Price determination in a competitive market

Question 1

Demand

Answer 1

The quantity of a good or service that consumers are willing and are able to buy in a given time period at a given price.

Question 2

Latent demand

Answer 2

The willingness for a good or service but not the ability to pay.

Question 3

Derived demand

Answer 3

Demand for a good/service originates from demand for another good/service

Question 4

Composite demand

Answer 4

A good/service is demanded for two or more different uses. If demand increases for on use then supply decreases for another use.

Question 5

Non-price determinants of demand

Answer 5

• Trends tastes and preferences
• (real) income levels
• Seasonal
• Interest rates
• Market size/population size/demographics
• Advertising/promotion
• Speculative demand
• New information about a good/service
• Linked goods (complimentry/substitute)

Question 6

What is supply

Answer 6

The quantity of goods and services that a firm is ready willing and able to supply at s given price in a given time period.

Question 7

Non-price determinants of supply

Answer 7

• Changes in costs of production
• Change in technology
• Government taxation and subsidy
• Unexpected changes in climate
• Number of firms in market

Question 8

Signalling function

Answer 8

Prices perform a signalling function – i.e. they adjust to demonstrate where resources are required.
Prices rise and fall to reflect scarcities and surpluses.
If prices are rising because of high demand from consumers, this is a signal to suppliers to expand production to meet the higher demand.
If there is excess supply in a market, the price mechanism will help to eliminate a surplus of a good by allowing the market price to fall.

Question 9

Incentive function

Answer 9

Through choices consumers send information to producers about their changing nature of needs and wants.
One important feature of a free-market system is that decision-making is decentralised, i.e. there is no single body responsible for deciding what to produce and in what quantities.

This is in contrast to a planned (state-controlled) economic system where there is significant intervention in market prices and state-ownership of key industries.

Question 10

Rationing function

Answer 10

Prices ration scarce resources when demand outstrips supply.
When there is a shortage, price is bid up – leaving only those with willingness and ability to pay to buy.