2 - Price Determination Flashcards
Demand?
The quantity of a good/service that consumers are willing and able to buy at a given price at a particular time
Extension?
(Decrease graph)
Contraction?
(Increase graph)
Income effect?
Assuming a fixed level of income,
As price falls, the amount consumers can buy with their income increases
= more demand
Substitution effect?
A fall in price of a good makes it cheaper than others
= more demand for it
= less demand for other goods
LEFT shift in demand
Out of fashion
Inferior goods
Changes in real income
RIGHT shift in demand
Normal goods
Changes in real income
Normal good?
For which demand increases as income rises
- vice versa
Inferior good?
For which demand decreases as income increases
Substitute good?
Alternatives to each other
Complementary good?
Often used together
known as joint demand
Condition of demand?
A determinant of demand that fixes the position of the demand curve
- population
- tastes + preferences
- personal income
- prices of complementary + substitute goods
Derived demand?
For a good / factors of production used in making another good/service
Composite demand?
Some goods have more than one use
Effective demand?
Desire for a good/service backed by an ability to pay
Price elasticity of demand
PED
Measure of how the quantity demanded of a good responds to a change in its price
How to calculate PED
% change in quantity demand
DIVIDED BY
% change in price
PED graphs
(Insert photo)
Factors determining PED
SUBSTITUTES
- the more a good has, the more price elastic it is
TIME
- as it becomes easier to change to alternatives because consumers had enough time to shop around
TYPE OF GOOD/SERVICE
- Necessities (inelastic)
- Luxuries (elastic)
- Habit forming goods (elastic)
- Different uses (inelastic)
Income elasticity of demand
YED
Measures how much the demand for a good changes with a change in real income
How to calculate YED
% change in quantity demanded of a good
DIVIDED BY
% change in real income
YEDs
Useful for:
Sales forecasting
- change in income and affect on demand
Pricing policy
- de/increase price
LOW YED = inferior goods produced
HIGH YED = normal goods produced
Useful for govt to know during booms and recessions
- what policies to use and what to allocate
Cross elasticity of demand
XED
Measure of how the quantity demanded of a good responds to a change in price of another good
How to calculate XED
% change in quantity demanded of good A
DIVIDED BY
% change in price of good B
XEDs
Substitutes - positive
Complements - negative
Independent/Unrelated goods - XED of 0
Supply?
The quantity of a good/service that producers supply to a market at a given price in a particular time
Determinants of supply of g/s
Reason for upwards sloping supply curve
- producers aim to maximise profit
All things being equal
- increase price = increase in profit
which gives incentive to expand population
= increase in supply
Firms will only produce more if price increases more than the costs
LEFT shift in supply
CHANGES TO THE COST IN PRODUCTION
- increase in one or more costs of production will decrease producers profits
INDIRECT TAXES
- on goods effectively increase costs for a producer
RIGHT shift in supply
IMPROVEMENTS IN TECHNOLOGY
- reduces costs of production and increased supply
CHANGES TO THE PRODUCTIVITY OF FACTORS OF PRODUCTION
- increased production of factors of production means more output for a firm
NO. OF SUPPLIERS
- an increase of suppliers in a market
Joint supply?
Where the production of one good/service involves the production of another
If the price of a product increases, then supply of it and joint products will also increase
E.g. petrol increases
= the level of drilling oil increases
Conditions of supply
- costs of production
- subsidies
- taxes imposed
- technical progress
Price elasticity of supply
PES
Measure of how the quantity supplied of a good responds to a change in its price
How to calculate PES
% change in quantity demanded
DIVIDED BY
% change in price
PES graphs
(Insert)
Factors determining PES
LENGTH OF PROD PERIOD
- firms can convert raw materials into finished goods
= more elastic supply
AVAILABILITY OF SPARE CAPACITY
- if firms have this and labour readily available
= production increases quickly in short run
Factors affecting PES
PERIODS OF IMPROVEMENT
- elastic supply
as it’s easy to attract new workers if a firm wants to expand
PERISHABLE GOODS
- inelastic supply
as they cannot be stocked for too long
FIRMS WITH HIGH STOCK LEVELS
- elastic supply
as they can increase supply quickly if they want to
INDUSTRIES WITH MORE MOBILE FACTORS OF PRODUCTION
- elastic supply
High PES is important to firms
Improve elasticity of supply by:
- flexible working patterns
- use of latest tech
- having spare production capacity
Short run supply
It’s price INELASTIC
Over short periods of time, firms can find it difficult to switch production from one good to another
Long run supply
All factors of production are variable, therefore the firm is able to increase its capacity
Supply is elastic as firms have longer time to react to changes in price and demand
Market equilibrium?
Price and output are stable
Disequilibrium?
There is excess demand/supply
Excess supply?
When the quantity supplied to a market is greater than the quantity demanded
Excess demand?
When the quantity demanded for a good/service is greater than the supply
Elasticity’s effect of new equilibrium
Price ELASTIC demand/supply
- greater impact on quantity
Price INELASTIC demand/supply
- greater impact on price
Competitive markets
When there is a large no. of buyers and sellers
No single producer/consumer can influence the allocation of resources of the market or its prices
Assumption that consumers/producers act rationally
CONSUMERS AIM
- maximise welfare by buying goods/services to maintain their quality of living
PRODUCERS AIM
- to provide what consumers with what they want at the lowest prices to maximise their profit by selling the most to them
Price mechanism?
Changes in demand/supply of a good/service
leads to a change in its price and the quantity bought/sold
Has 3 functions:
- acts as an incentive to firms
- acts as a signalling device
- acts to ration scarce resources
Advantages of Price Mechanism
- resources will be allocated efficiently to satisfy needs/wants
- it can operate without the cost of employing people to regulate it
- consumers decide what the product is
- minimum prices are kept as resources are used efficiently as possible
Disadvantages of Price Mechanism
- inequality in income
- public goods won’t be produced
- under-provision of merit goods
- over-provision of demerit goods
- people with limited skills suffer with unemployment or receive low wages
Consumer surplus?
When they pay less for a good than the amount they’ve prepared to pay
E.g. they bring £10 but it’s £8
Consumer surplus = £2
Producer surplus?
When they receive more for a product than the price they’re willing to accept
E.g. price is £15 but they would have happily sold it at £10
Producer surplus = £5
CARDS LEFT TO DO:
Oil
Agriculture
Housing
Transport
for demand
If a good has elastic demand:
Reduction in price
= increase in total revenue
Increase in price
(Vice Versa)
If a good has inelastic demand:
Reduction in price
= reduction in total revenue
(Vice Versa)
Market forces removing excess supply
If price is set ABOVE eq ☝🏽 Excess supply ☝🏽 More QS than QD ☝🏽 Prices fall ☝🏽 Supply contrasts, demand extends ☝🏽 Reach eq
Market forces removing excess demand
If price is BELOW eq ☝🏽 Excess demand ☝🏽 Demand outweighs supply ☝🏽 Force price rise ☝🏽 Demand contrasts, supply extends ☝🏽 Return to eq
