Price Mechanism & its applications Flashcards
Non-price determinants of DD
TIGERPIE T- Tastes and Preferences I- Income G- Government policies E- Exchange rates R- Prices of Related goods P- Population I- Interest rates E- Expectations of future prices
Allocative efficiency
Allocative efficiency is the situation in which society produces and consumes a combination of goods and services that maximises its welfare
Productive efficiency
Productive efficiency is achieved when all resources are fully and efficiently utilised.
PED
Price elasticity of demand (PED) is a measure of the responsiveness of the quantity demanded of a good to a change in its price, ceteris paribus
Determinants of PED
SHIT S- Number and closeness of substitutes H- Habituality of consumption I- Proportion of income spent T- Time horizon
PES
Price elasticity of supply (PES) is a measure of the responsiveness of the quantity supplied of a good to a change in its price, ceteris paribus.
Determinants of PES
MALTP M- Mobility of factors of production A- Availability of spare capacity L- Level of stocks and inventories (which is depends on the ease of storing the stocks) T- Time horizon P- Length and complexity of production
CED
Cross elasticity of demand (CED) is a measure of the responsiveness of the quantity demanded of a good to a change in the price of another good, ceteris paribus.
Determinants of CED
- the relationship between the two goods
2. the closeness of the relationship between the two goods
YED
Income elasticity of demand (YED) is a measure of the responsiveness of the quantity demanded of a good to a change in consumers’ income, ceteris paribus.
Determinants of YED
- nature of the good
- degree of necessity of the good
- level of income of the consumer base
Limitations in the application of elasticity concepts
- Computation issues
- Large amount of data collected, errors may be made that undermines the accuracy of the data. Hence, PED would be inaccurate and the use of it may not be reliable - Issues with prediction
- The values of elasticities are calculated based on past data, so that may not be relevant for current use. Given the nature of our present dynamic economy, such estimates may become outdated quickly - Ceteris Paribus assumption
- The statement of ‘ all other things being equal’ is a very strict assumption that cannot hold in reality. e.g. in the application of the PED concept, only the price of good is allowed to change while other factors of demand are assumed to remain constant. This is not true as NPD are always changing.
Minimum price (price floor)
A minimum price is a price floor, which is a legally established minimum price to prevent prices from falling below a certain level. The price is not allowed to fall below this level. To be effective, the price floor must be set above the market equilibrium price.
Maximum price (price ceiling)
A maximum price is a price ceiling, which is a legally established maximum price to prevent prices from rising above a certain level. Producers are prohibited from selling above a stipulated price. To be effective, the price ceiling must be set below the equilibrium price.
Demand
The demand of a good/service refers to the amount that consumers are able and willing to purchase at each given price over a given period of time.
Supply
The supply of a good or service refers to the amount of a good or service that producers are able and willing to offer for sale at each given price over a given period of time.
PAP ( fall in DD)
- With a fall in DD, at the original price, there is a surplus of (good) as Qd< Qs , this will lead to a downward pressure on (good) prices as producers will cut prices to attract consumers to buy (good).
- As price falls, consumers will increase their Qd of (good), and producers will decrease Qs of (good). Prices will continue to fall until the new equilibrium price of P1, and quantity traded of Q1, where the surplus is eliminated.
Specific tax
A specific tax will shift the supply curve vertically upwards by the amount of tax ($t). Since the amount of tax is same at all prices, supply curve shifts leftwards from S0 to S1`
Ad valorem tax
An ad valorem tax, or a percentage tax, is a tax pegged at a certain percentage of the price of the good. As price rises, the amount of tax to be paid rises. This results in an leftward pivotal shift of the supply curve from S0 to S1
Specific subsidy
A specific subsidy will shift the supply curve vertically downwards by the amount of subsidy ($s). Since the amount of subsidy is the same at all prices, supply curve shifts rightwards from S0 to S1
Ad valorem subsidy
An ad valorem subsidy is pegged at a certain percentage of the price of the good. As price rises, the amount of subsidy granted rises. This results in a rightward pivotal shift from S0 to S1.
Consumer Surplus
Consumer surplus is the difference between the maximum amount that consumers are willing and able to pay for a given quantity of a good and what they actually pay.
Producer Surplus
Producer Surplus is the difference between the amount received by producers for selling their good and minimum prices that they are willing and able to accept for supplying additional units of the good.
