Demand, supply and the market Flashcards
What are demand + supply used to do?
analyse the determinants of the price and quantity of an individual good or service
What is an endogenous variable?
where the value is determined WITHIN the model
2 key ones = the price and quantity of a good or service
What is an exogenous variable?
where the value is determined OUTSIDE the model
these are factors that cause a shift in the demand or supply curve
What happens if real income increases?
people have more to spend
If real income INCREASES, what happens to the demand curve?
the demand curve shifts to the right
↑ causes shift to →
↑→ right angle for RIGHT
If real income DECREASES, what happens to the demand curve?
the demand curve shifts to the left
↓ ←
What are complements?
goods that feed off each other
eg car and petrol
you can’t drive a car with out petrol
if price of petrol ↑, less people would buy cars
the demand curve for cars would shift inwards
What movement does ENDOGENOUS factors always cause?
a movement up or down the demand or supply curve
movement ALONG
What movement does EXOGENOUS factors always cause?
the demand or supply curve to shift inwards or outwards
shifting of the demand or supply curve
How do you describe the demand curve?
D for downward sloping
What is on the y axis (vertical axis) of the demand/supply curve?
price
What is on the x axis (horizontal axis) of the demand/supply curve?
quantity
Why is the demand curve downward sloping?
bc if you lower the price of the good, then more of the good is demanded
this is bc when the price is cheaper, existing consumers consume as well as new consumers
What does the demand curve represent?
planned purchases (not what actually happens)
What are key assumptions of the demand curve? (3)
1) no single consumer is able to influence the market price
2) there is an infinite number of consumers and producers in the market
3)all other influences on demand are assumed to be constant apart from the quantity and the price
What does the assumption that no single consumer is able to influence the market price mean?
consumers have to take prices as given, they’re only able to choose the quantity of goods that they’re willing to purchase
How would you describe the supply curve?
Upward sloping
this tells us that as the price of the good increases, the quantity supplied of the good increases
Why is a company likely to supply more if the price of a good increases?
because they have a chance to make a higher profit
What does the supply curve represent?
the willingness to supply of sellers at each possible price
What are the key assumptions of the supply curve?
sellers are price takers
(no single seller is able to influence the market price, sellers are only able to choose quantity)
Is the assumption that sellers are price takers realistic?
no
the real world is more complex than the simplified one that this model suggests
in the real world there are many markets where only a handful of suppliers exert a huge pressure on prices eg single water supply
What is the demand supply model a simplification of?
a complex world
What is achieved at the point of intersection between the demand and supply curve?
market equilibrium
What does the equilibrium point act as?
a centre for gravity for market prices
What do Comparative Statics involve?
comparing the equilibrium price and quantity before and after a change to the market
With Comparative Statics, what do we examine? (2)
1)the comparative statics of a shift in the demand and supply curves
2)how the slope of the demand/supply curve affects the equilibrium price + quantity that emerges after the change to the market
What does a steeper supply curve mean?
higher price rise and smaller increase in quantity
bc price is on y axis
What does a flatter supply curve mean?
lower price rise and bigger increase in quantity
bc quantity is on x axis
What does the extent to which the price and quantity depend on?
the slope of the demand or supply curve
What does a steeper DEMAND curve mean?
bigger price drop and smaller increase in quantity
bc downward sloping
What does a flatter DEMAND curve mean?
smaller price drop and bigger increase in quantity
What does consumer surplus mean?
the difference between the price that the consumers are willing to pay and the price that they actually pay
(price consumers pay - price willing to pay)
What does producer surplus mean?
the difference between the price sellers are willing to sell for and the price they actually receive
(price sellers receive - price willing to sell for)
What is the total gain from trading in the market?
CS + PS
(Consumer Surplus + Producer Surplus)
What is the term elasticity used to refer to?
the steepness or flatness of either the demand or supply curve
What is the demand called when the demand curve is STEEP?
inelastic
steep can’t be stretched so is inelastic
What is the demand called when demand curve relatively FLAT?
elastic
flat so can be stretched so elastic
When is demand inelastic?
when the demand curve is steep
When is demand elastic?
when the demand curve is relatively flat
What does the own price elasticity of demand measure?
how sensitive consumers are to a change in the price of the good
If consumers are highly sensitive to a change in the price then what is the demand?
elastic
really sad so stretch themselves to feel better
What happens if consumers are highly sensitive to a change in the price eg demand is price elastic?
consumers will drastically alter their planned purchases
If consumers are insensitive to price change then what is the demand?
inelastic
don’t care so don’t stretch
What happens when consumers are insensitive to price changes?
they will not alter their planned purchases by much
What is the equation for the value of elasticity?
% change in quantity demanded / % change in price
OR
proportionate change in demand / proportionate change in price
If the elasticity value > 1, what is the demand?
