3 - Price Determination Flashcards
What is a competitive market?
One where there are lots of sellers and buyers.
How is price determined in a competitive market?
Decisions on price are made by the overall market, and are usually fairly similar.
What happens when price is increased in a competitive market?
Some will stop buying the product completely, switching to a cheaper version, and some will buy less of the product.
What is the effect of market decisions?
They decrease the quantity demanded.
What does the demand curve of the graph show?
The relationship between the price of a good, and the quantity demanded.
What is the difference between movement along the demand curve, and s shift of the curve?
Movement along the demand curve only happens when the price changes. Shift of the demand curve happens when other factors shift the demand curve.
Which factors, other than price, affect the demand curve?
Seasons/Weather, Trends, Health, Information, birth rate, age of population, income levels, celebrity endorsement.
Which factors will fix the position of the demand curve?
The price of substitute goods, price of complementary goods, preferences, population size.
What are the examples of complementary goods?
Printers and Ink, Fish and Chips, Phones and phone chargers.
What are the examples of substitute goods?
Coke and Pepsi, Celebrations and Heroes.
What are the examples of inferior goods?
Buses, Aldi, Iphone 7, Economy Flights.
What are the examples of normal goods?
Cars, M and S, Iphone 15, Business Class.
What is the impact of a wet summer on demand for shorts?
An inward shift of the demand curve, from D1 to D2, because of poor weather conditions, causing a decrease in demand, resulting in a fall in quantity from Q1 to Q2.
What is the impact of a celebrity endorsement on a pair of trainers?
An outward shift of the demand curve, from D1 to D2, because of a celebrity endorsement, resulting in a fall in quantity from Q1 to Q2.
What does the law of supply state?
As the price of a product rises, businesses expand supply, because higher prices provide profit incentive for firms to expand production.
What does the supply curve show?
The relationship between market price, and how much of a firm can, and will, sell.
Why is the supply curve usually upward sloping?
Economists assume firms have the objective of maximising profit, as it continues to supply more of a good, as it’s profitable to do so.
Which factors cause a contraction of the supply curve?
Price of a product.
Which factors cause a shift in the supply curve?
Wage costs, raw material costs, energy costs, technical progress, taxes, subsidies.
Which factors cause a leftward shift of the supply curve?
Increase in wage costs, costs of production, firms leaving the market.
Which factors cause rightward shift of the supply curve?
Technical progress, reduction in production costs, firms entering the market.
What is the impact of government subsidies on the production of new electric cars?
As companies’ costs are reduced, they can produce more, as production costs have reduced, shifting the supply curve from S1 to S2.
What is the impact of passenger duty on the availability of short haul flight tickets?
The increase in tax means that supply decreases, as it costs more for an airline to take each passenger on a flight, resulting in quantity going from Q1 to Q2, shift in supply curve from S1 to S2.
What does an above equilibrium price mean for supply?
Excess Supply.
What are the factors which cause excess supply?
Increase in Supply, decrease in demand.
Why does an increase in supply cause excess supply?
It leads to lower unit costs, leading to companies producing more.
Why does a decrease in demand cause excess supply?
Adverse news stories lead to lower demand, as well as a fall in the price of substitutes.
What are the factors which cause excess demand?
Decrease in supply, increase in demand.
How does a decrease in supply cause excess demand?
Higher unit costs are a result of this, as well as higher raw material prices.
How does an increase in demand cause excess demand?
A successful advertising campaign, and an increase in the price of substitutes.
What is the impact of a good harvest on the supply of apples?
Good harvest, supply increases, supply curve shifts outwards, fall in price, increase in quantity.
What is the impact of a medical article suggesting herbal tea has health benefits?
Demand increases, demand curve shifts outwards, price increases, quantity increases.
Why does P1 show a disequilibrium price on an excess supply diagram?
Firms want to supply Q2, but households are only willing to purchase Q1, so sellers can’t fulfil their plans.
Why does Q2 show a disequilibrium in supply?
Households can buy exactly the quantity they want, but producers want to sell Q2, so if households don’t buy as many as are made, there is excess supply.
Why does P2 show a price disequilibrium?
Households are unable to buy as much as they would like to, at the current price. Households want to buy Q2, firms are only supplying Q1. Represents excess demand.
What are the four functions of the price mechanism?
Signalling, Incentive, rationing, allocative.
What are the alternatives to the price mechanism?
Barter system, central planning, rationing, waiting lists, lottery system, merit based allocation.
How do prices co-ordinate decision making of buyers and sellers?
Producers will use the most efficient methods of production to them at the time, to cut costs. Consumers buy from sellers who charge the highest price.
What are the advantages of the price mechanism?
