Applied Economics

Implications of Market
Pricing in Making Economic
Decisions

Market Pricing on Making Economic Decisions

Please read this article on Demand, Supply and Elasticity of Clean Water in the Philippines. This
will help you understand better our new lesson. Enjoy reading!

Demand, Supply and Elasticity of Clean Water in the Philippines

8/27/2015
According to an article created by Vice News, there are 55
people who die in the Philippines every day because of the
lack of clean water. As one can see clean water is greatly
needed by all people. As a student who is lucky to be given
all the necessities needed in life it would be normal not to
think of this because we normally do not notice it. However,
we need to. According to Katrina Arianne Ebora, who works
for UNICEF’s Water, Sanitation and Hygiene program in the
Philippines stated that “Over 30 million people in the
Philippines do not have access to improved sanitation
facilities.” Also, according to the PIS by 2050 the population
of the areas with poverty in Manila will reach over 9 million!
With the rising population of the Philippines there will be a
problem with the economy of clean water because there will
be too much demand for the supply of water.

The Marketing Price System

A shortage is when there is an excess demand for the quantity

supplied. While surplus is excess in supply.
For example, if there are 10 bottles of water and there are 20 students who
want drinking these, then there will be only 10 students whose demands are met
while the others will not be able to be given anything. There is shortage in the
supply.
If producers make too many bottles of water and consumers cannot by them
want to buy them, there will be surplus.

Price System in a Market Economy

Let us find out more about the price system. We have learned that demand is the willingness of the
consumers to buy goods and services. In economics, the willingness to buy goods and services
should be accompanied by the ability to buy, also called the “purchasing power”. This is referred to
as an effective demand.

EQUILIBRIUM CHARACTERISTICS
Equilibrium is a point of balance or The supply and demand are
a point of rest. It is also called balanced in equilibrium.
“market-clearing price”.

Equilibrium price is the price at The economic forces are balanced

which the producer can sell all the and in the absence of external
units he wants to produce and the influences, the (equilibrium) values
buyer can buy all the units he wants of economic variables will not
change.

Quantity demanded and quantities The amount of goods or services

supplied are equal. sought by buyers is equal to the
amount of goods or services
produced by sellers.
Price System in a Market Economy: Its Characteristics

Let us learn more! The prices of goods that we encounter everyday to the things we buy plays a
crucial role in determining an efficient distribution of resources in a market system. The prices
willhelp us to make every day economic decisions about our needs and [Link] are the
indications of the acceptance of a product; the more popular the product, the higher the price that
can be charged.
Example is when a tables are for sale in your community today and is assumed that they are not very
important as compared to other products or commodities that we need to survive especially that our
movements are very limited.

Neither the producers nor consumers can impactprices; consumers can buy whatever they want; nor
can producers make and sell whatever they want.

Prices are decided by interactions between the producers and the consumers. Price acts as a signal
for shortages and surpluses which help firms and consumers respond to changing market
conditions.

If a good is in shortage – price will tend to rise. Rising prices discourage demand, and encourage
firms to try and increase supply.
If a good is in surplus – price will tend to fall. Falling price encourage people to buy, and cause
firms to try and cut back on supply.
Prices help to redistribute resources from goods with little demand to goods and service

The market price is the point that the supply We explore more how equilibrium happens.
and demand curves intersect. (Judge, S. 2020) Let us analyze the chart below.
The chart shows a surplus – the quantity is
greater than demand. When quantity is
greater
than demand it causes prices to go down.

Figure 1.
The Equilibrium Point or the Market Price Point

Figure 2: Surplus Point

PRICES ARE MARKET DRIVEN

The producers can make what they

want and consumers are free to purchase
what they want. This means that customers live
in a market economy. When prices are high,
supply increases as many firms join the market
(Judge, S. 2020).
Let’s say the units of cellular phones.
The numbers of suppliers have increased
becauseof high prices of the cellular phones.
Whensmartphones were new in the market,
there were fewer producers and prices were
high. The high prices attracted the Figure 3. Shortage Point
producers
to join the market In shortage, quantity is less than the demand; it
 causes prices to go up due to scarcity

Example of which is the shortage in masks and

ethyl alcohol in the market. There is shortage in
the supply, thus, price tends to go up or tends to
go higher

Law of Supply and Demand

The law of supply and demand explains the interaction between the
sellers of a product and the buyers. It shows the relationship between the availability of a
particular product and the desire (or demand) for that product has on its price.

Law of Demand

What is a demand? Demand is the desire The demand curve is always downward
of a consumer to purchase goods or services sloping due to the law of diminishing
and willingness to pay a at for that product marginal utility.
or services at a given price.

If all other factors remain equal, the higher

the price of a good, the fewer people will
demand that good.
“the higher the price, the lower the quantity
demanded” and vice versa.

Law of Supply
The law of supply demonstrates the
quantities that will be sold at a given price.
The higher the price, the higher the quantity
supplied and vice versa. The law of supply says ……………….
“as the price of a product increases,
companies will produce more of the
Product”.

When graphing the supply vs. the price, ,

the slope rises.

How Do Supply and Demand Create an Equilibrium Price?

Equilibrium price is the price at which a producer can sell all the units he wants to
produce and a buyer can buy all the units he wants. Supply and demand are balanced,
or in equilibrium. The demand curve is downward sloping. This is due to the law of
diminishing marginal utility.

The supply curve is a vertical line; overtime,

supply curve slopes upward; the more suppliers
expect to charge higher, the more they will be willing
to produce and bring products to market. In the
Equilibrium point, the two slopes will intersect.
The market price is sufficient to induce suppliers to
bring to market that same quantity of goods that
consumers will be willing to pay for at that price.

