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Freakonomics (micro) > Price determination > Flashcards

Price determination Flashcards

1
Q

What is a demand curve

A

a curve showing how much of a good customers are willing to buy at each and every price level

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2
Q

What relationship does a demand curve show

A

the relationship between price and quantity demanded

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3
Q

What does a shift in the demand curve mean

A

Change in price

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4
Q

What is the relationship between price and quality demanded

A
  • As price falls, quality demanded rises
  • As price rises, quantity demanded falls
    (negative correlation)
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5
Q

What are the determinants of demand

A

-Price
-Consumer income
-Prices of other goods/services
-Consumer tastes and fashion
-other factors eg advertising

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6
Q

What does ceteris paribus mean

A

All other factors are the same- so often assume ‘ceteris paribus’ as many factors are uncontrollable

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7
Q

What is a normal good

A
  • A good that when price increases demand decreases and vice versa
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8
Q

What is a Veblen good

A
  • A luxury item that when price increases so does demand- ‘snob effect’- people will pay more to show status
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9
Q

What is a Giffen good

A
  • A basic good that when price increases, so does demand as it means alternatives are unaffordable
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10
Q

Example of Giffen good

A
  • 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
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11
Q

What is an inferior good

A
  • One where demand decreases as income increase ( eg Giffen goods)
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12
Q

What happens to demand of a good if price of a substitute rises

A
  • Demand will increase- cheaper alternative
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13
Q

What happens to demand of a good is price of a complimentary good increases

A
  • Demand will decrease- lesser reason to buy the good
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14
Q

How is an increase in demand shown on a demand curve

A

Shift to right

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15
Q

How is decrease in demand shown on demand curve

A
  • Shift to left
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16
Q

What is market equilibrium

A

When supply meets demand

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17
Q

What is supply

A
  • The quantity of goods that sellers are prepared to sell and any given price over a period of time
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18
Q

What are complements

A

Products that are bought alongside another product

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19
Q

Cross elasticity of demand for complements

A

Negative- as price of good Y increases demand for good X decreases

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20
Q

What does the demand for substitute goods depend on

A
  • Number and closeness of available substitutes
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21
Q

Cross elasticity of demand for substitutes

A
  • Positive- as price of good Y increases demand for good X will increase
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22
Q

Close substitutes have a ……. XED. why?

A

Higher- because demand for good X is more sensitive to a change in price of good Y

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23
Q

What is composite demand

A

means that an increase in demand for one good or service will restrict its availability for another use

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24
Q

Examples of composite demand

A
  • land- can be used for growing wheat or barley, but if barley being grown increases, wheat will have to decrease
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25
Q

What is derived demand

A
  • occurs as a result of demand for another good or service
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26
Q

Example of derived demand

A
  • demand for tinned tomatoes creates demand for metal used to make the tin
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27
Q

What is joint supply

A
  • When the production of a product creates a by-product that can also be supplied
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28
Q

Example of joint supply

A
  • Increased production of cows for beef will increase supply of leather
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29
Q

What happens to supply curve when there is increased production of a product in joint supply

A

supply curve shifts to left for both products ( leading to decrease in price for both products )

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30
Q

What is elasticity theory

A

Looks at the sensitivity of one variable in relationship to another

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31
Q

What does price elasticity of demand (PED) measure

A

Responsiveness of demand to a change in price

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32
Q

Formula for PED

A

%Change in quantity demanded
/
%change in price

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33
Q

How to remember PED formula

A

Dinner on a plate- D/P

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34
Q

What does a PED coefficient of 0 mean

A

Perfectly inelastic

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35
Q

What does perfectly price Inelastic mean

A
  • Demand will not change regardless of price, and so businesses can theoretically charge as high price as they want
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36
Q

What does a PED coefficient of 0 to -1 mean

A

Price inelastic

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37
Q

What does price inelastic mean

A

If price was to change the quantity demand would change by a lesser amount

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38
Q

What should businesses to with price inelastic products

A
  • Increase the price, as demand will fall by a smaller % therefore TR will increase
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39
Q

What does PED coefficient of 1 mean

A

Unitary (constant) elasticity

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40
Q

What would happen if firms increased or decreased price of unitary good

A
  • No change in TR
41
Q

What does PED coefficient of between 1- and infinity mean

A
  • Price elastic
42
Q

What does price elastic mean

A
  • If price was to change the quantity demanded would change by a greater amount
43
Q

What should firms do with a price elastic good

A

Lower the price as demand would increase by a greater amount, therefore TR would rise

44
Q

What does PED coefficient of Infinity mean

A
  • Perfectly elastic
45
Q

What does perfectly price elastic mean

A

IF price was to change the quantity demanded would be infinity- firms couldn’t increase price as there would be no demand

46
Q

What does a perfectly price inelastic demand curve look like

A

Vertical line

47
Q

What does a perfectly price elastic demand curve look like

A

horiztonal

48
Q

Why is PED coefficient usually negative

A

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

49
Q

How do substitutes determine PED

A
  • 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
50
Q

How does time determine PED

A
  • 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
51
Q

How does definition (Width) of market determine PED

A
  • 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
52
Q

How does the good being necessity or luxury determine PED

A
  • Demand for necessities price inelastic
  • Demand for luxuries price elastic
  • both depend on available substitutes
53
Q

