4.1.3 Price determination Flashcards
What is a market?
An institution connecting buyers with product and sellers with money.
What is demand?
The quantity of a product consumers are willing and able to buy at each price in a given time period
What are the determinants of demand?
- advertising/ marketing
- complementary product price/availability
- population
- substitute product price/availability
- branding/fashion/tastes
- disposable income
- environment/weather
What is the law of demand?
As price increases, quantity demanded falls, vice versa, ceteris paribus
What are some of the exceptions to the law of demand?
- Veblen goods - products for conspicuous consumption
- Speculate goods - bought as price increases in hope that price increase will continue
- Giffen goods - really inferior goods, demand decreases as income increases
What is marginal production?
The addition to total production from having one more worker
What is marginal cost?
The addition to total cost from buying one more unit
What is PED?
- Price elasticity of demand - the responsiveness of the quantity demanded of a product to changes in price of the product
- %ΔQDx / %ΔPx
What is totally inelastic demand?
What does it look like on a P-Q graph?
When PED = 0
Vertical line on P-Q graph
What is totally elastic demand?
What does it look like on P-Q graph?
When PED = -♾️
Horizontal line on P-Q graph
When PED is less than -1, is demand fairly elastic or inelastic?
When PED < -1, demand is fairly elastic
When PED is between 0 and -1, is demand fairly elastic or inelastic?
When -1 < PED < 0, demand is fairly inelastic
How can revenue be used to judge PED (if elastic or inelastic)?
- Elastic PED: increased price -> decreased revenue
- Inelastic PED: increased price -> increased revenue
What are the determinants of PED?
SPLAT:
- availability of Substitutes
- Proportion of income spent on product
- Luxury vs necessity
- Addiction/habit/branding (negative correlation)
- Time
What is supply?
The quantity of a product that producers are willing and able to supply onto the market at each price in a given time period
Why do firms supply?
To make profit (revenue - cost)
What is the law of supply?
As price increases, the quantity supplied increases, vice versa, ceteris paribus
What are the determinants of supply?
PINTSWC:
- Productivity
- Indirect taxes
- Number of firms/producers
- Technology
- Subsidies
- Weather
- Cost of production
What is consumer surplus?
The difference between what the consumers are willing to buy each product for and the price it actually costs
What is producer surplus?
The difference between what the producers are willing to sell each product for and the price they actually get
What is PES?
- Price elasticity of supply - the responsiveness of the quantity supplied of a product to changes in the price of that product
- %ΔQSx / %ΔPx
What is totally inelastic supply?
What does it look like on a P-Q graph?
When PES = 0
Vertical line on P-Q graph
What is totally elastic supply?
What does it look like on a P-Q graph?
When PES = ♾️
Horizontal line on P-Q graph
What is the elasticity of supply when PES is between 0 and 1?
Fairly inelastic
What is the elasticity of supply when PES is greater than 1?
Fairly elastic
What is unitary elasticity?
When PES = 1
Applies for all straight line supply through the origin
What are the determinants of PES?
- availability/cost of resource
- time
- amount of spare capacity
- amount of stock
- closeness of producer substitutes
- ease of entry to market
What is equilibrium/ allocative effieciency?
- When supply = demand
- Economic forces are in balance and so price and quantity supplied or demanded will not change, ceteris paribus
Why is equilibrium a desired quantity?
It balances cost and utility (allocative efficiency)
Where is productive efficiency on a PPF?
All points on a PPF curve
What happens when demand increases (shifts right)?
- Higher quantity is demanded, quantity equilibrium is supplied
- Shortage as D>S
- Buyers are willing to pay more, sellers take advantage and increase price
- Leading to an extension in supply, and a contraction in demand
- So price increases until equilibrium and market clears again
What happens when supply increases (shifts right)?
- Higher quantity supplied, quantity equilibrium demanded
- Surplus created as S>D
- Sellers will decrease price as buyers offer less
- Leading to a contraction in supply, and an extension in demand
- So price decreases until equilibrium
What is YED?
- Income elasticity of demand - the responsiveness of the quantity demanded of a product to changes in income
- %ΔQDx / %ΔY
What is the income elasticity when YED is greater than 1, and what type of good has this YED?
What does it look like on a Y-Q graph?
- Highly income elastic
- Luxury good
- Horizontal line
What is the income elasticity when YED is between 0 and 1, and what type of good has this YED?
Highly income inelastic
Necessity
What is the elasticity of income when YED is less than 0, and what type of goods have this YED?
Negative income elasticity
Inferior good
What is XED?
- Cross-price elasticity of demand - the responsiveness of the quantity demanded of one product to changes in price of another product
- %ΔQDx / %ΔPy
What type of products have a positive XED?
Substitutes
What type of products have a negative XED?
Complements
What type of products have an XED of 0?
Unrelated products
What type of products have an XED of ♾️?
Extremely closely related products
Why does price move in accordance with market forces?
To help allocate resource
What are the 3 functions by which price helps to allocate resource?
- Signal function - tells producers to increase quantity supplied
- Incentive - price increases so that firms can increase profit so producers switch to that product
- Rationing mechanism - price limits who can buy luxury items
What happens if price is allowed to fulfil the functions to help allocate resource?
More efficient allocation of resource, at the cost of inequality, provision of harmful products, and pollution/ environmental destruction
What is derived demand?
If the demand for a product increases, the demand for the resource used to make the product also increases (e.g. cars and steel)
What is joint demand?
If the demand for a product increases, the demand for a complimentary product will also increase
What is competitive demand?
If the demand for one product increases, the demand of a substitute will decrease
What is composite demand?
If more of a product is sold, the supply of a product made of the same resource will decrease
What is joint supply?
If the demand for a product increases, the supply of a by-product of this product will increase (e.g. beef and leather)
