● Supply is the part of stock which a supplier offers for sale at a particular point of time at
a particular price backed up by the willingness and ability to do so.
● Change in quantity supplied : Movement along the supply curve
● Change in supply : Shift of supply curve to the left or right.
● Ceteris Paribus the law of supply states that quantity supply is direct to the price, if
price increases supply extends and price decreases supply contracts.
● Factors affecting Supply:
1. Cost of the Factors of Production: Increase in cost of FOPs will cause increase in
first cost. Supply will shift to the left vice versa.
2. Indirect Taxes and Subsidies: Taxes increase costs; supply decreases. Subsidies
decrease costs; supply increases.
3. Price of related goods: competitive supply: Factors of production they control can
be used to produce more than one good. If price of a product rises because of
higher demand, producers will get attracted and aim to supply more of that
product causing movement along the supply curve of the product and a shift to
the left of the supply curve of the competitive good. (competing for resources)
4. Joint Supply: Example Crude oil ⇒ petrol and diesel ; by-product, if demand for
one increases, quantity supplied will increase and the supply will also increase
for the other goods in joint supply.
5. Future speculations :
6. Changes in technology : Better technology; more efficiency; lower costs;
increased supply
7. Weather for markets vulnerable to weather conditions
Reasons for the Law of Supply
8. Law of diminishing marginal returns: The law of diminishing marginal returns is a
theory in economics that predicts that after some optimal level of capacity is
reached, adding an additional factor of production will actually result in smaller
increases in output. As it becomes less efficient as land capital are constant.
9. Law of increasing marginal costs
● Price Elasticity of Supply is the responsiveness of the quantity supplied to a change in
price
● PES = % change is supply / % change in price
● Below is a photo summarizing all the types of price elasticity
1. PES = 0 ; Change o=in price will have no effect on quantity supplied. Supply is
perfectly inelastic. In the immediate time period supply curve is this.
2. PES = infinity ; Perfectly elastic supply. any change in price will cause an infinite
change in quantity supplied
3. PES < 1; inelastic supply. less than proportionate change
4. PES > 1; elastic supply; greater than proportionate change
5. PES = 1; Unit elasticity; proportionate change.
● Factors affecting PES:
1. Time period : Amount of time over which PES is measured . Longer the tie,
greater the elasticity. Immediate time period: all FOPs fixed; perfectly inelastic.
Short run: labour and resources not fixed; more elastic than immediate time
period. Long run: can increase all FOPs so value of PES is the most elastic.
2. Existence of unused capacity : If productive resources are not fully used, output
can be increased easily without costs.
3. Marginal Cost: The cost of producing one more unit, if high, PES will be inelastic,
vice versa
4. Mobility of FOPs: if FOPs can easily be switched from one productive use to
another, then PES will be relatively inelastic.
5. The ability to stock: If a firm is storing high levels of stock, it can react swiftly to a
change in price and PES will be relatively more elastic
● Market Equilibrium is the point at which demand and supply forces intersect. The price at
which this happens is called the Equilibrium Price.
● The equilibrium is self-righting as any price above it would coz an excess supply which
will cause the price to fall, similarly, any price below it would coz an excess demand
which will cause the price to rise till the time equilibrium is reached
● Price Mechanism is the term referring to this self-correction of price
● Functions of price mechanism (Invisible Hand):
1. Signal information to the producer and consumer
2. Ration Scarce resources: Price increases (Supply contracted) when demand is
greater than supply, therefore cutting demand
3. Price changes give incentives for producers to produce more and consumers to
consume more
● A consumer surplus happens when consumers pay less than they're willing to pay for a
product or service. Consumer surplus is based on the economic theory of marginal utility,
which is the additional satisfaction a consumer gains from one more unit of a good or
service.
● Producer surplus is the total amount that a producer benefits from producing and selling
a quantity of a good at the market price. The total revenue that a producer receives from
selling their goods minus the total cost of production equals the producer surplus.
● When a market is in equilibrium it is in a state of allocative efficiency
● Consumer Surplus + Producer Surplus = Social Surplus
● The point of Allocative Efficiency is where demand = supply
● At the point of allocative efficiency community surplus is maximised
● Consumer Surplus = Willingness to Pay Price – Market Price
● Producer Surplus = Market Selling Price – Economic Cost
● The supply curve can be called the Marginal Social Cost
● The demand curve can be called the Marginal Social Benefit
● Externality is the third part effect due to a production or a consumption of a commodity.
