10. Price Change
This chapter explores why prices change in the market. Price fluctuations occur due to shifts in demand and supply, external factors, and government interventions. Higher demand raises prices, while lower demand reduces them. Similarly, increased supply lowers prices, and reduced supply causes them to rise. The elasticity of demand and supply affects how significantly prices and quantities respond to changes. On a macro level, inflation (rising prices) and deflation (falling prices) impact the economy, influencing consumer behavior and business profits. Governments use monetary, fiscal, and trade policies to stabilize prices, manage inflation/deflation, and ensure economic balance and efficiency.
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1. Why Do Prices Change?
Prices change due to shifts in demand and supply, external factors, and government interventions.
A. Demand-Driven Price Changes
- Increase in Demand → Price Rises
- Example: New iPhone releases see high demand, leading to high initial prices.
- Decrease in Demand → Price Falls
- Example: DVDs became obsolete as streaming services gained popularity, reducing demand and prices.
- Factors Causing Demand Shifts:
- Changes in income, consumer trends, preferences, substitutes, and market size.
B. Supply-Driven Price Changes
- Increase in Supply → Price Falls
- Example: Mass production of smartphones leads to lower prices.
- Decrease in Supply → Price Rises
- Example: A shortage of wheat due to drought leads to higher bread prices.
- Factors Causing Supply Shifts:
- Changes in production costs, technology, natural disasters, and government policies.
2. Elasticity of Demand and Supply in Price Changes
- Elastic Demand: Small price changes lead to big demand changes (e.g., luxury goods).
- Inelastic Demand: Price changes have little effect on demand (e.g., essential medicines).
- Elastic Supply: Producers can quickly adjust output (e.g., soft drinks).
- Inelastic Supply: Hard to change production quickly (e.g., farming takes time).
3. Inflation and Deflation: Macroeconomic Price Changes
A. Inflation (Rising Prices Over Time)
- Causes:
- Demand-Pull Inflation: Excess demand raises prices.
- Cost-Push Inflation: Higher production costs push prices up.
- Monetary Inflation: Excess money supply devalues currency.
- Effects:
- Reduces purchasing power.
- Increases living costs.
- Can lead to wage-price spirals.
- Example: Oil price shocks increase transportation costs, causing widespread inflation.
B. Deflation (Falling Prices Over Time)
- Causes:
- Decreased consumer spending.
- Excess supply in the market.
- Effects:
- Companies earn less profit, leading to job losses.
- Consumers delay purchases, worsening economic slowdown.
- Example: The Great Depression saw extreme deflation, making people hold onto money instead of spending.
4. Government Interventions to Stabilize Prices
- Monetary Policy:
- Central banks adjust interest rates to control inflation/deflation.
- Raising interest rates discourages borrowing, slowing inflation.
- Lowering rates boosts spending and investment.
- Fiscal Policy:
- Governments use taxation and spending to influence demand.
- Lowering taxes increases consumer spending.
- Increasing government spending (infrastructure projects) boosts demand.
- Trade Policies:
- Import tariffs protect domestic industries but may raise prices.
- Export bans on essentials prevent domestic price spikes.
Conclusion: Key Takeaways
- Price Determination: Market forces (supply & demand) set equilibrium prices.
- Price Change: Prices shift due to supply/demand fluctuations, government policies, and global events.
- Elasticity Matters: Price sensitivity affects how businesses and consumers react.
- Inflation vs. Deflation: Both impact purchasing power and economic stability.
Government Role: Policies influence price stability and market efficiency.
Price Change Causes
Prices change due to demand shifts, supply shifts, inflation, deflation, and government policies.
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Elasticity of Demand
If demand is elastic, a price change causes a big shift in quantity demanded. If inelastic, demand remains stable.
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