increased by 10% demand would decrease by 20%
■ 가격이 1% 변할 때 Qd는 두배로 변화

Five categories of PED

- 회색 박스: initial revenue
- 빨간 박스: revenue after change in price
- Revenue = Qd x P
PED = 0 Perfectly Inelastic Demand The higher the
Elasticity, the
more elastic
PED is, the
more demand
will change
ex. Lifesaving drugs when price
changes
↓
- 아무리 P가 변해도 Qd는 그대로 ↓
- Qd is completely unresponsive to change s in ↓
price
- A change in the price will have no effect on the ↓
Qd at all
- ↑P = ↑ revenue by the same % ↓
0 < PED < 1 Inelastic Demand
↓
↓
↓
↓
ex. Petrol, Alcohol, tobacco
- More likely to be ↓
taxed
↓
↓
Steep

- P가 변하면 Qd는 조금 변한다

38
 - p를 많이 올려도 Q가 많이 변하지 않아
revenue ↑
- Qd is relatively less responsive to changes in
Price
- % Δ Qd < % Δ P
- a change in the price of the good leads to a
proportionally smaller change in the quantity
demanded of it

PED = 1 Unit Elastic Demand

- % change in Qd = % change in P
- a change in the price of the product leads to a
proportionate change in the quantity demanded
of it
- ↑P or ↓P, no change in revenue

1 < PED < ∞ Elastic Demand

flat

- Qd is relatively responsive to changes in price

- % Δ in Qd > % Δ in P
- a change in the price of the good leads to a
greater than proportionate change in the
quantity demanded of it

39
PED = ∞ Perfectly Elastic Demand

ex. Homogenous product

with many substitutes
- Potatoes, vegetables
- will consume all they can buy at any price
- one price only
- any increase in P will cause 0 in demand
- Qd is infinitely responsive to changes in price
- ↑ P or ↓P = zero revenue

Variable PED along the demand curve

➔ Price 가 높을때는 consumer 들이 상대적으로 responsive 함

➔ For a straight line, downward-sloping demand curve, the value of PED falls as price falls
◆ 가격이 떨어질 수록 사람들의 반응은 적다. 반응이 작다 = PED 작다
➔ Low​ priced products have a more ​inelastic​ demand than high-priced products, because
consumers are ​less concerned when the price of an inexpensive product rises than they are
when the price of an expensive product rises
➔ 똑같은 proportion 의 change 라도 initial price 에 따라 달라진다

40
 ★ When PED is elastic:
○ Firms should lower their price to get more revenue because in that case demand will
increase more than the price will decrease
★ When PED is inelastic:
○ Firms should higher the price to get more revenue because in that case demand will
remain while the price of a unit increases

At high P and Low Qd = elastic

| % change in Qd | (=large since the denominator of ΔQd/Qd : 10/20 is small)

| % change in P | (=small since the denominator of ΔP /P : 5/40 is large)

At low P and High Qd = inelastic

| % change in Qd | (=small since the denominator of ΔQd/Qd : 10/80 is large)

| % change in P | (=large since the denominator of ΔP /P : 5/10 is small)

The Slope of the Demand Curve

PED = || % change in P ||
% change in Qd

%change in Q change in Q /Q ΔQ P
PED = % change in P = change in P /P = ΔP × Q

PED = Slope x P x Q
➔ The slope of a straight line is always constant, therefore:
PED = a constant number x P/Q which is continuously changing (decreasing) as P↓ and Q↑
➔ PED becomes less elastic as P↓

Why PED varies along a straight line demand curve

and is not represented by the slope of the demand curve

Even though the linear line presents the same slope but PED varies at all points

proof :

