3.1.2 Price determination in a competitive market

Question 1

What are the factors that determine the demand for a good or service

Answer 1

Population
Advertising
Substitutes price
Income
Fashion/trends
Interest rates
Complements price

Question 2

Define demand

Answer 2

Demand is the quantity of a good/service that consumers are willing and able to buy at a given price at a particular time.

Question 3

What does a demand curve show?

Answer 3

The relationship between price and quantity demanded.

Extension - decrease in price and increase in quantity demanded

Contraction - Increase in price and decrease in quantity demanded

Question 4

What are the income and substitution effect?

Answer 4

Income effect - assuming a fixed level of income means as the price falls, amount that consumers can buy with their income increases and demand decreases.

Substitution effect - A fall in the price of a good means it’s cheaper so consumers increase demand for it and demand for the more expensive good decreases.

Question 5

How does demand affect normal goods and inferior goods?

Answer 5

Normal goods - Demand more of if real income increases.

Inferior goods - Demand less of if real income increases.

Question 6

Demand in interrelated markets: Define competitive, joint, derived and composite demand

Answer 6

Competitive - substitute goods

Joint - complementary goods

Derived - demand for a good used in making another good/service.

Composite - Goods that have more than one use

Question 7

Define price elasticity of demand and give its formula

Answer 7

How quantity demanded of a good responds to a change in its price

Queue before you pee

Formula: % change in QD / % change in price

Remember result is ALWAYS negative

Question 8

Define elastic, inelastic, perfectively elastic, perfectly inelastic and unit elasticity of demand / supply

Answer 8

Elastic - demand / supply is very responsive to a change in price PED / PES >1

Inelastic - Demand / supply is relatively unresponsive 0 < PED / PES < 1

Perfectively elastic - Demand / Supply = 0 when price changes

Perfectively inelastic - Demand / supply doesn’t change when price changes - 0

Unit elasticity of demand / supply - Change in demand / supply = change in price PED = +/- 1 (only + 1for supply)

Question 9

Define Income elasticity of demand and give its formula

Answer 9

Measures how much the demand for a good changes with a change in real income

Formula: % change in QD / % change in real income

Question 10

What is the relationship between YED and normal and inferior goods?

Answer 10

Normal goods :+ YED and as income rises, demand increases YED > 1
either ++ or – to make a +

Luxury good: YED > 1

Inferior goods: - YED and as income rises, demand decreases YED < 0

Question 11

Define cross elasticity of demand and give its formula

Answer 11

Measure of how the quantity demanded for one good responds to a change in the price of another good

Formula: % change in QD of good A / % change in price of good B

Question 12

What is the relationship between XED and substitute and complimentary goods?

Answer 12

Substitute: + XED
Compliments: - XED

Party Season Near Christmas

close compliments: XED is elastic
weak compliments: XED is inelastic
unrelated goods: XED = 0

Question 13

What is the relationships between PED and a firms total revenue?

Answer 13

Total revenue is maximized when PED = +/- 1
Elastic demand - reduce price to increase total revenue
Inelastic demand - Increase price to increase total revenue.

Question 14

What are the factors that influence elasticities of demand?

Answer 14

Substitutes
Percentage of income
Luxury or necessity
Addictive
Time

Question 15

What are the factors which determine the supply of a good or service?

Answer 15

Productivity
Indirect tax
Number of firms
Technology
Subsidies
Profitability in other goods
Weather
Cost of production

Question 16

What does a supply curve show?

Answer 16

The relationship between price and quantity supplied.

Question 17

Define supply

Answer 17

The quantity of a good / service that producers supply to the market at a given price at a particular time.

Due to higher prices implying higher profit, this will provide the incentive to expand production and increase supply:

Extension is supply: increase in price and an increase in QS

Contraction in supply: decrease in price and an decrease in QS

Question 18

Define joint supply

Answer 18

Production of one good / service involves the production of another

Question 19

Define price elasticity of supply and give its formula

Answer 19

Measure of how the quantity supplied of a good responds to c change in its price

Formula: % change in QS / % change in price

Remember result is ALWAYS positive

Question 20

What are the factors that influence PES?

Answer 20

Productivity log
Stocks held
Spare capacity
Suitability of resources
Time available

Question 21

What is the elasticity of supply in the short term?

Answer 21

Price inelastic - hard to switch production

Question 22

How does the interaction of demand and supply determine equilibrium prices in a market economy?

Answer 22

Equilibrium is when there is a balance so supply = demand AKA the market clearing price

Free market - equilibrium and quantity is determined by supply and demand

Question 23

What is the difference between equilibrium and disequilibrium?

Answer 23

Equilibrium: supply = demand
Disequilibrium: supply does not equal demand

Question 24

Why does excess demand and excess supply lead to a change in price?

Answer 24

An increase in demand from d to d1 leads to a price increase from p1 to p2 and supply extends from q1 to q2 creating a new equilibrium.

An increase in supply from s to s1 leads to a price decrease from p1 to p2 and demand extends from q1 to q2 creating a new equilibrium.

Question 25

How do changes in a particular market affect other markets?

Answer 25

competitive markets - availability and price