3.1.2 - Price Determination In A Competitive Market Flashcards
Define demand, and name the 2 types
Quantity of a good or service that consumer are willing to buy at a given price during a given time
2 types:
- Notional
- Effective
Market demand curves: what changes when the curve shifts along? (Axes)
Quantity
Market demand curves: what changes when there is a movement along the curve? And what do we call this increase and decrease on the supply curve?
Price
Increase in price P1 to P2 is an expansion of supply
Decrease in price P1 to P2 is a contraction of supply
What 7 factors cause a shift in demand?
- Income:
Increase in disposable income enables consumers to afford more goods - Quality:
Increase in quality of good encourages more consumers to buy it - Advertising:
Can increase brand loyalty to the goods and increase demand - Substitutes:
An increase in the price of substitutes
I.e increase in Samsung mobile prices will increase demand for apple phones - Complements:
Fall in price of complements will increase demand
I.e strawberries and cream - Weather / seasonal:
In cold weather there will be increased demand for certain goods
I.e ice cream - Expectations:
Of future price increase — a commodity may be bought due to speculative reasons
I.e gold
What is a normal good?
A good for which demand increases as income rises, and demand falls as income falls
What is an inferior good?
A good for which demand decreases as income rises and demand increases as income falls
What does the Law of Diminishing Utility state? Provide an example
As an extra unit of the good is consumed, the marginal utility i.e benefit derived from consuming the good falls
Therefore consumers are willing to pay less for the good
I.e chocolate — first bar will satisfy the consumer the most and so will be willing to pay more for it than a second bar, which will be less satisfactory
Define elasticity
The proportionate responsiveness of a second variable to an initial change in the first variable
State what PED is, and it’s equation
Price Elasticity of Demand
Is the responsiveness of change in demand to a change in price
% change in QD
————————
% change in price
Is a price elastic good’s demand responsive or unresponsive to a change in price? And is PED < > = 1?
Demand is very responsive to a change in price
(Change in price leads to even greater change in demand)
PED > 1
Is a price inelastic good’s demand responsive or unresponsive to a change in price? And what is PED’s value ( < > = 1)
Demand is relatively unresponsive to a change in price
PED < 1
What is the relationship between the change in price of a unitary good and the change in demand of a unitary good? And is PED < > = 1?
A change in demand is equal to a change in price
PED = 1
What is the relationship between the change in price of a perfectly inelastic good and the demand of a perfectly inelastic good? And is PED < > = 0?
Demand doesn’t change when price changes
PED = 0
What is the relationship between the change in price of a perfectly elastic good and the demand of a perfectly elastic good? And what does PED equal?
Demand falls to 0 when price changes
PED = infinity
What factors determine price elasticity of demand?
- substitutability:
Consumers respond to price rise by switching to a cheaper substitute - necessities / luxuries:
Demand for necessities is price inelastic whereas demand for luxuries is price elastic (generally speaking) - percentage of income:
Demand curves for households which spend a lot of money tend to be more price elastic than low income households - peak / off peak demand
- the width of market
What is YED and it’s formula?
Income Elasticity of Demand
Demonstrates affect of a change in demand in response to a change in income
% change in QD
————————
% change in I
What are the YED values for inferior and normal goods? ( < > 1) etc
Inferior goods: YED < 1
Normal goods: YED > 1
What is XED and it’s formula? What are 2 possible cases for XED?
Cross Elasticity of Demand
Is the responsiveness of a change in demand of one good, x, to a change in price of another good, y
% change in QD of X
——————————
% change in P of Y
possible cases:
- complementary goods
- substitute goods
Unrelated goods have a XED of 0
What do XED values enable firms to do?
XED allows firms to see how many competitors they have
Therefore they are less likely to be affected by price changes than other firms if they are selling complementary or substitute goods
Define supply
Quantity of a good or service that a producer is able / willing to supply at a given price during a given time period
What factors shift the supply curve
Outward
- higher productivity
- number of firms
- technology
- subsidies
Inward
- indirect taxes
- costs of production
What is PES and it’s formula?
Price Elasticity of Supply
Responsiveness of change in supply to a change in price
% change in QS
————————
% change in P
What factors influence PES
- Time scale
Short-run — supply is more price inelastic, long-run — supply price elastic - Spare capacity
If firm is operating at full capacity, there is no space left to increase supply - Level of stocks
If goods can be stored, firms can stock them and increase market supply easily - How substitutable FOP are
If Labour and capital are mobile, supply is more price elastic - Barriers to entry to the market
High barriers to entry means supply is more price inelastic — harder for new firms to enter + supply the market
Define equilibrium
State in which market supply and demand balance each other and as a result price becomes more stable
define disequilibrium
Internal / external forces which prevent market equilibrium from being reached / cause the market to fall out of balance
When does excess demand occur?
When price is less than the equilibrium price. Since prices decrease, it would attract consumers to the market leading to competition between buyers
When does excess supply occur?
When price is greater than the equilibrium price,
As price is greater than equilibrium, sellers would sense this as an opportunity to make profits and so supply increases
Define the 3 types of demand
- Derived demand:
When demand for one good is linked to the demand of another - Composite demand:
When the good demanded has more than one use - Joint demand:
When goods are bought together
Define joint supply
When increasing the supply of one good causes an increase / decrease in the supply of another good
What is the relationship between PED and firms total revenue?
PED < 1 (inelastic) = more revenue
PED > 1 (elastic) = more revenue
PED = 1 (unitary elastic) = no change to revenue
Which factors determine the supply of a good / service?
- productivity
- indirect taxes
- number of firms in the market
- technology
- subsidies
- weather
- cost of production
What is the market clearing price?
It occurs at market equilibrium when price has no tendency to change
Why does excess demand within a market mean a shortage? And what effect does this have on supply?
Demand is greater than supply (disequilibrium), demand price doesn’t equal supply price and quantity demanded doesn’t equal quantity supplied
> pushes prices up and causes firms to supply more
Define derived demand
When the demand for one good is linked to the demand for a related good. I.e the demand for bricks is derived from the demand for building new houses
Define composite demand
When the good demanded has more than one use. I.e milk, assuming there a fixed supply, an increase in the demand for cheese will mean more cheese is supplied therefore less butter can be supplied
Define joint demand
When goods are bought together, I.e a digital camera and a memory card