PED = || % change in P ||
% change in Qd

41
 | (Q1Q− Q0) |
= || (P 1− 0P 0) || × 100
| P0 |
| (ΔQ) | | ΔQ × P |
= | ΔP || = | ΔP × Q0 |
| Q

| P | |
0|

1 P0
= slope × Q0 ← ​원점과 그 점을 이은것과 같고, 이때 생기는 직선의 기울기는
모두
다르기 때문에 모든 점에서 PED는 달라진다

Determinants of PED
● The number of closeness of substitutes:
○ The more substitutes, the higher PED, if there are a lot of substitutes, consumers can
easily switch to another product when the price of the product increases
○ ex. If P of Pepsi ↑, consumers can switch to other soft drinks
→ high responsiveness of Qd
● The degree of necessity
○ The higher the need for the product, the lower PED. consumers will buy goods they
need anyway, regardless of the price.
○ ex. Food and Gasoline
● The time period over which PED is measured
○ The longer this time period, the higher PED. In the long run, consumers have more
time to look for alternatives/substitutes for a good. They will switch more often if the
price of the good increases.
● The proportion of income spent on the good:
○ The smaller this proportion, the lower PED. when the proportion of income spent on
a good is low, consumers will not notice or care about a price change and still buy the
same proportion of the good.
● The type of good:
○ Primary commodities have a lower PED than manufactured commodities. Primary
commodities are necessary for producers in order to produce. They will buy them
anyway, regardless of the price that is asked for them.
● Breadth of definition of the product
○ A broadly defined good will be more price elastic
● Other factors
○ Addictions
○ Brand loyalty

42
Applications of PED
● Examine the role of PED for firms in making decisions regarding price changes and
their effect on total revenue.
● Explain why the PED for many primary commodities is relatively low and the PED
for manufactured products is relatively high.
● Examine the significance of PED for government in relation to indirect taxes.

PED and Total Revenue

Total revenue: firm/producer 가 뭔가를 팔아서 자기한테 돌아오는 돈
=PxQ
=/ Profit
= profit - cost

If PED < 1 insensitive / inelastic (Qd 가 P 에 대해 insensitive 한 경우)

- P​↑​ x Q↓ = total revenue ↑
- Inelastic 한 경우, 가격을 높이는게 total revenue 를 올릴 수 있다
- P​↓ ​x Q↑ = total revenue ↓
➔ Inelastic 한 것들은 시간이 지날수록 가격이 ↑ 가는 성향

If PED > 1 (Qd가 P에 대해 sensitive 한 경우)

- P↓ x Q​↑​= total revenue: ↑
- P↑ x Q​↓​= total revenue: ↓
- Elastic 할 땐, 가격을 낮추는게 total revenue를 올릴 수 있다
- ex. 고가의 물건, 백화점 → 세일기간 ↑

Maximizing Total Revenue

PED = 1일때 total revenue is maximized

43
1. Primary commodities
a. def: Goods arising directly from the use of natural resources: agricultural products,
fishing, forestry + extractive product → ex. Oil & minerals
b. Most primary commodities have relatively low PED
i. They do not have close substitutes and they are necessary
c. Most manufactured products have relatively high PED
i. They are not as necessary as primary goods and they generally have
substitutes​ (except for medications, which are manufactured but inelastic
because they are necessary and have no substitutes)
ii. Manufactured goods are easily differentiated : 차별화 될 수 있다
d. Consequences of a low PED for primary commodities (supply 에 swing이 많다 -
weather conditions, natural disasters, crop diseases)
i. Low PED together with fluctuations in supply over short periods of time
create serious problems of primary commodity producers, because they result
in large fluctuations in primary commodity prices
1. Price volatility
2. Price fluctuation
2. Indirect tax
a. def. Taxes on spending to buy particular goods, paid indirectly to the government
through the seller of the good

44
 ➔ The more elastic the demand, the smaller the responsiveness drop in Qd
= The higher the tax revenue

Government 가 번 tax = tax revenue

= tax per unit x Q sold after tax
Government 가 inelastic demand 에 tax를 붙이는 이유:
- Less quantity change even when price increases
- Since elastic demand goods have high Qd change, when Qd decreases, it has a 큰 타격 on
manufactioners → more unemployment

Cross Price Elasticity of Demand and its Determinants

● Outline the concept of cross price elasticity of demand, understanding that it involves
responsiveness of demand for one good (and hence a shifting demand curve) to a
change in the price of another good.
● Calculate XED using the following equation: XED = percentage change in quantity
demanded of good X divided by percentage change in price of good Y
● Show that substitute goods have a positive value of XED and complementary goods
have a negative value of XED.
● Explain that the (absolute) value of XED depends on the closeness of the relationship
between two goods.

