4.1.3 - Price determination in a competitive market Flashcards
Define Demand?
Is the quantity of a good or service that consumers are able and willing to buy at a given price during a period of time
What is the relationship between the price and demand?
- Demand varies with price
- If the price is lower the more affordable the good and so consumer demand increases.
What are the factors that affect demand?
- Price
- Fashion
- Scarcity
- Price of other goods
- Income
- Substitutes
- Compliments
- Availability of credits
- Population
What does PIRATES stand for?
Population
Income
Related goods
Advertising
Tastes and fashions
Expectations
Seassonals
These are factors affectin demand
What is effective demand?
when a consumers desires to buy a product is backed up by an ability to pay for it
What is latent demand?
Exists when there is willingness to purchase a good but where the consumer lacks the real purchasing power to be able to afford the product.
Its affected by persuasive advertising
What is derived demand ?
The demand for product x might be strongly linked to the demand for the related product y - giving rise to the idea of a derived demand
Give an example of derived demand?
The housing market- When construction of new homes rises so too does the demand for materials used in new properties as well a demand for labour.
What is complementary demand?
As the demand for mobile phone handsets increases so too does demand for phone calls
Why is the demand curve downwards sloping?
- Lower prices consumers can afford to purchase more with income
- Secondly, a fall in price makes one goodrelatively cheaper than a substitue.
- Thirdly, a fall in price means that the consumer derives more benefit per pound spent on the product.
What is utility?
The measure of satisfaction that we get from purchasing and consuming a good or service.
What is total utility?
The total satisfaction from a given level of consumption.
What is amrginal utility?
The change in satisfaction from consuming an extra unit
What is the diminidhing marginal utility in terms of the demand curve?
Beyond a certain point, marginal utility may start to fall (diminish)
If marginal utility is falling then the consumers will only be prepared to pay a lower price
If marginal utility is falling then consumers will only be prepared to pay a lower price.
- explains demand curve
What is seasonal demand?
Seasonality refers to the flunctuations in output and sales related to the seassonal of the year.
What are substitutes?
They are replacements for another product.
What are complements?
Complements are said to be in joint demand.
Eg Fish and Chips
If the price of complement good x rises it will cause a fall in demand for good x
For normal products what happens to demand when incomes rises?
More is demanded
What are inferior goods?
They are cheaper poorer quality substitutes for some other good.
What happens to demand when someone has an higher income?
A consumer can switch from the cheaper substitute to preferred alternative.
As a result, less of inferior product is demanded at higher level pf income
What is income elasticity of demand?
There is a strong link between income and demand.
Eg New cars
What are some exceptions to the law of demand?
- specdulative demand - buyers just aren’t interested in the satisfaction they might get.
What is composite demand?
Exists where goods have more than one use- an increase in the demand for one product leads to a fall in supply of the other
What is the elasticity theory look at?
The sensitivity of one variable in relationship to another.
What is the price elasticity of demand?
It measures the responsiveness of demand to a change in price.
How is PED calculated?
%chnage in quantity demanded / % change in price= PED
Explain the inverse relationship between price and demand?
- When price falls we expect to see an expansion in demand
- When price rises we expect to see a contraction in demand
- Therefore an inverse relationship between price and demand
(giving a negative value of PED each time) - We ignore the sign but focus on the coefficent of elasticity
If the PED coefficent is 0 the demand is ….
- Perfectly inelastic - demand does not change when price changes.
so a business can charge as high price as it wants to.
If the PED is between 0<1 the demand is…
Price inelastic- A firm should raise P. D will decrease but total revenue will increase
If PED= 1….
The demand is said to unit elastic
Increasing or decreasing price will lead to no change in total revenue
If PED> 1 …
Then demand responds more than proprtionatley to a change in price.
I.e Demand is elastic
A firm should lower price, demand will increase, but total revenue will increase.
Why is PED imporant for a business?
- The effect of a change in price on quantity demanded
- The effect of a change in price on total revenue.
What is cross elasticity of demand?
The responsiveness of a change in demand of one good x to a change in price of another good Y
What is the formulae for cross elasticity of demand?
% change in quantity demanded of good x / % change in price of good Y
What is income elasticity of demand?
