Competitive markets and how they work Flashcards
Define producer surplus
The difference between the price a producer is willing to accept and the market price actually received
Define consumer surplus
The difference between what a consumer is willing to pay for a good or service and what they actually paid for it
A fall in the market price leads to…
An increase in consumer surplus
Define demand
The quantity of a good or service that consumers are willing and able to purchase at a given price over a specified period of time
What are the determinants of demand?
- Price of good or service
- Price of substitutes
- Prices of complements
- Disposable income and wealth
- Taste and fashion
In order to isolate the effect of just one determinant of demand, we can assume that…
All other determinants are constant (ceteris paribus)
What does the demand curve show?
The level of demand at each and every price
Why is the demand curve downwards sloping?
As the price falls, consumers become more willing and able to purchase the good or service
How would a change in the price affect demand?
If price falls, there is an extension of demand.
If price increases, there is a contraction of demand.
(known as the first law of demand)
How would a change in other determinants of demand affect demand?
A shift to right or left
What is supply?
The quantity of a good or service that producers are willing and able to sell at a given price over a specified period of time
What are the determinants of supply?
- The price of the good or service
- Changes in the costs of production
- Government policies: indirect taxes and subsidies
- Changes in technology
- The weather/climate
- Expectation of future prices and profits
What is a normal good?
A good with a positive income elasticity of demand
What is an inferior good?
A good for which an increase in income leads to a fall in demand
What is the formula for the price elasticity of demand?
% change in quantity demanded / % change in price
What does the PED measure?
It measures how responsive the quantity demanded of a product is to a change in it’s price
If PED is greater than 1..
It’s elastic
If PED is lower than 1..
It’s inelastic
When can demand be perfectly inelastic?
When PED = 0
- Demand is completely unresponsive to changes in price
- Demand curve would be parallel to the price axis
If PED is perfectly elastic..
The demand curve is parallel to the quantity axis
Define YED
The responsiveness of the quantity demanded to a change in income
How is the YED measured?
% change in quantity demanded / % change in income
The values of YED can be…
positive or negative
A good with a positive YED is called…
Normal
A good with a negative YED is called…
Inferior
What factors determine the PED?
S - Availability of substitutes
H - Whether the consumption of the good or service is habitual
I - The proportion of income spent on the good/service
T - The time available to change buying patterns
What are the limitations of the PED?
- Does not show actual cause and affect
- Data and statistics could be innacurate
- Hard to predict consumers behaviour
As income increases, demand for inferior goods…
decreases
Define XED
The responsiveness of the quantity demanded to a change in the price of another related good
How is the XED measured?
% change in the quantity demanded of good A / % change in price of good B
If the XED is positive..
The two products are subsitutes
If the XED is negative..
The two products are complementary
If two goods are substitutes, an increase in price of good B means the price of good A…
increases as well
If two goods are complementary, an increase in the price of good B will mean the demand for good A…
Falls
What does the size of the XED indicate?
The strength of the relationship between the two products
What elasticity of demand is used to measure taste and fashion?
none - there is no way of measuring this
What is PES?
Price elasticity of supply
Define PES
The responsiveness of the quantity supplied to a change in the price of the product
What is the formula for PES?
% change in Q supplied / % change in price
If PES is greater than 1..
It is elastic, and supply is highly responsive to a change in price
If PES is lower than 1..
It is inelastic, and supply is not very responsive to a change in price
If PES = 0, its…
perfectly inelastic, a change in price has no effect on the QS
Where is the equilibrium or market price set?
Where the demand curve intersects the supply
What is allocative efficiency?
Where consumer satisfaction is maximised
How does a market achieve allocative efficiency?
The market must function at the equilibrium position
