How Markets Work Flashcards
What is the main objective of consumers when making economic decisions?
to maximise utility
What is the main objective of producers when making economic decisions?
to maximise profit
What is meant by effective demand?
demand backed up by an ability to pay
Main determinants of the demand function
price, income, tastes and preferences, prices of other goods
What does a point on the demand curve show
the quantity of a good that will be bought at that price
What would cause a movement along the demand curve?
a change in the price of a product itself is the only thing that causes movement along the curve
What would cause a shift in the demand curve?
a change in the conditions of demand would cause a shift. this means more or less of a good is bought at every price level
Define price elasticity of demand (PED)
PED measures the responsiveness of demand to a change in price —› % change in QD / % change in P
Define income elasticity of demand (YED)
YED measures the responsiveness of demand to a change in income —› % change in QD / % change in Y
Define cross-elasticity of demand (XED)
XED measures the responsiveness of demand to a change in the price of another good —› % change in QD of good A / % change in P of good B
Define a normal good
a normal good is one where demand increases if income increases —› positive YED
Define an inferior good
an inferior good is one where demand decreases if income increases —› negative YED
Define substitute
a substitute is a good which is alternative to another good —› positive XED
Define complement
a complement is a good which is used with, or purchased at the same time as another good —› negative XED
How to calculate percentage change?
(new - old) / old x 100
Range of values for price elasticity of demand
0= perfectly inelastic
0- -1= inelastic
-1- -infinity= elastic
-infinity= perfectly elastic
Price elasticity of demand formula:
% change in QD / % change in P
Income elasticity of demand formula:
% change in QD / % change in Y
Cross-price elasticity of demand formula:
% change in QD of good A / % change in P of good B
Factors affecting the price elasticity of demand for a good
- Availability of substitutes— many close substitutes means PED will be more elastic as consumers can easily switch to an alternative if price rises
- Necessity or luxury— PED is inelastic when a good is a necessity and is more elastic when it’s a luxury
- Proportion of income— is the proportion of income sent is high then PED is more elastic as a price rise will have more of an affect on a persons budget
- Time— the longer the time period, the more elastic PED will be as it takes consumers time to change buying habits
Demand is inelastic and price increases, what is the affect on revenue?
revenue increases:
inelastic=> PED= 0 to -1
QD will fall by less (%) than the (%) price increase
Demand is inelastic and price falls, what is the affect on revenue?
revenue decreases:
inelastic=> PED= 0 to -1
QD will rise by less (%) than the (%) price decrease
Demand is elastic and price increases, what is the affect on revenue?
revenue decreases:
elastic=> PED= -1 to -infinity
QD will fall by more (%) than the (%) price increase
Demand is elastic and price falls, what is the affect on revenue?
revenue increases:
elastic=> PED= -1 to -infinity
QD will rise by more (%) than the (%) price fall
What are the determinants of supply (the supply function)?
Price Costs of production (land, labour, capital, enterprise) weather natural disasters technology
What does a point on the supply curve show?
how much of a good will be produced at that price level
What would cause a movement along a supply curve?
a change in the price of the good
What would cause a shift in the supply curve?
a change in the conditions of supply
e.g. technology, natural disaster
Define price elasticity of supply (PES)
PES measures the responsiveness of supply to a change in price
Range of values for price elasticity of supply
0= perfectly inelastic supply
0 to 1= inelastic supply
1 to infinity= elastic supply
infinity= perfectly elastic supply
Formula for price elasticity of supply:
% change in QS / % change in P
Factors affecting the price elasticity of supply for a good
- Availability of producer substitutes— the more producer substitutes (what a producer could produce instead of what they’re producing), the more elastic supply is
- Spare capacity— measures the degree to which the factors of production employed are working at max output, the more spare capacity the more elastic supply is
- Ability to store/stock pile— if a good can be stored without perishing then stock piles can be made and as price increases, stocks are released, storing means supply is more elastic
- Time— the longer the time period, the more able supply is to respond to a change in price and so the more elastic supply is
What is meant by ‘equilibrium’?
where supply=demand
it is a steady state where there is no tendency to change, unless there is an exogenous shock that pushes the market out of equilibrium
What is meant by the market clearing price?
this is the price at which the quantity supplied equals the quantity demanded
Adam Smith => called this the invisible hand of market forces:
excess supply causes price to drop until market clearing price is reached
excess demand causes price to rise^
What affect does a new supplier entering the market have in a competitive market?
a new supplier would increase supply in a market and ma cause price to fall
What is joint demand or complimentary goods?
goods which are consumed together
e.g. razors and shaving foam
What is the impact on two complimentary goods if there is an increase in market price of one of the goods?
an increase in the market price of one good will cause a fall in its demand resulting in the demand for the other also falling
