2. The allocation of resources

To find market demand, add the quantities demanded by every consumer at the same price. This is horizontal addition: prices stay aligned while quantities are summed.

On a demand diagram, price is on the vertical axis and quantity demanded on the horizontal axis. Plot each price–quantity pair and join the points. The curve normally slopes downward: with other conditions unchanged, a lower price is associated with a greater quantity demanded.

If the price falls from $8 to$5 and planned purchases rise from 40 to 65 units, the extra 25 units are an extension in demand. The curve has not shifted: two different points on the same demand curve are being compared.

Keep price on the vertical axis and quantity on the horizontal axis. Draw the original curve $D_1$. For an increase, draw $D_2$ to the right; at the same price, quantity demanded is higher. For a decrease, draw $D_2$ to the left; at the same price, quantity demanded is lower.

Reverse changes usually reverse the shift: fewer buyers, less favourable tastes, a cheaper substitute or a more expensive complement reduce demand. For an inferior good, the income effect may run opposite to the normal-good example, so state the assumption when income changes.

To find market supply, add the quantities supplied by every producer at the same price. Prices remain aligned while quantities are summed horizontally.

On a supply diagram, price is on the vertical axis and quantity supplied on the horizontal axis. Plot each price–quantity pair and join the points. The curve normally slopes upward: with other conditions unchanged, a higher price makes producing and selling additional units more worthwhile.

If the price rises from $12 to$16 and firms plan to sell 120 rather than 80 units, the extra 40 units are an extension in supply. This compares two points on the same curve; it does not draw a new supply curve.

Keep price on the vertical axis and quantity on the horizontal axis. Draw the original curve $S_1$. For an increase, draw $S_2$ to the right; at the same price, more is supplied. For a decrease, draw $S_2$ to the left; at the same price, less is supplied.

Reverse changes usually reverse the direction: higher productivity, discovery of resources, lower costs, favourable weather or a larger subsidy can increase supply; lost resources, higher costs or damaging weather can reduce it.

Example: if consumers switch from meat towards vegetables, vegetable prices may rise while meat prices fall. The higher expected return encourages land, labour and capital towards vegetable production; the weaker return discourages some meat production.

At $8, both sides plan to trade 50 units, so the equilibrium is$P_e = 8$and$Q_e = 50$. Equilibrium is identified by equality, not by the largest quantity or the highest price.

To draw the same result, place price on the vertical axis and quantity on the horizontal axis. Draw demand sloping downward and supply sloping upward. Label their intersection $E$; project from $E$ to the price axis for $P_e$ and to the quantity axis for $Q_e$.

Using the schedule from the previous card: at $6, quantity demanded is 60 and quantity supplied is 40, so the shortage is$60 - 40 = 20$units. At$10, quantity supplied is 60 and quantity demanded is 40, so the surplus is $60 - 40 = 20$ units.

With a shortage, buyers compete for limited output and sellers have an incentive to raise price. As price rises, quantity demanded contracts and quantity supplied extends. With a surplus, unsold stock encourages sellers to lower price; quantity demanded extends and quantity supplied contracts. Adjustment continues until $Q_d = Q_s$.

On a demand-and-supply diagram, read $Q_d$ from the demand curve and $Q_s$ from the supply curve at the same horizontal price line. The horizontal distance between those quantities measures the shortage or surplus.

To analyse a cause, first decide which curve shifts and in which direction. Keep the other curve fixed, mark the original intersection $E_1$, draw the shifted curve, then read the new intersection $E_2$. Compare both the price and quantity coordinates.

If demand for a product falls while its supply increases, both changes push the equilibrium price down. If demand rises while supply falls, both push the equilibrium price up. When the shifts push price in opposite directions, the price outcome depends on the relative size of the shifts.

Draw price on the vertical axis and quantity on the horizontal axis. Label the original curves $D_1$ and $S_1$ and their intersection $E_1$. Shift only the curve or curves changed by the stated market conditions, label the new intersection $E_2$, and project $E_1$ and $E_2$ to both axes. The coordinate comparisons, not the visual height alone, give the price and sales effects.

Suppose preferences shift towards solar energy while supply is unchanged. Demand shifts right from $D_1$ to $D_2$, so both equilibrium price and sales rise. If production technology instead improves while demand is unchanged, supply shifts right: price falls but sales rise.

