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microeconomics > price determination in a competitive market > Flashcards

price determination in a competitive market Flashcards

1
Q

what is elasticity theory?

A

looks at sensitivity of one variable in relationship to another

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2
Q

what is elasticity coefficient?

A

the measure of the response of one variable to changes in another variables

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3
Q

what do different signs in elasticity theory suggest?

A
    • sign= positive relationship (i.e. as income increase demand decreases)
    • sign= negative relationship (i.e. as price increases demand decreases)
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4
Q

how do you work out percentage change?

A

change in value/original value x 100%

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5
Q

what does price elasticity of demand (PED) mean?

A
  • measures responsiveness of demand to a change in price
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6
Q

how do you calculate PED?

A

% change in quantity demanded/% change in price

(dinner/plate)
*answer always positive

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7
Q

PERFECTLY INELASTIC- PED coefficient + explanation

A

PED coefficient - 0

explanation- demand doesn’t change as price changes (completely unresponsive)
could increase price as much as wanted and demand stays the same

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8
Q

PRICE INELASTIC- PED coefficient + explanation

A

PED coefficient- 0 –> 1

explanation- % change in quantity demanded is less than % change in price i.e. large change in price will lead to a smaller change in demand (demand is relatively unresponsive)
- firm should increase price in this situation as although demand will decrease a bit total revenue will increase

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9
Q

UNITARY ELASTIC- PED coefficient + explanation

A

PED coefficient- 1

explanation- % change in quantity demanded is exactly equal to % change in price (change in demand=change in price)
- increasing/decreasing price has no impact on on total revenue a

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10
Q

RELATIVELY ELASTIC- PED coefficient + explanation

A

PED coefficient - 1->infinity

explanation- % change in quantity demanded is more than % change in price (change in price= demand change by a greater amount)
- firm will want to decrease price to increase sales revenue

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11
Q

PERFECTLY ELASTIC- PED coefficient + explanation

A

PED coefficient- infinity

explanation- any change in price will cause demand to fall to zero
- firm couldn’t increase price as they would be no demand at all

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12
Q

PED elastic vs inelastic

A

PED= elastic (so coefficient is greater than 1), rise in price will cause total expenditure to fall (vice versa)

PED= inelastic (so coefficient is less than 1), a rise in price will cause total expenditure to rise (vice versa)

therefore total expenditure depends on the PED of the good/service

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13
Q

how do you calculate total revenue

A

TR= price x quantity

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14
Q

determinants of PED?

A

substitutes
time
addictiveness/habitual consumption
necessity or luxury
percentage of income
peak + off-peak

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15
Q

determinants of PED- substitutes + time

A

substitutes:
- no close/lack of substitutes= products likely to be inelastic (vice versa)
- several close substitutes= more price elastic

time:
- short-run= more inelastic as consumers find it difficult to change shopping habits
- long- run= more elastic consumers adjust to changing market conditions

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16
Q

determinants of PED- addictiveness/habitual consumption + necessity/luxury

A

addictiveness/habitual consumption:
- e.g. cigarettes= inelastic as they’re addictive so consumers demand them no matter what

necessity/luxury
- necessities demand= price inelastic
- luxuries demand= price elastic

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17
Q

determinants of PED- percentage of income + peak/off-peak

A

percentage of income:
- smaller % of income= more likely to be price inelastic as change in price is less noticed

peak/off-peak
- e.g. peak train times= tickets more price inelastic

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18
Q

cross elasticity of demand (XED) what is it?

A
  • measures responsiveness of a change in demand for one good (X), to change in price of another good (Y)
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19
Q

XED how to calculate?

A

% change in quantity demanded of good x/ % change in price of good y

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20
Q

determinants of XED?

A

substitutes
complements
unrelated goods (no relationship)

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21
Q

determinants of XED explained

A

SUBSTITUTES
- have a + XED (XED is greater than 0)
- as price of good y increases, demand of good x increases
- close substitutes= higher XED as consumer demand for good x will be more sensitive to change in price of good y

COMPLEMENTS
- have a - XED (XED is less than 0)
- as price of good y increases, demand of good x decreases
- close complements= higher XED as consumer demand for good x will be more sensitive to change in price of good y

UNRELATED GOODS
- XED will be 0
- change in price of good y will have no impact on demand of good x

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22
Q

cross price elastic vs inelastic

A

cross price inelastic
- coefficient= 0 -1
- as demand for good x change at less proportion than change in price of good y

cross price elastic
- coefficient= greater than 1
- as demand for good x changes at a greater proportion than the change in price of good y

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23
Q

XED relevance to business

A
  • substitutes- firms will try to differentiate from their competition (quality etc)
    –> through advertising, branding etc consumers are more likely to stick with their product
  • complements- firms create range of complements to accompany core products e.g. apple ecosystem
    more complements= more likely to increase total revenue
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24
Q

income elasticity of demand (YED) what is it?

