Price Determination In A Competitive Market

Question 1

What is demand?

Answer 1

Is the quantity of a good or service that consumers are able and willing to buy at a given price during a given period of time

Question 2

What is expansion on demand curve?

Answer 2

Lower price= more quantity

Question 3

What is Contraction on the demand curve

Answer 3

Higher price = lower quantity demanded

Question 4

What are the factors that shift the demand curve?

Answer 4

-population:larger the population higher the demand, also changing the population structure also affect demand such as distributions of different age groups

-income:if consumers have more disposable income demand increases.

-related goods: are substitutes (can replace another good) or complements (go together) one price decrease demand for other increase

-advertising: increase consumer loyalty to the good and increase demand

-taste and fashion: demand curve shift if consumer taste changes

-expectation: future price changes demand likely to increase in the present

-season: demand changes according to season

Question 5

What is the law of diminishing marginal utility?

Answer 5

-as and extra unit of the good is consumed the marginal utility I.e the benefit derived from consuming the good, falls therefore consumers are willing to pay less for the good (e.g more and more chocolate bars)

Question 6

What is price elasticity of demand? And what is the formula?

Answer 6

The responsiveness of a a change in demand to a change in price

%change in quantity demanded
———————————————
%change in price

Question 7

What is a price elastic good ? Draw the graph

Answer 7

•a good that is very responsive to change (leads to even bigger change in demand)
•numerical value >1

Question 8

What is a price inelastic good? Draw the graph

Answer 8

• a good that is relatively unresponsive to change in price
• numerical value <1

Question 9

What is a unitary elastic good ?

Answer 9

•has a change in demand that is equal to the change in price
•numeric value 1

Question 10

What is a perfectly inelastic good? Draw the graph

Answer 10

•has a demand that does not change when price changes
• numerical value is 0

Question 11

What is a perfectly elastic good ? Draw the graph

Answer 11

• has a demand which falls to 0 when the price changes
• numerical value is 0

Question 12

What are factors that influence price elasticity of demand?

Answer 12

•Necessity: have inelastic demand
Whereas luxury items are elastic demand

•substitutes: several alternatives then demand is more price elastic. Short run demand is less elastic as not enough time to find substitutes

•addiction: not sensitive to change (inelastic) as consumers addicted and therefore keep demanding

•proportion of income spent on the good: small proportion of income when price increases then inelastic

•durability if good: long lasting good then more elastic as consumers wait to buy another

•peak and off peak demand: tickets for train during peak time 9-5 is more inelastic

Question 13

What does tax shift? And how does it affect consumers and firms?

Answer 13

• shift the supply curve NOT the demand

•if a firm sells good with an inelastic demand they are likely to put most of the tax burden on consumer, increase in tax will decrease supply, increase price and cause contraction in QD this raises government revenue.

•if a firm sells good with elastic price demand then they are most likely to put the tax burden on themselves. This is not as effective for increasing government revenue unless they want to purposely reduce the demand

Question 14

What is a subsidy?

Answer 14

• a payment from the government to firms to encourage the production of a good and to their lower average costs.
•it has the opposite affect of tax as it increases supply as supply cure shifts right (not left).
•this increase consumer (lower prices) and producer (increased revenue)

Question 15

How to work out total revenue?

Answer 15

P x Q sold

Inelastic good-price increase- increase revenue

Elastic good-price increase- decrease revenue

Question 16

What is income elasticity of demand and what is the formula?

Answer 16

The responsiveness of a change in demand to a change in income

%change in QD
———————-
%change in Y

Question 17

What are inferior normal and luxury goods?

Answer 17

Inferior: those that see a fall in demand as income increases - <0

Normal: demand decreases and income increases >0

Luxury goods: increase in income causes and even bigger increase in demand >1

Question 18

What is cross elasticity of demand? And what is the formula?

Answer 18

• the responsiveness of a change in demand of one good to a change in price of another

%change QD of X
————————-
%change P Of Y

Question 19

What are complementary goods ?

