Lesson 4: Implications of Market Pricing in

Making Economic Decisions

EXPECTATIONS:
1. determine the implications of market pricing in
making economic decisions
2. explore the elasticity of demand and supply
3. solve problems on price elasticity of demand and
supply
4. value the implications of market pricing in decision
making
 RECALL
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 Supply Law of Demand

“The higher the price, the higher the “the higher the price, the lower the
quantity supplied and vice versa.” quantity demanded” and vice versa.
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.

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.
Lesson 4: Implications of Market Pricing in Making Economic Decisions
LET’S ANALYZE!
Lesson 4: Implications of Market Pricing in Making Economic Decisions
LET’S ANALYZE!
Lesson 4: Implications of Market Pricing in Making Economic Decisions
LET’S ANALYZE!

3. Using the chart above, kindly describe the point where

there is a

surplus ____________________________________

shortage ___________________________________

equilibrium in price _________________________

Lesson 4: Implications of Market Pricing in Making Economic Decisions
LET’S ANALYZE!
Lesson 4: Implications of Market Pricing in Making Economic Decisions
THE MARKETING PRICE SYSTEM

when there is an excess demand for the

SHORTAGE
quantity supplied; quantity is less than
the demand; it causes prices to go up
due to scarcity

SURPLUS when there is an excess in supply; the

quantity is greater than demand. When
quantity is greater than demand it causes
prices to go down.
Lesson 4: Implications of Market Pricing in Making Economic Decisions
PRICE SYSTEM IN A MARKET ECONOMY

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.
Lesson 4: Implications of Market Pricing in Making Economic Decisions
PRICE SYSTEM IN A MARKET ECONOMY

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

Equilibrium price is the price at which the The economic forces are balanced and in the absence
producer can sell all the units he wants to of external influences, the (equilibrium) values of
produce and the buyer can buy all the units he economic variables will not change.
wants

Quantity demanded and quantities supplied are The amount of goods or services sought by buyers is
equal. equal to the amount of goods or services produced by
sellers
Lesson 4: Implications of Market Pricing in Making Economic Decisions
PRICE SYSTEM IN A MARKET ECONOMY:
ITS CHARACTERISTICS

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 will help us to make
every day economic decisions about our needs and desires. They
are the indications of the acceptance of a product;
the more popular the product, the higher the price that can be charged.
Lesson 4: Implications of Market Pricing in Making Economic Decisions
PRICE SYSTEM IN A MARKET ECONOMY:
ITS CHARACTERISTICS

PRICE
acts as a signal for shortages and surpluses which help firms and
consumers respond to changing market conditions

Neither the producers nor consumers can impact prices; 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.

Prices help to redistribute resources from goods with

little demand to goods and services
Lesson 4: Implications of Market Pricing in Making Economic Decisions
PRICE SYSTEM IN A MARKET ECONOMY:
ITS CHARACTERISTICS

PRICE

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.
Lesson 4: Implications of Market Pricing in Making Economic Decisions
PRICE ELASTICITY OF DEMAND AND SUPPLY

PRICE ELASTICITY measures the responsiveness of the quantity

demanded or supplied of a good to a change in its
price

elastic or very responsive

unit elastic, or inelastic or not very responsive

Lesson 4: Implications of Market Pricing in Making Economic Decisions
EFFECTS OF CHANGE IN DEMAND AND SUPPLY

Indicates that quantity demanded or supplied

ELASTIC DEMAND
respond to price changes in a greater than
OR SUPPLY CURVE
proportional manner

is one where a given percentage change in price

INELASTIC DEMAND will cause a smaller percentage change in quantity
OR SUPPLY CURVE demanded or supplied

means that a given percentage changes in price

UNITARY ELASTICITY leads to an equal percentage change in quantity
demanded or supplied
Lesson 4: Implications of Market Pricing in Making Economic Decisions
CATEGORIES OF PRICE ELASTICITY

I. The Price Elasticity of Demand

II. The Income Elasticity of Demand (YED)

III. Cross Price Elasticity of Demand or (XED)

IV. Price Elasticity of Supply (PES)

Lesson 4: Implications of Market Pricing in Making Economic Decisions
Price elasticity of demand is the responsiveness of quantity
I. The Price Elasticity of Demand 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

% 𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 quantity 𝑑𝑒𝑚𝑎𝑛𝑑ed

𝑃𝐸𝐷 =
% 𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒
Lesson 4: Implications of Market Pricing in Making Economic Decisions
I. The Price Elasticity of Demand
the percentage change in price brings about a more than proportionate change in quantity
Elastic Demand (PED > 1) 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.

is when an increase in price causes a smaller % fall in demand. When the percentage change in
Inelastic Demand (coefficient of quantity demanded is less than the percentage change in price, and the coefficient of the
the elasticity is less than 1) elasticity is less than 1.

When the percentage change in demand is equal to the percentage change in price; the price
Unitary Elastic Demand elasticity of demand is one (1)

a small percentage change in price brings about a change in quantity demanded from zero to
Perfectly Elastic infinity; the coefficient of elasticity is equal to infinity (∞)

any change in price will not have any effect on the demand of the product.; the percentage
Perfectly Inelastic change in demand will be equal to zero (0)
Lesson 4: Implications of Market Pricing in Making Economic Decisions
I. The Price Elasticity of Demand

POINT ELASTICITY

a) The midpoint elasticity is less than 1. (Ed < 1). Price reduction leads
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).
Lesson 4: Implications of Market Pricing in Making Economic Decisions

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

% 𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑑𝑒𝑚𝑎𝑛𝑑
𝑌𝐸𝐷 =
% 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.
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
Lesson 4: Implications of Market Pricing in Making Economic Decisions

III. Cross Price Elasticity of Demand or (XED)

Cross price elasticity of demand is the effect on the change in demand of

one good as a result of a change in price of related to another product.

% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑 𝑜𝑓 𝑔𝑜𝑜𝑑 𝑋

X𝐸𝐷 =
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 𝑖𝑛 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
Lesson 4: Implications of Market Pricing in Making Economic Decisions

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. 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

% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑠𝑢𝑝𝑝𝑙𝑖𝑒𝑑

𝑃𝐸𝑆 =
% 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
Lesson 4: Implications of Market Pricing in Making Economic Decisions

IV. Price Elasticity of Supply (PES)

Lesson 4: Implications of Market Pricing in Making Economic Decisions
DETERMINANTS OF PRICE ELASTICITY OF SUPPLY
- If the cost of producing one more unit keeps rising as output rises or marginal cost rises
Marginal Cost rapidly with an increase in output, the rate of output production will be limited. The Price
Elasticity of Supply will be inelastic - the percentage of quantity supplied changes less than
the change in price. If Marginal Cost rises slowly, supply will be elastic.

Time Over time price elasticity of supply tends to become more elastic. The producers would
increase the quantity supplied by a larger percentage than an increase in price.

Number of The larger the number of firms, the more likely the supply is elastic. The firms can jump in
Firms to fill in the void in supply.

Mobility of If factors of production are movable, the price elasticity of supply tends to be more
Factors of elastic. The labor and other inputs can be brought in from other location to
Production increase the capacity quickly.

If firms have spare capacity, the price elasticity of supply is elastic. The firm can increase
Capacity output without experiencing an increase in costs, and quickly with a change in price