Flexible to changing market conditions, efficient allocation of resources, ability to adapt to changes in the market.
What are the disadvantages of the price mechanism?
Inequality of wealth is likely, people with limited abilities may suffer unemployment, public goods aren’t produced.
What do free market economists believe?
The price mechanism works because it’s better to have market failure than government failure.
What do intervention economists believe?
Markets often perform badly, government intervention can improve on free market of markets.
What is price elasticity of demand?
The responsiveness of quantity demanded of a good or service to a price change.
What is the formula for percentage change?
Change/original value x 100.
What does a PED of >1 mean?
It means that quantity changes more than price, so there is price elastic demand.
What does a PED of <1 mean?
Quantity has changed less than price, so there is less price inelastic demand.
What is price inelastic demand?
If price goes up, demand would fall a little, as the same people would likely still buy it, but not as much. e.g. Petrol.
What is unitary elasticity?
The value of PED is 1, and demand will drop by the same amount as price.
What does perfectly elastic demand look like?
A perfectly horizontal line.
What does perfectly inelastic demand look like?
A perfectly vertical line.
Which factors determine price elasticity of demand?
Substitutability, percentage of income, necessities or luxuries.
How does substitutability affect price elasticity of demand?
If there is a substitute for a product, consumers will switch their expenditure away from the good, and buy the substitute.
How does percentage of income affect elasticity of demand?
Demand curves for goods or services on which households spend a large proportion of their income are more elastic than small items.
How is elasticity of demand affected by whether the good is a necessity or a luxury?
Demand for necessities is usually price inelastic, demand for luxuries is usually elastic.
How does width of the market definition affect elasticity of demand?
The wider the definition of the market, the lower the elasticity of demand, Demand for bread produced by a particular bakery is likely to be more elastic than demand by all bakeries.
How does time affect elasticity of demand?
Demand is usually more elastic in the long run than in the short run.
What does it mean if total consumer expenditure increases in response to a price fall?
Demand is elastic.
What does it mean if total consumer expenditure decreases in response to a price fall?
Demand is inelastic.
What is income elasticity of demand?
Measures the extent to which the demand for a good changes in response to a change in income.
What does income elasticity of demand depend on?
If the good is normal or inferior.
What happens as disposable income increases?
Demand for normal goods will shift rightwards. Demand for inferior goods shifts leftwards.
What is income elasticity of demand for inferior goods?
Always below 0.
What is income elasticity for normal goods?
Always above 0.
How can normal goods be divided?
Necessities and luxuries.
What is the equation for income elasticity of demand?
IED= % change in quantity demanded/% change in income.
What are luxuries?
Products where income elasticity is more than one. More is spent on luxuries as a proportion of income, as income grows.
What are necessities?
Income elasticity is more than 0, less than 1. Less is spent as a proportion of income, as income grows.
What happens to demand for inferior goods as income rises?
It falls, as consumers switch to better alternatives, which become more affordable.
What happens to demand for normal goods, as income rises?
Increases as consumers have more disposable income, so they can afford things they couldn’t before.
What is cross elasticity of demand?
Measures the extent to which which the demand for a good changes in response to a change in the price of another good.
What is the equation for cross elasticity of demand?
XED = % change in quantity demanded/% change in price of another good.
What are the three types of cross elasticity?
Complementary goods, Substitutes, Absence of discernible demand relationship.
What type of cross elasticity do complementary goods have?
Negative - The price rise of one good leads to a fall in demand for the other good.
What type of cross elasticity do substitutes have?
Positive - Rise in price of one good causes demand to switch to a substitute good whose price hasn’t risen.
What will XED for two random goods be?
Zero - As a rise in the price of one good has no measurable effect upon demand for the other.
What is price elasticity of supply?
The extent to which the supply of a good changes in response to a change in price.
What is the equation for price elasticity of supply?
PES = % change in quantity supplied/% change in price.
What are the factors affecting price elasticity of supply?
Length of the production period, availability of accumulating factors, ease of switching between alternative methods of production.
How does length of the production period affect PES?
If firms can convert raw materials into finished goods very quickly, supply is more elastic than when several months are involved in production.
How does spare capacity affect price elasticity of supply?
When a firm possesses spare capacity, if labour and raw materials are readily available, production can be increased quickly in the short run.
How does ease of accumulating stock affect PES?
When stocks of unsold finished goods are stored at low cost, firms can respond quickly to a sudden increase in demand.
How does the ease of switching affect PES?
When firms can quickly alter the way they produce goods, supply is more elastic than when there is no choice. If firms produce a range of products, supply of any one product can be elastic.
How does the number of firms in the market affect PES?
The more firms there are in the market, the greater the PES.
