2. The price system and the microeconomy Flashcards
What is demand?
The quantity of a good/service consumers are willing and able to buy at a given price level, in a given time period
What causes a movement along the demand curve?
‣ Changes in price
‣ At a lower price, there is an expansion in demand
‣ At a higher price, there is a contraction in demand
What causes a movement along the supply curve?
‣ Changes in price
‣ At a lower price, there is a contraction in supply
‣ At a higher price, there is an expansion of supply
What causes the demand curve to shift?
*PASIFIC
‣ Population
‣ Advertising
‣ Substititue’s prices
‣ Income
‣ Fashion/trends
‣ Interest rates
‣ Competitor’s price
What causes the supply curve to shift?
*PINTS(C)
‣ Productivity
‣ Indirect taxes
‣ Number of firms
‣ Technology
‣ Subsidies
‣ Cost of production, (all of these relate to the cost of production)
What is the relationship between price and quantity demanded?
Inverse
‣ As price increases, quantity demanded decreases and vice versa *Assuming ceteris paribus
Knowledge, (AO1)
What is the definition and formula of price elasticity of demand?
o Price elasticity of demand refers to the responsiveness of a change in demand to a change in price
o The formula is:
PED = %change in Demand / %change in Price
Knowledge, (AO1)
Explain the significance of the value of PED?
Hint: = 0, = 1, greater than 1 and less than 1
o If PED is = 0, then it means it is perfectly inelastic, meaning that if the price changes, the demand does not change
o If PED is = 1, then it means that the good has unitary elasticity, which means the change in demand is equal to the change in price, (Same revenue)
o If PED is greater than 1, then it means it is very responsive to a change in price
o If PED is less than 1, then it means that the good’s demand is relatively unresponsive to a change in price
What factors affect PED?
o Proportion of income spent on the good/service
o Addictive
o Necessity or luxury
Knowledge, (AO1), and Analysis, (AO2)
Proportion of income spent on the good/service as a factor affecting PED.
*Use examples
o If the good takes up a small amount of income, (example: if the price of a magazine you buy increases from $1 to $1.50, then the demand is likely to be relatively price inelastic)
o This is because the new change in price, doesn’t require a significant proportion of income to be spent
o However, goods that take up a significant proportion of income, such as a car is likely to be more price elastic, (Example: if a car goes from $10,000 to $15,000 then a larger proportion of income will need to be spent)
o To conclude: If a good takes up a small proportion of income, then it is likely to be more price inelastic. However, if it takes up a large proportion, then it is likely to be more price elastic
Evaluation, (AO3)
Proportion of income spent on the good/service as a factor affecting PED.
*Do goods that a large proportion of income is normally spent on, always price elastic?
o If a good is classified as a veblen good, then it means that if the price increases, then the quantity demanded will also increase
o Meaning that in some instances, when a good requires a high proportion of income, the PED will not be price elastic, but rather price inelastic
Knowledge, (AO1), and Analysis, (AO2)
How addictive the good is, as a factor affecting PED.
o If a good is addictive, such as a demerit good like cigarettes, then it is likely to have an inelastic price elasticity of demand
o This is because consumers are addicted to them, meaning that they feel as though the need them to function, making them feel to them like they are necessities
o Therefore, these consumers will continue demanding the good, even if there is an increase in price
Knowledge, (AO1), and Analysis, (AO2)
Whether the good is a necessity or a luxury good as a factor affecting PED?
o If a good is a necessity and is crucial for living and or survival as a whole, then even if the price increases, the demand should be fairly unresponsive, meaning that PED should be inelastic, (Less than 1)
o However, if a good is a luxury and is not necessary for survival, then as the price increases, the quantity demanded is expected to fall, therefore making the PED price elastic, (Greater than 1)
Evaluation, (AO3)
Whether the good is a necessity or a luxury as a factor affecting PED?
And also, if luxury goods and necessities vary depending on people?
o If a good is classified as a veblen good, then it means that if the price increases, then the quantity demanded will also increase
o Meaning that in some instances, luxury goods, that fall under the classification of a veblen good, will not be price elastic, as an increase in price, won’t cause the quantity demanded to decrease, but will instead cause it to increase. Making the good price inelastic
o Another factor to consider is that someone’s necessity may be someone else’s luxury, meaning that PED may differ between consumers
Knowledge, (AO1)
What is the definition and formula for income elasticity of demand?
o YED measures the responsiveness of quantity demanded for a good or service, when there is a change in income
o YED = %change in quantity demanded / %change in income
Knowledge, (AO1)
What do the YED figures tell us?
o If the YED figure is positive, then it means the good is a normal good. This is because the quantity demanded of normal goods increases as incomes increases, therefore giving us a positive number
o If the YED figure is negative, then it means the good is an inferior good. This is because the quantity demanded of an inferior good decreases as income increases
If YED is below -1, what does it mean?
Elastic inferior good
If YED is between -1 and 0, what does it mean?
Inelastic inferior good
If YED = 0, what does it mean?
There is no relationship between income and quantity demanded
If YED is between 0 and 1, what does it mean?
Inelastic normal good
