Market Equilibrium and Price Elasticity Flashcards
What is a price mechanism?
Is the process by which the forces of supply and demand interact to determine the market price at which goods and services are sold and the quantity produced.
What is the market equilibrium?
Certain price level the quantity supplied and the quantity demanded of a particular commodity are equal
What is equilibrium?
Is achieved in an individual market when any consumer who is willing to pay the market price for a good or service is satisfied and any producer who offers their goods or services at the market price is able to sell their products. It occurs in the quantity demanded is equal to the quantity supplied that is when the market clears.
When does market equilibrium occur?
- Quantity demanded = quantity supplied
- The market clears
- There is no tendency to change
What happens when the quantity supplied exceeds the quantity demanded?
The sellers will offer to sell at a lower price they’ll be an expansion in demand and a contraction in supply
What happens when the quantity demanded exceeds the quantity supplied?
The consumers will start bidding of the price and there will be an expansion in supply and a contraction in demand.
What causes a change in equilibrium?
A shift in demand or supply
Price elasticity of demand
Measures the responsiveness of the quantity demanded to change in price.
% change in QD (divided) by % change in price
Elastic Demand
Strong response to change in price
Unit elastic demand
Amount spent by consumers stays constant
Inelastic demand
Weak response to price change
Price elasticity of demand effect on business
- decide on the optimal pricing strategy
- whether or not the change the price
Price elasticity of demand effect on government
- Pricing goods/services for the community
- predict the effects of changes in any indirect taxes
- accurately estimate the amount of revenue
Outlay method and equation
Price up = Revenue up = inelastic
Price up = Revenue down = elastic
Price up = Revenue same = unit elastic
Price (x) demand
Perfectly Elastic Demand
Horizontal straight line
Consumers will demand infinite quantities at the same price
Perfectly inelastic Demand
Vertical straight line
Consumers are willing to pay any price in order to obtain a given quantity of a good or service.
Price Elasticity of Supply
Measures the responsiveness of quantity supplied to a change in price.
% change in QS (divided) by % change in price
What will happen if there is an increase in price?
There will be an expansion in the supply meaning for most goods the price elasticity of supply is positive
Elastic supply
Increase in QS is bigger than increase in price
Inelastic supply
Decrease in QS is less than a decrease in price
Unit Elastic supply
The increase in QS is the same portion
Inelastic supply
A decrease in quantity supplied is less than an decrease in price
Perfectly elastic supply
- Straight horizontal line
- Supply an infinite quantity of good
- Below the price the supplier will not be willing to supply anything
Perfectly inelastic supply
- Straight vertical line
- Quantity supplied is fixed regardless of price
- e.g. one of a kind
5 ways the price mechanism affect the market
- Solving the economic problem - product markerts
- Producing what consumers demand
- Factor markets
- Allocative efficiency
- Competition
Product market
Interaction of demand and supply for outputs of production
Why do governments intervene?
The market price for goods/services in product markets may be too high or too low
Therefore, the equilibrium quantity may also be too high to too low
Market failure
Occurs when the price mechanism takes into account private benefits and costs of production to consumers and producers, but it fails to take into account indirect costs / social costs
Process of market failure
Do not produce desired outcomes (because the price mechanism takes account of the private costs)
BUT NOT THE SOCIAL COST AND BENEFITS
Which then the government must intervene
What does price intervention always lead to?
- Markert disequilibrium
- Excess in demand or supply
- A distribution of income
Outline price ceiling
The maximum price that can be charged for a particular commodity - it is a price intervention
- Redistributes money from sellers to buyers
- The price of some items is too high
- Excess in demand
Outline price floor
The minimum price that can be charged for a particular commodity - it is a price intervention
-Redistributes money from buyers to sellers
- The price of some items is too low
- Excess in supply
Public goods
Are good that private firms are unwilling to supply, as they are not able to restrict usage and benefits to those willing to pay for the good. Because of this government should provide these goods.
Merit goods
are goods that are not produced in sufficient quantity by the private sector because private individuals do not play sufficient value on those goods that is they both positive externalities that I’m not fully enjoyed by the individual consumer. Merit goods include education and healthcare
Positive externalities
Individual consumers do not consider the social benefits this includes museums, public parks and transport - quantity intervention
Why might quantity be too high/low
Individual business firms and individual consumers do not consider the social costs/benefits of the production and consumption of certain goods/services - these are externalities
What is an externality?
Externalities are external costs and benefits that private agents in a market do not consider in their decision-making process.
What do and don’t markets consider?
Markets consider the economic and social concerns and individual sellers and buyers
Do not consider the side effects that are directly reflected in the price mechanism (fails to represent the social costs or benefits of production)
Example of a positive and negative externality
POSITIVE:
Cleaning up the plastic in an area as it benefits the whole public when visiting
NEGATIVE:
1. Loss of biodiversity because of land clearing from mining
2. Soil erosion and increase soil salinity because of forestry and farming practices
Outline a pure competition
Many firms, very small
Homogeneous product
No barriers to entry
Theoretical
Outline a Monopoly
One firm only, generally large
No close substitutes
Extremely high barriers to entry
Example water supply
Price setters
Opposite to pure market
Outline a Monopolistic competition
Many firms, relatively small
Differentiated products
Relatively easy entry
Example motels, restaurants
Outline an Oligoply
A few relatively large firms
Usually differentiated products
High barriers to entry
Examples are supermarkets, banks, oil companies, airlines
Are the four market structures are they perfectly imperfect
Pure competition – perfect
Oligopoly - imperfect
Monopolistic competition - imperfect
Monolpy - perfect
