Section 2: Competitive Markets Flashcards
What is the price sold for a product decided by
The demand and supply in the market
What is demand
Demand is the quantity of a good/service that consumers are willing and able to buy at a given price, at a particular time
What are normal goods
Goods where the demand increases when the real income of the consumer increases
What is the x and y axis in a demand curve
x = quantity
y = price
What are inferior goods
Goods where the demand decreases when the real income of the consumer increases
What would happen to the demand curve of luxury items if there was a more equal distribution of income
Shift to the left (decrease in demand) because there would be less rich people to buy luxury items
What are substitute goods
Goods that are alternatives to each other
What do interrelated markets mean
Changes to one market affect another one
What is derived demand
Demand for a good or a factor in production used in making another good or service
What are complementary goods
Goods that are used together - in joint demand
What is composite demand
When a good is used for more than one purpose
What is the formula for PED
PED = Percentage Change in Quantity Demanded / Percentage Change in Price
When referring to changes in the amount of demand what terms are you supposed to use
Contraction
Expansion
What is the price elasticity of demand
It is a measure of how the quantity demanded of a good responds to a change in price
What are the three types of PED
Elastic
Inelastic
Unit Elastic
What is Elastic demand
When the PED is greater than one
What is Perfect Elastic Demand
When the PED is +/- infinity
This means that any price increases will take the demand to 0
Describe the relationship between price and quantity demanded when the demand is elastic
The price change will have a larger effect on quantity demanded
What is Inelastic Demand
When the PED is greater than 0 but less than 1
Describe the relationship between price and quantity demanded when the demand is inelastic
The price change will have a smaller effect on quantity demanded
What is Perfect Inelastic Demand
Has a PED of 0 and any change in price will have no effect on on the quantity demanded
What is Unit Elasticity of Demand
When the PED = +/-1
Describe the relationship between price and quantity demanded when the demand when the good has unit elasticity
When the percentage change in price is equal to the percentage change in quantity demanded
What is Income Elasticity of Demand
It measures how much the demand for a good changes with a change in real income
What is Income Elastic
YED > 1
What is the formula for YED
YED = Percentage Change in Quantity Demanded of a Good / Percentage Change in Real Income
What is Income Inelastic
YED < 1
What is Perfectly Inelastic Income
YED = 0
What is Cross Elasticity of Demand
A measure of how the quantity demanded of one good responds to a change in price of another good
What is the formula for XED
XED = Price Change in Quantity Demanded of Good A / Percentage Change in Price of Good B
What will the XED be if the goods are complementary and substitutes
Complementary = Negative XED
Substitutes = Positive XED
How does substitutes affects PED
The more substitutes a good has the more price elastic the demand is - that’s because the consumers can easily switch to something else if the price rises
Give 4 reasons the type of good affects PED
Demand for essential items is price inelastic (non-essential is price elastic)
Demand for habit-forming goods tends to be price inelastic
Demand for purchases that cannot be postponed tends to be price inelastic
Demand for products with several different uses tends to be price inelastic
How does the percentage of income spent on good affect the PED
Demand for goods that require a large percentage of income is more price elastic than products that take a smaller percentage
Consumers are more likely to shop around for the best price for an expensive good
How does time affect PED
In the long run demand becomes more price elastic as it becomes easier to change to alternatives because consumers have had more time to shop around
Habits and loyalties may change
Equation for total revenue
Price per Unit x Quantity Sold
Explain how the PED changes along the demand curve
Minus infinity at high price/zero demand
To an elasticity of -1 at the midpoint
To an elasticity of zero at zero price/high quantity
When is total revenue is maximised in relation to PED
When the PED = +/-1
If a good has elastic demand what will a reduction in price do to the total revenue
Increased firms total revenue
What is the YED of a luxury item
YED > 1
Explain the difference in YED in normal and inferior goods
Normal - Positive YED (0 < YED <1)
As income increases quantity demand increases
Inferior - Negative YED (YED < 0)
As income rises, quantity demand falls
A rise in income will lead to good being replaced
If a good has inelastic demand what will a reduction in price do to the total revenue
Decreased firms total revenue
What is the XED of complements
Negative XED
Increase in price of a good it will decrease the demand of it’s complements
What is the XED of substitutes
Positive XED
A fall in price of a good will decreases the demand of the substitute
The closer the substitutes the more positive the XED
What does it mean if a good has a negative XED
It is independent
What is supply
The quantity of a good or service that producers supply to the market at a given price, at a particular time
What is the x and y axis of a supply curve
x = Quantity of Supply
y = Price
What terms should be used when describing increase or decrease in supply
Contraction and Extension
Explain the supply curve
Higher the price of product means higher product which means higher incentive to increase production
What are marginal firms
Firms that are just breaking even
What are the 4 factors that can cause a shift in the supply curve
Changes to the costs of production
Improvements in technology
Changes to the productivity of factors of production
Indirect taxes and subsidies
Changes to the price of other goods
Number of suppliers
What are the 4 factors that can cause a shift in the supply curve
Changes to the costs of production
Improvements in technology
Changes to the productivity of factors of production
Indirect taxes and subsidies
Changes to the price of other goods
Number of suppliers
Explain how the improvements in technology can cause a shift in the supply curve
Can increase supply because it will decrease the costs of production