ELASTIC eg package holidays
(bigger value so has to stretch to fit so elastic)
If the elasticity value < 1, what is the demand?
INELASTIC eg wheat
(smaller value so doesn’t need to stretch to fit in)
What are goods with INELASTIC demand called and why?
necessities (eg wheat or rice)
bc if price of wheat increased, you wouldn’t change your entire diet, can’t change this overnight
however in long term, people will shift diet to non-wheat products, so demand curve becomes elastic (altering)
–> short term demand curve = inelastic
long term demand curve = elastic
What are goods with ELASTIC demand called and why?
luxuries eg package holidays
if package holiday price increases, people will decide to organise trip themselves
–> dramatic drop in quantity demanded of package holidays
In the long-run what is demand likely to be and why?
elastic because consumers have had more time to process price change + adjust their expenditures accordingly
What is the Marginal Revenue firm of a curve?
the additional extra revenue that it gets from selling an additional unit of it’s good or service
What do you have to do if you want to sell more as a firm?
lower your prices
you have to lower it on extra units you sells AND on pre-existing units
Why is the Marginal Revenue Curve < market demand curve?
bc you have to lower your price to sell additional units
When demand is elastic, what is the marginal revenue?
Positive
bc high elasticity of demands means that lowering the price a little bit will increase the demand considerably
When demand is inelastic, what is the marginal revenue?
negative
At the point on the graph when the price =0, what is the demand?
the demand will be unitary elastic
(it will exactly equal 1)
What happens if the demand for cough medicine is price ELASTIC and you decrease the price?
the revenue from new sales will be greater than the fall in existing sales
What happens if the demand for cough medicine is INELASTIC and you decrease the price?
new sales revenue < the fall in existing sales
What happens if the demand for cough medicine is UNIT ELASTIC and you decrease the price?
the increase in revenue from new sales will exactly offset the drop in revenue from existing sales
What does the cross price elasticity of demand measure?
the responsiveness of the quantity demanded of a good (i) to a change in the price of good (j)
what is the formula for the cross price elasticity of demand?
% change in quantity demanded of good i/ % change in the price of good j
what does the sign of cross price elasticity depend on?
whether goods (i) and (j) are substitutes or complements
What is the sign of cross price elasticity if goods (i) and (j) are SUBSTITUTES?
positive
because having subs on the bench is positive in case players are injured
What is the sign of cross price elasticity if goods (i) and (j) are COMPLEMENTS?
negative
bc getting complements about your shoes is bad
What is the formula for the Income Elasticity of Demand?
% change in quantity demanded of a good / % change in consumer income
What does the size/sign of income elasticity depend on?
whether the good or service is classified as being ‘normal’, ‘inferior’ or ‘luxury’
If a good is classified as ‘normal’, what elasticity does it have?
elasticity > 0
bc it is normal to be > 0
If a good is classified as ‘inferior’, what elasticity does it have?
elasticity < 0
bc if you’re inferior, you’re not important so lowest of low, less than 0
If a good is classified as ‘luxury’, what elasticity does it have?
elasticity > 1
bc luxuries are rated more than 1 star so has to be > 1
What are organic eggs an example of?
NORMAL GOODS
–> so have positive income elasticity demand
bc if you increase consumers’ income, they’re likely to increase their consumption of organic eggs
What are cheap frozen meals an example of?
inferior goods
–> have negative income elastic demand
bc when consumer’s income increases, they shift consumption from frozen meals to fresh ingredients
What are restaurant meals an example of?
luxury good
–> have positive/very high income of elasticity + demand
bc consume more luxury goods when income increases
What are the steps to visually show inelastic demand? (4)
1) draw steep demand curve (downward sloping)
2) look at Po (initial price) and Qo (initial quantity demanded)
3) increase the price by a large amount to get (P1)
4) find from the demand curve (drawing dotted curves) that the decrease in quantity (Q1) is not that much bc people don’t alter
What has to be satisfied to show that a good has highly inelastic demand?
|P1 - Po| > |Q1 - Qo|
absolute value of the change in price > the absolute value of the change in quantity
What does the law of demand state?
if the price of a good increases, quantity demanded decreases
What would the elasticity tell us?
how much we can expect the quantity demanded to decrease by
What has to be satisfied for a good to have highly ELASTIC demand?
|P1 - Po| < |Q1 - Qo|
less than bc elastic = flat slope
absolute value of the change in price < the absolute value of the change in quantity
What are the steps for drawing ELASTIC demand?
1) draw flat demand curve
2) look at Po and Qo
3) increase price by small amount to get P1
4) find from demand curve (drawing dotted lines) that decrease in quantity (Q1) is a big increase bc people drastically alter
