1.2 Market Flashcards
What is demand?
The number of goods and services customers are willing to buy at a given price
When does effective demand occur?
When customers are willing and able (they have money) to buy at a given price
What is the relationship between quantity demanded and price?
It is an inverse relationship
- as the price increases, the quantity demanded decreases
- as price decreases, the quantity demanded increases
- hence the demand curve slopes downwards from left to right
What are the price factors leading to a change in demand and how do they affect the demand curve?
A change in price leads to a movement along the demand curve
What are the non price factors affecting demand?
- price of other goods: complements (goods consumed together e.g. bread and jam) and substitutes (replacement goods)
- advertising and branding
- changes in consumer income
- changing demographics
- external shocks
- seasonality
- changes in fashion and tastes
A change in any factors affecting demand not to do with price will shift the entire demand curve to the left or right
For example, if a firm increases its instagram advertising there will be an increase in demand as more consumers become aware of the product
What are normal goods?
Goods where demand rises when consumer income rises and falls when consumer incomes fall
E.g. superdry hoodies
What are interior goods?
A good for which the quantity demanded decreases when income increases e.g. supermarket hoodies
What is supply?
The number of goods/services businesses are willing and able to sell at a given price in a specific time period.
What is the relationship between supply and price?
It is a direct relationship as:
- when the price increases, the quantity supplied increases
- as the price decreases, the quantity supplied decreases
- at higher prices, businesses are incentivised to supply mote of the product
Hence the supply curve slopes upwards from left to right
What does a change in price cause the supply curve to do?
A movement along the supply curve
What are some examples of non-price factors affecting supply and what do these cause?
- changes in cost of production
- new technology (lower cost of production)
- indirect taxes (increase in cost of production)
- government subsidies (money paid to the firm by the government for each unit produced) (reduce cost of production)
- external shocks
A change in any other factors that is not money that affects supply will shift the entire supply curve to the left or right.
E.g. if a firm’s cost of production increases due to the increase in the price of a key resource, there will be a decrease in supply as the firm can now only afford to produce fewer products
What is a market?
Any place that buyers and sellers can meet to trade at an agreed price
E.g. McDonald’s or EBay
Based on this interaction with buyers, sellers will gradually adjust their prices until there is an equilibrium price and quantity that works for both parties:
- at the equilibrium price, sellers will be satisfied with the rate/quantity of sales and buyers will be satisfied that the prosciutto provides benefits worth paying for
What is equilibrium?
Where demand = supply (no shortages or surpluses)
What does a rise in demand cause price to do?
Increases
What does a fall in demand cause price to do?
Decreases
What does a rise in supply cause price to do?
Fall
What does a fall in supply cause prices to do?
Increase
What is price elasticity of demand?
A metric that calculates how responsible quantity demanded is to a change in price (elastic or in elastic)
What does the price elasticity of demand help us calculate?
How responsive the change in quantity demanded will be to the price (responsiveness is different for different types of products
ALWAYS NEGATIVE
How can price elasticity of demand be calculate?
% change in quantity demanded/% change in price
To calculate a % change = new value - old value/old value x 100
What does the numerical value of PED indicate?
The responsiveness of a change in quantity demanded to a change in price
Why will PED always be negative?
Due to the inverse relationship between price and quantity
(If price goes up, quantity demanded goes down)
(If price goes down, quantity demanded goes up)
What does it mean if price elasticity of demand is greater than 1?
The good is elastic meaning demand is more responsive to a change in price
E.g. luxury products such as smart watches or foreign holidays
What does it mean if PED is between 0 and 1
The product is inelastic meaning demand is less responsive to a change in price
E.g. necessities such as bread, milk, and toothpaste or addictive products such as cigarettes and alcohol.
What are the factors affecting PED?
- Availability of substitutes: (PED will be more price inelastic for goods with fewer substitutes e.g. petrol has fewer substitutes and is more price inelastic whereas chocolate bars have more substitutes and are more price elastic
- proportion of income spent: the smaller the proportion of income we spend on a product the more price inelastic the demand will be e.g. a small amount of income is spent on salt and so the demand for salt will be more price inelastic, whereas buying a new car tastes up a bigger proportion of consumer income and so is more price elastic in demand.