Answer 19

• have a negative XED, if one good becomes more expensive the quantity demanded for both goods will fall

•close comments: decrease in price of one good causes a huge rise in demand of another (elastic)

•weak comments: increase in price of one good causes a small fall in the demand of the other (inelastic)

Question 20

What are substitute goods?

Answer 20

•goods that can replace another good so XED is positive and demand curve is upwards sloping

•close substitutes: a small increase in the price of good X leads to large decrease in QD of good Y (elastic)

•Weak substitutes: a large decrease in teh price of good X leads to a small increase in QD of good Y (inelastic)

Question 21

What are unrelated good?

Answer 21

• have a XED equal to 0

Question 22

Why are firms interested in XED?

Answer 22

It allows them to see how much competitors they have therefore they are less likely to be affected by price changes by other firms if they are selling complementary goods or substitutes

Question 23

What is supply?

Answer 23

The quantity of a good or service that a producer is able and willing to supply at a given price during a given period of time

Question 24

Why do supply curves slope upwards?

Answer 24

•If price increases it is more profitable for the firm to supply the good
•high prices encourage new firms to enter the market because it seems profitable
• with larger outputs firms costs increase so they need to charge a higher price to cover the cost

Question 25

What is the theory of profit motive?

Answer 25

Firms are driven by the desire to make large profits

Question 26

What shifts the supply curve ?

Answer 26

Supply not price

Question 27

What are factors that shift the supply curve? PINTSWC

Answer 27

•productivity: higher productivity cause an outward shift

•indirect taxes: inward shift in supply

•number of firms: the more firms the larger the supply

•technology: more advanced tech cause an outward shift

•subsidies: can cause an outward shift in supply

•weather: agricultural produce, favourable conditions will increase supply

•cost of production: if cost of production falls firms can afford to supply more

Question 28

What is price elasticity of supply and what is the formula?

Answer 28

The responsiveness of a change in suly to a change in price

%change in QS
———————
%change in P

Question 29

What happens if supply is elastic?

Answer 29

Firms can increase supply quickly at little cost
Numeric value >1

Question 30

What happens if supply is inelastic?

Answer 30

And increase in supply will be expensive for firms and take a long time
Numerical value <1

Question 31

What is a perfectly inelastic supply?

Answer 31

Supply is fixed so if there is a change in demand it cannot be met easily
=0

Question 32

What is perfectly elastic supply?

Answer 32

PES=infinity
Any quantity demanded can be met without changing price

Question 33

What factors influence PES

Answer 33

• time scale: in the short run supply is more inelastic because producers cannot quickly increase supply

•spare capacity: if firm overrating at full capacity there is no space to increase supply

•levels of stock: if goods can be stored then firms can stock them and increase market supply easily

•how substitutable factors are: if labour and capital are mobile supply is more price elastic because resources can be allocated to where extra supply is needed

•barriers to entry to the market: higher barriers to enter means supply is more inelastic because it is difficult for new firms to enter and supply the market

Question 34

What is equilibrium price and demand?

Answer 34

This is when supply meets demand (cross)
At market equilibrium, price has no tendency to change (known as the market clearing price)

Question 35

What is excess demand

Answer 35

When demand is greater than supply, disequilibrium.
This is a shortage in the market, this causes firms to supply more therefore demand will contract when prices increase

Question 36

What is excess supply?

Answer 36

When the price is above P1
Supply is at Q2
And demand is at Q1 (there is a surplus of supply)
Price will fall back to P1 as firms lower their prices market will return to equilibrium

Question 37

New market equilibrium

Answer 37

When the supply or demand curve shift due to the PIRATES or PINTSWC, new market equilibriums are established

Question 38

What is derived demand?

Answer 38

•When the demand for one good is linked to the demand for a related hood.

Question 39

What is composite demand?

Answer 39

• when the good demanded has more than one use

Question 40

What is joint demand?

Answer 40

When goods are bought together

Question 41

What is joint supply?

Answer 41

When increasing the supply of one good causes an increase or decrease in the supply of another good