2-Price determination in a competitve market Flashcards
Competitve market
a market in which the large number of buyers and sellers possess good market information and can easily enter or leave the market
Supply
the quantity of a good or service that firms are willing and able to sell at given prices in a given period of time
Demand
the quatitiy of a good or service that consumers are willing and able to buy at given prices in a given period of time.
Effective demand
Latent demand
effective: the desire for a good or service backed by an ability to pay
latent: Not backed by ability to pay
Condition of demand
a determinant of demand, other than the good’s own price, that fixes the position of the demand curve
Increase in demand effect on demand curve?
rightward shift of the demand curve
decrease in demand effect on demand curve?
leftward shift of the demand curve
What can cause demand to shift? (7 Determinants of demand)
PIRATES
P- Population. The larger the population, the higher the demand. Changing the structure of the population also affects demand, such as the distribution of different age groups.
I- Income. If consumers have more disposable income, they are able to afford more goods, so demand increases.
R- Related goods. Related goods are substitutes or complements.
A- Advertising. This will increase consumer loyalty to the good and increase demand.
T- Tastes and fashions
E- Expectations. This is of future price changes. If speculators expect the price of shares in a company to increase in the future, demand is likely to increase in the present.
S- Seasons.
Others
- law
- interest rates
- Consumer confidence
Normal good
demand increases when income rises
inferior good
demand falls when income rises
Price elasticity of demand
measures the responsiveness of quantity demanded to a change in the price of the good
PeD= %change in quantity demanded/ %change in price
PeD for perfectly elastic demand
How it will look on a demand curve?
Infinite
Horizontal line
Fall in price leads to a huge increase in total revenue
PeD for elastic demand
How it will look on a demand curve?
PeD < -1
Shallow negative gradient
A fall in price means quantity demanded rises proprtioanlly more then the price cut, total revenue rises
PeD for unitary demand
How it will look on a demand curve?
PeD=1
Curve starts of negatively steep then goes shallow
Change in price bring about the same proprtiante change in quantity demanded
PeD for inelastic demand
PeD between 0 and -1
Steep negative gradient
When price falls, quantity demanded increases but by a smaller proportion then the fall in price, total revenue falls
PeD for completely inelastic demand
PeD=0
Vertical line
When prices fall, quantity demanded does not change at all, so total revenue falls.
Factors determining price elasticity of demand
- Availability of substitutes: Close substitutes, demand for the product is highly elastic
- Proportion of income spent on good:Big ticket items are more elastic
- Necessities or luxuries: luxuries usually have elastic demand
- Time
Income elasticity of demand
The responsiveness of quantity demanded to a change in income
YeD for inferior good?
negative
YeD for normal good?
positive
Cross elasticity of demand
Measures the responsiveness of quantity demanded of one good to a change in price of another
what would the XpeD be for a substitute
positive
what would the XpeD be for complimentary goods
negative
What’s the law of supply?
As a goods price rises, more is supplied
main determinants of supply?
Joint supply Objectives of firms Indirect tax Number of sellers in the market Technological improvements Expectations about future prices Regulation and bureuaccuracy Subsidies Price of raw materials Labour productivity Wage rates
JOINTERS PCW
What are the 3 functions of price?
Rationing-when prices rise consumers ration their consumption
Incentive-when price rises, producers have the incentive to make more because more profit per good sold
Signalling-when prices rise it acts as a signal to entrepreneurs from other industries that their are high profits to be made and they should enter the market
Composite demand
A good that is demanded for more than one purpose so that an increase in demand for one purpose reduces the supply for the other purposes. Eg, steel for cars and scaffolding
Derived demand
When the demand for one good or service comes from the demand for another good or service. . Eg, labour
YeD for Normal necessities
Normal necessities have an income elasticity of demand of between 0 and +1 for example, if income increases by 10% and the demand for fresh fruit increases by 4% then the income elasticity is +0.4. Demand is rising less than proportionately to the rise in income. (Inelastic)
YeD for Luxury goods and services
Luxury goods and services have an income elasticity of demand > +1 i.e. demand rises more than proportionate to a change in income – for example a 8% increase in income might lead to a 10% rise in the demand for new kitchens. The income elasticity of demand in this example is +1.25.
Oppurtunity Cost
The next best alternative forgone when an economic desicion is made.
It is the next best alternative, not a range of alternatives.
Diminishing marginal utility
The law of diminishing marginal utility states that as an extra unit of the good is consumed, the marginal utility, i.e. the benefit derived from consuming the good, falls. Therefore, consumers are willing to pay less for the good.
Equilibrium price
Price at which demand is Equal to supply and there is no tendency to change
Disequilibrium price
Price at which demand is NOT equal to supply and there is a tendency to change
If a firm sells inelastic products who recieves the greater tax burden?
If a firm sells a good with an inelastic demand, they are likely to put most of the tax burden on the consumer, because they know a price increase will not cause demand to fall significantly.
This is effective for raising government revenue.
What’s a subsidy
A subsidy is a payment from the government to firms to encourage the production of a good and to lower their average costs. It has the opposite effect of a tax because it increases supply.
What are the factors that affect price elasticity of supply?
-Time
Raw materials need to be found, extracted, processed
-Availability of stocks or stockpiling
-The ease of switching between alternative production
-Availability of spare capacity
-Number of firms in the market and with which firms can enter a market
-Ability to alter production methods
TRATANA
Excess supply
When quantity supplied at a particular price is greater then quantity demanded, there is a disequilibrium
Excess demand
When quantity demanded at a particular price is greater than quantity supplied, and there is a disequilibrium
Minimum price
A price floor below which the price of a good or service is not allowed to decrease
Maximum price
A price ceiling above which the price of a good or service is not allowed to increase
Name some problems with a price floor
Produces surplus (waste of our limited resources)
Black markets
Dependent on size of the change
Difficult to impose, monitor and enforce
Needs to have effective consequences if not done
Excess supply
When quanitity supplied at a paricular price is greater than quanitity demanded, there is a disequilibirum
Excess demand
when quantity demanded at a particular price is greater than quantity supplied, and there is a disequillibirum
Picture a diagram of an increase in demand for chick peas.
Describe it.
short run and long term
Say there is an increase in demand for chickpeas due to a change in fashion/trend
This will increase the demand for chickpeas from D TO D1.
In the short run the price of chickpeas does not change but the quanitity demanded increases to QD.
Suppliers may not notice this immediatley so at the original price of p, only QS is produced.
Reuslting in a disequilibrium in this case a shortage of QD TO QS.
This shortage puts an upwards pressure in prices.
As prices rise, firms are incentivised to produce more and so there is an extension in supply.
Consumers ration their consumption with higher rices and so there is a contraction in deman.
A new equilibrium is arrived at P1 and Q1.
Maximum price (price ceiling)
A price ceiling above which the price of a good or service is not allowed to increase
Minimum price (price floor)
A price Floor below which the price of a good or service is not allowed to decrease
Commodity
a good that is traded, but usually refers to a raw material or semi-manufactured good that are traded in bulk. Often they are unbranded (homogenous) where all firms products are undistinguishable from each other.
How would you descirbe agriculture price?
very volatile
