3. Price Determination In A Competitive Market Flashcards
Elasticity
The proportionate responsiveness of a second variable to an initial change in the first variable
Price elasticity of demand
Measures the extent to which the demand for a good changes in response to a change in the price of that good.
How does substitutability determine price elasticity of demand
When a substitute exists for a product, consumers respond to a price rise by switching expenditure away from the good and buying a substitute whose price has not risen. When very close substitutes are available, demand for the product is highly elastic. When there are little substitutes for a product——> demand is likely to be inelastic.
How does percentage of income determine price elasticity of demand
Demand curves for goods and services on which households spend a large proportion of their income tend to be more elastic than those of small items that account for only a small fraction of income- households will be more responsive to items which households spend a large portion of their income
How do necessities or luxuries determine price elasticity of demand
It is the existence of substitutes that really determines price elasticity of demand, not the issue of whether the good is a luxury or a necessity.
How does the ‘width’ of the market definition determine price elasticity of demand
The wider the definition of the market under consideration, the lower the price elasticity of demand.
How does time determine price elasticity of demand
For many goods and services, demand is more elastic in the long run than in the short run because it takes time to respond to a price change.
Short run
The time period in which at least one factor of production is fixed and cannot be varied.
Long Run
The time period in which no factors of production are fixed and in which all the factors of production can be varied
What is an inferior good?
an inferior good is a good whose demand decreases when consumer income rises,
If total consumer expenditure increases in response to a price fall, demand is:
Elastic
If total consumer expenditure decreases in response to a price fall, demand is:
Inelastic
If total consumer expenditure remains constant in response to a price fall, demand is:
Neither elastic nor inelastic
Income elasticity of demand:
Measures the extent to which the demand for a good changes in response to a change in income; it is calculated by dividing the percentage change in quantity demanded by the percentage change in income
What direction does a demand curve shift for an inferior good when disposable income rises
Left
What direction does a demand curve shift for a normal good when disposable income rises
Right
Income elasticity is always _______ for an inferior good and ______ for a normal good
Negative / positive
Cross-elasticity of demand
Measures the extent to which the demand for a good changes in response to a change in the price of another good; it is calculated by dividing the percentage change in quantity demanded by the percentage change in the price of another good
Possibilities of demand relationships between goods
. Complimentary goods (or joint demand )
. Substitutes (or competing demand)
. An absence of any discernible demand relationship
What goods have negative cross-elasticities of demand
Complementary goods (as the price increases for one, demand decreases for the other)
For most demand relationships between two goods, are most cross-elasticities of demand elastic or inelastic ?
Inelastic (for both substitutes and complements)
What goods have negative cross-elasticities of demand
Complimentary goods
Market
A voluntary meeting of buyers and sellers with exchange taking place
Demand
The quantity of a good or service that consumers are willing and able to buy at given prices in a given period of time
Supply
The quantity of a good or service that producers are willing and able to sell at given prices in a given period of time.
Competitive markets
Markets in which the large number of buyers and sellers possess good market information and can easily enter or leave the market
Ruling market price (also known as equilibrium price)
The price at which planned demand equals planned supply
Effective demand
The desire for a good or service backed by an ability to pay.
Market demand
The quantity of a good or service that all the consumers in a market are willing and able to buy at different market prices.
Individual demand
The quantity of a good or service that a particular individual is willing and able to buy at different market prices.
Ceteris paribus
“all other things being equal“
Condition of demand
A determinant of demand, other than the good’s own price, that fixes the position of the demand curve
Main conditions of demand
. The prices of substitute goods (or goods in competing demand)
. The prices of complementary goods (or goods in joint demand)
. Personal income (or more strictly, personal disposable income, after tax and receipt of benefits)
. Tastes and preferences
. Population size, which influences total market size
Substitute good
Alternative goods that could be used for the same purpose
Complementary goods
When two goods are compliments, they experience joint demand
Increase in demand
A rightward shift of the demand curve
Decrease in demand
A leftward shift of the demand curve
Normal good
A good for which demand increases as income rises and demand decreases as income falls
(EXTENSION): Possible explanations for upward-sloping demand curves
. Speculative demand (housing, shares or a foreign currency)
. Veblen goods
. Goods for which consumers use price as an indicator of quality
Market supply
The quantity of a good or service that all the firms in a market plan to sell at given prices in a given period of time
Profit
The difference between total sales revenue and total costs of production
Total revenue
All the money received by a firm from selling its total output
Condition of supply
A determinant of supply, other than the good’s own price, that fixes the position of the supply curve
The main conditions of supply:
. Costs of production, including
-wage costs
-raw material costs
-energy costs
-costs of borrowing
. Technical progress
. Taxes imposed on firms, such as VAT, excise duties and the business rate
. Subsidies granted by the governments to firms
Increase in supply
A rightward shift of the supply curve
Decrease in supply
A leftward shift of the supply curve
Why do supply curves slope upwards
Higher prices lead to higher profits, encouraging existing firms to produce more and attracting new firms into the market.
Price elasticity of supply
Measures the extent to which the supply of a good changes in response to a change in the price of that good.
If the supply curve intersects the price axis, the curve is ______
elastic at all points, though elasticity falls towards unity as you move from point to point up the curve.
If the supply curve intersects the quantity axis, the curve is ______
inelastic at all points, though elasticity rises towards unity as you move from point to point up the curve
If the supply curve passes through the origin, elasticity…
Elasticity equals unity (+1) at all points on the curve.
Ad valorem tax
Tax expressed as a percentage
Factors determining price elasticity of supply
.The length of the production period
.The availability of spare capacity
.The ease of accumulating stocks
.The ease of switching between alternative methods of production
.The number of firms in the market and the ease of entering the market
Time
. Time
- Market period supply
- Short-run supply
- Long-run supply
The market period
a very short period in which the supply of a commodity is fixed
How is the elasticity of supply during the market period supply
Completely inelastic
How does the length of the production period effect the price elasticity of supply
If firms can convert raw materials into finished goods very quickly, supply will be more elastic
How does the availability of spare capacity effect the price elasticity of supply
When a firm possesses spare capacity, and if labour and raw materials are readily available, production can be increased quickly in the short run.
How does the ease of accumulating stocks effect the price elasticity of supply
When stocks of unsold goods are stored at low cost, firms can respond quickly to a sudden increase in demand. Firms can respond to a price fall by diverting current production away from sales and into stock accumulation.
How does the ease of switching between alternative methods of production effect the price elasticity of supply
When firms can quickly alter the way they produce goods - for example, by switching between the use of capital and Labour - supply tends to be more elastic than when there is little or no choice.
How does the number of firms in the market and the ease of entering the market affect price elasticity of supply
Generally, the more firms there are in the market, and the greater the ease with which a firm can enter and leave, the greater the elasticity of supply
How do the following elasticities look like for time and its effect on price elasticity of supply
Market period supply - perfectly inelastic (firms cannot immediately increase output)
Short-run supply- elastic
Long run supply - the most elastic
Market equilibrium
A market is in equilibrium when planned demand equals planned supply, where the demand curve crosses the supply curve.
Market disequilibrium
Exisits at any price other than the equilibrium price, when either planned demand<planned>planned supply</planned>