Cross Price Elasticity of Demand (XED)

➔ A measure of the responsiveness of demand for one good to a change in the price of another
good

45
 ➔ A measure of how much the quantity demanded of one product responds to a change in the
price of another product
➔ To measure the effect a change in the price of one product has on the demand for a certain
other good

| % Δ change in Qd of good A |
XED = | %Δ change in P of good B |
- Shows the relationship between the two products
- B의 가격이 1% 변했을 때 A의 Qd는?
- If the price of good B increases by a certain percentage, the quantity demanded of good A
will increase by XED x that percentage
- ex, XED = -2 and the price of B increased by 10% = demand for A decreases 20%

➔ Can be POSITIVE or NEGATIVE

➔ Positive:
◆ XED > 0
◆ Goods A and B will be SUBSTITUTE goods because an increase in the price
of good B increases the demand for Good A
◆ QA and PB changes in the same direction
◆ The greater the value of positive XED, the greater the substitutability
between two goods
➔ Negative:
◆ XED < 0
◆ Goods A and B will be COMPLEMENTARY goods because an increase in the
price of good B decreases the demand for good A
◆ QA and PB changes in different direction
◆ The greater the absolute value of the negative XED, the greater
complementarity between two goods
● -4 처럼 절대값의 값이 커질 수록 서로 더 관계가 되어 있다는 것.
➔ Zero XED
◆ Unrelated products
◆ XED = 0
● No responsiveness of Product A to a change in the price of B

Calculating XED
A1 tickets:
- P: 1000 → 1050
- Qd: 200 → 0
A2 tickets:
- P: 1000
- Qd: 200 → 400

46
A1:
50
P changed / average of P = 1025 = 4.9%

A2:
Qd changed / average of Qd = 200
300 = 67%

XED for A2 tickets relative to A1’s price:

67%
- 5% = 13.4

XED: 13.4

Applications of Cross Price Elasticity of Demand

● Examine the implications of XED for businesses if prices of substitutes or complements

change.

1. Substitutes:
a. A single firm producing substitute products - when a business produces a line of
products that are similar to each other, it must consider XED
i. ex. Coca-Cola and Sprite: two goods that are substitutes with high value of
XED
1. A fall in the price of Coca-Cola would be followed by a fall in the
demand for Sprite
2. Increased sales of Coca-Cola, if its demand is price elastic, would
come at the expense of Sprite sales
b. Substitute produced by rival business:
i. XED allows firms to predict the effect on the Qd for their product (and hence
revenue) if rival firm changes its price
c. Substitutes and mergers between firms:
i. Two rival firms producing substitutes with a high XED may want​ to merge to
eliminate competition between them
1. Mergers: firms 들의 merge: 합병/take-over
2. Market share: 더 많은 consumer 들을 dominate 할 수 있다
3. Increased market power → increased price → increased profitability
2. Complements:

47
 a. Knowledge of XED can be useful because if a complement’s price rises, this may
result in a drop in demand for a firm’s product. Such information can lead to
collaboration between firms where both may gain from a lower price
i. ex. Hotels
1. 다른 비즈니스의 consumer 들을 attract (increase in marketing)
b. It is also possible to use XED to predict the impact of an indirect tax on one good on
the sales of a complementary good
i. If two goods have a relatively high XED, a larger tax on one could result in a
significant decrease in sales of the other

1. 1st strategy: Market Skimming / Price Skimming

a. Market 에 substitute가 없는 상황
b. The firm changes the highest initial price that customer will pay
i. Early adopters or trend-setters will buy even though the high price - satisfied
c. After all people who would have consumed at high price, the firm lowers the price to
attract other customers as well, more price sensitive segment of consumers
2. 2nd strategy: penetration pricing
a. There are lots of substitutes
b. The firm offers a low price for a new product or service during its initial offering in
order to lure customers away from substitutes
c. When the market share increases, the firm tries to higher price
i. The aim of this strategy is to increase market share of product, providing
opportunity to increase price, once this objective has been achieved.

Income Elasticity of Demand and its Determinants

● Outline the concept of income elasticity of demand, understanding that it involves

responsiveness of demand (and hence a shifting demand curve) to a change in income.
● Calculate YED using the following equation. YED percentage change in quantity demanded
percentage chang = e in income
● Show that normal goods have a positive value of YED and inferior goods have a negative value of
YED.
● Distinguish, with reference to YED, between necessity (income inelastic) goods and luxury
(income elastic) goods.

