Price System and the Microeconomy. Flashcards
What is the importance of price system?
The price mechanism is the means of allocating resources in a market economy.
The producer gets signals on what products to focus on through changes in price.
What is Market?
A market is where buyers and sellers get together to trade. (Not necessarily a physical shop as a typical town may have.)
Describe equilibrium and efficiency of prices.
Prices are set by markets, are always moving into and out of equilibrium and can be both efficient and inefficient in many ways, over different time periods.
Define demand and it’s types.
The quantity of a product that purchasers are willing and able to buy at various prices per period of time, all other things being equal.
Notional Demand: Not backed up on the ability to pay, speculative only.
Effective Demand: Demand supported by the ability to pay.
Law of Demand?
If price increases, demand decreases and vice versa… (ceterus paribus)
A change in price changes the quantity demanded and this is shown by movements along the curve.
Non-Price factors influencing demand?
- Income: The ability to pay (effective demand) is vital.
For normal goods, if income increases demand increases.
For inferior goods, if income increases demand decreases. (Goods used because higher quality goods cannot be afforded.)
- Price and Availability of:
Substitutes: can satisfy the same wants/needs. The degree of substitutability determines the change in demand of one product if demand of other is unchanged.
If price of substitute decreases, demand decreases. (Inverse rs)
Complimentary: These goods have joint demand. If demand of one increases, demand of other increases. (Direct rs)
- Fashion, tastes, attitudes: these come under individual behavior. (Trends)
Define Supply.
Quantities of a product that suppliers/producers are willing and able to sell at various prices per period of time. (ceterus paribus)
Law of Supply?
If price increases, supply increases.
(More profit for producer, hence more eager to sell…)
Changes in price are represented by movements along the curve.
Non-price factors influencing supply?
- Costs: supply decisions taken by companies are invariably driven by the costs of producing and distributing their products to consumers.
(Labor, energy and transportation costs.) - Size and Nature of Industry: If an industry is growing in size, there is more supply.
This growth may attract new producers which will increase competition and cause a fall in prices which will increase demand and supply.
(In some industries, supply can be deliberately restricted to keep up prices.) - Change in price of other products: If a competitor lowers it’s price, less will be supplied by other firms who keep their prices unchanged and vice versa.
- Govt. Policy:
Tax: will cause reduction in supply if tax burden is taken on by the producer.
Subsidy: will increase supply.
- Other factors:
Weather conditions, droughts, frost. May affect agricultural markets.
Define Elasticity, Elastic and Inelastic changes.
Elasticity is the responsiveness of one variable following a change in another. (Numerical Value)
Elastic: relative change in demand/supply is greater than change in price.
Inelastic: relative change in demand/supply is less than change in price.
Explain price elasticity of demand.
Responsiveness of demand to a change in price.
PED = % change in quantity demanded/
% change in price
(Value will be negative due to inverse nature of demand and price, ignore sign otherwise.)
PED < 1: Inelastic.
PED > 1: Elastic.
PED = 0: Unitary Elastic. (ΔP=ΔD)
PED = 0: Perfectly Inelastic. (Vertical line on graph.)
PED is infinite: Perfectly Elastic. (Horizontal line on graph.)
Perfectly Inelastic: demand does not change price.
Perfectly Elastic: product sold at given price.
Describe Factors affecting PED.
- Range and Quality of Substitutes:
The greater the number of substitutes/the more of a close substitute the product is will determine whether it’s elastic or inelastic.
(Inelastic if no substitutes.)
- Whether or not a product is a necessity, how habit forming it is and the brand image of the product affects elasticity.
- Percentage of income spent on product:
The more it is, the greater the impact is on the consumer upon price change.
The price elasticity of demand tends to be low when spending on a good is a small proportion of their available income.
- Time:
PED becomes elastic overtime. A change in price in the short term is more elastic as spending patterns are harder to change. Overtime however, they can get used to the changed prices.
Explain income elasticity of demand.
Responsiveness of quantity demanded to change in income.
% Change in quantity demanded/
% Change in income
Normal Goods: Increase in income leads to an increase in quantity demanded. (positive numerical value.)
Inferior Goods: Increase in income leads to a decrease in quantity demanded. (negative numerical value.)
Sign tells type of good, numerical tells elasticity.
Explain cross elasticity of demand.
Responsiveness of quantity demanded for one product following the change in price of another related product.
% Change in quantity demanded for product A/
% Change in price of product B.
Substitutes: (positive values)
If price of B goes up, quantity demanded of A decreases and vice versa.
Complimentary: (negative values)
If the price of B goes up, quantity demanded of A increases and vice versa.
Business relevance of demand elasticity.
Businesses use demand/price variations to maximize revenue. If inelastic, price can be increased. (Restaurant meals more expensive during festivals, stadium seats more expensive during finals.)
YED can show how whether product is normal or inferior and so on…
XED will show whether products are complimentary or not, companies will want to sell complimentary goods as well to increase revenue.
