Price Determination in a Competitive Market

Question 1

What is the law of demand?

Answer 1

The law of demand is the principle that as the price of a good rises, quantity demanded falls.

Question 2

What are the 4 main determinants of demand?

Answer 2

• Individual preferences
• Prices of substitute goods
• Prices of complementary goods
• Disposable incomes and wealths

Question 3

What is the formula for price elasticity of demand (PED)?

Answer 3

% change in quantity demanded of good A
////  ÷  ////
% change in price of good A

Question 4

When calculating price elasticity of demand, does it matter if a number is negative or not?

Answer 4

No. The only thing that matters is the size of the number itself, not whether it is positive or negative.

If a good is elastic, PED will be greater than 1 (>1). For example, 2.5 or -2.5.
If a good is inelastic, PED will be lesser than 1 (<1). For example, 0.4 or -0.4.

Question 5

What is the PED for inelastic demand?

Answer 5

Anything lesser than 1 (PED = <1).

So between >-1 and

Question 6

What is the PED for elastic demand?

Answer 6

Anything greater than 1 (PED = >1)

So >1 or

Question 7

What is the PED for perfectly inelastic demand?

Answer 7

PED = 0

Question 8

What is the PED for perfectly elastic demand?

Answer 8

PED = ∞

So ∞ or -∞.

Question 9

What is the PED for unitary elastic demand?

Answer 9

PED = 1

So 1 or -1.

Question 10

What are the 4 main influences on prince elasticity of demand?

Answer 10

• Degree of necessity
• Habit-forming goods (e.g. tabacco)
• Substitutes
• Time (In the short run it may be hard to find alternatives but over a longer period alternatives are found.)

Question 11

What is the formula for income elasticity of demand (YED)?

Answer 11

% change in quantity demanded of good A
////  ÷  ////
% change in income

Question 12

What are normal goods?

Answer 12

Goods where an increase in income causes an increase in demand for them.

Question 13

What are inferior goods?

Answer 13

Goods where an increase in income leads to a fall in demand for them.

Question 14

What are luxury goods?

Answer 14

Goods where an increase in income causes a bigger percentage (%) increase in demand for them.

Question 15

What is the formula for cross price elasticity of demand (XED)?

Answer 15

% change in quantity demanded of good B
////  ÷  ////
% change in price of good A

Question 16

What are substitutes (substitute goods)?

Answer 16

Substitute goods are products that rival each other and have similar, or the same purpose.

Question 17

What are compliments (complimentary goods)?

Answer 17

Complimentary goods are products that are used together.

Question 18

What is joint demand?

Answer 18

Joint demand is if a product has higher demand, the demand for it’s complement /s will increase because they are consumed together.

Question 19

What are the 4 main determinants of supply?

Answer 19

• Costs of of production
• Changes in technology
• Prices of other goods that can be made by the supplier (joint supply and competitive supply)
• Indirect taxes and subsidies

Question 20

What is joint supply?

Answer 20

When production of one good automatically leads to provision (supply) of another.

e.g. beef and leather

Question 21

What is competitive supply?

Answer 21

When the supplier can only provide (supply) more of one good by producing less of another.

e.g. a farmer using land to grow carrots reduces the land available to grow potatoes.

Question 22

What is the formula for price elasticity of supply (PES)?

Answer 22

% change in quantity supplied of good A
////  ÷  ////
% change in price of good A

Question 23

What are the main factors that influence price elasticity of supply (PES)?

Answer 23

• Time (may take time to employ new resources)
• Spare capacity
• Ease of switching products (difficult in some industries, e.g. farming where a crop may have already been planted)

Question 24

What is composite demand?

Answer 24

Composite demand is when a good has more than one use so increased want (demand) for one product leads to a fall in supply of another.

e.g. oil for petrol or plastics and milk for butter or yoghurt.

Question 25

What is derived demand?

Answer 25

Derived demand is when an increase in want (demand) for a product leads to increase in want (demand) for it’s components.

e.g. higher demand for pens, thus higher demand for graphite.

Question 26

Define microeconomic equilibrium.

Answer 26

Microeconomic equilibrium is when the quantity of demand equals the quantity of supply with no tendency for change.