Chapter 2- Price Determination In A Competitive Market

Question 1

Three functions of price?

Answer 1

…………………..:….if price increases
Rationing function- consumers are more rational
Incentive function- producers produce
More
Signalling function- entrepreneurs enter the market

Question 2

Define demand?

Answer 2

Demand is the amount that consumers are willing and able to buy at each given price level

Question 3

When is there an extension in demand?

Answer 3

An EXTENSION in demand arises when price falls

Question 4

When does a contraction in demand occur?

Answer 4

A contraction in demand is when there is an increase in price

Question 5

Study diagram

Answer 5

Study diagram in book on demand

Question 6

What are the determinants of demand?

Answer 6

• consumer tastes and preferences
• prices of substitutes
• prices of complementary goods
• change in income
• advertising and publicity
• change in population
• consumer confidence
• change in quality
• weather conditions
• the law
• uncertainty of future prices
• fashion
• interest rates

Question 7

Define substitute?

Answer 7

A substitute is a replacement for another product

Question 8

Define complementary goods?

Answer 8

Complementary goods are goods that are consumed together

Question 9

Define normal goods?

Answer 9

Normal goods are goods and services that will see an increase in demand when income rises

Question 10

Define composite demand?

Answer 10

Composite demand is when a good is demanded for more than one purpose so that an increase in demand for one purpose reduces the supply for the other purpose

*graph is like a ppf one see book for an example

Question 11

Define derived demand?

Answer 11

Derived demand is when the demand for one good or service comes from the demand for another good or service

Eg if u demand more electronics, u demand more labour(in china)

Question 12

Define price elasticity of demand?(PeD)

Answer 12

The responsiveness of quantity demanded to a change in the price of the good

Question 13

Formula for ped?

Answer 13

Ped= %🔺Qd/%🔺P

Question 14

What does it mean when Ped is above 1?

Answer 14

• If the number is above 1, the good has a PRICE ELASTIC DEMAND-> the bigger the number, the flatter the curve, the greater the elasticity
• A FALL in price means quantity demanded RISES by PROPORTIONATELY MORE THAN THE PRICE CUT
• A fall in price will lead to a increase in revenue because there will be a more than proportional change and so a big responsiveness
• STUDY DIAGRAMS IN BOOK

Question 15

What does it mean when Ped is between 0&1?

Answer 15

• between 0&1 means the good has price inelastic demand.
• when price falls, quantity demanded increases but by a SMALLER PROPORTION than the fall in price
• demand is relatively unresponsive to price changes
• when price falls, total revenue will FALL
• there are more customers, but each one paying a proportionally lower price and therefore overall revenue falls.

*study diagrams

Question 16

Factors that determine Ped?

Answer 16

• availability of substitutes-> more substitutes, more elastic
• time eg out at pub and want to hire a taxi - at 3pm elastic but at night inelastic
• whether the good is luxury (elastic but can be argued to be inelastic) or necessity (inelastic)
• proportion of income spent on a good > if its a cheap good eg freddos then inelastic
• habit forming products eg tobacco

Question 17

When is Ped

1) perfectly inelastic
2) perfectly elastic
3) unitary elastic

Answer 17

1) perfectly inelastic is when PeD=0. 🔝
2) perfectly elastic is when PeD=infinity➖

3) Unitary elastic is when PeD=1
- directly proportional. its significance is that the percentage rise/fall in price is the same as the percentage fall/rise in quantity demanded and so total revenue is the same at each price

Question 18

PeD - how will the revenue depend on the elasticity of demand?

Answer 18

If price falls

• If the product is inelastic, total revenue will decrease as its unresponsive and so quantity increases but BY A SMALLER PROPORTION than the FALL IN PRICE
• If the product is elastic, revenue will quantity demanded RISES BY PROPORTIONALLY MORE THAN THE PRICE CUT and so is responsive. Total Revenue will increase

If price rises
Inelastic- rise in TR
Elastic- fall in TR

Question 19

Define YeD - income elasticity of demand?

Answer 19

The responsiveness of quantity demanded to a change in income

Question 20

Yed formula?