- luxury or necessity (necessities are required as part of consumers’ daily needs and therefore are more price inelastic) (luxuries are not essential and are therefore more price elastic in demand e.g. Nike air Jordan’s)
- time (the longer the time period under consideration the more price elastic the demand for a good or service is likely to be (consumers have more time to find substitutes)
(The shorter the time period under consideration the more price inelastic the demand for a good or service is likely to be
E.g. if the price of petrol increases making driving more expensive, there is little that consumers can do in the short term. however, they may switch to alternatives such as public transport in the long term. - brand loyalty e.g. coke consumers are more brand loyal to coke and refuse to buy Pepsi, even though their taste is very similar
What is the significance of PED to businesses?
If businesses can determine the PED of their products, they can adjust their pricing strategy to maximise their revenue.
If demand for their profits is relatively price inelastic (PED < -1), raising the price will lead to an increase in total revenue. However, lowering the price will lead to a fall in total revenue. (Price skimming strategies are best employed for products that are price inelastic in demand)
If demand for their products is relatively price elastic (PED > -1), raising the price will lead to a fall in total revenue. However, lowering the price will lead to a rise in total revenue
Competitive pricing strategies are best employed for products that are price inelastic in demand
What is price skimming?
Where the selling price is initially set as high as possible and then gradually lowered over a period of time. (Mostly used when companies have a strongly established brand identity)
What is competitive pricing?
Process for products are set based on competitors prices
What is the relationship between price elastic demand and total revenue?
PED is greater than 1
An increase in selling price reduces the total amount of revenue generated from sales
A reduction in selling price increases the total amount of revenue generated from sales
Curve a lot flatter than with inelastic demand.
What is relationship between price inelastic demand and total revenue?
PED is between 0 and 1
An increase in selling price increases the total amount of revenue generated from sales
A reduction in selling price reduces the total amount of revenue generated from sales
Curve a lot steeper than with elastic demand
What is income elasticity of demand (YED)?
Reveals how responsive the change in quantity demanded is to a change in come
What do changes in income cause?
Changes to the demand for products
Businesses are interested in how much the quantity demanded will change for different products
How Is income elasticity of demand (YED) calculated?
% change in quantity demanded/%change in income
What is a good with a positive YED value considered?
A normal good (normal goods are classified as necessities or luxuries
What is a good with a negative YED considered as?
An inferior good
(A good for which the quantity demanded decreases when income increases)
If the YED is greater than 1 what does this mean?
The item is a luxury e.g. a smart watch or cinema visit
Demand rises when income rises and demand falls when income falls
Demand is responsive to a change in income (income elastic)
If the YED is between 0 and 1 what does this mean?
The good is a necessity e.g. bread, milk and toothpaste
Demand is not very responsive to a change in income (income inelastic)
What does it mean if the YED is less than 0?
The good is an inferior good e.g. canned food, public transport or unbranded goods
Demand rises when income falls (negative income elasticity)
Demand falls when income rises
What are the factors that influence YED?
During a recession, wages usually fall and demand for inferior goods rise while demand for luxury goods falls.
During a period of economic growth and rising wages, demand for luxury goods increases while demand for inferior goods decreases.
Other influences on income include the minimum wage wage, legislation, taxation and increased international trade
YED is also influenced by the nature of the good ( if it’s inferior or normal.
What is the significance of YED to businesses?
Understanding the income elasticity of demand is useful to businesses as it can help them plan their production and products
Planning in this way will help them to generate higher profits and have less exposure to downturns in the economy
Production planning: if a business can determine YED for its products and they can accurately predict changes income, then it can plan whether to increase or decrease production.
Production planning is easier when YED is relatively inelastic, as demand is likely to be more constant
Product planning: The economy goes through different stages over time, from recession to recovery and growth and so incomes will fluctuate
This is known as the Business Cycle
During a recession, producers of inferior goods will benefit from higher demand but will lose out when incomes rise and consumers return to normal goods