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Income Elasticity of Demand
➔ To measure the effect that a change in income of consumers has on the demand for a certain
product
➔ A measure of the responsiveness of demand to changes in income

% change in Qd
YED = % change in income
- Y = income
- If the income of consumers is increased by a certain percentage, the quantity demanded the
good will increase by YED x that percentage
- If YED = -2 and the income of consumer has increased by 10%, demand for the good will
decrease by 20%

➔ Can be POSITIVE or NEGATIVE

◆ YED is Positive:
● YED > 0
● NORMAL GOOD
● When income increases, so does the consumption of the good
● Demand and income change in the same direction
○ ex. Cars
◆ YED is Negative:
● YED < 0
● INFERIOR GOOD
● When income increases the consumption of the good will decrease
● Demand and income move in opposite directions
○ ex. Hamburgers

When positive YED, YED > 0

● 0 < YED < 1
○ Income inelastic demand
○ % Δ in Y > % Δ in Qd
○ Necessities are income inelastic goods
● YED > 1
○ Income elastic demand
○ % Δ in Y < % Δ in Qd
○ Luxuries are income elastic goods

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*decrease / increase 인지 잘 봐야함

Applications of income Elasticity of Demand

● Examine the implications for producers and for the economy of a relatively low YED
for primary products, a relatively higher YED for manufactured products and an even
higher YED for services.

Applications of YED
1. Implications for ​producers
a. YED > 1
i. Income elastic
ii. Luxury good
1. Bec an increase in income will lead to a spectacular increase in
demand for these goods
2. ex. Jewelry, sports cars
iii. Secondary + Tertiary

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 iv. Demand grows faster than total income
v. In a growing economy (income ↑ time period), the ​industries with high
YEDs will experience the most rapid increases in demand​, and this
information is useful for new firms​ making a decision ​which line of
production to go into​ as well as for ​existing firms planning investments for
the future
vi. Luxuries​ are the ​most affected products during an economic downturn
(income 불경기- 제일 타격을 많이 받음) when national income declines
→ firms may wish to diversify their output with lower YED or
Negative YED products like Inferior good, necessity.

b. 0 < YED < 1

i. Income inelastic
ii. Necessity good
1. Bec an increase in income won’t change the demand for these goods
that much, consumers will need them anyway.
2. ex. Food and medicine
iii. Demand grows slower than total income
iv. Primary sector products ex. Oil, agricultural​ output have ​low YED value
v. Potentially beneficial implications for producers as ​demand is stable despite
fluctuations​ in the business cycle.
vi. 한번에 떼돈 벌기 힘들다
c. YED < 0
i. In a recession, inferior goods may experience rapid growth as consumers with
falling incomes switch away from a normal good
ii. The producers can prepare for loss of revenue by producing diversified
products
2. Implications for the ​economy
a. Primary products​ usually have a ​low YED​, while ​manufacturing products​ usually
have ​higher YED​s, and ​services​ as a group have the ​highest of all
b. Due to these differing YED values, there is a change in the structure of economies in
many countries over time
→ with growth in incomes, there is a relatively more rapid growth in manufacturing
and even faster growth of services, while the primary sector experiences slowest
growth of all.

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Economic Sectors:
1. Primary sector (primary products)
a. Income - inelastic
b. 0 < YED < 1
2. Secondary sector (manufactured products)
a. Income - elastic
b. YED > 1
3. Tertiary sector (services)
a. YED >>1

→ 점점 내려갈 수록 income 이 1% 변했을 때 Qd가 더 많이 늘어남

→ income의 증가에 대해 Qd가 늘어난다

Primary → Secondary → Tertiary

- Primary 에서 하나만 늘어나도 뒤에서 할 수 있는게 훨씬 많아짐 → ↑YED

Price Elasticity of Supply and its Determinants

● Explain the concept of price elasticity of supply, understanding that it involves

responsiveness of quantity supplied to a change in price along a given supply curve.
● Calculate PES using the following equation. PES percentage change in quantity supplied
percentage chang = e in price
● Explain, using diagrams and PES values, the concepts of elastic supply, inelastic supply, unit
elastic supply, perfectly elastic supply and perfectly inelastic supply.
● Explain the determinants of PES, including time, mobility of factors of production, unused
capacity and ability to store stocks.

