4.1.3 = S/D + PED,XED etc Flashcards
What is demand in a market?
The quantity of a good or service consumers are willing and able to buy at a given price in a given period of time.
Which way does the demand curve slope?
Down
Why is there an inverse relationship between price and quantity demanded?
1) The income effect - Ceteris paribus..As prices rise, the proportion of income required to purchase the good/service rises, decreasing the willingess and ability of the consumer to buy good/service…reducing Q demanded.
2) The substitution effect - Cetiris paribus..as prices rise, other goods and services become relatively cheaper, increasing their consumption and reeducing the willigness of consumers to pay higher prices.
What are non-price factors that shift the demand curve?
PASIFIC
Population - Increase in population, increase in willigness and ability of consumers to buy goods and services, increase demand, shifts right
Advertising - Positive advertising may result in more consumers willing and able to purchase the good at the same price, shifting demand right
Substitute goods price - If their price increases, competitiveness of this good increases, willigness and ability to consume the good increases, shifting D right.
Income - Income rises, willigness and ability to consume good increases, demand curve shifts right
Fashion - Changes in taste toward the consumption of the good
Interest Rates - Rates decrease, cost of borring decreases, cheaper for conusmer to borrow and spend, meaning the willigness and ability to consume goods that are typically bought on credit will increase
Complementary goods price - I.E Bread and butter. If price for one decreases then willigness to buy other increases AND ability increases due to increase in disposable income.
What is supply in a market?
The quantity of a good/service that producers are willing and able to produce at a given price in a given time period.
Which way does the supply curve slope?
Up
Why is there a direct relationship between price and quantity supplied?
Sellers like to make money, so as price rises, a seller will want to produce at a higher quantity to capititlise, therefore the supply increases.
What are the non-price factors that shift the supply curve?
Think PINTS in Weatherspoons are Cheap (PINTSWC)
Productivity - Labour productivity increases, there is an increase in output with no increase in cost, reducing cost of production, increasing firms willigness and ability to supply, shifting S right
Indirect tax - An expenditure tax that increases a firms costs of production. This reduces their willigness and ability to supply, shifting the supply curve left and up. The vertical distance between the two is the indirect tax.
Number of firms in the market - If these increase, the total supply increases, supply curve shifts right and down.
Technology - Improvements in tech will improve the productive efficiency of a company, reducing costs, increasing willigness and ability to supply, shifting supply right.
Subsidies - Money given to producers to reduce costs, increasing willigness and ability to supply, shifting supply right. The vertical distance between the two curves represents the subsidy.
Weather - Good weather can provide an increase in agricultural yield, increasing supply, shifiting right
Costs of factors of production - Rent, wages, raw material costs, transport costs, regulation, gas and electric. This decrease, willigness and ability to supply increases, shifting curve right.
What is the ‘price mechanism’?
The way in which price changes in response to changes in supply or demand, so that a new equilibrium position is reached.
What is ‘equilibrium’ in the price mechanism? What is another term for it? What does it show?
Where demand equals supply, AKA the ‘Market Clearing Price’.
It shows allocative efficiency, because the resources being used by firms to produce goods/services are perfectly following consumer demand.
What is the ‘price mechanism’ effective at doing?
At equilibrium, the price mechanism is most effective at efficiently allocating scarce resources to satisfy as many wants as possible and solving the basic economic problem.
What are the four functions of the price mechanism? What is their collective purpose?
Talk through an example of each.
The purpose of the four key functions of the price mechanism is to attain equilibrium.
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Allocate - Prices allocate scarce resources efficiently at equilibrium
*the resources being used by firms to prodce goods/services perfectly follow consumer demand.
Signal - Prices signal to producers the existence of shortages / surpluses in the market and the need for more/less resources
*if the producers price is above equilibrium, they will be signalled by full warehouse stores and perishing products, telling them there is excess supply, producers now know to reduce price toward equilibirum or lower output and shift supply right.
Inscentive - Prices provide inscentives for producers to change output to maxamise profits
*if the producers price is below equilibium, they will be signalled by long queues or sold out products, inscentivising them to raise prices, mitigate excess demand and maximise profits
*if above equlibrium, signal, inscentive to lower output
Ration - Prices ration scarce resources by encouraging or discouraging consumption
*higher prices ration demand by discouraging consumption
In a free market, why would a price above equilibrium not last?
NO DIAGRAM
1) Signal to producers that they have excess supply I.E empty tables at restaraunts. To clear this producers reduce price, signalling that there is excess supply and less resources needed in the market.
