4.1.3 Price Determination in a competitive market Flashcards
Define supply
Is the quantity of a good or service that a producer is willing and able to supply onto the market at a given price in a given time period
What is the basic law of supply and the reasonings for it
Is that as the price of a product rises businesses expand supply to the market
Profit motive
Production and costs
New entrants into the market
What is a supply curve
What does it represent
Shows the relationship between market price and how much a firm is willing and able to sell (shows marginal cost curve)
Represents minimum price firms would accept to produce quantity
Define marginal cost
The additional cost of producing one more unit of output
What does a supply curve represent
The quantity of goods and services that can be sold in current market conditions. A increase or decrease in the supply curve can change the price of output. Can change based on wants of people
What is the acronym for factors that can change supply
Productivity
Indirect taxes- inward shift of supply (tax to produce)
Number of firms in the market
Technology
Subsidies- outwards shift of supply (money granted by gov to keep price low)
Weather/natural disaster/war
Cost of production
Define Joint supply
Is where an increase/decrease in the supply of one good leads to an increase/decrease in the supply of a by product
E.g. contraction in the market of Lamb will reduce the supply of wool
Define Demand
The quantity of a good or service that purchasers are willing and able to buy at a given price in a given time period
What is the basic law of demand
Is that demand varies inversely with price - lower prices make products more affordable for customers
What is the formula for average revenue
Total revenue / output
What does a demand curve represent
Shows us the price we would need to sell at in order to sell different quantities of output
What are the factors that cause a change in the total demand at any price
Acronym
Population - higher population means more demand
Advertising : makes you think your wants are needs
Substitute goods (price of) : competitors pricing effect demand
Interest rates: cost of borrowing and reward for saving
Fashion and trends: based on time of year and social preferences
Income: higher incomes means more spending
Complementary goods: demand for one good can increase demand for another. E.g. cars and fuel
What can the demand curve also represent
Average revenue
Marginal utility
Define marginal utility
The change in satisfaction from consuming an extra unit
Define total utility
The total satisfaction from a given level of consumption
What effect will an increase in demand have on the demand curve
Will cause a rightwards shift
What effect will a decrease in demand have on the supply curve
Cause a leftwards shift
What are the social and emotional factors influencing demand
Social awareness - health risks of products
Social norms- changing normal behaviour
Social pressures- forced into buying products
Demand for products can have a strong emotional attachment
Define price determination
Where the forces of supply and demand are used to establish the general level of price for a good or service
What does the point where the supply curve and demand curve meet represent
The total welfare at current market conditions
The most allocative efficient level of output (the level which best meets the needs and wants of society)
The price determination and equilibrium
Define customer surplus
Where is it shown on the price determination graph
The additional benefit consumers gain from purchasing a good below the maximum price they would have been willing to pay for it.
Above the equilibrium point
Define producer surplus
Where is it shown on the price determination graph
The additional benefit producers gain from selling a good above the minimum price they would have been willing to sell it for
Below the equilibrium
Define the total welfare
The equal sum of both consumer surplus and producer surplus, both benefit from it
How would an increase in population change the price determination graph
An increase in demand
What would an increase of the cost of production of cars have on the price determination graph
The supply curve would decrease
What would an increase in the price of wheat (complementary good) and a decrease in subsidies for bread producers do to the price determination graph
A decrease in the supply curve
A decrease in demand curve
What would an increase in productivity of boats and a decrease in interest rates have on the price determination graph
A increase in the supply curve
A increase in the demand curve (people will not think saving is worth doing so will spend)
Define indirect tax
Imposed on producers and is sometimes passed on to the consumers as part of the price
What are the two examples of indirect tax
VAT(Value added tax) Excise duty(fixed amount e.g. £1 per bottle of wine)
How can the effect of indirect tax be seen on a s&d grapn
The vertical distance between the original supply amount and the supply amount with the effect of indirect tax.