A
  • measures responsiveness of a change in demand to a change in income
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25
Q

how to calculate YED?

A

%change in quantity demanded/% change in income

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26
Q

what type of goods are relevant in YED?

A

normal goods + inferior goods

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27
Q

normal goods YED?

A
  • have a positive (+) income elasticity of demand
  • as income increases, demand for product increases
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28
Q

YED- normal necessity

A

co-efficient= 0 –> 1
- income inelastic–> demand changes at lower proportion than increase in income (relatively unresponsive to change in income)

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29
Q

YED- normal luxury

A

co-efficient= greater than 1
- income elastic –> demand changes at higher proportion than the increase in income (more responsive to change in income)

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30
Q

YED- standards of living

A
  • wealthier countries= more likely to have consumers with higher disposable incomes= greater spending power + more likely to spend on luxuries= firms produce products to suit these needs
  • global standards of living are rising= we expect to see more ppl move away from inferior goods + towards luxury
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31
Q

YED- the economic cycle

A
  • economies in a decline= lower disposable incomes + consumers move from luxuries to necessities + inferior (vice versa) –> firms identify economic state e.g. recession etc + produce goods/services to meet demand of consumers
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32
Q

YED- inferior goods

A
  • always have a negative (-) income elasticity of demand
  • because demand for products decreases as income increases
  • YED coefficient= less than 0
33
Q

YED- KEY POINTS

A
  • higher standard of living= ppl demand for luxuries tends to increase as they already have necessities
  • poorer consumers tend to spend more on necessities
  • normal goods that are necessities have a lower positive YED coefficients than luxuries
34
Q

price elasticity of supply (PES) what is it?

A

measures responsiveness of a change in supply to a change in price

35
Q

PES how to calculate it?

A

% change in quantity supplied/% change in price

36
Q

PES price inelastic vs elastic

A

price inelastic
- coefficient= less than 1
- increase in price= increase in S but to less of a proportion to the change in price

price elastic
- coefficient greater than 1
- an increase in price= increase in demand to a greater proportion to the change in price (vice versa)

37
Q

PERFECTLY ELASTIC- coefficient + explanation

A

coefficient - 1

explanation- quantity supplied is completely unresponsive to the change in price
- firms would supply same amount at any given price

38
Q

PRICE INELASTIC- coefficient + explanation

A

coefficient- 0 –>1

explanation- % change in quantity supplied is less than % change in price
- may be due to incentive for firm to increase supply isn’t enough

39
Q

PRICE ELASTIC- coefficient + explanation

A

coefficient- 1 –> infinity

explanation- % change in quantity supplied is greater than the change in price
- may be because firm may find it easy to increase supply as the incentive is greater etc

40
Q

PERFECTLY ELASTIC- coefficient + explanation

A

coefficient- infinity

explanation- if price changed quantity supplied would fall to zero

41
Q

PES- KEY POINT

A
  • firms try to increase their PES
  • more elastic PES coefficient= firms more flexible in changing supply of its products= making it more competitive
  • this contrasts PED where firms want more inelastic coefficient
42
Q

determinants of PES

A

PRICE
HOW SUBSTITUTABLE FACTORS ARE
SPARE CAPACITY
STOCKS
TIME FRAME ALLOWED
ARTIFICIAL LIMITS

43
Q

determinants of PES- price + how substitutable factors are

A

PRICE
- increase in price= incentive for firms to increase supply due to more profit

HOW SUBSTITUTABLE FACTORS ARE
- when it’s possible + can be achieved at low cost then supplies will be elastic

44
Q

determinants of PES- spare capacity + stocks

A

SPARE CAPACITY
- spare capacity= firms can expand outward easily to meet rising demand without upward pressure on costs e.g. having spare resources etc

STOCKS
- low level of stocks= supply inelastic (vice versa)
- e.g. spare warehouse + storage space

45
Q

determinants of PES- time frame allowed + artificial limits

A

TIME FRAME ALLOWED
- momentary= fixed supply
- short run= inelastic supply
- long run= elastic supply
(gets more elastic over time)

ARTIFICIAL LIMITS
- e.g. impact of patents that limit which firms can supply a product
e.g. paracetamol (lots of firms) vs neurofen (1 firm)

46
Q

price mechanisms what are they?

