1.2 Price determination in a competitive market

Question 1

Definition of a market

Answer 1

A situation in which buyers and sellers come together to engage in trade

Question 2

Definition of demand

Answer 2

The quantity of a good or service that consumers are willing and able to buy at given prices in a particular time period

Question 3

Definition of effective demand

Answer 3

Consumers desire to buy a good , backed up by the ability to pay

Question 4

What is the law of demand?

Answer 4

As the price of a good/service increases, the quantity demanded decreases (an inverse relationship)

Question 5

What is a demand curve?

Answer 5

A curve that shows the relationship between the price of a product and the quantity of the product demanded

Question 6

What is the difference between ‘quantity demanded’ and ‘demand’

Answer 6

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’

Question 7

What are movements along the demand curve?

Answer 7

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)

Question 8

Definition of conditions of demand

Answer 8

Factors other than the price of the good that lead to a change in position of the demand curve

Question 9

What are shifts of the demand curve?

Answer 9

An increase in demand causes a rightward shift of the demand curve.

A decrease in demand causes a leftward shift of the demand curve.

Question 10

What factors lead to shifts of the demand curve? (6)

Answer 10

1. Changes to incomes - as incomes increase, demand for most products will rise (not inferior goods)
2. Changes in population - as population increases, demand for most products will rise
3. Changes in tastes and fashions - as a product becomes more fashionable, demand will increase
4. Changes in advertising - if a business spends more on advertising its products, demand should increase
5. Changes in price of substitutes - an increase in price of a substitute good will lead to an increase in demand for the alternative
6. Changes in the price of complements - an increase in the price of a complementary good will lead to a fall in demand

Question 11

Definition of supply

Answer 11

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

Question 12

What is the law of supply?

Answer 12

As price of a good increases, the quantity supplied by a firm will increase

Question 13

What is a supply curve?

Answer 13

A curve that shows the relationship between the price of a product and the quantity of the product supplied

Question 14

What are movements along the supply curve?

Answer 14

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)

Question 15

Shifts of a supply curve

Answer 15

An increase in supply causes a rightward shift of the supply curve

A decrease in supply causes a leftward shift of the supply curve

Question 16

Factors which cause a shift of the supply curve (4)

Answer 16

1. Changes in production costs - if costs increase (eg. raw materials costs rise) then supply will decrease
2. Changes in technology/productivity - if there is a technological improvement, this will increase productive efficiency, and supply will increase
3. Changes in indirect taxation - a rise in tax (eg. VAT) will lead to a decrease in supply
4. Changes in subsidies (payment to producers to encourage output) - an increase in a subsidy will increase supply

Question 17

Definition of market equilibrium

Answer 17

Where quantity demanded equals quantity supplied in a market

Question 18

How does an increase in demand affect the market equilibrium?

Answer 18

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.

Question 19

How does a decrease in demand affect the market equilibrium?

Answer 19

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

Question 20

How does an increase in supply affect the market equilibrium?

Answer 20

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

Question 21

How does a decrease in supply affect the market equilibrium?

Answer 21

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.

Question 22

Definition of market disequilibrium?

Answer 22

A situation where the quantity demanded does not equal the quantity supplied

Question 23

Definition of excess supply

Answer 23

When the quantity supplied exceeds the quantity demanded, when the price is more than the equilibrium price

Question 24

Definition of excess demand

Answer 24

When the quantity demanded exceeds the quantity supplied, when the price is less than the equilibrium price

Question 25

Definition of price elasticity of demand (PED)

Answer 25

The responsiveness of the quantity demanded of a good/service to a change in price

Question 26

Price elasticity of demand equation (PED)

Answer 26

% change in quantity demanded / % change in price

Question 27

Price inelastic demand values

Answer 27

0-1 (bigger number on bottom)

Question 28

Price elastic demand values

Answer 28

> 1 (bigger number on top)

Question 29

Unitary elastic demand value

Answer 29

1 (change in price leads to same change in quantity demanded)

Question 30

Perfectly inelastic demand value

Answer 30

0 (change in price leads to no change in quantity demanded)

Question 31

Perfectly elastic demand value

Answer 31

∞ (change in price leads to an infinitely large change in quantity demanded)

Question 32

Determinants of PED (5)

Answer 32

S (substitutes) P (proportion of income) L (luxury or necessity) A (addictive or not) T (time to respond)

Question 33

PED and revenue relationship

Answer 33

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

Question 34

Definition of price elasticity of supply (PES)

Answer 34

The responsiveness to the quantity supplies of a good/ service to a change in price

Question 35

Price elasticity of supply equation

Answer 35

% change in quantity supplied / % change in price

Question 36

What will all PES values be?

Answer 36

positive (as price and supply have a positive relationship)

Question 37

Key values for PES

Answer 37

0-1 price inelastic supply >1 price elastic supply 1 unitary elastic supply 0 perfectly inelastic supply ∞ perfectly elastic supply

Question 38

unitary elastic supply diagram

Answer 38

exact change in quantity supplied to a change in price

Question 39

perfectly inelastic supply diagram

Answer 39

no change in quantity supplied

Question 40

perfectly elastic supply diagram

Answer 40

change in price leads to an infinitely large change in quantity supplied

Question 41

Determinants of PES (4)

Answer 41

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)

Question 42

Definition of income elasticity of demand (YED)

Answer 42

The responsiveness of the quantity demanded of a good/service to a change in income

Question 43

Income elasticity of demand equation

Answer 43

% change in quantity demanded / % change in income

Question 44

Income elasticity of demand key values

Answer 44

-ve negative income elasticity (inferior goods) 0-1 income inelastic (necessities) >1 income elastic (luxuries)

Question 45

Definition of cross elasticity of demand (XED)

Answer 45

The responsiveness of the quantity demanded of good A to a change in price of good B

Question 46

Cross elasticity of demand equation

Answer 46

% change in quantity of A demanded/ % change in price of B

Question 47

Cross elasticity of demand key values

Answer 47

-ve = complements +ve = substitutes

Question 48

Definition of joint demand

Answer 48

Goods that tend to be demanded together ie. complementary goods (such as cars and fuel)

Question 49

Definition of joint supply

Answer 49

When the production of one good leads to the production of another good (eg. the production of beef and leather arising from cattle farming)

Question 50

Definition of composite demand

Answer 50

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)

Question 51

Definition of derived demand

Answer 51

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)