Measure of the responsiveness of demand to a change in income
What is the formulae for income elasticity of demand?
% change in quantity demanded/% change in income
What type of income elasticity do normal goods have?
Positive income elasticity
What type of income elasticity do luxury goods have?
> +1
What type of income elasticity do necessaties have?
> 0 and <+1
What type of income elasticies do inferior goods have?
negative
What is the relationship between income elasticities and inferior goods?
- Inferior goods are those which see a fall in demand as income rises
- Eg ‘ The value options at supermarkets could be seen as inferior . As income increases, consumers switch to branded good’
- YED>0
The relationship between normal goods and income elasticity?
With normal goods demand increases as income increases YED>0
What is the relationship between luxury goods and income elasticity?
With luxury goods an increase in income causes an even bigger increase in demand.
YED>1
What is the coefficent for substitutes in cross elasticity of demand?
- Close substitutes have a strongly positive cross price elasticity of demand
What is the coefficent for complements in cross elasticity of demand?
- When there’s a strong complementary relationship, the cross elasticity will be highly negative.
- eg software games.
What is the coefficent for unrelated products in cross price elasticity ?
- Unrelated products have zero cross elasticity
What is the relationship between close substitutes and cross price elasticity?
A small rise in price of x causes large rise in demand for Y
What is the relationship between weak substitutes in cross elasticity
A large rise in price of s leads to small increase in demand for T
What is the relationship between close complements in cross elasticity?
A small fall in price of A causes a large rise in demand for B
What is the relationship between weak complements and cross elasticity?
A large drop in price of E causes only small rise in demand for F
What is the relationship between PED and firms total revenue?
When demand is elastic (price elasticity), price and total revenue have a negative relationship, meaning that price rises lead to lower total revenue
What are some factors influencing PED?
- necessity
- substitutes
- addictions or habits
-Proportion of income spent on good - Durability of good
- Peak and off peak demand
What is supply?
Supply is the quantity of a good or service that a producer is able and willing to supply at a givem price during a given period of time.
What does the supply curve show?
It shows the relationship between price and quantity supplied
What causes the upward sloping supply curve?
- If price increases it is more profitable for firms to supply the good so supply increases.
- High prices encourage new firmsn to enter the market because it seems profitable so supply increases.
- Therefore, with larger outputs of supply the incentive to rxpand production is presented therefore they need hgher prices to cover costs.
In perfect competition what is the supply curve also nown as>
The marginal cost curve (MC)
What DOES NOT shift the supply curve?
Price
What Mnemonic can help with recalling factors shifting the supply curve?
PINTSWC
What factors shift the supply curve?
Productivity
Indirect taxes
number of firms
technology
subsidies
weather
costs of production
(macro-supply curve can be shifted by exchnage rates)
What is PES?
It’s a measure of the responsiveness of supply to a change in price.
What is the PES formulae?
Measures the responsiveness of supply to a change in price.
What happens if supply is elastic?
Producers can increase their output without a rise in cost or a time period.
What happens if supply inelastic?
Firms find it hard to chnage their production in a given time period.
What is the formuale for PES?
%change in Quantity supplied/ % change in price
What is the coefficent for when Supply is Price elastic ?
PES is >1
what is the coefficent when supply is price inelastic?
<1
what is the coefficent when supply is perfectly inelastic?
0
What is the coefficent when supply is perfecly elastic?
Infinity
What factors influence PES?
- Time scale- In the short run supply is more inelastic but in long run is more price elastic.
- Spare capacity
- level of stocks
- How substitutable factors are
- Barriers to entry to the market
When is a market at equlibrium?
When price and output are stable and when there’ a balance in the market and supply is equal to demand .
What are the determinants of equlibrium?
- Supply and demand.
( Known as market forces)
What does disequlibrium mean?
- When suppply and demand are not equal the market is in disequilibrium
- eg when theres an excess supply or excess demand the market will be in disequilbrium
What would happen to excess supply if price is set above the equibrium?
- Supply will contract and price will reduce
What are the types of demand?
- Derived demand- This when the demand for one good is linked to the demand for a related good.
- Composite demand- When the good demanded has more than one use (E.g Milk)
- Joint demand - when goods are bought together such as a digital camera and a memory card