A
  • means by which decisions of consumers + businesses interact to determine the allocation of resources
    –> interaction of demand + supply in a market economy that allocates scarce resources amongst competing needs + wants
  • Adam Smith referred to it as ‘invisible hand of the market’ –> resources allocated through price mechanisms in a free market economy
  • 3 functions of price mechanisms if any function breaks down= market failure can occur
47
Q

price mechanisms- what are the 3 functions

A
  • rationing
  • incentive
  • signalling
48
Q

price mechanisms- rationing function

A
  • prices ration scarce resources when demand exceeds supply
  • when there’s a shortage= prices rise= only those with willingness + ability to pay to buy
49
Q

price mechanisms- incentive functioning

A
  • incentive function encourages producers to increase or decrease profits
  • when prices of good/service rise= incentivises producers to reallocate resources from a less profitable market to maximise profits
  • falling prices incentivises reallocation of resources to a new market
50
Q

price mechanisms- signalling function

A
  • price acts as a signal to consumers + new firms entering the market
  • change in price= signal about where resources are wanted (markets with increasing prices) + where they’re not (markets with decreasing prices)
    –> allows consumers + producers to make informed decisions
  • high price= signals producer to produce more of that good/service + signal to other producers to enter the market
  • falling price= signals to consumers to purchase more of a product –> all causes shifts in demand + supply curves
51
Q

demand curve- what does it show

A
  • shows relationship between price and quantity demanded
  • y axis= price
  • x axis= quantity demanded
52
Q

demand curve for a normal good

A
  • always negatively sloped
  • as price falls, quantity demanded increases (vice versa)
53
Q

demand curve- movements along the curve

A
  • change in price causes a movement along the curve
  • rise in price= contraction along demand curve as quantity demanded decreases
  • decrease in price= expansion along demand curve as quantity demanded increases
54
Q

demand curve- rational choice theory

A

ppl make logical decisions that’ll maximise their personal benefits

55
Q

demand curve- demand meaning

A

quantity of a good/service that consumers are willing + able to buy at any given price

56
Q

ceteris paribus

A

‘all other factors stay the same’
e.g. if raise a price of a good you assume other factors (consumer income etc) don’t change
–> allows us to identify impact of changes in one factor

57
Q

determinants of the demand for goods + services

A
  • price of good
  • consumer income
  • prices of other goods + services
  • consumer tastes or fashion
58
Q

determinants of the demand- price + consumer income

A
  • price of good
    if price of normal good/service increase demand will decrease (vice versa)
    BUT for veblen goods the ‘snob effect’ means ppl may pay more as price increases due to increased status etc –> would have a + slope on demand curve
  • consumer income
    income increases= demand for normal goods increases (shown by outward shift)
  • inferior good- demand decreases as income increases
    certain inferior goods where demand rose as income rose (giffen goods)
    e.g. price of bread up= poor family has no income to spend on meat etc so has to spend even more money on bread
59
Q

determinants of the demand- prices of other goods + services, consumers tastes or fashion

A

prices of other goods + services
- SUBSTITUTE product- (alternative) e.g. coke price increase so demand for pepsi increase
- COMPLEMENTARY product- bought alongside a good/service e.g. price of fish increases so demand for chips decreases

consumer tastes or fashion
- more fashionable, advertised products etc= increased demand

other factors:
- population changes (size + age)
- advertising
- level of comp in market
- future expectations of price
- seasons
- marginal utility i.e. the benefit of consuming a good, falls –> consumers less willing to buy e.g. eating 1 chocolate bar= satisfies more so won’t/will be less willing to pay for another at higher price

60
Q

shifts in demand curve

A
  • increase in demand= outward shift (to the right)
  • decrease in demand= inward shift (to the left)
  • determinants cause this shift
61
Q

supply curve- what is it?

A

shows relationship between price + quantity supplied
often positively sloped as higher prices imply higher profits= incentive to expand production

–> price of product rise= supply rises (vice versa) –> higher prices= firms more likely to cover the costs= they’ll make a profit –> higher prices is a incentive for firms to expand production

62
Q

what is supply?