If the effect is harmful, the externality is negative . If the effect is beneficial, the
externality is positive. If no externalities exist, socially efficient allocation of resources,
maximum community surplus, no market failure. Vice versa
● 4 types of externalities:
○ Positive and negative externality of production
○ Positive and negative externality of consumption
● Marginal Social Benefit = Marginal Private Benefit + Marginal External Benefit (positive
or negative)
● Marginal Social cost = Marginal Private cost + Marginal External cost (positive or
negative)
Positive externality of consumption
● Merit goods are goods which have a positive externality and these are usually under
produced and under consumed. They are beneficial to those who consume them and
also provide external benefits to third parties.
● Marginal Social cost > Marginal Private cost
● In a free market people will consume where the MSC meets MPB at Q1 but socially
efficient level of consumption will be at Q where MSC = MSB. Under-allocation of
resources to this market.(welfare loss). If quantity is increased welfare to the society will
increase.
● Link to the PPC curve
● Higher consumption of them will lead to socially desirable conditions
● Examples of merit goods are education and healthcare (vaccines)(covid 19)
● Merit goods tend to shift the PPC outwards
● Government aims to increase the demand of merit goods (consumption) by :
○ Legislation: Passing laws. PROBLEMS : people resent laws, needs to be
provided free of charge
○ positive advertising : Increased awareness, causes MPB to shift to the right
towards MSB, increasing welfare. PROBLEMS: high cost, long time to take effect
○ subsidising : Shifts MPC downwards, lowers price, causing extension in demand
so that socially efficient level of consumption is reached. PROBLEMS : Limited
budged, opportunity cost, reallocation of budget. (fig 2)
● Positive externalities of Production
● Production of a good or service creates external benefits that are favourable for third
parties. Society gains whereas the firm does not. Therefore MSC < MPC which is
socially undesirable.
● Positive externality of production increases the supply curve and shifts it downwards
● Firm would produce at Q1 where MPC meets MSB but it's below the socially optimum
output Q where MSB meets MSC. There is a welfare loss. Under-allocation of resources
as firm would not want to incur higher costs for society's gain.
● Example, firm spent money on high quality training, An industrial company providing first
aid classes for employees to increase workplace safety.
● Government aims to decrease the MSC by various ways which include:
○ Subsidies: increases supply and the supply curve shifts downwards therefore the
new curve is below the original MPC. PROBLEMS: Opportunity cost, level of
subisidy
○ Direct provision of training. Problems : high costs.
● Negative externality of consumption
● Demerit goods are goods that have a external cost to society. Demand for them is higher
thsn it should be from society's point of view. When MSB < MPB market failure occurs
and this is the due to the negative externality of consumption.
Examples: smoking, alcohol, petrol causing air pollution
● In a free market the quantity traded is Q1 where MPB = MSC as consumers would want
to maximise their private utility and ignore negative externality of consumption whereas
socially optimum consumption should have been at Q where MSB = MSC. and there is
an over consumption of cigarettes, which is socially undesirable. welfare loss
● Demerit goods are goods that create a negative externality when produced and
consumed
● Government would want to reduce the welfare loss caused by the negative externality of
demerit goods and it can do this by:
○ Indirect taxes: this would raise the supply curve upwards and this will reduce
consumption to the socially efficient output. PROBLEMS: Indirect taxes are
regressive, inelastic demand.
○ Regulations : decrease the demand for the product therefore decreasing MPB
and decreasing welfare loss. PROBLEMS: Opposition may argue rights to
choose for themselves, Large companies may use their legal power.
Implementation costs.
○ Education : Consumers dont have perfect information about harmful effects.
Increase awareness. PROBLEMS: High costs, irrational consumer behaviour:
addiction, continue to consume despite knowing its dangers.
○ Another way is nudge theory
Negative externality of production
● In free markets, profit maximising producers are unconcerned about the external costs
and only take into account their private costs. Negative externality of production
decreases the supply of a product and the MSC>MPC
● In a free market producers do not take MSC into consideration
● Example, firm producing pollution, environment has to pay the cost not the firm therefore
MSC > MPC
The firm will produce at Q1 as it only considers its private costs. It should produce at Q
where. MSB = MSC. Misallocation , welfare loss, overproduction
Common Pool Resources:
● Typically natural resources, are rivalrous and non-excludable (no one can be excluded
from using the common resource, for example fishing tuna), they are sub-tractable,
available to all for consumption and it can only be limited by high prices.
● When something is made available for all, people will work in their best interest trying to
maximise private benefit and minimise private cost, they would not consider the external
costs their actions have.(negative externality of production)(posing threats to
sustainability)
● In absence of effective management, these resources will be degraded.
