3.1.2 Price determination in a competitive market Flashcards
What are the factors that determine the demand for a good or service
Population
Advertising
Substitutes price
Income
Fashion/trends
Interest rates
Complements price
Define demand
Demand is the quantity of a good/service that consumers are willing and able to buy at a given price at a particular time.
What does a demand curve show?
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
What are the income and substitution effect?
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.
How does demand affect normal goods and inferior goods?
Normal goods - Demand more of if real income increases.
Inferior goods - Demand less of if real income increases.
Demand in interrelated markets: Define competitive, joint, derived and composite demand
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
Define price elasticity of demand and give its formula
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
Define elastic, inelastic, perfectively elastic, perfectly inelastic and unit elasticity of demand / supply
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)
Define Income elasticity of demand and give its formula
Measures how much the demand for a good changes with a change in real income
Formula: % change in QD / % change in real income
What is the relationship between YED and normal and inferior goods?
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
Define cross elasticity of demand and give its formula
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
What is the relationship between XED and substitute and complimentary goods?
Substitute: + XED
Compliments: - XED
Party Season Near Christmas
close compliments: XED is elastic
weak compliments: XED is inelastic
unrelated goods: XED = 0
What is the relationships between PED and a firms total revenue?
Total revenue is maximized when PED = +/- 1
Elastic demand - reduce price to increase total revenue
Inelastic demand - Increase price to increase total revenue.
What are the factors that influence elasticities of demand?
Substitutes
Percentage of income
Luxury or necessity
Addictive
Time
What are the factors which determine the supply of a good or service?
Productivity
Indirect tax
Number of firms
Technology
Subsidies
Profitability in other goods
Weather
Cost of production
What does a supply curve show?
The relationship between price and quantity supplied.
Define supply
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
Define joint supply
Production of one good / service involves the production of another
Define price elasticity of supply and give its formula
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
What are the factors that influence PES?
Productivity log
Stocks held
Spare capacity
Suitability of resources
Time available
What is the elasticity of supply in the short term?
Price inelastic - hard to switch production
How does the interaction of demand and supply determine equilibrium prices in a market economy?
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
What is the difference between equilibrium and disequilibrium?
Equilibrium: supply = demand
Disequilibrium: supply does not equal demand
Why does excess demand and excess supply lead to a change in price?
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.
How do changes in a particular market affect other markets?
competitive markets - availability and price
