1.5 Market Equilibrium And Price System Flashcards
Define market equilibrium
When the price in a market is such that the quantity that consumers wish to buy is exactly balanced by the quantity firms wish to supply.
How can you identify market equilibrium?
Bringing demand and supply together
What do natural forces do in a free market?
They can be expected to encourage prices to adjust to the equilibrium level.
Where is excess supply on a supply and demand diagram?
Above equilibrium between S and D
Where is excess demand on a supply and demand curve?
Below equilibrium between S and D
What is the demand for labour an example of?
Derived demand - demand for a FOP or good which derives not from the factor or good itself but from the goods and services that it produces.
What are the curves on a labour market diagram expected to look like and why?
Same as usual. Demand downward sloping as when the price of labour is low firms will demand more of it. Supply upward sloping as people offer themselves for work when the rage is relatively high.
What is one possible cause of unemployment?
Wage rate being set above the equilibrium level.
Define unemployment is
Results when people seeking work at the going wage cannot find a job.
Which type of demand is foreign exchange and example of?
Derived demand as people want currency for the goods or services they can buy.
For a market for pounds, how would you label the X axis and the Y axis?
X- price of pounds / exchange rate
Y- amt of pounds per period
What can the price of money be seen as?
Opportunity cost. Instead of holding money someone might invest in something that would provide a rate of return represented by the rate of interest.
Draw a graph showing the market for money.
X axis- interest rate Y axis- quantity of money per period Normal demand curve Straight vertical supply curve Equilibrium labelled as r*
Define comparative static analysis.
Examines the effect on equilibrium of a change in the external change affecting a market
(Simplifies: shows effects of shifts in demand/ supply on equilibrium)
What is the effect of interrelated markets?
A series of knock on effects spreading across markets that are interrelated after a change in one market.
What can using the demand and supply model suggest?
Possible explanations for volatility in prices in commodity markets (and others)
Define elasticity
Measures how the sensitivity of one variable to changes in another variable.
Define price elasticity of demand
Measures sensitivity of quantity demanded to a change in
PRICE OF A GOOD OR SERVICE
Give the equation for PED
% 🔼 QD / % 🔼 Price
What is demand also known as it when it is highly price sensitive?
Demand is price elastic.
What is the value of PED if demand is price elastic?
Greater than 1
More change in quantity demanded than price
Why is PED always negative?
The demand curve slopes downward and changes in price and quantity are in the opposite directions.
What is elasticity mostly reliable for?
Small changes in price and is unreliable for large amounts.
What is the value of PED when demand is price inelastic?
Less than 1
Show price elasticity on a graph.
(Pg 50)
- demand curve, axis labelled price and quantity
- mid point of curve labelled unit elasticity
- top half of the curve labelled as price elastic
- bottom half of the curve labelled as price inelastic
What is the value for unit elasticity?
-1
Explain why the top half of a demand curve is elastic.
Price is higher. Percentage change in price is overall lower.
Quantity is lower. Percentage change in quantity is overall higher.
Using the equation value expected to be greater than 1.
(And vice versa at the bottom of the curve)
Why are firms interested in PED?
They may want to know how a change in price will affect total revenue (quantity multiplied by price).
How to check if total revenue has increased (price elasticity of demand)?
Mark in both equilibriums. Calculate the areas of both boxes and see where total revenue is greater.
As you move down the demand curve what happens to elasticity and total revenue?
Price changes increAse total revenue at first but as you move down it decreases due to the elasticities. What
Elastic demand
For a price increase total revenue….
For a price decrease total revenue….
a) decreases
b) increases
Unit elasticity
For a price increase total revenue….
For a price decrease total revenue….
1) stays the same
2) stays the same
Inelastic demand
For a price increase total revenue….
For a price decrease total revenue….
1) increases
2) decreases
What can a firm do if it is aware of PED for its product?
Anticipate consumer response to its price changes, can be a powerful strategic tool.
What does a perfectly inelastic demand curve look like and why?
Vertical
%QD does not change at all (0)
What is the value of PED if something is perfectly elastic/ inelastic?
0
What does a perfectly elastic demand curve look like?
Horizontal line
Value of elasticity is infinity as consumers demand unlimited quantities at this price.
What happens if price rises in a perfectly elastic demand curve?
Demand would fall to 0
Draw a unit elasticity curve
Rectangular hyperbola
Why? If price changes total revenue has to remain constant.
List 4 factors that influence PED
1) Availability of substitutes
2) Necessity vs Luxury
3) How significant the good is in overall expenditure
4) Time period
How does availability of substitutes influence PED?
If close substitutes are readily available, good has elastic demand.
Goods with no substitutes tend to be more inelastic.
How does necessity vs. luxury affect demand?
Goods that are seen as necessities tend to be inelastic. (Links to substitutes as it possibly means not many alternatives)
Goods that are seen as luxury tend to be more elastic.
How does the significance of a good in overall expenditure affect PED?
If a good is a smaller part of household expenditure, it is more inelastic.
If a good is a larger part of household expenditure it is not elastic.
How does time period affect PED?
People may respond stronger in the long run rather than short run.
E.g. petrol prices increasing. short term limited effects but long term people may adjust patterns of consumption to price change and get diesel cars.
Demand is more elastic in the long run.
Define YED (income elasticity of demand)
Measures the sensitivity of a quantity demanded to a change in
CONSUMER INCOMES
Give the equation for YED
% 🔼 QD / % 🔼 Consumer Income
Is YED always negative like PED? Why?
Can be positive or negative due to inferior/ normal goods.
Distinguish the elasticies for a normal good and an inferior good
For normal goods as income rises demand increases. YED will be positive .
For inferior goods as income increases demand decreases. YED will be negative.
Define superior (luxury) goods.
Income elasticity of demand is positive and greater than 1 (as income rises consumers spend proportionally more on the good)
Define XED (cross elasticity of demand)
Measures responsiveness of quantity demanded of a good or services to a change in
THE PRICE OF SOME OTHER GOOD OR SERVICE
What does cross elasticity show?
Reveals the interrelationships between the goods.
If XED is positive what does it suggest about the two goods?
They are substitutes.
If XED is negative what does it suggest about the two goods?
They are complements
When will XED be positive?
When the price of Y increases and the demand for X also increases.
(Positive- substitutes)
When will XED be negative?
When an increase in the price of Y results in a decrease in demand for X.
(Negative- complements)
Define price elasticity of supply
Measures responsiveness of quantity SUPPLIED of a good/ service to a change in the
PRICE OF THAT GOOD OR SERVICE
Is PES positive or negative and why?
Positive because the supply curve is upward sloping.
Increase in market price induces firms to supply more output to the market
Give the equation for PES
% 🔼 QS / % 🔼 Price