Explain how the changes to the costs of production can cause a shift in the supply curve
Increase in costs of production (raw materials, wages etc.) will decrease profits and decrease supply (curve shifts to the left)
Give 4 reasons why knowledge of elasticities of demand is useful to firms
Can be used for sales forecasting - YED of product and changes in income are known then sales levels can be predicted
YED can be used in pricing policy (reduction in price of a normal good in an expected fall in incomes will limit the reduction in demand)
May choose to supply products that have a range in YED so they can still earn revenue whether the economy is in recession or boom
XED can tell them how to react to changes in the price of related products to ensure maximise demand for their products
Explain how knowledge of elasticities of demand is useful to governments
Need to know demand for goods during booms or recession when they’re setting their policies
Explain how changes to the productivity of factors of production can cause a shift in the supply curve
Increase output
Give 2 reasons why indirect taxes and subsidies can cause a shift in the supply curve
Tax on good increases costs for a producer - supply is reduced and the supply curve shifts to the left
A subsidy reduces costs for a producer - this does the opposite of a tax
Explain how changes to the price of other goods can cause a shift in the supply curve
A firm may increase production to a good where the price increases to increase profit
Explain how number of suppliers can cause a shift in the supply curve
Increase in suppliers will increase supply
What is Price Elasticity of Supply
A measure of how the quantity supplied of a good responds to a change in its price
What is the formula for PES
PES = Percentage Change in Quantity Supplied/Percentage Change in Price
Is PES generally positive or negative and why
Positive - generally the higher the price the greater the supply
What are the 3 types of PES
Elastic
Inelastic
Unit Elastic
What values of PES is elastic
PES > 1
What values of PES is Inelastic
0 < PES < 1
What values of PES is Unit Elastic
PES = 1
Describe the relationship between price and quantity supplied when the supply is elastic
This means that price will have a larger effect on quantity supplied
Describe the relationship between price and quantity supplied when the supply is inelastic
This means that price will have a lower effect on quantity supplied
Describe the relationship between price and quantity supplied when the supply is unit elastic
This means that the percentage change in price is equal to the percentage change in quantity supplied
What does Perfect Elasticit Supply mean
Any fall in price means the quantity supplied would fall to zero
What values does Perfect Elastic Supply have
PES of +/- infinity
What values does Perfect Inelastic Supply have
PES of 0
What does Perfect Inelastic Supply mean
Any change in price will have no effect on the quantity supplied
Which PES is optimal to firms (give 3 reasons)
They aim to have a high PES
They aim to respond quickly to changes in price and demand so they need to make their supply as elastic as possible
Give 3 ways a firm can have a high PES
Flexible working patterns
Latest tech
Spare production capacity
In the short term is price Elastic, Inelastic or Unit Elastic
Inelastic
Over short periods of time a firm may find it difficult to switch production from one good to another
The firms capacity is also fixed
Which factor of production in the short run is fixed
Capital - a firm can recruit more employees and buy more materials but it takes time to build additional facilities
In the long term is price Elastic, Inelastic or Unit Elastic
Elastic (generally)
In the long run all the factors of production are variable so a firm is able to increase its capacity
Firms have longer to react to changes in price and demand
Give 4 factors that affect PES
Periods of unemployment supply tends to be elastic - more workers for firms
Perishable goods - inelastic supply as they can’t be stored for long
Firms with high stock levels have elastic supply - can increase supply quickly
Industries with more mobile factors of production have more elastic supply
What is market equilibrium
When supply meets demand and price and output is stable
What are market forces
The free interaction between supply and demand
On a graph where can market equilibrium be found
When the supply curve and the demand curve intersects
How would you describe the market when supply and demand don’t meet
Market disequilibrium
What is excess supply
Quantity supplied to a market is greater than the quantity demanded
What is excess demand
Demand for a good is greater than the supply
Why does excess supply or demand not exist for long in a free market
Market forces act to remove excess supply or demand
What happens if there is a shift in demand or supply curves
The market equilibrium will change
Explain how elasticity affects the point of new equilibrium if the supply or demand curve shifts
If price is elastic shifts in demand/supply will have a greater impact on price rather than quantity
If price is inelastic shifts in demand/supply will have a greater impact on quantity rather than price
Give 2 conditions to a competitive market
Large number of sellers and buyers
No single consumer or producer can influence the allocation or the price that goods can be bought at
What is the price mechanism
Changes in supply and demand in goods leads to changes in its price and to the quantity bought or sold
In a competitive market what is the assumption that are made about consumers and producers
Assumed to act rationally
What is the invisible hand of the market
The price mechanism allocates goods and services in an impersonal way
What are the 3 functions of the price mechanism
Acts as an incentive to firms - higher price allows firms to make more goods
Acts as signalling device - changes in price show changes in supply and demand and act as a signal to producers and consumers
Acts to ration scarce resources - if there is high demand for a good but it has low supply then the price will be high
Give 4 advantages to the price mechanism
Resources are allocated effectively to satisfy consumers’ wants and needs
Price mechanism can operate without the cost of employing people to regulate it
Consumers decide what is and isn’t produced by producers
Price are kept to their minimum as resources are used as efficiently as possible