Price Elasticity of Supply (PES)

➔ A measure of the responsiveness of the quantity of a good supplied to changes in its price

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 ➔ Price 의 변동으로 producer들이 얼마나 responsive 한지
➔ A measure of how much the quantity supplied of a product responds to a change in the price
of the product
➔ To measure the effect a change in price has on the supply for a certain good
➔ 얼마나 쉽게, flexible 하게 production quantity 를 늘릴 수 있는지

%Δ in Qs
PES = % Δ in P
★ Sign is important
○ Typically positive: there is a positive relationship between price and quantity supplied

→ if price increases by a certain percentage, quantity supplied will increase by PES x that percentage
ex. PES = 2 and price increased by 10%, supply would increase by 20%

PES = 0 Perfectly Inelastic Supply The higher the

Elasticity, the
more elastic
PES is, the more
Supply will
change when
ex. Supply of Picasso price changes
painting, sports stadium
↓
↓
↓
↓
- Qs is completely unresponsive to changes in ↓
price ↓
- a change in the price will have no effect on the
Qs at all ↓
↓
↓
↓
↓
↓

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0 < PES < 1 Inelastic Supply

x- intercept 로 시작해서
steep 하게 그리기

Primary, tertiary

- Qs is relatively unresponsive to changes in the

price
- % Δ in Qs < % Δ in P
- a change in the price of the good leads to a
proportionally​ ​smaller change​ in the quantity
supplied of it

PES = 1 Unit Elastic Supply

Starts from the origin

- Tangent doesn't
matter

- % Δ in Qs = % Δ in P
- A change in the price of the product leads to a
proportionate change in the quantity demanded
of it
- Unit elastic S curve passes through the origin

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1 < PES < ∞ Elastic Supply

y- intercept 에서 시작해서
조금 flat 하게

Secondary manufacturing
good

- Qs is relatively responsive to changes in price

- % Δ in Qs > % Δ in P
- a change in the price of the good leads to a
greater than proportionate change​ in quantity
supplied of it

PES = ∞ Perfectly Elastic Supply

No example
Only theoretical curve
This is very flexible

- Qs is infinitely responsive to changes in price

Determinants of PES
➔ When explaining whether or not a certain product is elastic or inelastic, use the
determinants to explain
● Length of time
○ The ​longer the time period​ a producer has to respond to price changes, the ​more
elastic the supply​. In a short period of time the producer may be unable to obtain all
necessary resources and technology in order to increase output in response to a price
increase
● Mobility of factors of production

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 ○ The more​ easily and quickly resources can be shifted​ out of one line of production
and into another, the ​greater the responsiveness​ of Qs to changes in price, and hence
the greater the PES
○ Flexibilty: 가격의 변동으로 인해 생산해야될 말아야될 상품을 잘 정해서 그것에
맞게 재료를 써야함
○ 빵이나 피자는 mobility 가 high 해서 PES 가 큼
○ 농산물이랑 나는 mobility 가 낮아서 PES 가 낮음
● Unused capacity of firms
○ If firms have ​machines, equipment or labour that are not being fully used​, then it is
easier to expand production​ in the event that price increases, simply by making use of
the idle (unemployed, unused) resources, and therefore the more elastic the supply
○ 최대 생산량 중 사용되지 않은 부분
○ 많을수록 가격이 올랐을 때 금방 Qs 를 늘릴 수 있음
● Ability to store stocks
○ If a firm can store stock easily and inexpensively, then in the event of a price increase
it is more likely to have available stock that can be sold in the market, and the more
elastic the supply
○ High ability to store stock : increase elasticity
○ Mostly manufacturing goods have ability to store stocks - exceptions: airplanes
○ 저장해두고 바로 팔 수 있음
○ 금방 Qs 늘릴 수 있음

Applications of Price Elasticity of Supply

● Explain why the PES for primary commodities is relatively low and the PES for
manufactured products is relatively high.

Primary Commodities vs Manufactured Goods

Why primary commodities have a lower PES compared with the PES of manufactured products
1. The time needed for Qs to respond to price changes
a. ex. Agricultural products need to go through their natural growing time, and forestry
needs an especially long time for trees to grow.
b. For other primary products (extractive goods), ​time​ (capital resource 를 arrange 할
때 시간이 걸림) is needed to make the ​necessary investments
2. There is a limited amount of new land that can be brought into cultivation
a. 농사 지을 땅이 이미 없다 → few idle resources left in the economy + lack of space
capacity
3. Agricultural products are hard to be stored for a long time

Consequences of a low PES for primary commodities

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 ● The combination of relatively inelastic demand and inelastic supply for commodities means
that any changes in D or S will result in large swings in prices
→ large revenue fluctuations or unstable revenue for producers

Important Observation
- Both low PED and low PES contribute to price and income stability of primary commodities
- 생산자들의 income도 불안점
- Steep demand curve, steep supply curve
- Change in demand / supply → price fluctuation
- Problem: LEDCs are producing primary commodities
- Very dependent and unstable

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