Price determination Flashcards
What is a demand curve
a curve showing how much of a good customers are willing to buy at each and every price level
What relationship does a demand curve show
the relationship between price and quantity demanded
What does a shift in the demand curve mean
Change in price
What is the relationship between price and quality demanded
- As price falls, quality demanded rises
- As price rises, quantity demanded falls
(negative correlation)
What are the determinants of demand
-Price
-Consumer income
-Prices of other goods/services
-Consumer tastes and fashion
-other factors eg advertising
What does ceteris paribus mean
All other factors are the same- so often assume ‘ceteris paribus’ as many factors are uncontrollable
What is a normal good
- A good that when price increases demand decreases and vice versa
What is a Veblen good
- A luxury item that when price increases so does demand- ‘snob effect’- people will pay more to show status
What is a Giffen good
- A basic good that when price increases, so does demand as it means alternatives are unaffordable
Example of Giffen good
- Bread- a rise in price in bread means poor families cannot afford other products such as meat anymore, and so spend MORE of their income on bread
What is an inferior good
- One where demand decreases as income increase ( eg Giffen goods)
What happens to demand of a good if price of a substitute rises
- Demand will increase- cheaper alternative
What happens to demand of a good is price of a complimentary good increases
- Demand will decrease- lesser reason to buy the good
How is an increase in demand shown on a demand curve
Shift to right
How is decrease in demand shown on demand curve
- Shift to left
What is market equilibrium
When supply meets demand
What is supply
- The quantity of goods that sellers are prepared to sell and any given price over a period of time
What are complements
Products that are bought alongside another product
Cross elasticity of demand for complements
Negative- as price of good Y increases demand for good X decreases
What does the demand for substitute goods depend on
- Number and closeness of available substitutes
Cross elasticity of demand for substitutes
- Positive- as price of good Y increases demand for good X will increase
Close substitutes have a ……. XED. why?
Higher- because demand for good X is more sensitive to a change in price of good Y
What is composite demand
means that an increase in demand for one good or service will restrict its availability for another use
Examples of composite demand
- land- can be used for growing wheat or barley, but if barley being grown increases, wheat will have to decrease
What is derived demand
- occurs as a result of demand for another good or service
Example of derived demand
- demand for tinned tomatoes creates demand for metal used to make the tin
What is joint supply
- When the production of a product creates a by-product that can also be supplied
Example of joint supply
- Increased production of cows for beef will increase supply of leather
What happens to supply curve when there is increased production of a product in joint supply
supply curve shifts to left for both products ( leading to decrease in price for both products )
What is elasticity theory
Looks at the sensitivity of one variable in relationship to another
What does price elasticity of demand (PED) measure
Responsiveness of demand to a change in price
Formula for PED
%Change in quantity demanded
/
%change in price
How to remember PED formula
Dinner on a plate- D/P
What does a PED coefficient of 0 mean
Perfectly inelastic
What does perfectly price Inelastic mean
- Demand will not change regardless of price, and so businesses can theoretically charge as high price as they want
What does a PED coefficient of 0 to -1 mean
Price inelastic
What does price inelastic mean
If price was to change the quantity demand would change by a lesser amount
What should businesses to with price inelastic products
- Increase the price, as demand will fall by a smaller % therefore TR will increase
What does PED coefficient of 1 mean
Unitary (constant) elasticity
What would happen if firms increased or decreased price of unitary good
- No change in TR
What does PED coefficient of between 1- and infinity mean
- Price elastic
What does price elastic mean
- If price was to change the quantity demanded would change by a greater amount
What should firms do with a price elastic good
Lower the price as demand would increase by a greater amount, therefore TR would rise
What does PED coefficient of Infinity mean
- Perfectly elastic
What does perfectly price elastic mean
IF price was to change the quantity demanded would be infinity- firms couldn’t increase price as there would be no demand
What does a perfectly price inelastic demand curve look like
Vertical line
What does a perfectly price elastic demand curve look like
horiztonal
Why is PED coefficient usually negative
In normal goods, if price increases, demand decreases and vice versa, so the % change of either demand or price will be negative, leaving a negative total
How do substitutes determine PED
- Number and closeness of available substitutes determine PED- if there are a lack of close substitutes the product is likely to be very price inelastic and vice versa
How does time determine PED
- In short run products likely to be inelastic as consumers find it difficult to change shopping habits
- In long run products more elastic as consumers adjust to changing market
How does definition (Width) of market determine PED
- As market widens, PED more inelastic- eg cigarettes are price inelastic as there are no close substitutes, however demand for specific brands of cigs will be more elastic
How does the good being necessity or luxury determine PED
- Demand for necessities price inelastic
- Demand for luxuries price elastic
- both depend on available substitutes
How does % of income determine PED
- People pay more attention to ‘big ticket’ items
- therefore items which only make up a small amount of income, people unlikely to notice a change in price so will be more inelastic
What is income elasticity of demand (YED)
