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Resource Allocation c.

Perfect information
Perfect competition
An Open Source Education Project Consumer surplus – The excess of what a consumer is willing to pay over
what he actually pays
Free market economy – Decisions about production and consumption are
left to those who are willing and able to participate in the market place
1. Private ownership of economic resources Producer surplus – The excess of what a producer is actually paid over
2. Profit maximisation for consumers, maximum satisfaction for what he is willing to be paid
3. Price mechanism determines demand and supply

What to produce: Consumer sovereignty – Consumers have the

purchasing power to dictate what goods are produced

How to produce: Cheapest method of production

For whom to produce: Consumers with purchasing power gets the goods
that have been produced

Demand – Willingness and ability of consumers to purchase

Law of Demand – The quantity demanded of a good is inversely related

to its price

Change in quantity demanded – Movement along the demand curve

Change in demand – Shift of demand curve

Elasticity of Demand
Factors Affecting Demand
1. Price elasticity of demand – degree of responsiveness of quantity
demanded to a change in price of the good
1. Household income
2. Income elasticity of demand – degree of responsiveness of quantity
a. Normal goods
demanded to a change in income
b. Inferior goods
3. Degree of responsiveness of quantity demanded of a good to a
2. Taste and preferences
change in price of another good
3. Prices of related goods
a. Substitutes
Price Elasticity of Demand
b. Complements
4. Speculations
5. Population structure and size
6. Government policies
7. Climate and weather

Types of Demand
1. Usually a negative value due to the law of demand
1. Individual demand
2. Price elastic demand – Elasticity < -1
2. Market demand
a. A change in price of the good brings about a more than
3. Complimentary demand (compliments)
proportionate change in quantity demanded
4. Competitive demand (substitutes)
3. Price inelastic demand – Elasticity > -1
5. Derived demand (factors of production)
a. A change in price of the good brings about a less than
6. Composite demand
proportionate change in quantity demanded
4. Unit elastic demand
Supply – Willingness and ability of producers to produce goods
a. A change in the price of the good brings about a
proportionate change in quantity demanded
Law of Supply – The quantity supplied of a good is proportional to the
5. Perfectly elastic demand
price of a good
a. A change in the price of the good will bring about an infinite
Change in quantity supplied – Movement along the supply curve change in quantity demanded
b. Horizontal demand curve
Change in supply – Shift of supply curve 6. Perfectly inelastic demand
a. A change in the price of the good will not bring about any
Factors Affecting Supply change in the quantity demanded
b. Vertical demand curve
1. Costs of production
2. Goals of firm Factors Affecting Price Inelasticity of Demand
3. Technological improvements
4. Government policies 1. Availability of substitutes
5. Speculations 2. Proportion of income spent on good
6. Climate and weather 3. Necessities vs luxury goods
7. Number of producers 4. Time period
8. Prices of related goods
a. Competitive supply (substitutes in production) Price Elasticity of Demand Affecting Total Revenue
b. Complementary supply (complements in production)
1. Elastic
Types of Supply

1. Individual supply
2. Market supply
3. Competitive supply
4. Complementary supply

Market Equilibrium

1. Interaction of demand and supply

2. Neither surplus nor shortage arises

3. Conditions
a. No external benefits 2. Inelastic
b. No external costs
1. Productivity (MPP changes)
2. Price of good (MR changes)
3. Demand for goods and services using skills offered by labour market
4. Market value of product

Elasticity of Demand for Labour

1. Degree of responsiveness of the level of employment to a change in

wage levels
2. Effect of wage increase on the employment level

Factors Affecting Elasticity of Demand for Labour

1. Time period
3. Unit elastic
2. Proportion of wages to total cost
a. Loss = gain
3. Price elasticity of demand of products
Income Elasticity of Demand 4. Supply of substitute factors
5. Strength of economy
6. Ease of substitution of resources (eg. labour and capital)