How does % of income determine PED

A
  • 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
54
Q

What is income elasticity of demand (YED)

A

Measure of responsiveness of demand to a change in income

55
Q

YED formula

A

% change in quantity demanded
/
%change in income

56
Q

What does YED coefficient of -1 to 1 mean

A

Income inelastic

57
Q

What does income inelastic mean

A
  • Demand changes at a lower proportion than change in income
58
Q

What does YED coefficient of <-1 OR >+1 mean

A

Income elastic

59
Q

What does income elastic mean

A

Demand changes at a higher proportion than the increase in income

60
Q

What are incentives (price mechanism)

A
  • When prices rise, producers encouraged to increase output as this will mean higher TR
61
Q

What is rationing (price mechanism)

A

When demand exceeds supply, prices increase to ration resources, limiting supply of good to those who can afford

62
Q

What is signalling (price mechanism)

A
  • Price changes signal to consumers or producers whether to increase or decrease their total production or consumption
63
Q

How does importance of a good determine YED

A

At higher standards of living consumer incomes see additional demand towards luxury goods as demand for necessities is satiated

64
Q

How does level of income effect YED

A
  • 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
65
Q

Relevance to business- standards of living (YED)

A
  • 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
66
Q

Relevance of economic cycle to business ( YED)

A

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

67
Q

What is cross elasticity of demand (XED)

A

A measure of responsiveness of demand for one good (X) to a change in price of another good (Y)

68
Q

Formula for XED

A

% Change in quantity demanded of good X
/
% Change in price of good Y

69
Q

What does an XED coefficient of -1<+1 mean

A

Cross price inelastic

70
Q

What does cross price inelastic mean

A
  • Demand for good X changes at a lesser proportion than the change in price of good y
71
Q

What does XED coefficient of <-1 Or >+1 mean

A

Cross price elastic

72
Q

What does cross price elastic mean

A
  • Demand for good x changes at a greater proportion than the change in price of good Y
73
Q

What determines XED

A
  • Whether good is a
    -substitute
    -compliment
    -has no relationship
74
Q

What does it mean for XED if the product is a substitute

A
  • Positive XED
  • As price of Y increases, demand for X increases also
  • Close substitutes have higher XED ( elastic)
75
Q

What does it mean for XED if product is a complement

A
  • Negative XED
  • As price of Y increases, demand for X decreases
  • Close complements have a higher XED (Elastic)
76
Q

What does it mean for XED if products have no relationsjhip

A
  • Change in price of good X has no impact on demand for good Y
  • XED 0
77
Q

How to firms try to change the XED of substitutes

A
  • 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
78
Q

How to firms attempt to change the XED of complements

A
  • Produce a range of complements for their core products eg Apple accessories
    -a firm selling a range of complements likely to increase TR
79
Q

What is price elasticity of supply (PES)

A
  • A measure of responsiveness of supply to a change in price
80
Q

Formula for PES

A

%Change in quantity supplied
/
%Change in price

81
Q

How to remember PES formula

A

Supper on a plate (Supply/price)

82
Q

What does a PES coefficient of 0 mean

A
  • Perfectly inelastic
83
Q

What does perfectly inelastic PES mean

A

If price was to change the quantity wouldn’t be effected- firm would supply the same amount at any given price

84
Q

What does PES coefficient between 0 and 1 mean

A
  • Price inelastic
85
Q

What does price inelastic PES mean

A
  • If price was to change the quantity supplied would change by a lesser amount
  • This may be because of difficulties in increasing supply
86
Q

What does PES coefficient of 1 mean

A
  • Unitary
87
Q

What does unitary PES mean

A

Increasing or decreasing price will lead to a proportional change in supply

88
Q

What does a PES coefficient of between 1 and infinity mean

A
  • Price elastic
89
Q

What does Elastic PES mean

A
  • 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
90
Q

What does PES coefficient of infinity mean

A
  • Perfectly elastic
91
Q

What does perfectly elastic PES mean

A
  • If price was to stay the same or increase the quantity supplied would be infinite
  • If price decreased the quantity supplied would be 0
92
Q

What are the determinants of Elasticity of supply

A
  • Price
  • Availability of factor substitutes
  • Spare production capacity available
  • Stocks (inventories) available to meet demand
  • Time frame allowed
  • Artificial limits of supplied
93
Q

How does price effect PES

A
  • 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
94
Q

How does availability of factor substitutes effect PES

A
  • 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
95
Q

How does spare production capacity available effect PES

A
  • When there is spare capacity, businesses can expand output easily to meet rising demand without upwards pressure on costs
  • more capacity, more elastic
96
Q

how do stocks available effect PES

A
  • 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
97
Q

How does time frame effect PES

A
  • Becomes more elastic as response time increases
    -Momentary period- fixed supply
    -Short run- inelastic supply
    -Long run- elastic supply
98
Q

how do artificial limits on supply effect PES

A
  • Eg the impact of patens that limits which firms can supply a product
  • Heinz beans- more inelastic
  • Beans- more elastic

Freakonomics (micro) (2 decks)

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