Give 4 disadvantages to the price mechanism
Inequality in wealth and income is likely
Under provision in merit goods
People with limited skills or ability to work will suffer unemployment or receive very low wages
Public goods won’t be produced
Give an example of how the price mechanism can have unintended consequences
Offering payments to blood donors may reduce amount of blood donors because some of them will be disturbed by receiving payments for donating blood
What is a consumer surplus
When a consumer pays for a product less than what they were prepared to pay for
What is a producer surplus
When a producer sells a product at a price below the equilibrium price
Where is the producer and consumer surplus on a price and quantity graph in relation to the supply and demand curves
Consumer surplus - the area below the demand curve and above the equilibrium line
Producer surplus - the area above the supply curve and below the equilibrium price line
What is a subsidy
When a government pays a producer to lower the price of a good to increase its demand
What are indirect taxes
When a government places a tax on a good to increase the price of a product to decrease the demand
What does a subsidy do the demand curve
Shift it to the right
Describe the relationship between the PES of a product and the amount of consumer and producer gain when subsidies are granted
The more price inelastic the demand curve is, the greater the consumer’s gain is from the subsidy
The more price elastic, the greater the producer’s gain is from the subsidy
What does taxation of a good to the supply curve
Shift to the left
Describe the relationship between the PES of a product and the amount of consumer and producer burden when taxation happens
The more price inelastic the demand curve is, the greater the tax burden for the consumer
The more price elastic, the greater the tax burden for the producer
What resource is very important in transportation
Many goods are made from or stored in plastic - those goods are also transported in modes of transportation that consumes oil
What can an increase in the price of oil do to the economy of a country
Can cause inflation - this is because it will increase the price of the majority of goods because oil is essential to the majority of items
Describe the fluctuation of oil prices
Fluctuate widely with increases and decreases rapidly over time
Describe the elasticity of the demand for oil
The demand for oil is price inelastic because oil is so important and increase in price doesn’t affect demand
Describe the elasticity of the supply of oil
The supply of oil is price inelastic because it is difficult to increase the supply of oil in the short term - exploration of new oil takes time
What happens to the demand for oil when there is an economic boom and recession
Falls during recession and increases during boom because oil is used in most economic activity
Explain how the US dollar can affect the demand for oil
Oil is priced in US dollars so if the value of the dollar is low then more oil can be purchased by speculators holding other currencies
What happens to the demand for oil if the demand for products made from crude oil increases and explain this type of demand
Increases the demand for oil
This type of demand is derived demand
As living standards improve what happens to the demand for oil
Increases - can be linked to an increase in the consumption of goods and services
Name an organisation that has significant control over the price of oil
The Organisation of Petroleum Exporting Countries (OPEC)
Members include large oil exporting countries such as Saudi Arabia and Venezuela
They can agree to cut or increase oil production which therefore affects the price
Give 3 factors that can affect the supply of oil in the long run (in relation to the actual of process of extraction)
Size of remaining oil reserves
Cost of extracting oil
The efficiency and cost of technology needed to extract
Why might oil reserves restrict the supply of oil
To keep the price high
What would happen to the price of houses if the supply of houses increased
The price would decrease
Give 4 factors that affects the demand of housing
State of the economy has a big impact - high unemployment leads to lower prices and lower demand and the opposite is true for low employment
High living standards increase demand for housing
Fall in the cost of renting may decrease demand to buy
If interests rates rise for mortgages then the demand for house purchases will decrease
What is a substitute for buying a house
Renting one
Explain the price elasticity of housing
In the short term PED of housing is inelastic because there is no substitute for housing
Explain the price elasticity of supply of housing
Inelastic because the supply can’t be increased quickly because the production of houses takes time
Supply can also be affected by availability of materials and workers, suitable land and restrictive government regulations
Explain the 3 knock on effects of house prices
If house prices rise and there’s and increase in demand for houses this can create job opportunities for construction workers
Higher house prices increase the value of peoples assets and can increase consumer confidence
Increased house sales encourage spending on furniture and other goods
Describe the type of demand for transport
Derived demand
Always results for demand for other goods and services :
- People want to get to places for work, leisure and
holidays
- Firms want to bring factors of production together
Describe the income and price elasticity of transport
Positive income elasticity of demand because it is a normal good
Demand is price elastic to some extent - people might cut back on leisure travel if prices rise
Describe the YED for bus, car and air travel
Car and air travel are generally considered to have a positive YED but bus travel has negative YED
What is the price elasticity of car travel
Quite low - people value the convenience and comfort of driving and the substitutes are considered poor in comparison
Give 3 things that the demand for car travel depends on
Cost of journey - petrol
Income - car ownership and usage rise with real income
Substitutes - increase in car price could lead to a switch in the mode of transport but the substitutes are considered poor substitutes
Complements - the price of car insurance or parking can have an effect on car demand
What is the XED of cars
Low because the major drop in quality in cars and trains or buses
