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Social Science 2 – Principles of Economics
Chapter 2 – The Prices of Goods and Services
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Introduction
-Many unschooled individuals do not really understand how prices of goods and services are being determined. More often that not, people think that prices are determined by the government. (i.e rice, gasoline, and apartment.)-The role of the price system has been very crucial in the operations of the economy.-In a market economy or capitalists economy, prices of goods and services are determined by the interaction between supply and demand of goods and services. -The government does not interfere; so that whenever demand is greater than supply, the prices increase. -On the other hand, if supply is greater than demand, prices decrease.
- Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 20
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Price and the Price System
-Price is the value of a product or service. It is expressed in terms of monetary unit like peso, dollar, or yen.
-Price System – it determines the allocation of goods and services among the members of society. It simply means that goods and services that are being acquired by the people by paying them with their money.
-More money means more goods and services.
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 21
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Demand
-Demand is the schedule of various quantities of commodities which buyers are willing and able to purchase at a given price, time and place.
-It is determined by factors such as: income, population, taste and preference, price expectation and prices of related goods.
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 21
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Determinants of Demand Explained
-1. Income – People buy more goods and services when their incomes increase. Thus, a change in income brings about a change in the demand for goods and services; either an increase or decrease which is directly related to change in income.
-2. Population – more people means more demand for goods and services.
-3. Tastes and Preferences – Demand for goods and services increases when people like or prefere them.
-4. Price expectation – When people expect the prices of goods, especially basic commodities like rice, soap, cooking oil, or sugar to increase tomorrow or next week, they buy more of these goods.
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 21
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Determinants of Demand Explained
-5. Prices of related goods – When the price of a certain product increases, people tend to buy a substitute product (competitor).
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 23
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Law of Demand
-Consumers are most likely to buy more goods and services as price decreases, and buy less goods and services as price rises.-Such general tendencies of consumers can be explained by two reasons:-1. Income effect. At lower prices, an individual has a greater purchasing power. This means he can buy more goods and services.-2. Substitution effect. Consumers tend to buy goods with lower prices. In case the price of a product they are buying increase, they look for substitutes whose prices are lower.
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 23
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Validity of the Law of Demand
- The theory (law of demand) is only true if the assumption of ceteris paribus is applied. It means “all other things equal or constant”.
- The law of demand is correct if the determinants of demand are held constant; that is, there is no change in income, taste, or population.
- Ex. If the price of a transistor radio increases by 20 percent then the quantity demanded for such good decreases. This is true if the income of the buyer has increased by 100 percent. (more purchasing power.)
- To make the law of demand valid, population or number of buyers should be the same. Precisely, the reason why there are more goods and services that are being demanded at present despite high prices is the great increase in population.
- Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 24
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Changes in Demand vs. Change in Quantity Demanded
- Changes in demand refer to changes in the determinants of demand like income, population, price expectation, and so forth.
- For instance, an increase in population also increases demand for good and services, or decrease in income also reduces demand.
- The change in quantity demanded is brought about by changes in price. Wherever there is a change in price (increase or decrease), there is a corresponding change in quantity demanded.
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 25
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Changes in Demand vs. Change in Quantity Demanded
- For example, lower price results to more units of goods. In the change in demand, it is caused by changes in the determinants of demand.
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 25
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Supply
- Supply is the schedule of various quantities of commodities which producers are willing and able to produce and offer at a given price, place and time. Its determinants are:
- - technology, cost of production, number of sellers, prices of other goods, price expectations, taxes and subsidies.
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 25
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Determinants of Supply Explained
- 1. Technology – this refers to the techniques or methods of production. i.e. Modern vs. Traditional technologies.
- 2. Cost of Production – In producing goods, raw materials are needed, together with laborers.
- 3. Number of Sellers – More sellers or more factories mean an increase in supply. Conversely, smaller number of sellers or factories means less supply.
- 4. Prices of other goods – Changes in the price of rice may likely encourage a rice farmer to produce more corn if this gives him more profit.
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 28
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Determinants of Supply Explained
- 5. Price expectations. If producers expect prices to rise very soon, they usually keep their goods and then release them in the market when the prices are already high.
- 6. Taxes and Subsidies – Certain taxes increase cost of production. Higher taxes discourage production because it reduces the earnings of businessmen.
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Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 29
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Law of Supply
- As price increases, quantity supply also increases, and as price decreases, quantity supply also decreases.
- This direct relationship between price and quantity supplied is the law of supply.
- Producers are willing and able to produce and offer more goods at a higher price than a lower price.
- No businessman is willing to produce goods if he makes no profit.
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 29-30
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Law of Supply
- However, the law of supply is only correct if we apply the assumption of ceteris paribus. This means the law of supply is valid if the determinants of supply like cost of production, technology, prices of goods and so forth are constant.
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 29-30
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Changes in Supply vs. Changes in Quantity Supplied
- Changes in supply pertain to changes in the determinants of supply.
- Ex. A decrease in the cost of production increases supply.
- For example, if the price increases from P 3.00 to P. 4.0 , there is a corresponding increase in quantity supplied.
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 31
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The Law of Supply and Demand
-The law of demand and supply states that when supply is greater than demand, the price decreases. When demand is greater than supply, price increases. When supply is equal to demand, price remains constant. -Market Price or Equilibrium Price – it means both sellers and buyers have mutual agreement.-Producers are able and willing to offer the same quantity of goods which buyers are willing and able to purchase at a given time.
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 31
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The Law of Supply and Demand
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 32
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The Law of Supply and Demand
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 33
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The Law of Supply and Demand
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 34
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The Law of Supply and Demand
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 34
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The Law of Supply and Demand
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 35
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The Law of Supply and Demand
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 35
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Price System
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 38
-A price system is a mechanism of allocating goods and services through the rise or fall of prices caused by interplay of supply and demand forces.
-One favorable argument for the price system is its efficiency in distributing goods and services.
-Another argument in favor of the price system is the presence of personal freedom. Producers are free to produce goods and services to satisfy their own economic interests as long as these do not conflict with legal and moral traditions.
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Criticisms Against the Price System
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 39
-Free competition does not really exist long enough. Self-interests of businessmen force them to drive away their rivals through cut-throat competition.
-In the process of competition, it is the big companies that become the price leaders – no longer the free interplay of demand and supply.
-Another case against the price system is the unfair distribution of goods and services.
-Social goods like ant-pollution, rural electrification, irrigation, or highways cannot be allocated efficiently through the price of system.
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The Role of Government
Source: Fajardo, F. (2001) Economics – Third Edition, Rex Bookstore: Manila p. 40
-In view of the limitations of the price system, the government has to regulate and supervise production, distribution, and consumption of good and services.
-It interferes in the allocation of goods and services in order to protect and promote the welfare of the poor.
-In developing countries, the role of the government has been active and more direct. Infrastructures like roads, bridges, schools, hospitals, etc. have to be set-up.
-Economic growth means more employment, production and income.
