Price Elasticity And Determinants In A Competetive Market Flashcards
Define PES
Measure responsiveness of quantity supplied to a change in price
How to workout PES
% change in supply/ % change in price
Reasons for supply to be elastic or in elastic
Production lag
Stocks
Spare capacity
Availability of factors of production
Time period
Ped formula
%change qd / %change price
Describe inelastic demand
Qd not responsive to price changes
Value between 0 and -1
% change qd< % change price
Perfectly inelastic= 0
Factors affecting PES
- Availability of substitutes
- Luxury goods have an elastic demand
Necessity goods have an inelastic demand - Proportion of Income spent on good
= high % of income spent on a good (e.g. a car), change in price have large effect on consumer= good will be price elastic - Time Period =short run, consumers won’t respond to price changes= good will be price inelastic
In the long run, consumers may change spending habits and lifestyle to save money= good will be price elastic - Brand Image = strong brand image, like Coca Cola= price inelastic= consumers willing pay more for these products as opposed to other substitutes
- Habitual Consumption & Addictive Goods =bought on regular basis, like a magazine= price inelastic= consumers in a habit of consuming them regardless of a price change
Why is price elasticity of demand important for businesses?
Helps them to determine optimal price point for their products or services.
A thorough understanding of price elasticity of demand can help businesses to increase revenue and profits
How can price elasticity of demand be used by governments?
Govs can use ped to make decisions about taxation and regulation. Eg if a product has an inelastic demand, a tax on it will generate more revenue for the gov, without causing a significant decline in demand
define cross elasticity of demand
measures the responsiveness of the demand for a product following a change in price of another product
= concept is useful in analyzing relationships between substitute and complementary goods
how to get positive CED (XED)
must be a positive relationship between the change in price of product B with the change in demand of product A
= if product A increase their price, demand for subsitutue product B will increase
CED formula (XED)
% Change in Quantity Demanded of A / % Change in Price of B
describe CED of substitutes (XED)
positive cross price elasticity of demand
= increase in price of one product will lead to a rise in demand for its substitute
describe CED of complements (XED)
if CED is negative= two goods are complements
= increase in the price of good B= results in a decrease in the quantity demanded of good A, and vice versa
define income elasticity of demand
compares the % change in income with the % change in demand
income elasticity of demand formula
% change in demand/ % change in income
describe inferior goods
- goods or services that are of lower quality or lower value compared to other goods in the same category
- Demand for inferior goods tends to decrease as consumer income increases= as consumers have more disposable income, they are able to afford higher quality or higher value alternatives.
- Inferior goods have a negative YED=means that YED < 0
- When real incomes are falling during a period of recession if wages are rising more slowly than prices= then market demand for inferior goods will rise
- eg. lidl food replaced by waitrose, public transport, cheap clothes
importance of income elasticity for businesses
- knowledge of YED helps firms predict the effect of changes in macro economic cycle on their sales
- luxury products with a high-income elasticity see greater sales volatility over a business cycle than necessities where demand is less sensitive to changes in the economic cycle
- important for businesses to have diversified product range
- higher value-added products increase profit margins – this is because they have a high YED and a low PED
Factors affecting responsiveness of supply
Production lag
Stocks
Spare capacity
Substitutability
Time
What happens if PED is elastic
Reduction in price= increase in total revenue
Describe income elasticity of demand under inferior goods
Demand increases as income increases
Describe income elasticity if demand under normal goods
Demand stays the same or changes very slightly
Define determination of equilibrium market prices
Refers to point where supply and demand for good or service intersect
= producers willing to supply what consumers are willing to buy
Define equilibrium
Quantity demanded equals quantity supplied in a market for a particular good
What happens at market disequilibrium of shortage
firms increase prices
As price rises= contraction along demand= lower demand
= extension long supply curve
= cause increase of price until no shortage and supply
What happens at market disequilibrium of supply surplus
Firms will decrease price= cause extension along demand= increase demand
Cause contraction along supply curve as less is being supplied
Describe the function of the price mechanisms
- allocate scarce resources efficiently
- ration scarce resources by encouraging consumption
- signal excess demand and supply and need to increase or decrease resources
- incentivise producers to increase or decrease output to increase profit
Define effective demand
Willingness and ability of consumers to purchase goods at different prices
= shows amount of goods that consumers are actually buying and supported by their ability to pay
Define joint supply
Refers to situation where production and supply of one good leads to production and supply of another good
= means that a good is a by-product of other goods
E.g. farming lamb affect the supply of wool
what does negative, positive etc demand mean for XED
positive XED= substitute good
negative XED= complementary good
more than 1= demand between goods is price inelastic
less than 1= price inelastic
0= perfectly inelastic
