Price Determination in a Competitive Market

Question 1

Describe Price elasticity of demand

Answer 1

• PED = %Δ Quantity Demanded / %Δ Price

- PED measures how responsive the quantity demand is relative to changes in the price of the good.

Question 2

Describe income elasticity of demand

Answer 2

• YED = %Δ Quantity Demanded / %Δ Income

- YED measures how responsive quantity demanded of a good/service is relative to a change in income.

Question 3

Describe cross elasticity of demand

Answer 3

• XED measures the responsiveness of a change in the quantity demanded of one good (X), relative to a change in demand for another good (Y)
• XED = %Δ Quantity demanded (X) / %Δ Price (Y)

Question 4

Define inferior goods

Answer 4

• The demand for inferior goods experiences a fall when income rises.
• Inferior goods have a YED < 0
• EG) As income rises consumers switch to better quality branded goods, second hand car market.

Question 5

Define luxury goods

Answer 5

• The demand for luxury goods experiences a relatively large increase in demand as income rises.
• Luxury goods have a YED > 1
• EG) Holidays, holiday homes, luxury clothing, luxury cards etc.

Question 6

Define normal goods

Answer 6

• The demand for normal goods experiences a rise in demand as income rises.
• Normal goods have a YED > 0

Question 7

A good/service with a PED > 1

Answer 7

-Goods/services with a PED > 1 are considered to be price elastic, due to the fact a change in price has a large effect on the quantity demanded.

Question 8

A good/service with a PED < 1

Answer 8

-Goods/services with a PED < 1 are considered to be price inelastic, meaning changes to the price of a good will have minimal effect on the quantity demanded (competitive markets).

Question 9

A good/service with a PED < 1

Answer 9

-Goods/services with a PED < 1 are considered to be price inelastic, meaning changes to the price of a good will have minimal effect on the quantity demanded (competitive markets).

Question 10

A good/service with a PED = 0

Answer 10

• A good/service with a PED = 0 is considered to be perfectly price inelastic, therefore changes to price has zero effect on quantity demanded.
• Vertical demand curve.

Question 11

A good/service with a PED = ∞

Answer 11

• A good/service with a PED equal to infinity is said to be perfectly price elastic, meaning price cannot change from a particular point and demand ceases to exist if price alters.
• Horizontal demand curve.

Question 12

A good/service with a XED < 0 (negative)

Answer 12

• Compliments
• Goods/services with a negative cross elasticity of demand are said to be complementary. As the price of one good increases the quantity demanded for both goods will decrease.

Question 13

A good/service with a XED > 0 (positive)

Answer 13

• Substitutes
• A good/service with a positive XED is referred to as a substitute, due to the fact an increase in the demand for one good will lead to a fall in the demand for another substitute good and vise versa.

Question 14

Define demand

Answer 14

-Demand refers to the quantity of a particular good or service that consumers are willing to buy at a particular price.

Question 15

Describe why the demand curve is downward sloping

Answer 15

• Law of diminishing returns states
• Consumers incentivised to pay the lowest price possible for a good/service, less consumers willing to pay higher prices.
• Inverse relationship between quantity demanded and price exists.

Question 16

Factors that cause a shift in the supply curve

Answer 16

• Changes in productivity/development of technology
• Taxation
• Subsidies
• Changes to costs of production
• Resource/raw material prices
• Number of firms in the market

Question 17

Describe why the supply curve is upward sloping

Answer 17

• At higher prices firms are incentives to produce more as it is profitable todo so.
• A firms costs may increase as output increases therefore pushing prices higher.

Question 18

Describe price elasticity of supply

Answer 18

• PES = %Δ Quantity supplied / %Δ Price

- PES measures how responsive the quantity supplied of a good/service relative to changes in price.

Question 19

A good/service with a PES > 1

Answer 19

• Goods/services with a PES of > 1 are considered to have an elastic supply. Changes to the price of a good/service leads to a relatively large change in quantity supplied.
• Firms can easily increase/decrease supply with changes in prices.

Question 20

A good/service with a PES > 1

Answer 20

• Goods/services with a PES of > 1 are considered to have an elastic supply. Changes to the price of a good/service leads to a relatively large change in quantity supplied.
• Firms can easily increase/decrease supply with changes in prices.

Question 21

A good/service with a PES < 1

Answer 21

• Goods/services with a PES < 1 are considered to be price inelastic, meaning a change to the price of a good/service has minimal effect on the quantity supplied by a firm
• More difficulty for firms to alter supply with inelastic supply.

Question 22

Describe derived demand

Answer 22

• Derived demand refers to demand for a particular good/service which is derived/related to the demand for another related good or service.
• EG) The demand for labour is derived from the demand for the market in which labour is demanded.
• EG) The demand for glass is derived from the demand for construction of buildings.

Question 23

Describe composite demand

Answer 23

• Composite demand for a good refers to goods which have more than one use. An increase in demand for a specific good may lead to a reduction in supply of another.
• EG)Increases in the demand for oil in the manufacturing industry may lead to a fall in demand for plastics that require oil.

Question 24

Describe joint supply

Answer 24

• Joint supply occurs when changes to the supply of one good/service leads to an alteration in the supply of another related good/service.
• EG) Increasing the supply of cow meat –> increase in the supply of leather.