E - 3) Price determination in a competitive market Flashcards
What is effective demand?
Demand supported by intention and ability to buy
What is latent demand?
Willingness to buy, but not yet ability to buy
What is joint/complimentary demand?
Demand for one good is closely linked to the demand for another - two or more goods that go well together
What is derived demand?
When demand for one product drives the demand for another
What is composite demand?
Good is demanded for more than one use
What is individual demand?
A consumer’s demand for a good or service
What is market demand?
All consumers’ demands in the market summed together
What are the types of movement along the demand curve and why do they occur?
- Extension: movement to the right - quantity demanded increases due to a fall in price
- Contraction: movement to the left - quantity demanded decreases due to a rise in price
What is ceteris paribus?
- All other influencing factors are held constant
What factors cause shifts in demand?
Changes in:
- Tastes/preferences
- Incomes
- Prices of related goods (complements and substititues)
- Size and structure of population
- Interest rates
- Law
- Expectations
Why does the demand curve slope downwards?
- Substitution effect - consumers substitute in favour of the good that becomes relatively cheaper
- Real income effect - if the price falls, the consumer will gain purchasing power. This extra ‘income’ available for spending can be used to buy more of the good
Why might consumers be irrational in terms of demand?
- Bounded rationality and bounded self-control
- Biases in decision making - rules of thumb, anchoring, availability, social norms
- The importance of altruism and perceptions of fairness
- Choice architecture and framing
- Nudges
- Default choices, restricted choice and mandated choice
What is price elasticity of demand (PED) and its formula?
- The responsiveness of quantity demanded of a good, to a change in its price
- PED = %∆ quantity demanded ÷ %∆ price
Why is PED negative?
Because the quantity demanded is inversely related to the price
What are the types of PED, and their values and gradients?
- Perfectly inelastic: PED = 0 | Gradient = vertical
- Inelastic: PED = 0 <—> -1 | Gradient = steep
- Unitary: PED = -1 | Gradient = diagonal
- Elastic: PED = -1 <—> -∞ | Gradient = shallow
- Perfectly elastic: PED = -∞ | Gradient = horizontal
What is PED like along straight-line demand curves?
- NOT the gradient of the curve
- Varies all the way along the curve
- = -1 at mid-point of curve
- Inelastic at low prices
- Elastic at high prices
What factors affect PED?
- Availability of close substitutes
- Cost of switching suppliers
- Breadth of product definition
- Degree of necessity
- Time frame when making choice
- Brand loyalty
- Percentage of income spent on product
- Habitual demand
What are uses of PED?
- Determination of pricing policy / impact on revenue
- Indication of competition faced (number and closeness of substitutes)
- Price setting in price discrimination
- Government decision on which goods to tax indirectly
What is income elasticity of demand (YED) and its formula?
- The responsiveness of demand for a good, to a change in income
- YED = %∆ demand ÷ %∆ income
What types of goods have positive and negative YEDs?
- Positive YED: normal goods - when income rises, quantity demanded increases
- Negative YED: inferior goods - when income rises, quantity demanded decreases
What are the types of goods and their values of YED?
- Inferior goods: -∞ <—> 0
- Necessity (normal) goods: 0 <—> 1
- Luxury (normal) goods: 1 <—> ∞
What are normal and inferior goods with examples?
Normal goods:
- Products or services for which demand increases as consumer income rises
- When people’s incomes go up, they tend to buy more of these goods
- Examples: restaurant meals, holidays, higher-end electronics
Inferior goods:
- Products or services for which demand decreases as consumer income rises
- When people’s incomes increase, they typically buy less of these goods and may shift to higher-quality alternatives
- Examples: lower-quality or generic foods, used or older-model cars, certain low-cost generic products
What are uses of YED?
- Visualising effect of recession / growth on demand
- Business planning for product range
- Helps firms anticipate future demand
What is cross elasticity of demand and its formula?
- The responsiveness of demand for a good, to a change in the price of a related good
- XED = %∆ demand for good A ÷ %∆ price of good B
What types of goods have positive and negative XEDs?
- Positive XED: substitute goods - when price of good B rises, demand for good A increases (and vice versa)
- Negative XED: complementary goods - when price of good B rises, demand for good A decreases (and vice versa)
What are subsititues and complements with an example?
- Substitutes: goods that can be used in place of each other to satisfy a similar need or desire. Example: tea and coffee
- Complements: goods that are typically consumed or used together because they enhance each other’s value. Example: tennis rackets and tennis balls
What are uses of XED?
- Marketing strategies like selling complements together / in bundles
- If a competitor changes its price, firms can work out the effect on their demand
What is joint supply?
Two or more goods that derive from a single production process - a change in the supply of one good leads to a change in the supply of a by-product
What is individual supply and market supply?
Individual: a singular producer’s supply of a good/service
Market: all producers’ supplies to the market summed together
What are the types of movement along the supply curve and why do they occur?
- Extension: movement to the right - quantity supplied increases due to a rise in price
- Contraction: movement to the left - quantity supplied decreases due to a fall in price
Why does the supply curve slope upwards?
- Higher market prices motivate firms to supply more as they expect more profit.
- Producing more increases the marginal cost of production so firms need higher prices to cover these costs (Law of Diminishing Returns)
What factors cause shifts in supply?
Changes in:
- Costs of production
- Production technology
- Weather/climate
- Events (e.g. strikes, pandemics)
- Indirect taxes
- Producer subsidies
- Price of substitutes in production
- Number of firms supplying to the market
What is the market?
Created by the interaction of buyers (demand) and sellers (suplly)
What is price elasticity of supply (PES) and its formula?
- The responsiveness of quantity supplied of a good, to a change in its price
- PES = %∆ quantity supplied ÷ %∆ price
What are the types of PES, and their values and gradients?
- Perfectly inelastic: PES = 0 | Gradient = vertical
- Inelastic: PES = 0 <—> 1 | Gradient = steep
- Unitary: PES = 1 | Gradient = diagonal
- Elastic: PES = 1 <—> ∞ | Gradient = shallow
- Perfectly elastic: PES = ∞ | Gradient = horizontal
What factors affect PES?
- Time period
- Bottlenecks in supply
- Breakdowns in supply chains
- Spare capacity
- Stock levels
- Availability of producer substitutes
- Ease of entry into the market
How do substitutes work in interrelated markets?
If supply of a good shifts left, this increases the market price, so the demand for a substitute will shift to the right (and vice versa)
How do complements and joint deamand work in interrelated markets?
If the supply of a good shifts right, this decreases its market price, which will cause demand for the complement to shift right (and vice versa)
How does composite deamand work in interrelated markets?
If the demand for a good increases, the quantity increases, this causes supply to shift left in the market for the good that is in composite demand (and vice versa)
How does joint supply work in interrelated markets?
If the demand for a good decreases (left shift), then the market equilibrium quantity falls, so the supply of a good in joint supply will decrease (shift left) (and vice versa)
How does derived demand work in interrelated markets?
If the demand for a final good increases, then the demand for the factors of production used to produce it will also increase (and vice versa)