Supply of Labour

1. Positive income elasticity 1. Upward sloping as more labour supply at higher wage rates
a. Rightward shift of demand curve
b. Normal and luxury goods (inelastic) Factors Affecting Supply of Labour
2. Negative income elasticity
a. Leftward shift of demand curve 1. Ease of entry of new labour
b. Inferior goods 2. Population structure
3. Zero income elasticity 3. Wages and working conditions in alternative industries
a. Basic necessities
Elasticity of Supply of Labour
Cross Price Elasticity of Demand
1. Degree of responsiveness of quantity of labour supplied to a change
in wage levels

Determination of Equilibrium Wage Rate

1. Wages paid to workers will depend on their contribution to employers’

1. Positive cross price elasticity
a. Substitutes
2. Negative cross price elasticity
Other Determinants of Wages
a. Complements
3. Zero cross price elasticity
1. Minimum wage laws
a. Unrelated goods
2. Racial/gender discrimination
3. Influence of trade unions
Price Elasticity of Supply
4. Imperfect information

Money Market (Loanable Funds)

• Diagrams plotted with Interest Rate vs Quantity of Loanable Funds

1. Price elastic supply
Demand for Loanable Funds
a. Eg. Manufactured goods
2. Price inelastic supply 1. Downward sloping
a. Eg. Agricultural goods a. More demand as lower interest rate → Lower cost of
3. Unit elastic supply
a. Straight line from origin
Supply of Loanable Funds
4. Perfectly elastic supply
a. Horizontal supply curve
1. Upward sloping
5. Perfectly inelastic supply
a. More savings as higher interest rate → Higher rate of
a. Vertical supply curve

Factors Affecting Elasticity of Supply

Currencies Market (Foreign Exchange)

1. Time period
2. Existence of spare capacity (short run) • Diagrams plotted with (eg.) Price of S$ in US$ vs Quantity of S$

3. Storage and perishability

Demand for Currencies
4. Availability and mobility of factors of productions
5. Number of firms 1. Downward sloping

Labour Market a. Lower exchange rate causes greater demand of the

country’s currency to purchase goods and services
• Diagrams plotted with Wages vs Number of workers employed
2. Generated by:
a. Exports
b. Foreign direct investments
Demand for Labour
c. Capital inflows
1. Graphically, Demand = Marginal Revenue Product
Supply of Currencies
2. Marginal Revenue Product = Marginal Physical Product x Marginal
Revenue (MRP = MPP x MR)
1. Upward sloping
3. MRP – Increase in total revenue contributed by the employment of an
a. Lower exchange rate causes dearer foreign goods and
additional worker
hence lower supply of domestic currency to import the
4. MPP falls, MR constant
2. Generated by:
Factors Affecting Demand for Labour
a. Imports
b. Investment overseas
c. Capital outflows 1. Prevent overcharging and allow equitable distribution of scarce
2. Release more resources for urgent needs

Purpose of Indirect Taxes

1. Improve resource allocation and achieve social efficiency Effects of Price Ceiling
2. Government revenue
1. Shortage of good
2. Black market may result

Price floor → price set above the equilibrium price

Graphically, tax will cause a leftward shift of the supply curve

Purpose of Price Floor

Burden of Tax

1. Protect workers’ wages

Supply is elastic → Burden of the tax falls more on the consumers
2. Stabilise prices
Supply is inelastic → Burden of the tax falls more on the producers
Effects of Price Floor
Purpose of Subsidies
1. Surplus of good produced
1. Encourage consumption and production (of goods which generates 2. Guaranteed higher wage for employed
positive externalities) 3. Inflated production costs and consumption prices
4. For agricultural products, surplus is bought by the government, and is
an inefficient allocation of resources

Graphically, subsidy will cause a rightward shift of the supply curve

Price controls → market at disequilibrium level → persistent shortages or


Price ceiling → price below equilibrium price

Purpose of Price Ceiling