1.3 Price determination in a competitive market Flashcards
What is a market?
a voluntary meeting of buyers and sellers with exchange taking place
What is demand?
the quantity of a good or service that consumers and willing and able to buy at given prices in a given time period
What are normal goods?
one where, if price rises, demand will fall and vice versa
i.e. a negative correlation
What are veblen goods?
‘snob effect’ - people pay more when the price of products increase
due to increases status given to buyer
What are inferior goods?
one where demand decreases as incomes increase
own label products’ demand will decrease when incomes increase
What are substitute products?
acts as an alternative, creating competition
e.g. beef and lamb
What are complementary products?
bought along side a product or service
e.g. Fish & Chips
Printer & Ink
What are the determinants of demand?
- Price of the good
- Consumer income
- Prices of other goods and services
- Consumer taste or fashion
- Other factors
How does the price of a product determine demand?
normal goods - price rises, demand falls. vice versa
How does consumer income determine demand?
inferior goods - when incomes increase, demand decreases
or
when incomes increase demand for normal goods also increase.
How does the prices of other goods and services determine demand?
- substitutes
- complementary
How does consumer taste and fashion determine demand?
tastes and trends change overtime, often manipulated by advertising
if a product is more trendy and fashionable, the demand will increase
Other factors that determine demand?
- Population
- Advertising
- Competition
What is elasticity?
looks at the sensitivity of one variable in relationship to another
What is an elasticity coefficient?
the measure of response of one variable to changes in another variable
What is Price elasticity of demand (PED)?
measure the responsiveness of demand to a change in price
% change in qd / % change in p
What does it mean when a product is price inelastic?
a price change won’t significantly affect the quantity demanded. price inelastic products are usually necessities
coefficient of less than 1
What is PED determined by?
- Substitutes
- Time
- Definition of the market
What does it mean when a product is price elastic?
a price change will significantly affect the quantity demanded. price elastic products are usually luxury goods
coefficient of greater than 1
How do substitutes determine PED?
if there are no close or a lack of available substitutes the product is likely to be very price inelastic
and vice versa
How does time determine PED?
- Short run - products are likely to be more price inelastic as consumers find it difficult to change shopping habits
- Long run - products are likely to be price elastic as consumers adjust to changing market conditions
How does the definition of the market determine PED?
as we widen the market so PED becomes more inelastic
e.g. cigarettes are very price inelastic as there are no close substitutes
however, the demand for specific brands will have a higher PED
What is Income elasticity of demand (YED)?
measures the responsiveness of demand to a change in income
What is YED determined by?
- Whether the good is a necessity or luxury
- The level of income of a consumer
How does a necessity or luxury determine YED?
at higher standards of living, increased consumer incomes see additional demand tend towards luxury goods as demand for necessities is satisfied
How does the level of income of a consumer determine YED?
Poorer consumers spend on necessities, as they become wealthier YED for necessities moves towards zero
Normal goods that are necesities will have a lower positive YED coefficient (inelastic)
when incomes increase -> more likely to spend on luxuries
these will have a higher positive YED coefficient (elastic)
What is Cross-elasticity of demand (XED)?
measures the responsiveness of demand for one good, x, to a change in price of another good, y
% change in qd of good x / % change in price of good y
What is XED determined by?
- Substitutes
- Complements
- Has no relationship
How do substitutes determine XED?
Will have a positive XED, as price of good Y increases, demand for good X increases.
Close substitutes will have a higher XED as consumer demand for good X will be more sensitive to a change in price of good Y.
e.g. if pepsi prices rise, coke demand would rise
How do complements determine XED?
Will have a negative XED as price for good x increases, demand for good y decreases.
Close complements will have a higher XED as consumer demand for good x will be more sensitive to a change in price of good y.
e.g. if printer prices rise, ink demand would fall
How do products with no relationship determine XED?
the change in price of good Y will have no impact on the demand for good X. XED will be zero
What is supply?
the amount of a good or service that producers are willing and able to sell at any given price in a given time period
Who are producers?
those that create and supply goods and services to a market
Who are profit maximisers?
firms, because they want to make as much profit as possible
What are the determinants of supply in a market?
- The impact of changing costs of production
- Technological progress
- Prices of other goods and services
- Government policy e.g. tax & subsidies
- Other factors e.g. expectations
What are indirect taxes?
are those placed on goods and services produced by individuals and firms
What are subsidies?
they involve finance provided to producers to encourage them to produce goods & services
What is taxation?
a charge placed on individuals or firms. governments use taxation to finance their spending
How does the cost of production determine supply?
if the cost of producing increases, it becomes more expensive for firms to supply. Leads to firms reducing output
vice versa
How does technological progress determine supply?
with advanced technology firms can supply at a more productive and efficient manner.
large scale machinery allows them to spread fixed costs over greater output making cost per unit produced cheaper
How does the price of other goods and services determine supply?