PED compares percentage changes, so it can compare responsiveness across products measured in different units. A large response in quantity relative to the price change means demand is price-elastic; a small response means demand is price-inelastic.

For a normal downward-sloping demand curve, price and quantity demanded move in opposite directions, so the calculated PED is negative. When classifying responsiveness, economists usually compare its magnitude, $|PED|$, with 1.

Calculate each percentage change from its original value, then divide the quantity percentage by the price percentage. Example: price rises by 5% and quantity demanded falls by 4%, so $PED = -4\% / 5\% = -0.8$. Its magnitude is 0.8, therefore demand is price-inelastic.

The formula can also recover a quantity response: if $PED=-1.7$ and price falls by 5%, quantity demanded changes by $(-1.7)\times(-5\%)=+8.5\%$. The two negative changes produce a positive quantity response.

A particular luxury-chocolate brand is likely to have more elastic demand than salt: other brands can substitute for it, it is less necessary, its purchase can be postponed and it may take a larger share of income. Salt as a broad, low-cost necessity has fewer close alternatives.

On a demand diagram, expenditure or revenue is the rectangle with height equal to price and width equal to quantity demanded. Compare the original $P_1\times Q_1$ rectangle with the new $P_2\times Q_2$ rectangle after a movement along the demand curve.

Suppose price falls from $10 to$8 while sales rise from 100 to 140 units. Revenue changes from $10\times100=$1000 to $8\times140=$1120. Quantity rose proportionately more than price fell, so demand was elastic over this change and the price cut increased revenue.

With elastic demand, the proportionate quantity response dominates the price change. With inelastic demand, the price change dominates the smaller quantity response. At unitary elasticity, the two percentage effects offset.

A government seeking reliable revenue may prefer to tax a product with relatively inelastic demand, because quantity bought falls by a smaller percentage. If its priority is a large reduction in consumption or imports, a more elastic response makes a given price increase more powerful, although tax revenue then depends on the size of the quantity fall.

PES compares percentage changes, so responsiveness can be compared across products measured in different units. If quantity supplied changes by a larger percentage than price, supply is elastic; if it changes by a smaller percentage, supply is inelastic.

Along a normal upward-sloping supply curve, price and quantity supplied move in the same direction, so PES is normally positive. A high PES means producers can adjust output strongly; a low PES means production constraints limit the response.

Calculate each percentage change from its original value, then divide the quantity percentage by the price percentage. If price rises by 10% and quantity supplied rises by 15%, $PES=15\%/10\%=1.5$, so supply is elastic.

The formula can recover a quantity response. If $PES=2$ and price falls by 10%, quantity supplied changes by $2\times(-10\%)=-20\%$. Price and quantity supplied fall together along the curve.

New houses and ships tend to be inelastic in supply in the short run because construction takes time, uses specialised resources and cannot be supported by large finished stocks. A storable product made quickly with spare capacity is more likely to have elastic supply.

PES often rises over time. For example, a crop cannot expand immediately if new plants take years to mature, but producers may plant more, obtain equipment and reorganise resources before the long run.

If demand for a product rises, its price and expected profit may rise. Firms then have an incentive to expand output and draw labour, capital and materials towards that market. Consumer choices and producer responses therefore coordinate allocation without a central planner.

Whether living standards improve depends on which effects dominate. Strong competition and useful information may produce choice, lower costs and responsiveness. However, high inequality, external costs, missing public goods or monopoly power can cause resources to be allocated away from what benefits society most.

$$Social\ benefit = Private\ benefit + External\ benefit$$

$$Social\ cost = Private\ cost + External\ cost$$

Build an explanation as a chain: identify what is ignored or missing, show how that changes the private incentive, then state whether output or consumption becomes too high, too low or absent.

A strong answer names the affected third party or missing provision and completes the direction of change: which good receives too many or too few resources, and why social welfare falls.

The two routes operate together. A private firm may respond to consumer demand and profit, while government taxes harmful activity, subsidises beneficial activity or supplies a service directly. The word mixed describes this combination, not an exact fifty-fifty division.

The strongest judgment is conditional: ask whether the market failure is important, whether government has reliable information, whether the policy reaches the intended group, and whether its benefit exceeds its financial and opportunity cost.

Match instrument to failure: information or standards may call for regulation; external costs may call for tax, quota or regulation; external benefits may call for subsidy or direct provision; public goods may need direct provision; monopoly may call for regulation, ownership change or a price ceiling.