● Example: commercial fishers: they want as many fish as possible but they aren't prudent
enough to think about the future and how that natural resource is degrading due to the
exploitation (sustainability)
● The Tragedy of the Commons: the tendency of a resource, unowned ⇒ non
excludable, to be overused and under-maintained
https://www.youtube.com/watch?v=bs2P0wRod8U
● No one owns a common resource
● The tendency of all rational producers acting rationally in their own self interest will result
in a fall in social welfare as there is degradation of resources and a threat to
sustainability. This is called Tragedy of the commons.(reference to the doughnut
model)They degrade the common pool resource for their own private benefit
● Remedies for tragedy of the commons:
○ command and control: legislations limiting the use of common resources
○ cultural norms: stigmatisation can avoid the tragedy
○ creating property rights: i.e. making common resource excludable;
■ Real world example: New Zealand's ITQ system
● Atmosphere is a common pool resource as it is non excludable and it the toxins being
put into puts a threat for humanity and it isn't sustainable. Degradation happens due to
emissions and waste.
Ways to limit
● Agreements: The Kyoto protocol, Paris agreement (real world examples). OBJECTIVE:
Cutting global emissions of greenhouse gases, increasing countries' ability to deal with
the effects of climate change(financially supporting developing countries), and mitigation
(increasing carbon sinks)
● Market based approaches: tradable permits, carbon taxes
● Tradable permits: limits on the ability of users to access a resource. In case of
atmosphere, the maximum amount of greenhouse gases that can be emitted. If they emit
fewer gases than they are permitted, they can sell these. Thus creating a market for
emissions. Depends on ability to Monitor, strength of punishments, companies might
take in extra costs, are the allowances sufficient to bring about change.
● A carbon tax raises the cost of production and the supply curve moves closer to the
MSC therefore reducing welfare loss. This will encourage firms to use less carbon,
renewable resources for electricity, generates government revenue (might be used in
subsidising renewable resources) PROBLEMS: Government needs to accurately
calculate the external costs and then set taxes. Firms may just chose to pay the high
cost and still produce the same output.
● Producers have two choices to a carbon tax: keep emitting carbon and pay money,
switch to a cleaner source and avoid paying the tax
● Command and control approches: regulations and legislations
● Examples include: emission regulati ons, laws to protect endangered species, banning
use of plastics, laws regarding emission and pollutants etc. DRAWBACKS: access to a
lot of information required, regulations might make exports uncompetitive, monitoring is
difficult and expensive. They strictly mandate the way consumer behave
● other : subsidising renewable energy sources. DRAWBACKS : high cost, opportunity
cost.
● Tragedy of the commons suggests that when individuals think about themselves and not
their actions on the society, everything fails
● Lack of public goods is market failure
○ Public goods are non excludable and non rivalrous, therefore no private firm
would want to produce these
● Government might provide the public goods itself like military, roads
● It also might work in a partnership with a private firm, such as Air India
LACK of public goods
● they are not provided in a free market. Since they are of benefit to society the lack of
them is therefore a market failure. eg: national defence, strrelights
● non excludability: It is impossible to stop other people to use it after its been provided
even if they havent paid for it (Free rifer problem) No one will play for it in the hope that
somebody else will do it. Profit maximising producaers will not provide it as there is not
incentive to do so, they wi9ll not be able to recover the cost of production and make a
profit
● another chracteristic: non rivulrous: pne person using the resource doesnt reduce the
value of the good for others.
● Another type: quasi public goods: they dont have all characteristics of a public good
● However technology is maiing it easier to charge people using the public good
preventing the free rifer problem for eg: electronic road pricing scheme. Incentivising
private sector producers to provide these public goods.
WAys government can provide:
● direct provision: The government offers by using the taxpayer's obey to fund the
provision
● or partnership with private firms. The government will provide the financing necessary
and then allow the private producer to run it.
HL portion
Information asymmetries
● allocative efficiency can only be achieved if both buyers and sellers are aware of what
products are available and the range of prices. there should be perfect information.
which is never the case
● usually one party in an economic transaction has more information than the other
resulting in information asymmetries and market failure.
Types:
Adverse selection
● read the book
Real-world examples
1.
q2 :
https://indianexpress.com/article/cities/ahmedabad/live-emissions-trading-permits-worth-rs-2-78-
l-traded-in-surat-6004534/
1. Unnati
Unnati concentrates on youth empowerment for unemployed and
economically backward students, helping them to get vocational training
with a certification of 100% job guarantee. The social transformation
training programme is spread over 50 days, and has been specially
designed for students between the age of 18-25, who belong to
economically backward sections, and underprivileged backgrounds who
often end up unemployed, as they are not well skilled.
nudge theory
examples: consumers makea do not salways make rational decision. india making it compusary
for cigarette companies to use plain paclkaging wiht graphic images to sligh;y nudge consumers
to reduce their consimption They still have thrir freedom of choice but they are nudged to
choose differently