Measure of responsiveness of demand to a change in income
YED formula
% change in quantity demanded
/
%change in income
What does YED coefficient of -1 to 1 mean
Income inelastic
What does income inelastic mean
- Demand changes at a lower proportion than change in income
What does YED coefficient of <-1 OR >+1 mean
Income elastic
What does income elastic mean
Demand changes at a higher proportion than the increase in income
What are incentives (price mechanism)
- When prices rise, producers encouraged to increase output as this will mean higher TR
What is rationing (price mechanism)
When demand exceeds supply, prices increase to ration resources, limiting supply of good to those who can afford
What is signalling (price mechanism)
- Price changes signal to consumers or producers whether to increase or decrease their total production or consumption
How does importance of a good determine YED
At higher standards of living consumer incomes see additional demand towards luxury goods as demand for necessities is satiated
How does level of income effect YED
- Poorer consumers tend to spend higher % of income on necessities
- as they become wealthier YED for necessities move towards 0 as consumers are satisfied with the amount of the product
- as incomes increase they are likely to spend some income on luxuries
Relevance to business- standards of living (YED)
- Wealthier countries are likely to have consumers with higher disposable incomes
-meaning they have greater spending power and are likely to use this to buy luxury goods and services - therefore firms produce superior products here
Relevance of economic cycle to business ( YED)
When economy recovering and leading to a boom incomes increase and so consumers spend a greater portion of this increase on necessities firstly and then luxury goods and vice versa
What is cross elasticity of demand (XED)
A measure of responsiveness of demand for one good (X) to a change in price of another good (Y)
Formula for XED
% Change in quantity demanded of good X
/
% Change in price of good Y
What does an XED coefficient of -1<+1 mean
Cross price inelastic
What does cross price inelastic mean
- Demand for good X changes at a lesser proportion than the change in price of good y
What does XED coefficient of <-1 Or >+1 mean
Cross price elastic
What does cross price elastic mean
- Demand for good x changes at a greater proportion than the change in price of good Y
What determines XED
- Whether good is a
-substitute
-compliment
-has no relationship
What does it mean for XED if the product is a substitute
- Positive XED
- As price of Y increases, demand for X increases also
- Close substitutes have higher XED ( elastic)
What does it mean for XED if product is a complement
- Negative XED
- As price of Y increases, demand for X decreases
- Close complements have a higher XED (Elastic)
What does it mean for XED if products have no relationsjhip
- Change in price of good X has no impact on demand for good Y
- XED 0
How to firms try to change the XED of substitutes
- Differentiating their products from comp- eg M&S- ‘not just any food’
- Advertising and branding of the product- consumers less likely to switch- feeling of familiarity
- More close substitutes mean less ability to rise prices
How to firms attempt to change the XED of complements
- Produce a range of complements for their core products eg Apple accessories
-a firm selling a range of complements likely to increase TR
What is price elasticity of supply (PES)
- A measure of responsiveness of supply to a change in price
Formula for PES
%Change in quantity supplied
/
%Change in price
How to remember PES formula
Supper on a plate (Supply/price)
What does a PES coefficient of 0 mean
- Perfectly inelastic
What does perfectly inelastic PES mean
If price was to change the quantity wouldn’t be effected- firm would supply the same amount at any given price
What does PES coefficient between 0 and 1 mean
- Price inelastic
What does price inelastic PES mean
- If price was to change the quantity supplied would change by a lesser amount
- This may be because of difficulties in increasing supply
What does PES coefficient of 1 mean
- Unitary
What does unitary PES mean
Increasing or decreasing price will lead to a proportional change in supply
What does a PES coefficient of between 1 and infinity mean
- Price elastic
What does Elastic PES mean
- If price was to change the quantity supplied would change by a greater amount
- Firms find it easier to increase supply or incentive to increase supply has become greater
What does PES coefficient of infinity mean
- Perfectly elastic
What does perfectly elastic PES mean
- If price was to stay the same or increase the quantity supplied would be infinite
- If price decreased the quantity supplied would be 0
What are the determinants of Elasticity of supply
- Price
- Availability of factor substitutes
- Spare production capacity available
- Stocks (inventories) available to meet demand
- Time frame allowed
- Artificial limits of supplied
How does price effect PES
- Increases in price act as an incentive for firms to increase supply
- at higher price levels contribution per unit (selling price-variable cost) is higher
How does availability of factor substitutes effect PES
- When factor substitution is possible and can be achieved at low cost, supply will be elastic
- When factors are highly specialised, substitution is harder so supply is inelastic
How does spare production capacity available effect PES
- When there is spare capacity, businesses can expand output easily to meet rising demand without upwards pressure on costs
- more capacity, more elastic
how do stocks available effect PES
- A low level of stocks makes supply inelastic
- when stocks can be released onto the market, supply is elastic e.g Heinz factory make 500,000 more tins of beans than the amount sold
How does time frame effect PES
- Becomes more elastic as response time increases
-Momentary period- fixed supply
-Short run- inelastic supply
-Long run- elastic supply
how do artificial limits on supply effect PES
- Eg the impact of patens that limits which firms can supply a product
- Heinz beans- more inelastic
- Beans- more elastic