Firms can use their factors of production to produce a range of products.
If price of good A increases, this might make it more profitable to switch from supplying good B in order to supply good A.
New firms enter markets with higher prices as their is a greater incentive to make profit.
How does government policies determine supply?
- Indirect taxes - make it more expensive to produce, leading to a decrease in supply
- Subsidies - goverment grants, make it more cheaper to produce. leads to supply increasing
What are other factors that determine supply?
Expectations of future events
Degree of competition in market
Power of firms
Supply curve rules
y axis = price
x axis = quantity
supply increase = shift right
supply decrease = shift left
What is the Price elasticity of Supply (PES)?
measures the responsiveness of supply to a change in price
% change in quantity supplied / % change in price
What is the PES determined by?
- Price
- Ease of switching production methods
- Time
- Accumulating stocks
- Space capacity
- Length of production period
How does price determine PES?
higher prices acts as an incentive for firms to increase supply
higher price = higher profits
How does the ease of switching production methods determine PES?
number and closeness of substitutes help determine PES
if it is easy for firms to change production of its products (e.g. tables to chairs) then PES is likely to be very price elastic and vice versa
easier it is to switch production the higher the PES
How does time determine PES?
Short run - products are likely to be more price inelastic as producers find it difficult to increase production
Long run - products are likely to be more price elastic as producers adjust to changing markets
e.g. buying machinery, new factories
How does accumulating stocks determine PES?
if stocks of unsold goods can be stored at low costs the firms can respond quickly to a sudden increase in demand
if price falls, firms can also divert from sales into stock accumulation
this changes whether the good is perishable or not
How does spare capacity determine PES?
if a firm possesses spare capacity (labour and raw materials are readily available) then production can be increased quickly in the short run
How does the length of production period determine PES?
if firms can convert raw materials into finished goods quickly (hours or days) then supply will be more elastic than if it takes several months
What is market equilibrium?
the point at which demand is equal to supply.
at this price all products have been sold and the market has cleared
What is market clearing price?
the price at which all products are sold and the market has cleared
What is market disequilibrium?
occurs when either demand or supply is greater than the other
if planned supply > planned demand then price falls
if planned supply < planned demand then price rises
What is excess supply?
buyers demand less at higher prices, and firms wish to produce more at higher prices, leads to too much supply.
to solve this firms need to lower prices to get rid of excess products.
What is excess demand?
buyers demand more at lower prices but firms wish to supply less.
leads to too much demand.
to improve profitability firms could raise prices, thus reducing excess demand.
What are market forces?
always pushing prices towards market equilibrium
What happens to the supply or demand curve when there is a change in price + Change in any other factor?
Change in price leads to a movement along the curve.
However,
Change in any other factor leads to a shift in the curve.
Shift in demand curve occurs when:
There are changes in:
1. consumer income
2. prices of other g / s
3. consumer taste and fashion
4. other factors e.g. advertising
Shift in supply curve occurs when:
There are changes in:
1. cost of production
2. technological progress
3. prices of other g / s
4. taxes + subsidies
5. other factors e.g. expectation
What is the Rationing function of price mechanism?
resources are scarce, demand exceeds supply and prices are driven up. this is to discourage demand and conserve resources.
contraction of demand along the demand curve.
What is the Incentive function of price mechanism?
higher prices provide an incentive to existing producers to supply more and increase their revenue and profits.
extension of supply along the existing supply curve.
What is the Signalling function of price mechanism?
price changes send contrasting messages to consumers and producers about whether to enter or leave a market.
Rising prices - consumers to reduce demand
Rising prices - producers to enter market
Conversely, falling prices signals consumers to enter and producers to leave.
shifts in demand and supply curves
What is competitive market?
when demand for g/s in a market changes, it impacts other markets
firms move away from market where demand has fallen and into where demand increases
What is joint demand?
goods that are complements are in joint demand
complements have a -XED
e.g. Printer and ink are in joint demand
Demand for substitute goods depend upon?
- Number and closeness of available substitutes
- Substitutes have a +XED
What is composite demand?
increase in demand for one g/s will restrict its availablity for another use.
increase in demand for wheat will see a reduction in land available for barley, leading to a decrease in supply for barley and a rise in price for it
e.g. Land can be used to grow wheat or barley
What is derived demand?
when demand for a product occurs as a result of demand for another g/s
all finished products create derived demand
e.g. demand for tinned tomatoes creates demand for the metal used
What is joint supply?
when the production of a product creates a by-products that can also be supplied
when this occurs the supply curve will shift to the right for both products
also leads to a decrease in price for both products
e.g increased production of sheep for meat will increase supply for wool
