Micro Flashcards
Non price determinants of demand
- Changes in Income
- demand forNormal goods increases
- demand for inferior goods decreases - Prices of Other goods (substitutes&complements)
- Tastes/Preferences
- Size of pop.
- Change in age structure
- Change in income distribution
- Change in government policy
Non price determinants of supply
- Costs of factors of productions
- State of Technology
- Expectations of future prices/demand
- Government Intervention
how do you calculate PED?
%change in quantity demanded of a product
————————divided by————————–
% change in price of the product
Range of values of PED
0 to NEGATIVE infinity
when is demand for a product deemed to price elastic?
when the change in the quantity demanded of a good is MORE THAN PROPORTIONAL TO the change in the price of a good.
(when PED is between -1 and negative infinity)
when is demand for a product deemed to price inelastic?
when the change in the quantity demanded of a good is LESS THAN PROPORTIONAL to the change in the price of a good.
(when PED is between0 and -1 )
Increasing the price of good whose demand is inelastic…..
……. leads to an increase in total revenue
Increasing the price of good whose demand is elastic…..
……. leads to a decrease in total revenue
Total revenue
Price of a product x quantity traded of a product
Determinants of PED
- Time period (D=more price elastic over longer time)
- Number and closeness of substitutes
- how widely a product is defined (e.g. bread & white bread)
- extent to which product is a necessary
how to measure XED?
%change in quantity demanded of product X
————————divided by————————–
% change in price of product Y
If XED is positive…………
…………. an indication that the goods are substitutes
If XED is negative…………
…………. an indication that the goods are complements
Demand is said to be cross INELASTIC……..
…………if the XED value is between -1 and 1
Demand is said to be cross ELASTIC……..
…………if the XED value if it is NOT between -1 and 1
What is the business relevance of XED?
- Allows a firm to predict the effect a change in price of another product from another firm will have on their own revenue
- Allows firms to set prices of their own products to effect demand of their other products allowing them to influence their own total revenue.
How do you calculate YED?
%change in quantity demanded of a product
————————divided by————————–
% change in consumer income
A product is deemed a NORMAL good if……..
……….the YED value is POSITIVE
A product is deemed an INFERIOR good if……..
……….the YED value is NEGATIVE
Demand for a product is deemed income inelastic if…………
……….the YED value is between 0 and 1
Demand for a product is deemed income elastic if…………
……….the YED value is greater than 1
Products with low but positive YED are called…….
…….necessity goods
What is the business relevance of YED estimates?
Indicate prospects for firms (effect of economic growth and recessions on revenue)
How do you calculate PES?
%change in quantity supplied of a product
————————divided by————————–
% change in price of the product
What is the range of PES values?
0 to +infinity
when is supply deemed perfectly price inelastic?
when the PES value = 0
when is supply deemed price inelastic?
When PES is between 0 and 1
when is supply deemed unit elastic?
When PES is 1
When is supply deemed elastic?
When PES is between 1 and infinity.
When is supply said to be perfectly price elastic?
when PES= infinity
Determinants of PES:
- Marginal Cost (relationship between output and cost)
- Time period considered (more time longer to increase capacity and therefore supply more price elastic)
- Ability to store stock (more able to store=more elastic)
Types of Market failure
- Lack of public goods
- Undersuply of merit goods and oversupply of demerit goods
- Existence of externalities
- Imperfect Information
- Imperfect Competition
How do you calculate MP?
Change in TP
——divided by———-
Change in V
How do you calculate AP?
TP
————————divided by————————–
V
How does imperfect competition lead to market failure ?
In imperfectly competitive markets there is either one firm or several large firms which have a degree of market power meaning they are able to restrict output below the equilibrium quantity by raising prices in the hope of increasing total revenue and profit.
Profit is maximised (aim of monopolists) at the point where marginal cost is equal to marginal benefit.
A monopolists marginal revenue falls twice as quickly as the price consumers are willing to pay as output increases.
Therefore monopolists restrict output to the point where MR is equal to S (MSC), meaning the price rises to the point at which that quantity meets the demand curve (MSB). This leads to market failure
Increasing returns to scale
Occurs when long run average costs (LRAC) is falling as output increases
This means that a % increase in all factors of production leads to a greater % increase in output therefore reducing LRAC
Constant returns to scale
When long run average costs are constant as output increases.
