Price Determination In A Competitve Market Flashcards
Perfectly competitive market
Market has many buyers and sellers
Determinants of demand for goods and services
Price determination is how forces of demand for goods and services and supply in a market interact to determine the price
Demand
Quantity or a good or service that consumers are able and willing to buy at a given price during a given period of time.
Varies with price. Lower price more affordable so consumer demand increases
Movement along a demand curve
Caused by changes in price
Shifting the demand curve
Population - larger population the larger the demand.
Income - the more disposable income they are able to afford more goods so demand increases.
Consumers wealth affects demand
Related goods - substitutes or complements
Advertising which will increase consumer loyalty to good and increase demand
Tastes and fashion - demand curve will shift if consumer tastes change
Seasons - demand changes according to season
Diminishing marginal utility
Demand curve is downwards sloping which shows the inverse relationship between price and quaint
- law of DMU states that as extra unit of good is consumed, the marginal utility which is the benefit derived from consuming, decreases so consumers are willing to pay less for the good
Price elasticity of demand PED
Responsiveness of change in demand to a change in price
Price elastic - very responsive to a change in price and PED >1
Price inelastic - demand that is relatively unresponsive to a change in price and PED <1
Unitary - change in demand which is equal to change in price PED = 1
Perfectly inelastic - demand which does not change when price changes and PED = 0
Perfectly elastic - demand which changes to zero when price changes PED = Infinity♾️
Factors influencing PED
Necessities
- necessary good such as bread or electricity will have inelastic demand. If price increases significantly, consumers will still demand bread and electricity because they need it
Luxury goods are more elastic
Substitutes
- if good has several substitutes then the demand is more price elastic and elasticity can change within markets . Close and ,ore available the submarines are the more price elastic the demand
Habitual consumption
- e.g smoking as consumers become addicted to them and therefore continue demanding even if price increases
Proportion of income spent
- if good takes up. Small proportion of income demand is likely the relatively price inelastic but if good takes up a large proportion of income, demand is likely to be relatively price elastic
Elasticity of Demand and tax revenue
Burden of an indirect tax will fall directly on consumers and firms depending on if the good has an elastic or inelastic demand
Taxes shift SUPPLY CURVE!!!
If a firm sells good with inelastic demand they are likely to put most of the burden on the consumer as they know a price increase will not cause demand to fall significantly
Increasing in tax will decrease the supply from S1 to S2 which increases prices from P1 to P2 AND DEMAND CONTRACTS FROM Q1 TO Q2
Effective for raising government revenue
Elasticity of demand and subsidies
Subsidy is payment from gov to firms to encourage production or a food and lower their AC.
Increases supply
PED and total revenue
Total revenue = Average price x quantity sold
TR = P X Q
If a good has an inelastic demand, firms can raise its price and quantity sold will not fall significantly. This will increase total revenue
If a good has elastic demand and firm raises its price, quantity sold will fall which will reduce total revenue
Income elasticity of demand YED
Responsiveness of a change in demand to a change income
Inferior goods - as income increases, demand falls e.g value option at supermarkets. As income increases consumers switch to branded goods YED < 0
Normal goods - demand increases as income increases YED>0
Luxury goods - as income increases , results in an even bigger increase in demand YED >1 e.g holiday have an elastic income
During periods of prosperity such as economic growth, real incomes are rising, firms might switch to producing more luxury goods and fewer inferior goods as demand for luxury goods will be increasing.
Cross price elasticity of demand
Measures responsiveness of a change in demand of one good to a change in price of another
% change in quantity demanded of X / % change in quantity demanded of y
Complementary goods have a negative XED- If one good becomes more expensive the quantity demanded for both goods will fall.
Close complements - small fall in price of good X leads to a larger inc in QD of Y
Downwards sloping
Substitutes - can replace another good so XED is positive and demand curve is upwards sloping. If price of one brand of TV increases, consumers might switch to another brand
Upward sloping
Unrelated goods - XED equal to zero e.g price of a bus journey has no effect on demand for tables
Firms are interested in XED as it allows them to see how many competitors they have
Supply
Quantity of a good or service that a producer is able and willing to sell at a given price during a given period of time
If price increases, it is more profitable for firms to supply the good so supply increases
High price encourage new firms to enter the market as it seems profitable so supply increases
With larger outputs firms costs increase so they need to change a higher price to cover the costs
Movements along supply curve
Changes in price cause move,enter along supply curve and is based on the theory of the profit motive. Firms are driven by desire to make larger profits
Shifting the supply curve
PINTSWC
Productivity - higher productivity causes an outward shift in supply as average costs for the firm fall
Indirect taxes - causes inward shift in supply to the left
Number of firms - more firms there are the larger the supply
Technology - more advanced the technology causes an outward shift in supply
Subsidies- cause a rightward shift in supply
Weather - agriculture. Favourable conditions increase supply
Costs of production - if costs rise e.g higher wages there will be an inward shift in supply
Price elasticity of supply
The responsiveness of a change in supply to a change in price
If supply is elastic then firms can increase supply quickly at little cost PES >1
If supply is inelastic, an increase in supply will be expensive for firms and take a long time PES<1
Perfectly inelastic has PES = 0 As supply is fixed so if there’s a change in demand it cannot be met easily
Supply is perfectly elastic when PES = ♾️. Any quantity demanded can be met without changing peice
Factors affecting PES
Time scale - In the short run supply is more price in elastic , because producers cannot quickly increase supply in the long run, supply becomes more price elastic
Spare capacity - If the firm is operating at full capacity there is no space left to increase supply if there are spare resources. For example in a recession there are lots of spare an unemployed resources so supply can be increased quickly.
Levels of stock e.goods can be stored firms can stock them and increase market supply easily. However if perishable then firms cannot stock for long so supply is more price inelastic
Substitutes - if labour and capital are mobile supply is more pric elastic as rescinds can be allocated to where extra supply is needed. For example if workers have transferable skills they can be reallocated to produce a different good and increase supply
Barriers to entry - higher barriers to entry means supply is inelastic as it is harder for new firms to enter and supply the market
Market equilibrium
Supply = demand
At market equilibrium price has no tendency to change which means this is the market clearing price
Price mechanism refers to how supply and demand interact to set the market prive
Market disequilibrium - excess demand
Demand is greater than supply which can be calculated by Q3 - Q2 is a state of disequilibrium. There’s excess demand and there’s a shortage in the market which pushes price up and causes firms to supply more. Since prices increase there’s a movement along demand curve and demand will contact.
Excess supply
If price is too high there is a excess supply and supply is greater than de,and and there is a surplus which is equal to Q 3 - Q1.
So firms reduce price and supply less which would encourage more demand so surplus is eliminated and new market equilibrium is at Q2 P1
Derived demand
The demand for one good is linked to the demand for related good. For example, the demand for labour is derived from the goods delivered produces for example, if the demand for cause increases in the man will able to produce those goods will increase
Composite demand
This is when the good demanded has more than one use. An example is milk which can be used for cheese and butter.
Joint demand
When goods are brought together such as digital camera, and a memory card, an increase in demand for digital cameras is likely to lead to an increase in demand for memory cards
