1.2 Price determination in a competitive market Flashcards
Definition of a market
A situation in which buyers and sellers come together to engage in trade
Definition of demand
The quantity of a good or service that consumers are willing and able to buy at given prices in a particular time period
Definition of effective demand
Consumers desire to buy a good , backed up by the ability to pay
What is the law of demand?
As the price of a good/service increases, the quantity demanded decreases (an inverse relationship)
What is a demand curve?
A curve that shows the relationship between the price of a product and the quantity of the product demanded
What is the difference between ‘quantity demanded’ and ‘demand’
Movements along the demand curve, caused by changes in price, is a change in the ‘quantity demanded’
Shifts of the demand curve, caused by a change in the determinants of demand, leads to ‘a change in demand’
What are movements along the demand curve?
Changes in the quantity demanded of a good that results from a change in that good’s price. A decrease in price leads to an increase in quantity demanded (an extension of demand)
Definition of conditions of demand
Factors other than the price of the good that lead to a change in position of the demand curve
What are shifts of the demand curve?
An increase in demand causes a rightward shift of the demand curve.
A decrease in demand causes a leftward shift of the demand curve.
What factors lead to shifts of the demand curve? (6)
- Changes to incomes - as incomes increase, demand for most products will rise (not inferior goods)
- Changes in population - as population increases, demand for most products will rise
- Changes in tastes and fashions - as a product becomes more fashionable, demand will increase
- Changes in advertising - if a business spends more on advertising its products, demand should increase
- Changes in price of substitutes - an increase in price of a substitute good will lead to an increase in demand for the alternative
- Changes in the price of complements - an increase in the price of a complementary good will lead to a fall in demand
Definition of supply
The quantity of a good or service that a firm is willing and able to supply at a given price in a given period of time
What is the law of supply?
As price of a good increases, the quantity supplied by a firm will increase
What is a supply curve?
A curve that shows the relationship between the price of a product and the quantity of the product supplied
What are movements along the supply curve?
An increase in price leads to an increase in quantity supplied (an extension of supply)
A decrease in price leads to a decrease in quantity supplied (a contraction of supply)
Shifts of a supply curve
An increase in supply causes a rightward shift of the supply curve
A decrease in supply causes a leftward shift of the supply curve
Factors which cause a shift of the supply curve (4)
- Changes in production costs - if costs increase (eg. raw materials costs rise) then supply will decrease
- Changes in technology/productivity - if there is a technological improvement, this will increase productive efficiency, and supply will increase
- Changes in indirect taxation - a rise in tax (eg. VAT) will lead to a decrease in supply
- Changes in subsidies (payment to producers to encourage output) - an increase in a subsidy will increase supply
Definition of market equilibrium
Where quantity demanded equals quantity supplied in a market
How does an increase in demand affect the market equilibrium?
An increase in demand would lead to a rightward shift of the demand curve. This would also lead to an increase in the equilibrium price and quantity.
How does a decrease in demand affect the market equilibrium?
A decrease in demand would lead to a leftward shift of the demand curve. This will also lead to a decrease in equilibrium price and quantity
How does an increase in supply affect the market equilibrium?
An increase in supply would lead to a rightward shift of the supply curve. This will also lead to a decrease in equilibrium price and an increase in quantity
How does a decrease in supply affect the market equilibrium?
A decrease in supply would lead to a leftward shift of the supply curve. This will also lead to an increase in the equilibrium price and a decrease in quantity.
Definition of market disequilibrium?
A situation where the quantity demanded does not equal the quantity supplied
Definition of excess supply
When the quantity supplied exceeds the quantity demanded, when the price is more than the equilibrium price
Definition of excess demand
When the quantity demanded exceeds the quantity supplied, when the price is less than the equilibrium price
Definition of price elasticity of demand (PED)
The responsiveness of the quantity demanded of a good/service to a change in price
Price elasticity of demand equation (PED)
% change in quantity demanded / % change in price
Price inelastic demand values
0-1
(bigger number on bottom)
Price elastic demand values
> 1
(bigger number on top)
Unitary elastic demand value
1
(change in price leads to same change in quantity demanded)
Perfectly inelastic demand value
0
(change in price leads to no change in quantity demanded)
Perfectly elastic demand value
∞
(change in price leads to an infinitely large change in quantity demanded)
Determinants of PED (5)
S (substitutes)
P (proportion of income)
L (luxury or necessity)
A (addictive or not)
T (time to respond)
PED and revenue relationship
If a firm has price inelastic products, it should increase prices in order to increase revenue.
If a firm has a price elastic product, it should decrease the price in order to increase revenue
Definition of price elasticity of supply (PES)
The responsiveness to the quantity supplies of a good/ service to a change in price
Price elasticity of supply equation
% change in quantity supplied / % change in price
What will all PES values be?
positive (as price and supply have a positive relationship)
Key values for PES
0-1 price inelastic supply
>1 price elastic supply
1 unitary elastic supply
0 perfectly inelastic supply
∞ perfectly elastic supply
unitary elastic supply diagram
exact change in quantity supplied to a change in price
perfectly inelastic supply diagram
no change in quantity supplied
perfectly elastic supply diagram
change in price leads to an infinitely large change in quantity supplied
Determinants of PES (4)
Time taken to extend supply
Size of spare capacity (eg, machinery, factory space or labour that is not fully utilised)
Available stocks (finished or partly finished goods)
Mobility of factors of production (switching factors of production)
Definition of income elasticity of demand (YED)
The responsiveness of the quantity demanded of a good/service to a change in income
Income elasticity of demand equation
% change in quantity demanded / % change in income
Income elasticity of demand key values
-ve negative income elasticity (inferior goods)
0-1 income inelastic (necessities)
> 1 income elastic (luxuries)
Definition of cross elasticity of demand (XED)
The responsiveness of the quantity demanded of good A to a change in price of good B
Cross elasticity of demand equation
% change in quantity of A demanded/ % change in price of B
Cross elasticity of demand key values
-ve = complements
+ve = substitutes
Definition of joint demand
Goods that tend to be demanded together
ie. complementary goods (such as cars and fuel)
Definition of joint supply
When the production of one good leads to the production of another good
(eg. the production of beef and leather arising from cattle farming)
Definition of composite demand
When a good is demanded for more than one distinct use.
(therefore an increase in the demand for one of those uses reduces the supply available for other uses)
Definition of derived demand
When a particular good or factor of productions necessary for the provision of another good or service.
(eg. an increase in demand for healthcare is likely to lead to an increase in the demand for doctors and nurses)