A % increase in all factrs of production leads to same % increase in output therefore LRAC remains same
Decreasing returns to scale
Occurs when LRAC is rising as output increases in all factors of production leads to smaller % increase in output.
Different economies of scale that may benefit a firm as it increases the scale of its output
1) specialisation
2) division of labour
3) bulk buying
4) financial economies
5) transport economies
6) larger machines
7) promotional economies
Problems with subsidy
1) difficult to measure the extent of m.f in order to determine correct size of subsidy
2) No guarantee that producers will use money to increase output (may use it to increase profit)
3) Opportunity cost of subsidy
4) Effectiveness depends on how price elastic D is
5) Effect on international markets (in particular the foreign markets in developing countries)
Different forms of internal diseconomies of scale
1) control & communication problems
2) alienation & loss of identity
Example of external economies of scale
Growth in one geographical area leads to a nearby educational institution starting courses related to the skills needed in the relevant industry meaning workers are being trained at mo extra cost to the firm therefore reducing the unit cost
Potential benefits of a monopoly (compared to a perfectly competitive market)
- Because they earn supernormal profit in the long run monopolists will have more funds available for R&D and a greater incentive to undertake research as the benefits of better research will only accrue to the monopolist (monopoly may therefore be more dynamically inefficient)
- There is no guarantee that MC in the industry under a monopolist will be equal to the MC in the industry under perfect competition (especially if there are economies of scale economies may be able to supply more output at a lower price)
when is productive efficiency achieved?
Occurs when average cost meets marginal cost
where is allocative efficiency achieved?
where Demand/average revenue equals marginal cost.
Where p= MC
Most efficient allocation of resources.
Linear demand function
Qd=a-bP
Linear supply function
Qs=c+dP
Aims of firms
- Profit maximisation
- Satisficing
- Growth maximisation
- Revenue maximisation
- Corporate social responsibility
where is profit maximised?
When marginal revenue is equal to marginal cost
-the point at which the difference between total revenue and total cost is maximised.
Assumptions of effect competition model
- Large number of consumers non of whom demand enough of the product to influence the price
- There is a large number of firms all of which are small relative to the size of the industry
- Firms produce homogenous products
- No barriers to entry or exit in the industry
- There is perfect information of the market among both consumers and producers
- There is perfect resource mobility
what do barriers to entry include?
Economies of scale
Brand loyalty
Legal barriers (eg intellectual property rights, nationalised industries)
Assumptions of oligopoly
- Industry dominated by small number of large firms
- High barriers to entry
- Interdependence between oligopolists important
Why is there allocative inefficiency in monopolistically competitive markets?
It is NOT because the firm’s ability to restrict output and increase price (like in monopoly).
It is because of consumers’ desires for variety.
Primary goal of a cartel
If cartel jointly agree output levels they can effectively act as a monopolist restricting output in the industry and charging high prices enabling them to earn supernormal profits.
Why is there an incentive for cartel members to cheat?
In a cartel the individual firm raises its profit at the expense of the other firms in the cartel.
Why is non-price competition between firms common in an oligopoly?
The threat of pice wars which could lead to less profit for all firms in the industry.
Examples of non-price competition:
- Sponsorship deals
- Advertising
- Special distribution features (e.g. free delivery)
- Use of Brand names to target different markets segments
Why is there price rigidity in oligopolistic industries in the absence of collusion?
Explained by kinked demand curve model.
This therefor leads to price rigidity for three reasons:
1. firms are afraid to raise prices above the current market price because other firms won’t and they will loose trade
2. firms are afraid to lower prices below current market point as they don’t want to enter price war
3. shape of MR means if MC was to rise MC might still equal
Wy is there a kinked demand curve?
- start on assumption firm only know one point on demand curve (the point they are on at the moment)
- if it raises its price above this point, it can assume that its competitors won’t and thus a lot of demand would be lost to competitors
- If the firm would lower its price then competitors would follow
- this leads to the formation of a kinked demand curve, which becomes more price elastic above the point ‘a’ and less price elastic below it.
- the MR curve will also mimic this as gradient of MR= 2x gradient of AR
- however MR curve will have vertical section at the level of output that correlates to point a on the AR curve.
Necessary condition for price discrimination to take place
- Producer must have some ability to set prices (some degree of market power)
- Consumers must have different price elasticities of demand for the same product
- Producer must be able to separate consumers and ensure resale of the product (for a higher price) does not occur