What is tax incidence
The division of the tax burden between producers and consumers
Consumers benefit more than producers as it gives them an extra cost of production
Define a subsidy
Payments from the government to producers to reduce their costs. This is done to increase supply and therefore reduce the market equilibrium price
How can you identify the effect of a subsidy on a S&D graph
The vertical distance between the original supply amount and the supply with the effect of a subsidy
What is the incidence of a subsidy
Is who benefits from the effect of a subsidy. Usually producers and consumers equally benefit as market price goes down and producers do not decrease price by how much subsidies they get.
Define price elasticity of demand
Measures the responsiveness of demand after a change in the goods own price
What is the formula for price elasticity of demand
% change in quantity demanded / % change in price
What are price elastic demand graphs
How does the slope look
Measure quantity demanded in response to price change. For elastic goods to increase revenue reduce the price.
Is a flatter line
What are price inelastic demand graphs
How does the slope look
Shows that for inelastic goods to increase revenue the price must increase
Is a much steeper line
What is price elastic demand
Means that as the price increases for a product the demand decreases
What is price inelastic demand
Means that as price increases it does not have a big overall change on demand (e.g.cigarettes)
How can you tell whether a good is price elastic or price inelastic demand
Elastic price is greater than one
Inelastic price is less than one
+ and - do not matter
Calculate the Price elasticity demand when :
a) price of £1, quantity demanded of 100 units
b) price of £1.10, quantity demanded of 50 units
Is it elastic or inelastic
PED = %change in quantity demanded/ % change in price
£1 -> £1.10 = +10%
100 units -> 50 units = -50%
PED = -50/10 = -5
Means that it is elastic
Calculate the Price elasticity of demand when :
a) price = £10, QD =1000 units
b) price = £12 , QD = 900 units
Is it elastic or inelastic
PED = % change in QD / % change in price
Price £10 -> £12 = +20%
QD 1000 units -> 900 units = -10%
PED = -10% / 20% = -0.5
Means it is an inelastic good
Describe the relationship between price elasticity of demand and revenue
The price movement of an elastic good will cause the revenue to move in the opposite direction (increased price means decreased revenue)
The price movement of an inelastic good will cause the revenue to move in the same direction (increased price means increased demand)
What does perfectly inelastic demand mean
What does perfectly elastic demand mean
Can it happen
Perfectly inelastic is a straight vertical line on the graph which means any price change will not effect demand
Perfectly elastic is a straight horizontal line on the graph which means any price change will being demand down to 0
It is very rare for demand to be perfectly inelastic/elastic
Define Income elasticity of demand (YED)
Shows how responsive the demand for a product is to a change in real income
What is the formula for Income elasticity of demand (YED)
% change in quantity demanded / % change in real income
What is a normal good
What is its elasticity
Is a product where as income rises demand increases
It has a positive income elasticity
Its YED has to be greater than 0 to be a normal good
What is an inferior good
What is its elasticity
Where increased income leads to a fall in demand (supermarket beans)
Negative income elasticity
Its YED has to be less than 0 for it to be inferior
What does a normal good curve look like
It has a positive slope with a low gradient
Shows that as income goes up demand also goes up
What does a inferior good curve look like
Has a negative slope with a steep gradient
Shows how a increase in income reduces quantity
Calculate the Income elasticity of demand when :
a) income = £10,000, Qd = 2,000
b) income = £12,000, Qd= 3,000
Is it a normal good or an inferior good
YED = % change in Qd / % change in real income
Y 10,000 -> 12,000 = +20%
Qd 2000 -> 3000 = +50%
YED= 50/20 = 2.5
Is a normal good
Calculate the Income elasticity of demand when:
a) Y=£20000, Qd= 1000 units
b) Y=£30000, Qd= 500 units
YED = change in quantity demanded / change in real income
Y 20000 -> 30,000 = +50%
Qd 1000 -> 500 = -50%
YED = -50% / 50% = -1
Less than 1 so is an inferior good
What does effective demand mean
Where a person has a demand for a product and can afford it
Define Cross Price Elasticity of Demand (XED)
Measures the responsiveness to of demand for good x following a change in the price of good y
