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2. Price Mechanism

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Chapter 2 : main menu

2.1Nominal price and relative price

Progress Checkpoint 1

2.2 DemandTheory in Life 2.1

Progress Checkpoint 2

2.3 Supply Progress Checkpoint 3

2.4The determination of equilibrium price

Concept Explorer 2.1

Progress Checkpoint 4

Theory in Life 2.2

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Progress Checkpoint 1

If the nominal price of a cup of coffee is $10, while that of a can of coke is $5, what is the relative price of :(a) a cup of coffee in terms of coke?

(b) a can of coke in terms of coffee?

5$

10$ = 2 cans of coke

10$

5$ = 0.5 cup of coffee

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Theory in Life 2.1

The law of demand and clearance sales

The general manager of a department store wants to increase sales. Different strategies are suggested to him: advertisement on TV, free gifts to customers, lucky draw, etc. He eventually decides to offer 70% discount on all items. Can you tell the rationale behind his choice?

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Theory in Life 2.1

The law of demand and clearance sales

The general manager knows that customers act according to the law of demand. If he reduces the prices of the items sold in his store, the quantities demanded will rise. This will help to increase sales.

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Progress Checkpoint 2

If the price of a good is $100, the quantity demanded in the market is 30 units. If the sellers are only willing to sell 20 units, what is the quantity bought?

The quantity bought is 20 units because the sellers are willing to sell 20 units only. The quantity that can be bought is less than the quantity demanded.

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Progress Checkpoint 2

The HKSAR government decides to impose a charge on the accident and emergency service provided by public hospitals so as to reduce its abuse.

Can you use an economics law to support why this may work?

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Progress Checkpoint 2

If the charge is imposed, the price (cost) of using the accident and emergency service provided by public hospitals will increase, and its quantity demanded will decrease.

This is implied by the law of demand.

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Progress Checkpoint 3

If the price of a good is $100, the quantity demanded in the market is 30 units. If the sellers are willing to sell 50 units, what is the quantity sold?

The quantity sold is 30 units. This is because the quantity demanded in the market is 30 units only, which is less than the quantity supplied.

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Concept Explorer 2.1

Equilibrium & disequilibrium A market is either in equilibrium or disequilibrium,

depending on the level of market price.

8570554025Qs (units)

1535557595Qd (units)

108642Price ($)

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Concept Explorer 2.1

8570554025Qs (units)

1535557595Qd (units)

108642Price ($)

Remain constant5555Equilibrium55556

Decrease1515Disequilibrium

(surplus of 70 units)851510

Increase2525Disequilibrium

(shortage of 70 units)25952

Change in price

Quantity sold

Quantity bought

Equilibrium / Disequilibrium

Qs (units)

Qd (units)

Price ($)

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Concept Explorer 2.1

Since the buyers can buy and the sellers can sell the quantity they want at $6, the price has no tendency to change.

The market is in equilibrium.

Q

Price ($)

0

2

4

6

8

10

15 25 55 85 95

D

SSurplus

Shortage

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Concept Explorer 2.1

The market price at $6 is the equilibrium price, while the quantity transacted at 55 units is called equilibrium quantity.

Q

Price ($)

0

2

4

6

8

10

15 25 55 85 95

D

SSurplus

Shortage

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Progress Checkpoint 4

Refer to the following market demand and supply schedules :

Price ($) 100 200 300 400 500

Qd (units) 160 135 110 85 60

Qs (units) 72 91 110 129 148

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Progress Checkpoint 4

(a) Draw the market demand and supply curves.

(b) What are the equilibrium price and quantity?

(c) At the price of $200,(i) what are the quantity demanded and the quantity

transacted? Are they the same?

(ii) what is the size of shortage or surplus? Mark it in your diagram.

(iii) how will the seller change the price?

(d) What is the price level with a surplus of 88 units?

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Progress Checkpoint 4

(a)

D

S

91 110 135

200

300

Price ($)

shortage

Quantity0

(b) Equilibrium price = $300.Equilibrium quantity = 110 units.

(c)(i) At the price $200,Qd = 135 unitsQt = 91 units.They are not equal.

(ii) Shortage size = 44 units.

(iii) The seller will raise the price.

(d) At the price $500, Qd = 60 units and Qs = 148 units.

Surplus size = 88 units.

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Theory in Life 2.2

Shortage and surplus(a) Housing stocks piling up the market

Since 1998, the transaction volume of real properties in Hong Kong has substantially dropped. It is estimated that there are currently 60,000 vacant flats in Hong Kong. The director of a well-known property agency said, “We predict that the prices of real properties will continue to fall, at least for the coming six months.”

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Theory in Life 2.2

Shortage and surplus(b) People scrambled for MTRC shares

The sales of MTRC shares by HKSAR government has invited boiling response from the public. There are insufficient shares for all subscribers to buy. The government spokesman said that the price of the MTRC shares sold next time will be slightly adjusted upward …

Can you use the concepts of shortage and surplus to explain the phenomenon mentioned above?

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Theory in Life 2.2

As there are vacant flats, the housing market is in surplus. Refer to the diagram. The price of flats is P, which is above the equilibrium level.

The quantity demanded at Qd is less than the quantity supplied at Qs.

Hence the market is in surplus (excess supply).

In such case, the quantity transacted (Qt) is equal to the quantity demanded at Qd.

Quantity of flats

Qd||

Qt

Qs

P

D

SsurplusPrice ($)

0

(a)

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Theory in Life 2.2

As there are insufficient shares for all subscribers to buy, the market of MTRC shares is in shortage. Refer to the diagram. The price of shares is at P, which is below the equilibrium level.

The quantity demanded at Qd is greater than the quantity supplied at Qs.

Hence the market is in shortage (excess demand).

In such case, the quantity transacted (Qt) is equal to the quantity supplied at Qs.

Quantity of MTRC shares

Qs||

Qt

Qd

PD

S

shortage

Price ($)

0

(b)

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End of Chapter 2