1.3 Price determination in a competitive market Flashcards
Law of demand
As price increases, quantity demanded decreases. As price decreases, quantity demanded increases.
Market
anywhere where buyers and sellers come together, a price is agreed and a transaction takes place
Price
that which is given up in an exchange to acquire a good or service
Demand
the quantity of a good or service that consumers are willing and able to buy at given prices in a given period of time
Consumer expenditure
the amount of money consumers spend on a given quantity of goods in a given period of time
Rationing function of prices
rising prices ration demand for a product
Consumer surplus
a measure of the economic welfare enjoyed by consumers; surplus utility received over and above the price paid for a good
Utility
the satisfaction or economic welfare an individual gains from consuming a good
Law of diminishing marginal utility
for a single consumer, the marginal utility derived from a good diminishes for each additional unit consumed
Normal good
when the demand for a good increases as incomes rises and demand decreases as income fall
Inferior good
when the demand for a good decreases as income rises and demand increases as income falls
Complementary good
a good which is in joint demand, or which is demanded at the same time as the other good
Substitute good
a good in competing demand, or which can be used in place of the other good
Direct tax
a tax which cannot be shifted by the person legally liable to pay the tax onto someone else. They are normally levied on income and wealth
Causes of changes in demand (7)
- change in price or related goods
- changes in incomes
- Fashions, Tastes and preferences
- Advertising and branding
- Demographic change
- External shocks
- Seasonal factors
Describe an increase in demand
a rightward shift of the demand curve
Describe a decrease in demand
a leftward shift of the demand curve
Describe an extension in demand
the increase in quantity demanded due to a fall in price
Describe a contraction in demand
the fall in the quantity demanded due to a rise in price
Total revenue
the total amount of money a firm receives by selling goods or services
Total revenue formula
Price x Quantity
Marginal revenue
the change in total revenue generated by an additional unit of output
Marginal revenue formula
change in total revenue / change in quantity
Price elasticity of demand (PED)
measures the extent to which the demand for a good changes in response to a change in the price of that good
PED formula
% change in quantity demanded / % change in price
Perfectly price inelastic
The quantity demanded does not change in response to price changes; PED = 0
Perfectly price elastic
Buyers are prepared to buy any amount at a given price, but demand falls to zero if the price rises; PED = - ∞
Describe an inelastic PED
PED < 1
Describe an elastic PED
PED > 1
Factors affecting PED (5)
- how close substitutes are to product
- availability of substitutes
- change of price of luxuries
- addiction
- whether purchase can be postponed
Income
the flow of money a person or household receives in a particular time period
Income elasticity of demand (YED)
measures the extent to which the demand for a good changes in response to a change in the income of consumers.
YED
% change in quantity demanded / % change in income
What is the YED for normal goods?
positive
What is the YED for inferior goods?
Negative
Cross elasticity of demand (XED)
measures the extent to which the demand for a good changes in response to a change in the price of another good.
XED formula
% change in quantity demanded of good X / % change in price of good Y
What is the XED for complementary goods?
Negative
What is the XED for substitutes?
Positive
Total cost
the whole cost of producing a particular level of output
Producer revenue
the amount of money received by producers from selling a given quantity of goods in a given period of time
Incentive function
when prices for a good/service rise, it incentivises producers to reallocate resources from a less profitable market to this market in order to maximise their profits
Producer surplus
a measure of the economic welfare enjoyed by firms or producers: the difference between the price a firm succeeds in charging and the minimum price it would be prepared to accept
Indirect tax
a tax which can be shifted by the person legally liable to pay the tax onto someone else, for example through raising the price of a good being sold by the taxpayer. They are normally levied on spending
Ad valorem tax
a tax added on as a percentage, such as VAT
Tax per unit
a set tax levied per good sold, regardless of the good’s price, such as passenger duty on airfares; causes a leftward shift in supply curve
Subsidy
a payment made by government or other authority, usually to producers, for each unit of the relevant good they produce; causes a rightward shift of the supply curve
Law of supply
producers offer more of a good as its price increases and less as its price falls
Describe an increase in supply
a rightward shift of the supply curve
Describe a decrease in supply
a leftward shift of the supply curve
Describe an extension of supply
a movement along the supply curve to the right (higher price & higher quantity supplied).
Describe a contraction of supply
movement along the supply curve to the left (lower price & lower quantity supplied).
Producer revenue =
producer surplus + the cost to producers of supplying
Factors affecting supply (8)
- Changes in costs of production
- Introduction of new technology
- Indirect taxes
- Government subsidies
- External Shocks
- changes in productivity
- changes in prices of other goods
- new firms entering the market
Price elasticity of supply (PES)
measures the extent to which the supply of a good changes in response to a change in the price of that good
PES formula
% change in quantity supplied / % change in price
Factors determining PES (6)
- The length of production period
- The availability of spare capacity
- The ease of accumulating stocks
- The ease of switching between alternative production methods
- The number of firms in the market
- The ease of entering the market
Shortage
Excess demand
Surplus
Excess supply
Equilibrium price
price where quantity supplied equals quantity demanded.at this price there is no shortage or surplus, and there is no tendency for the market price to change
Free market forces
forces in free markets which act to reduce prices when there is excess supply and raise prices when there is excess demand
Deadweight loss
the loss of welfare when the maximum attainable level of total welfare is not achieved
Joint supply
when one good is produced, another good is also produced from the same raw materials (e.g. beef and leather)
Joint demand
a good which is demanded at the same time as another good (e.g. printers and ink cartridges)
Competing demand
a good which can be used in place of the other good
Composite demand
demand for a good which has more than one use (e.g. oil for plastics and oil for petrol)
Derived demand
Quantity demand for a good which is an input into the production of another (e.g. houses and bricks)
Incidence of tax
The tax burden on the taxpayer
Incidence of subsidy
the subsidy burden on the subsidy recipient
Impact of changing price on revenue when demand is price elastic
reduction in price causes an increase in total revenue
Impact of changing price on revenue when demand is price inelastic
a price increase causes an increase in total revenue
Impact of changing price on revenue when demand is unitary price elastic
total revenue will remain unchanged as price changes