Answer 20

YeD= %🔺Qd / %🔺income(Y)

Question 21

For what values of YeD is it a:

1) normal good
2) inferior good

Answer 21

If YeD is positive it’s a normal good

If YeD is negative it’s an inferior good

Question 22

For what values of Yed is the good:

1) necessity
2) luxury

Answer 22

Necessity 1>yed>-1 (near 0)

Luxury above 1 eg 20 = very elastic

Question 23

Define XPed- Cross Price Elasticity of Demand?

Answer 23

A measure of the responsiveness of quantity demanded of one good to a change in the price of another good

Question 24

Formula of XPed?

Answer 24

%🔺in QD of good A ➗%🔺in price of good B

Question 25

What does it mean when XPed is POSITIVE?

Answer 25

When Xped is positive, the good is a SUBSTITUTE. ``` +ve/+ve = if price of good B rises the demand of good A rises -ve/-ve = if price of good B decreases the demand of A decreases ``` Big +ve = strong substitute Small -ve = weak substitute

Question 26

What does it mean when XPed is NEGATIVE?

Answer 26

If XPed is negative, then the good is a COMPLEMENTARY product +ve/-ve= if the price of good B decreases, the demand for good A increases -ve/+ve= if the price of good B increases, the demand for good A decreases Big-ve = strong compliment Small -ve = weak compliments

Question 27

What does if mean when XPed is close to 0?

Answer 27

When XPed is close to 0 they are unrelated goods as there is 0 responsiveness * big numbers =elastic * small numbers= inelastic

Question 28

Define supply?

Answer 28

Supply is the amount offered for sale at each given price level

Question 29

When is there an extension and contraction in supply?

Answer 29

Extension in supply is when price INCREASES Contraction is when price DECREASES

Question 30

What are the determinants of supply?

Answer 30

1) Prices of raw materials 2) technological improvements 3) changes in labour productivity 4) Regulation and bureaucracy(law) 5) Wage rates 6) Subsidies 7) Indirect taxes 8) Expectations about future prices 9) objectives of firms 10) Number of sellers in the market 11) joint supply

Question 31

Define joint supply?

Answer 31

When one good is produced another good is also produced from the same raw materials Eg Beef and leather - anything with a by product

Question 32

Define Price Elasticity of supply (PeS)?

Answer 32

Measures the responsiveness of quantity supplied to changes in the price Formula = %🔺in QS/ %🔺in P *PeS is always going to be positive because as price increases firms produce more because they are profit maximising and they are rational(incentivising)

Question 33

For what values is PeS 1) perfectly inelastic 2) perfectly elastic 3) proportionally responsive

Answer 33

1) perfectly inelastic PeS=0🔝 2) perfectly elastic peS =infinity➖ 3) proportionally responsive PeS =1 /

Question 34

What factors affect the price elasticity of supply?

Answer 34

-time (more time, more elastic) - Raw materials need to be found, extracted, processed -availability of stocks or stock piling (if low and difficult to store- inelastic -the ease of switching between alternative production( if factors of production are easily moved from one production use to another then elastic if nit inelastic - availability of spare capacity (if there is unused capacity, PeS elastic. If producing at capacity, PeS inelastic - number of firms in the market and ease with which firms can enter a market(the easier,the flatter) - ability to alter production methods(technology) -

Question 35

Define equilibrium?

Answer 35

The price at which demand is equal to supply and there is no tendency to change

Question 36

Define disequilibrium?

Answer 36

- the price at which the market supply does not equal demand | - there is likely to be a further change or reaction by buyers or sellers

Question 37

Define excess supply?

Answer 37

Excess supply is when quantity supplied at a particular price is greater than quantity demanded

Question 38

Define minimum price?

Answer 38

A price floor below which the price of a good or service is not allowed to decrease Eg minimum wage

Question 39

Define excess demand?

Answer 39

When quantity demanded at a particular price is greater than quantity supplied

Question 40

Define maximum price?

Answer 40

A price ceiling above which the price of a good or service is not allowed to increase