PRICE ELASTICITY OF DEMAND AND SUPPLY

Can you guess what happened with this mom in a

market?
You may write your reaction in the shape
towards her.
Price elasticity measures the responsiveness
of the
quantity demanded or supplied of a good to a
change in its price.
Elasticity can be described as: a) elastic or
very responsive and b) unit elastic, or inelastic
or not very responsive. (source: Investopedia)

Effects of Change in Demand and Supply

Elastic demand or supply curve indicates that quantity demanded or supplied respond to
price changes in a greater than proportional manner.
Inelastic demand or supply curve is one where a given percentage change in price will
cause a smaller percentage change in quantity demanded or supplied.
Unitary elasticity means that a given percentage changes in price leads to an equal
percentage change in quantity demanded or supplied.

CATEGORIES OF PRICE ELASTICITY

According to Agarwal, P. (2018) and Judge, S. (2020), there are four categories of price
elasticity are the following:

I. The Price Elasticity of Demand

Price elasticity of demand is the responsiveness of quantity demanded, or how
much quantity demanded changes, given a change in the price of goods or services.

*The mathematical value is negative. A negative value indicates an inverse relationship

between price and the quantity demanded. But the negative sign is ignored (Judge, S.
2020).

Price Elasticity of Demand (PED)= % change in quantity demanded % Change

in price
 Figure 4 Price Elasticity of Demand

a) Elastic Demand (PED > 1) - the percentage change in price brings about a more than
proportionate change in quantity demanded.

When the percentage change in quantity demanded is greater than the percentage
change in price, and the coefficient of the elasticity is greater than 1.
Example real estate- housing - There are many different housing choices. People may
live in a townhouses, condos, apartments, or resorts. The options make easy for people to
not pay more than they demand.

b) Inelastic Demand (coefficient of the elasticity is less than 1) – is when an increase

in price causes a smaller % fall in demand.

When the percentage change in quantity demanded is less than the percentage change
in price, and the coefficient of the elasticity is less than 1.

Example Gasoline – gasoline has few alternatives; people with cars consider it as a
necessity and they need to buy gasoline. There are weak substitutes, such as train riding,
walking and buses. If the price of gasoline goes up, demand is very inelastic. Other
Examples: Diamonds, aircon, Iphone, Cigarettes

c) Unitary Elastic Demand - When the percentage change in demand is equal to the
percentage change in price, the product is said to have Unitary Elastic demand.

Unitary elastic - PED or the price elasticity of demand is 1

d) Perfectly Elastic - a small percentage change in price brings about a change in

quantity demanded from zero to infinity.

Perfectly elastic - the coefficient of elasticity is equal to infinity (∞)

e) Perfectly Inelastic - the PED is =0 any change in price will not have any effect on
the demand of the product.

Perfectly inelastic - the percentage change in demand will be equal to zero (0)
POINT ELASTICITY

a) The midpoint elasticity is less than 1. (Ed < 1). Price reduction lead to reduction in the
total revenue of the firm.

b) The demand curve is linear (straight line), it has a unitary elasticity at the midpoint. The total
revenue is maximum at this point.

c) Any point above the midpoint has elasticity greater than 1, (Ed > 1).

II. The Income Elasticity of Demand (YED)

The income elasticity of demand is the relationship between changes in quantity demanded
for a good and a change in real income.
• YED = % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑑𝑒𝑚𝑎𝑛𝑑 % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑖𝑛𝑐𝑜𝑚𝑒

Normal Goods – are those goods for which the demand rises as consumer income rises;
positive income elasticity of demand so as consumers’ income rises more is demanded at
each price. These goods shift to the right as income rises.

YED is positive. As income rises, the proportion spent on cheap goods will reduce as
now they can afford to buy more expensive goods.

Example (the demand for units of air-conditioning increases as the income of the consumer
increases and the demand for electric fan decreases)
Normal good: units of air-conditioning; Inferior good: electric fan

The Inferior Goods – the demand decreases when consumer income rises; demand
increases when consumer income decreases)

Shifts to the left as income rises. YED is negative. • As income rises, the proportion spent
on cheap goods will reduce as now they can afford to buy more expensive goods.

Examples: the demand for cheap/generic electronic goods (let say electric fans) will fall
as people income rises and they will switch to expensive branded electronic goods (unit of
air-conditioning)

III. Cross Price Elasticity of Demand or (XED)

Cross price elasticity of dmand is he effect on the change in demand of one good as a
result of a change in price of related to another product.

• XED = % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑 𝑜𝑓 𝑔𝑜𝑜𝑑 𝑋 % 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑔𝑜𝑜𝑑 𝑌 • • If

the value of XED is positive - substitute goods
• If the value of XED is negative – complements goods
• If the value of XED is zero - two goods are unrelated

IV. Price Elasticity of Supply (PES)

The measure of the responsiveness of quantity to a change in price. It is the percentage

change in supply as compared to the percentage change in price of a commodity.
PES = % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑆𝑢𝑝𝑝𝑙𝑖𝑒𝑑 % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒

If supply is elastic, producers can increase

output without a rise in cost or a time
delay. If supply is inelastic, firms find it
hard to change production in a given time
period.

PES = % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑆𝑢𝑝𝑝𝑙𝑖𝑒𝑑 % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒

If Pes > 1 = supply is price elastic
Pes = 0 = supply is perfectly inelastic
Pes = infinity = supply is perfectly elastic
Pes < 1 = supply is price inelastic

PRICE ELASTICITY OF SUPPLY

Elastic Supply Inelastic Supply

Perfecly Inelastic Supply Perfectly Inelastic Supply