4.1.3 price determination in a competitive market Flashcards
What is a market?
anywhere buyers and seller meet to exchange goods and services
competitive market
A market in which the large number of buyers and sellers possess good market information and can easily enter or leave the market.
equilibrium price
the price at which planned demand for a good or service exactly equals planned supply
supply
the quantity of a good or service that firms are willing and able to sell at given prices in a given period of time
demand
the quantity of a good or service that consumers are willing and able to buy at given prices in a given period of time
Market demand
the quantity of a good or service that all the consumers in a market are willing and able to buy at different market prices
normal good
a good for which the demand increases as income rises and decreases as income falls
inferior good
A good for which demand decreases as income rises and demand increases as income falls
Elasticity
the proportionate responsiveness of a second variable to an initial change in the first variable
price elasticity of demand
measures the extent to which the demand for a good changes in response to a change in the price of that good
income elasticity of demand
measures the extent to which the demand for a good changes in response to a change in income, it is calculated by dividing the percentage change in quantity demanded by the percentage change in income
cross elasticity of demand
Measures the extent to which the demand of a good changes in response to a change in the price of another; it is calculated by dividing the percentage change in quantity demanded of one good by the percentage change in the price of the other good
profit
Total revenue - total costs of production
total revenue
the money a firm receives from selling its output, calculated by multiplying the price by the quantity sold
price elasticity of supply
measures the extent to which the supply of a good changes in response to a change in the price of that good
Equilibrium
a state of rest or balance due to the equal action of opposing forces.
Where supply and demand meet
Disequilibrium
a situation in a market when there is excess supply or excess demand
excess supply
when firms wish to sell more than consumers wish to buy, with the price above the equilibrium price
excess demand
When consumers wish to buy more than firms wish to sell, with the price below the equilibrium price.
Joint supply
when one good is produced, another good is also produced from the same raw materials
Competing supply
when raw materials are used to produce one good they cannot be used to produce another good. If two goods can be produced by the same factors of production, the supplier must decide
Composite supply
Composite demand happens when goods or services have more than one use so that an increase in the demand for one product leads to a fall in supply of the other. E.g. milk which can be used for cheese, yoghurts, butter
complementary good
A good in joint demand, or a good which is demanded at the same time as the other good
substitute goods
a good in competing demand, namely a good which can be used in place of another good
Composite demand
Demand for a good which has more than one use
derived demand
Demand for a good which is an input into the production of another good
Law of Demand
As the price of a good falls, more is demanded (vice versa)
Extension in demand
An increase in quantity demanded as a result of a reduction in price (movement to the right on the curve)
Contraction in demand
decrease in quantity demanded due to a rise in price (movement to the left on the curve)
Determinants of demand
Population Advertisements Substitutes Income (disposable) Fashion Income tax Complements
Perfectly elastic demand
PED is usually negative as most goods follow the law of demand
- change in price>change in demand: INELASTIC (PED -1>x>0)
- change in price
elastic demand
An increase in price leads to a larger fall in demand which causes revenue to fall
Unit elasticity of demand
A good has unit elasticity when the % price change = the % demand change.
inelastic demand
PED is between 0 and 1. Price increase is more than the fall on demand therefore it is good for firms as they can make more revenue
Perfectly inelastic demand
A perfectly inelastic demand is a demand where the quantity demanded does not respond to price.
Perfectly elastic demand
PED is infinity. Any increase in price means demand will fall to zero. Consumers will buy all they can at a given price but will not pay higher. Any increase in price will mean 0 demand, any decrease will mean less profit
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YED normal
if the YED of a product is POSITIVE i.e. x>0, then the good is normal as demand rises as income rises.
YED inferior
If the YED of a product is NEGATIVE i.e. x<0, then the good is inferior as demand reduces as income rises.
Perfectly inelastic YED
Any change in income does not affect demand i.e. salt. If you got richer, why would you buy more salt than usual?
How to calculate PED?
% change in quantity demanded / % change in price
How to calculate YED?
% change in quantity demanded / % change in income
How to calculate XED?
% change in quantity demanded of good A / % change in price of good B
XED substitute
if the XED of some goods is POSITIVE then they are substitutes because an increase in the price of one leads to an increase in the demand of another.
XED complementary
If the XED of some goods is NEGATIVE then they are complementary because an increase in the price of one leads to a decrease in the demand of another
XED of zero?
Unrelated goods, i.e. changes in the price of bananas has no relation to change of demand for slippers
Law of supply
as price increases, quantity supplied increases
Determinants of supply
Costs of production Technology Indirect taxes Subsidies Exchange rates Price of other goods No. Of suppliers
How to calculate PES?
% change in quantity supplied / % change in price
PES elastic
PES>1. Means producers can increase output without arising costs/ a time delay
PES perfectly elastic
PES=infinity. Fall in price causes supply to fall to zero as firm is already selling at lowest possible price
PES Unit elastic
PES=1. change in supply=change in price
PES inelastic
between 0 and 1. Increase in supply is less than increase in price
PES: Perfectly inelastic supply
change in price does not lead to a. change in supply because it is fixed e.g. auction goods
Factors affecting PES
Time taken to expand supply (length of production process) Size of spare capacity Availability of stock Ease of Switching production # of firms in the market