What is the formula for cross price elasticity of demand
% change in quantity demanded of Y / % change in price of x
Calculate the cross price elasticity of demand:
a) price of playstation = £250, Qd of xbox = 5 million units
b) price of playstation= £300, Qd of xbox = 6 million units
Is it an example of a substitute good or a complementary goods
XED = % change in demand of y / % change in price of x
XED = +20% / +20% = 1
Over 0 so is a substitute good
Calculate the cross price elasticity of demand:
a) price of games = £50, Qd of consoles = 4million units
b) price of games = £30, Qd of consoles = 5million units
Is it substitute or complementary
XED = % change in demand of Y / % change in price of x
Xed = 25% / -40% = - 0.625
Less than 0 so complementary good
How do you know whether cross price elasticity of demand is substitute or complementary
Substitute if over 0
Complementary if under 0
What are substitute goods
Products in competitive demand
An increase in price will increase demand for a competitors good
What are complementary goods
Are products in joint demand
A fall in price for one product will increase demand for another (e,g. Fall in price of xbox games will increase demand for Xbox consoles)
What are close substitutes
Have a strong positive cross price elasticity of demand
Small change in price causes a big change in consumer demand
Define price elasticity of supply (Pes)
Measures the relationship between change in quantity supplied and a change in price
What is the formula for price elasticity of supply
% change in quantity supplied / % change in price
What does elastic supply mean
What does inelastic supply mean
Output can be increased without a rise in cost
Its hard to change level of production
How can you tell whether the price elasticity of supply is elastic or inelastic
Greater than 1 is elastic
Less than 1 is inelastic
What does a elastic supply graph look like
Shows how a increase in market price will lead to a major increase in quantity supplied to the market
What does an inelastic supply graph look like
Shows how a Increase in market price will lead to a small increase in quantity supplied to the market
What are the 4 factors effecting price elasticity of supply
Spare production capacity (plenty of supply means output can be increased without a rise in costs)
Stocks of finished products (able to respond to change in demand)
Ease and cost of factor substitution/mobility (if capital and labour is mobile resources can be mobilised to supply extra output)
Time period and production speed (firm needs time to adjust production levels)
What factors could mean a firm has inelastic supply of demand
Does not have enough resources available
Factors substitution is not easily substitutable
Not enough finance available
Are products elastic or inelastic in the short run or long run
Products are elastic in the long run
Products are inelastic in the short run
Why do governments intervene in markets
Is done to combat market inequities and to promote economic fairness as well as maximising social welfare
What is minimum pricing
What do they do
Represents the minimum price a product can be sold for , imposed by the government
Is used to give producers a higher price to sell at or reduce the consumption of food
How can minimum pricing be seen on a graph
Is a straight line which reduces quantity demanded and increases quantity supplied by producers. Creates excess supply.
Increases producer surplus and decreases consumer surplus causing a net welfare loss
What is maximum pricing
Where the government put a regulation on the maximum price a good can be sold for
How can maximum pricing be seen on a graph for the housing market
Putting a maximum price on housing will reduce supply and will cause excess demand , causing inefficiency in the market.
Excess Demand
There will be an increase in consumer surplus and decrease in producer surplus.
What is unitary elastic demand
Where the PED is 1
What is composite demand
What is derived demand
When a good is demanded for more than one distinct use
When a good or factor of production is necessary for the provision of another good/service. E.g. increased demand for healthcare leads to an increased demand for nurses and doctors.
What are the determinants for the price elasticity of demand
Availability of close substitutes Percentage of income spent on the product Nature of the product (necessity or not) Broad or specific market Time period
Define joint demand
When a good is purchased alongside another good as it helps satisfy a need or want
E.g. milk and tea
