Competitive markets Flashcards
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Income effect
as price falls, the amount that consumers can buy with their income increases therefore demand increases
Substitution affect
Fall in price of one good means consumers will increase demand for cheaper good and reduce demand for more expensive good
Factors that cause shift in demand curve
- changes in taste and fashion
- changes to people’s real income (the amount of goods/services that a consumer can afford to purchase with their real income)
How changes in real income affect different types of goods
Normal goods - those which people demand more if their real income rises. YED>0
Inferior goods - those which people demand less of if their real income rises. YED<0
Luxury goods - more equal distribution causes demand for luxury goods to decrease - less rich people
Substitute goods
An increase in the price of one good will increase the demand for its substitutes. XED>0
Complementary goods
Often used together, in joint demand. If the price of one good increases, the demand for both goods decreases. XED<0
Derived demand
The demand for a good or a factor of production used in making another good or service
Composite demand
Some goods have more than one use e.g. oil can be used to make plastics or for fuel. This means changes in demand for fuel will lead to changes in demand curve for plastics
PED equation
%change in quantity demanded / %change in price
Elastic demand
PED > 1
Perfect elastic demand has PED +/- infinity; any increase in price means demand will fall to zero
Inelastic demand
0
Unit Elasticity of demand
PED = +/- 1
Good has unit elasticity if %change in price = % change in quantity demanded
Income elasticity of demand
YED = % change in quantity demanded of a good / % change in real income
Cross elasticity of demand
XED = % change in quantity demanded of good A / % change in price of good B
If two goods are substitutes, XED = Positive
If two goods are complementary, XED = Negative
Factors influencing price elasticity of demand
1) Substitutes - the more substitutes, the more elastic. Number of substitutes depends on how closely it’s defined
2) Type of good (or service) - essentials = inelastic. Non essentials = elastic
- Demands for goods that are habit forming are inelastic
- Demand for purchases that can’t be postponed are inelastic (e.g. emergency plumbing to fix a broken pipe)
- Demand for products with several uses (water) are inelastic
3) % of income spent on good - If high % of income, more elastic
4) Time - in LR, demand more elastic - easier to find alternatives
Factors that cause shift in supply curve
- changes to costs of production (e.g. raw materials, wages etc.)
- improvements in tech -> reduce costs of production -> increase supply
- increased productivity of a factor of production -> more output from a unit of the factor
- indirect taxes and subsidies -> taxes increase costs for producer
- > subsidies reduce cost
- changes to price of other goods
- number of suppliers
Price elasticity of supply
PES = % change in quantity supplied / % change in price
Elastic supply PES>1
Inelastic supply 0
Why is high PES important to firms?
Firms aim to respond quickly to changes in supply and demanded therefore need to make supply elastic
Measures to improve elasticity of supply: flexible working patterns, using new tech, having spare production capacity
Short run
time period when a firm’s capacity is fixed, and at least one factor of production is fixed
Long run
All factors of production are variable -> firm can increase capacity
Supply in SR and LR
SR: hard to switch between production of goods in short time therefore inelastic
LR: firms have longer to react to changes in supply and demand therefore more elastic
Factors that affect PES
- during periods of unemployment -> easier to attract new workers therefore elastic
- perishable goods (fruit and veg) can’t be stored for long therefore inelastic
- firms with high stock levels are able to increase supply quickly if they want therefore elastic
- industries with more mobile factors of production tend to be more elastic
Functions of the price mechanism
1) Acts as incentive to firms
2) Acts as signalling device e.g. change in price
3) Acts to ration scarce resources
Advantages of price mechanism
- resources allocated efficiently to satisfy consumers’ needs and wants
- can operate without cost of employing people to regulate
- consumers decide what is and isn’t produced by producers
- prices kept to min as resources used efficiently
Disadvantages of price mechanism
- inequality in wealth and income is likely
- underproduction of merit goods and over production of demerit goods as not all socially optimum level
- low skilled people will suffer unemployment or low wages
- public goods not produced
Consumer surplus
- the difference between the price that a consumer is willing to pay for a good or service and the price they actually pay
- the area below the demand curve and above the equilibrium point
Producer surplus
the difference between the price that a producer is willing to supply a good or service at and the price they actually receive for it
- the area above the supply curve and below the equilibrium price line
