B: Price Determination In A Competitive Market Flashcards
There is an ___ relationship between price and demand.
There is an INVERSE relationship between price and demand
Define Demand
Demand refers to the quantity of a good or service that consumers are willing and able to buy at given prices in a particular time period
How is ‘ceteris Paribus’ relevant when we discuss the demand schedule?
CETERIS PARIBUS is the assumption we make when we consider the law of demand (involving price). Here we are assuming all other possible determinants of demand are held constant
What is the econplusdal pneumonic for factors that shift demand?
PASIFIC
What are the terms in the mnemonic for factors that shift demand?
Population, Advertising, Substitute’s price, Income, Fashion/tastes, Interest rates, Complement’s price
What is a joint demand?
Complementary goods, demanded together
What are goods in competitive demand?
This is where one good can be used as an alternative to the other
What are goods in composite demand?
This is where goods are demanded for more than one distinct use so an increase in demand for one use means a decrease in supply for another use
What does it mean for goods to be in derived demand?
When a good or factor of production is necessary for the provision of another good/service.
What is the definition for price elasticity of supply?
Price elasticity of supply measures the responsiveness of the quantity supplied of a good or service to a change in price
What is the equation for PES?
PES = %change in Quantity Supplied / %change in price
What type of elasticity does barley have from this example:
A 20% increase in the price of barley leads to a 5% increase in quantity supplied.
PES = +5/+20 = +0.25
It has price INELASTIC supply because the change in price has led to a smaller percentage change in quantity supplied. The supply curve will be relatively steep (between 0 and 1)
What type of price elasticity of supply do carpets have in this example?
A 5% fall in the price of carpets leads to a 10% fall in quantity supplied.
PES = -10/-5 = +2.0
The change in price has led to a greater percentage change in quantity supplied. The supply curve will be relatively shallow (greater than 1)
What is unitary elastic supply?
When the PES is exactly one. A change in price leads to the exact same change in quantity supplied.
What is the acronym for the determinants of price elasticity of supply (and what each word stands for)?
P- production lag
S- stocks
S- spare capacity
S- substitutability of factors of production
T- time
How does Time affect the price elasticity of supply?
In the short run, supply is price inelastic whereas in the long run, supply is price elasticity. This is because in the Short run there is at least one fixed factor of production (land and capital) so it is difficult to expand supply. In the long run, all factors of production are variable so it easier to increase or decrease production.
How do production lags (how long it takes to expand supply) affect price elasticity of supply?
If it is difficult or time consuming to increase production, e.g. building a new oil refinery, then supply will tend to be more price inelastic?
How does the size of spare capacity determine the price elasticity of supply?
Firms with machinery, factory space or labour that is not fully utilised will be more able to expand production in the short run. Supply will therefore tend to be more price elastic.
How does the substitutability of factors of production affect price elasticity of supply?
If firms can easily adjust the way they use their factors of production such as capital and labour to respond to changes in firms, then supply will tend to be relatively price elastic. However, if a firm has highly specialised equipment and employees, then supply will tend to be relatively price inelastic.
How does the availability of stocks affect the price elasticity of supply of goods?
Firms with stocks of finished or partly finished goods will be able to respond relatively quickly to a price increase and so supply will tend to be more price elastic.
Define price elasticity of demand
A measure of the responsiveness of quantity demanded of a good to a change in its price.
What do we have to ignore in PED calculations and why?
The negative sign. Apart from a few cases, the value for PED is negative because of the inverse relationship between price and quantity demanded. In practice, we ignore the sign when presenting the results of calculations
What type of PED is this?
A 50% increase in the price of petrol leads to a 10% fall in quantity demanded.
PED = -10/+50 = - 0.2
Price inelastic demand since a change in price has led to a smaller percentage change in the quantity demanded
What type of PED is this?
10% reduction in price of cars leads to a 15% increase in quantity demanded
PED = -10/15 = -1.5
Price elastic demand because change in price has led to a larger percentage change in quantity demanded.
What type of PED is this?
An extremely small increase in the price of a product leads to the quantity demanded falling to zero
Perfectly elastic demand. The change in price has led to an infinitely large change in quantity demanded
If demand is price elastic, a reduction in price leads to ______ in total revenue
AN INCREASE
If demand is price inelastic, a price increase leads to _______ in total revenue
If demand is price inelastic, a price increase leads to AN INCREASE in total revenue
What is the mnemonic (and what each letter stands for) for the determinants of price elasticity of demand?
S - substitutes (close)
P - percentage of income
L - luxury or necessity
A - addiction (habit forming)
T- time period
How can percentage of income spent on the product be a determinant of PED?
If a product accounts for a relatively large percentage of a consumer’s income such as a new car, a change in price is most likely to have have a significant effect on disposable income. Opposite for less expensive products.
Define income elasticity of demand
A measure of the responsiveness of quantity demanded to a change in income
What type of goods have a negative income elasticity of demand and why?
Inferior goods. Because an increase in income has led to a fall in demand.
What type of YED is this and what type of good is this:
A 10% increase in real income leads to a 20% increase in demand for foreign holidays.
YED = 20/10= 2
Income elastic demand. The increase in real income has led to a greater percentage increase in demand. Income elastic products are often referred to as luxury goods.
What type of goods have income inelastic demand
Basic goods or necessities
Define Cross elasticity of demand
A measure of the responsiveness of demand for a product following a change in price of another product
What is the equation for XED ?
XED = percentage change in quantity demanded of A / percentage change in price of B
What do the signs mean for XED products?
If it is positive (S+) then they are substitutes
If it negative then they are complements
How do we know from the XED value whether we have strong complements or weak complements?
If they are complements, the value will be negative. If it is less than -1 (so bigger than one but with a negative in front of it), then they are strong complements
Define supply
The quantity of a good or service that firms plan to sell at given prices in a particular time period
What is the mnemonic for the things that shift a supply curve?
Population
Indirect taxes
No of firms
Technology
Subsidies
Weather
Costs of production