2) The lower price inscentivises producers to reduce output to make more profit, causing a contraction of supply.
3) The rationing function dictates that lower prices encourage greater consumption, an extension of demand.
4) With the contraction of supply and extension of demand, equilibrium is now met and there is an efficient allocation of resources.
In a free market, why would a price below equilibrium not last?
1) Producers find their products selling out quickly and many customers who are not able to purhcase their goods. To capitilise on this producers will raise prices, the rise in price signals that there is excess demand in the market.
2) The higher price and therefore higher profit margin inscentivises the producer to increase output in order to maximise profit, cuasing an extension of supply.
3) The increase in prices causes consumers to be less willing and able to purchase the good through the rationing function, causing a contraction in demand.
4) The extension of supply and contraction of demand causes the market to absorb the excess demand, returining prices to equilibrium where resources are being allocated efficiently and meeting consumer demand.
What happens to the price mechanism when demand shifts right?
When demand shifts right and price remains at P1, quantity demanded has increased to Q2 while supply remains at Q1, meaning there is excess demand.
1)Producers see excess demand through selling out quickly, long queues for products, customer orders not being filled etc. Producers then raise prices as a response to this.
2) The rise in price signals that there is excess demand.
3) Higher prices inscentivises firm to produce more, causing an extension of supply.
4) Through the rationing function of the price mechanism, higher prices cause consumers to buy less, causing a contraction in demand.
5) A higher price from P1 to P2 coupled with supply increase from Q1 to Q3 means the market finds a long term equilibirum without excess demand and there is now an efficient allocation of resources.
see flashcard for diagram
What happens to the price mechanism when demand shifts left?
When demand shifts left and prices remain at P1, quantity demanded has decreased from Q1 to Q3 while quantity supplied remains at Q1, meaning there is excess supply.
Then follow ASIR for excess supply, decrease in prices from P1 to p2, market returns to long term equilibrium and there is now an efficient allocation of resources.
see flashcard for diagram
What happens to the price mechanism when supply shifts right?
see flashcard for diagram
When supply shifts right and prices remain at P1, quantity supply has increased from Q1 to Q3 while demand at this price remains at Q1, meaning there is excess supply, shown in red.
ASIR -> Excess supply, too much stock, lower prices, signal to producers there is excess so they are inscentivised to produce less, this contracts supply, lower prices via rationing function disencourages consumption, contracting demand, price lowering to P2 coupled with contractions in supply and extensions in demand causes market to find new equilibrium at P2 Q2, creating the most efficient allocation of resources.
What happens to the price mechanism when supply shifts left?
see flashcard for diagram
When supply shifts left and price remains at P1, quantity demanded remains the same however quantity supplied has decreased to Q3, creating excess demand (in red).
ASIR -> Products selling out, long queue times, producers raise prices to clear this, rise in prices signals excess demand, producers are inscentivised to increase output to make profit, causing an extension of supply, via the rationing mechanism consumers are encouraged to spend less as prices are higher, contracting demand.
Price rising to P2, coupled with extension in supply from Q3 to Q2 and contraction in demand from Q1 to Q2 forms a new equilibirium without excess demand, an efficient allocation of resources.
What is PED?
Price Elasticity of Demand measures the responsiveness of quantity demanded given a change in price.
In simpler terms: how consumers react to a change in price.
What is the formula for PED?
% change in Q demanded / % change in price
How do you calculate a % change?
(change / original value) x 100
How is PED usually presented?
A single digit number, usually negative because of the inverse relationship between price and quantity, the minus sign is left unwritten.
What are the 5 different types of PED? What are they numerically? What do they mean? How are they presented on a graph?
Elastic - PED greater than 1, a certain % change in price will result in a greater % change in demanded. On a demand graph, this is less steep gradient, closer to horizontal, ofc sloping down.
Inelastic - PED less than 1, a certain % change in price will result in a lesser % change in quantity demanded. On a demand graph, this is a steep gradient, closer to vertical, ofc sloping down.
Perfectly elastic - PED = Infinity. Meaning any change in price will result in quantity demaned falling to 0. Consumers are willing to purchase all they can at this price, if price rises demand will decrease infinitly and if prices fall demand will increase infinitly. On a demand graph, this is a perfectly horizontal line.
Perfectly inelastic - PED = 0. Meaning any change in price will result in NO change in quantity demanded. On a demand graph, this is a perfectly vertical line.
Unit elastic - PED = 1. Any change in price will result in a proportionally equal change in demand. Price rises by 10%, demand will fall by 10%. A demand curve with unit PED throughout is like a drop in on a skateboard ramp.
