4.1.3 Price determination

Question 1

What is a market?

Answer 1

An institution connecting buyers with product and sellers with money.

Question 2

What is demand?

Answer 2

The quantity of a product consumers are willing and able to buy at each price in a given time period

Question 3

What are the determinants of demand?

Answer 3

• advertising/ marketing
• complementary product price/availability
• population
• substitute product price/availability
• branding/fashion/tastes
• disposable income
• environment/weather

Question 4

What is the law of demand?

Answer 4

As price increases, quantity demanded falls, vice versa, ceteris paribus

Question 5

What are some of the exceptions to the law of demand?

Answer 5

• 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

Question 6

What is marginal production?

Answer 6

The addition to total production from having one more worker

Question 7

What is marginal cost?

Answer 7

The addition to total cost from buying one more unit

Question 8

What is PED?

Answer 8

• Price elasticity of demand - the responsiveness of the quantity demanded of a product to changes in price of the product
• %ΔQDx / %ΔPx

Question 9

What is totally inelastic demand?
What does it look like on a P-Q graph?

Answer 9

When PED = 0

Vertical line on P-Q graph

Question 10

What is totally elastic demand?
What does it look like on P-Q graph?

Answer 10

When PED = -♾️

Horizontal line on P-Q graph

Question 11

When PED is less than -1, is demand fairly elastic or inelastic?

Answer 11

When PED < -1, demand is fairly elastic

Question 12

When PED is between 0 and -1, is demand fairly elastic or inelastic?

Answer 12

When -1 < PED < 0, demand is fairly inelastic

Question 13

How can revenue be used to judge PED (if elastic or inelastic)?

Answer 13

• Elastic PED: increased price -> decreased revenue
• Inelastic PED: increased price -> increased revenue

Question 14

What are the determinants of PED?

Answer 14

SPLAT:
- availability of Substitutes
- Proportion of income spent on product
- Luxury vs necessity
- Addiction/habit/branding (negative correlation)
- Time

Question 15

What is supply?

Answer 15

The quantity of a product that producers are willing and able to supply onto the market at each price in a given time period

Question 16

Why do firms supply?

Answer 16

To make profit (revenue - cost)

Question 17

What is the law of supply?

Answer 17

As price increases, the quantity supplied increases, vice versa, ceteris paribus

Question 18

What are the determinants of supply?

Answer 18

PINTSWC:
- Productivity
- Indirect taxes
- Number of firms/producers
- Technology
- Subsidies
- Weather
- Cost of production

Question 19

What is consumer surplus?

Answer 19

The difference between what the consumers are willing to buy each product for and the price it actually costs

Question 20

What is producer surplus?

Answer 20

The difference between what the producers are willing to sell each product for and the price they actually get

Question 21

What is PES?

Answer 21

• Price elasticity of supply - the responsiveness of the quantity supplied of a product to changes in the price of that product
• %ΔQSx / %ΔPx

Question 22

What is totally inelastic supply?
What does it look like on a P-Q graph?

Answer 22

When PES = 0
Vertical line on P-Q graph

Question 23

What is totally elastic supply?
What does it look like on a P-Q graph?

Answer 23

When PES = ♾️
Horizontal line on P-Q graph

Question 24

What is the elasticity of supply when PES is between 0 and 1?

Answer 24

Fairly inelastic

Question 25

What is the elasticity of supply when PES is greater than 1?

Answer 25

Fairly elastic

Question 26

What is unitary elasticity?

Answer 26

When PES = 1 Applies for all straight line supply through the origin

Question 27

What are the determinants of PES?

Answer 27

- availability/cost of resource - time - amount of spare capacity - amount of stock - closeness of producer substitutes - ease of entry to market

Question 28

What is equilibrium/ allocative effieciency?

Answer 28

- When supply = demand - Economic forces are in balance and so price and quantity supplied or demanded will not change, ceteris paribus

Question 29

Why is equilibrium a desired quantity?

Answer 29

It balances cost and utility (allocative efficiency)

Question 30

Where is productive efficiency on a PPF?

Answer 30

All points on a PPF curve

Question 31

What happens when demand increases (shifts right)?

Answer 31

- 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

Question 32

What happens when supply increases (shifts right)?

Answer 32

- 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

Question 33

What is YED?

Answer 33

- Income elasticity of demand - the responsiveness of the quantity demanded of a product to changes in income - %ΔQDx / %ΔY

Question 34

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?

Answer 34

- Highly income elastic - Luxury good - Horizontal line

Question 35

What is the income elasticity when YED is between 0 and 1, and what type of good has this YED?

Answer 35

Highly income inelastic Necessity

Question 36

What is the elasticity of income when YED is less than 0, and what type of goods have this YED?

Answer 36

Negative income elasticity Inferior good

Question 37

What is XED?

Answer 37

- Cross-price elasticity of demand - the responsiveness of the quantity demanded of one product to changes in price of another product - %ΔQDx / %ΔPy

Question 38

What type of products have a positive XED?

Answer 38

Substitutes

Question 39

What type of products have a negative XED?

Answer 39

Complements

Question 40

What type of products have an XED of 0?

Answer 40

Unrelated products

Question 41

What type of products have an XED of ♾️?

Answer 41

Extremely closely related products

Question 42

Why does price move in accordance with market forces?

Answer 42

To help allocate resource

Question 43

What are the 3 functions by which price helps to allocate resource?

Answer 43

1. Signal function - tells producers to increase quantity supplied 2. Incentive - price increases so that firms can increase profit so producers switch to that product 3. Rationing mechanism - price limits who can buy luxury items

Question 44

What happens if price is allowed to fulfil the functions to help allocate resource?

Answer 44

More efficient allocation of resource, at the cost of inequality, provision of harmful products, and pollution/ environmental destruction

Question 45

What is derived demand?

Answer 45

If the demand for a product increases, the demand for the resource used to make the product also increases (e.g. cars and steel)

Question 46

What is joint demand?

Answer 46

If the demand for a product increases, the demand for a complimentary product will also increase

Question 47

What is competitive demand?

Answer 47

If the demand for one product increases, the demand of a substitute will decrease

Question 48

What is composite demand?

Answer 48

If more of a product is sold, the supply of a product made of the same resource will decrease

Question 49

What is joint supply?

Answer 49

If the demand for a product increases, the supply of a by-product of this product will increase (e.g. beef and leather)