Price Elasticity And Determinants In A Competetive Market

Question 1

Define PES

Answer 1

Measure responsiveness of quantity supplied to a change in price

Question 2

How to workout PES

Answer 2

% change in supply/ % change in price

Question 3

Reasons for supply to be elastic or in elastic

Answer 3

Production lag
Stocks
Spare capacity
Availability of factors of production
Time period

Question 4

Ped formula

Answer 4

%change qd / %change price

Question 5

Describe inelastic demand

Answer 5

Qd not responsive to price changes
Value between 0 and -1
% change qd< % change price
Perfectly inelastic= 0

Question 6

Factors affecting PES

Answer 6

• 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

Question 7

Why is price elasticity of demand important for businesses?

Answer 7

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

Question 8

How can price elasticity of demand be used by governments?

Answer 8

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

Question 9

define cross elasticity of demand

Answer 9

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

Question 10

how to get positive CED (XED)

Answer 10

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

Question 11

CED formula (XED)

Answer 11

% Change in Quantity Demanded of A / % Change in Price of B

Question 12

describe CED of substitutes (XED)

Answer 12

positive cross price elasticity of demand
= increase in price of one product will lead to a rise in demand for its substitute

Question 13

describe CED of complements (XED)

Answer 13

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

Question 14

define income elasticity of demand

Answer 14

compares the % change in income with the % change in demand

Question 15

income elasticity of demand formula

Answer 15

% change in demand/ % change in income

Question 16

describe inferior goods

Answer 16

• 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

Question 17

importance of income elasticity for businesses

Answer 17

• 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

Question 18

Factors affecting responsiveness of supply

Answer 18

Production lag
Stocks
Spare capacity
Substitutability
Time

Question 19

What happens if PED is elastic

Answer 19

Reduction in price= increase in total revenue

Question 20

Describe income elasticity of demand under inferior goods

Answer 20

Demand increases as income increases

Question 21

Describe income elasticity if demand under normal goods

Answer 21

Demand stays the same or changes very slightly

Question 22

Define determination of equilibrium market prices

Answer 22

Refers to point where supply and demand for good or service intersect
= producers willing to supply what consumers are willing to buy

Question 23

Define equilibrium

Answer 23

Quantity demanded equals quantity supplied in a market for a particular good

Question 24

What happens at market disequilibrium of shortage

Answer 24

firms increase prices
As price rises= contraction along demand= lower demand
= extension long supply curve
= cause increase of price until no shortage and supply

Question 25

What happens at market disequilibrium of supply surplus

Answer 25

Firms will decrease price= cause extension along demand= increase demand
Cause contraction along supply curve as less is being supplied

Question 26

Describe the function of the price mechanisms

Answer 26

• 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

Question 27

Define effective demand

Answer 27

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

Question 28

Define joint supply

Answer 28

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

Question 29

what does negative, positive etc demand mean for XED

Answer 29

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