A

the quantity of a good/service that producers are willing + able to sell at any given price

63
Q

determinants of supply in market

A

impact of changing costs of production
technological progress
prices of other goods + services
govt policies e.g. taxes, subsidies

64
Q

determinants of supply in a market- impact of changing costs of production + technology

A

impact of changing costs of production
- costs of production are created by the price of factor inputs i.e. factors of production
- if cost increases= more expensive to supply product= can decrease output (vice versa)
- tech improvements can help reduce costs of production

technological progress
- better tech= more efficient production + cost effective= profitable to supply more

65
Q

determinants of supply in a market- prices of other goods + services
govt policies e.g. taxes, subsidies

A

prices of other goods + services
- if price of good A increases, may be more profitable to stop producing good B + only producing good A
- if prices are rising firms will enter market due to greater incentive to make profits

govt policies e.g. taxes, subsidies
- indirect taxes= more expensive tp create a product= supply decreases
- subsidies (finance provided to producers)= cheaper to produce a product= supply increases

other factors:
- expectations for the future
- weather events etc

66
Q

shifts in supply curve

A
  • increase in supply= outward shift (to the right)
  • decrease in supply= shift to the left= inward shift
  • to show a bigger change in supply show a bigger shift (leave a bigger gap)
67
Q

key point

A
  • shifts happen because of determinants + movements along the curves due to price
68
Q

what is market equilibrium?

A
  • in market- interaction of demand + supply determines equilibrium price
  • market equilibrium- point at which demand=supply
    –> known as market clearing price as all products will be sold at this price –> buyers get exact amount they want to buy + sellers sell exactly the amount they want to sell at this price. nothing is left over (markets cleared)
  • any change in demand/supply= new equilibrium price
69
Q

market equilibrium- excess supply

A
  • price is above market equilibrium
  • quantity demanded is lower than supply as firms wish to supply more at a higher price
  • too much supply= firms need to decrease price to get rid of excess products
  • amount of excess supply= difference between supply + demand
70
Q

market equilibrium- excess demand

A
  • price is below market equilibrium
  • quantity demanded exceeds supply –> firms have less incentive to supply at lower price so there’s too much demand (firms would need to increase price to reduce this excess demand)
71
Q

market equilibrium- market forces

A

market forces= always pushing prices towards market equilibrium
- too much supply= reduce price
- too much demand= increase price
- change in price will lead to movement along the supply/demand curve BUT change in any other factor (determinants of supply/demand)= shift in demand/supply curve

72
Q

market equilibrium- shifts in demand curve

A
  • increase demand= outward= price will rise + quantity demanded = new market equilibrium
  • shift in demand= movement along supply curve
  • decrease in demand shown by inward shift= price fall + quantity demanded= new market equilibrium
  • shift in demand= movement along supply curve
73
Q

market equilibrium- shifts in supply curve

A
  • increase in supply= outward shift= price falls + quantity supplied increase= new market equilibrium= movement along demand curve
  • decrease in supply= inward shift= price rises + quantity supplied decreases= new market equilibrium= shifts in supply= movement along demand curve
74
Q

interrelationship between markets

A

changes in one market will affect other markets
- competitive market operates through interaction of demand + supply
- as demand of goods + services changes in a market= impacts other markets
- firms move away from markets with low demand + towards high demand/increasing demand markets –> this leads to an increase in supply as firms move to new markets
- introduction of new product/supplier= further impacts goods + services in competitive market –> depends upon relationship between these products

75
Q

interrelationship between markets- joint demand

A
  • goods that are complements= in joint demand
  • complements = negative XED (as price good A increases demand of good B decreases)
  • increase in demand for one good= increase in demand of another good, vice versa
  • demand for substitutes= depends on variety of factors
    –> rise in price of beef= rise in demand for lamb (vice versa)
  • positive XED (price of good A increases, demand of good B decreases)
  • close substitutes= higher XED as consumer choice will be more sensitive
76
Q

interrelationship between markets- composite demand

A
  • occurs when there’s competing uses of a good/service
  • increase in demand for one good/service= restricts its availability for another use –> therefore there’s competing uses for the same product
    e.g. land can be used to grow barley OR wheat –> increase production of wheat due to high demand= less land available for barley= price of barley rises
77
Q

interrelationship between markets- derived demand

A
  • occurs when a particular good/factor of production is necessary for the provision of another good/service
  • demand for one good is related to demand of a related good e.g. tinned tomatoes demand increases= demand for metal used to make tin increases in demand
  • increase in demand for a product will create a derived demand for a related good/service
78
Q

interrelationship between markets- joint supply

A
  • occurs when the production of one good creates a by-product that also can be supplied (production of another good)
  • increase in supply of one product will lead to an increase in the supply of another product e.g. sheep for meat will increase supply of wool, or wheat + shreddies
    –> this will cause supply curve to shift outwards for both products and price to decrease

microeconomics (2 decks)

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