Supply, demand, elasticity of markets Flashcards
define market
any place where transactions take place between buyers and sellers
EG. shares are traded in a stock market
scarcity MUST EXIST for a market to exist
define demand
demand is the willingness and the ability of customers to pay a certain price in a market to obtain a particular good or service
(want or willingness of a consumer/group of consumers to buy a good or service)
It is sometimes referred to as effective demand to distinguish it from a want or desire to buy something
what is the difference between quantity demanded and demand
demand refers to an entire demand curve
quantity demanded refers to a point on the demand curve
what does the law of demand state
the quantity demanded for a good or service falls as it price rises, ceteris paribus
Likewise, the quantity demanded rises at lower prices
what does a demand curve show
the inverse relationship between price and quantity demanded of a product
\ line- linear, negative gradient
y axis- price
x axis- quantity demanded
what are the 3 causes of the negative relationship between price and demand
- The income effect- as price falls, the real income of customers rises, i.e. they are able to buy more products at lower prices
- The substitution effect- as the price of a good or service falls, more customers are able to pay, so they are more likely to buy the product, ie. substitute it for alternative products that they might not have previously bought
- Diminishing marginal returns- as people consume more of a particular good or service, the utility (return or satisfaction) gained from the marginal unit declines, so customers only purchase more at a lower price
what does the market demand curve refer to
the sum of all individual demand for a product
it is found by adding up all individual demand at each price level
define substitute
products that compete to satisfy the same consumer demand, such as Coca Cola or Pepsi
define complement
a good or service that is in joint demand with another (eg. cars and petrol)
define normal goods
products for which demand rises as consumer incomes rise
define inferior goods
products for which demand tends to fall as consumers’ incomes rise
ie. customers switch to a superior (luxury) product as their income rises- for example canned food products vs fresh food products
acronym for non-price determinant of demand
HIS AGE
Habits, Fashion and Tastes Income Substitutes and Complements Advertising Government policies Economy
how do changes in non-price factors affect the demand curve
it causes a shift in the demand curve
Increase in demand -> rightwards shift (more quantity demanded at all price levels)
Decrease in demand-> leftwards shift (less quantity demanded at all price levels)
effect of habits, fashion and tastes on demand
products that become fashionable cause an increase in demand
unfashionable items reduce the level of demand
effects of income on demand
higher levels of income mean that customers are able and willing to buy more goods and services
effects of substitutes and complements on demand
if the price of a product falls, then it is likely that the demand for the substitute product will also fall
If the price of a product increases, then the demand for its complementary good is likely to fall
effect of advertising on demand
marketing messages are used to inform, remind and persuade customers to buy a firm’s products
Advertising increases demand for products
effect of government policies on demand
rules and regulations such as the legal age to purchase certain products, laws to on where and how to use products may affect demand
effect of economy on demand
whether the country is in recession or boom has an impact on the spending patterns of the population
eg 2008 global financial crisis caused the demand for most goods and services around the world to decline
how would higher interest rates affect demand
it would increase demand for savings schemes but reduce the amount of money people want to borrow from banks, including mortgages for house purchases
how would price affect the demand curve
Rise in price- contraction of in the quantity demanded of a product (moves upwards, left)
Fall in price- expansion in the quantity demanded (moves downwards, right)
PRICE ELASTIC
Consumer demand for a product is
described as price elastic if a small change in its price
causes a larger proportionate demand response.
PED >1 demand is elastic
=1 d is unit elasticity
∞ = d is perfectly price elastic
PRICE ELASTICITY OF DEMAND
The responsiveness of consumer demand for a product to a change in its price.
PRICE ELASTICITY OF SUPPLY
The responsiveness of producer supply of a product to a change in its price
PRICE INELASTIC
Consumer demand for a product is described as price inelastic if a small change in its price causes a less than proportionate demand response.
PRICE MECHANISM
The market mechanism that guides decisions taken by different producers and consumers about how scarce resources should be allocated between competing uses.
Formula for PED
%∆Qd ÷ %∆P
%∆ = (Difference/ Original)100
PED is usually ____
negative because of the law of demand
Increase in price (+), decrease quantity demanded (-) -> neg. n (-)
Decrease in price (-), increase quantity demanded (+) -> neg. n (-)
PED= ∞
Demand is perfectly price elastic
Customers switch to buying other substitutes if firms increase their price
____ horizontal line
PED = 1
Demand is unit price elastic, given ∆P -> %Qd
curve with decreasing negative gradient
PED = 0
Demand is perfectly price inelastic -> regardless of the price, quantity demanded does not change
-> suggests there are no substitutes for the product
vertical straight line
PED < 1
Demand is inelastic
When the price changes, quantity demand will change proportionally less than change in price
eg. Price raises by 5%, quantity demanded decreases by 10% -10/25=0.4
%∆P> %∆Qd
PED > 1
Demand is price elastic
For any given price change, there is a greater proportionate change in quantity demand
eg. Price falls by 5% but quantity demanded goes up by 15%
%∆P< %∆Qd
Describe the changes in PED value for a downwards sloping linear demand curve
The value of PED increases as price level rises because customers are more responsive to changes in prices at higher levels (price now accounts for a greater proportion of consumer’s income)
The gradient of the linear demand curve will remain the same, but the %∆D is greater at higher price levels
if demand is ‘price elastic’ …?
the percentage fall in demand is greater than the percentage increase in price
Consumer demand for a product is
described as price elastic if a small change in its price
causes a larger proportionate demand response
what affects price elasticity of demand (acronym)
SPLAT
Substitutes Percentage of income Luxury/Necessity Addictive/habit forming Time Period
how do substitutes affect PED
MORE SUBSTITUTES -> MORE PRICE ELASTICITY OF DEMAND
the greater the number, availability and price of close substitutes there are for a good or service, the higher the value of its PED will tend to be -> price elastic demand
Products with few substitutes (such as private education and prescribed medicine) have price inelastic demand
how does percentage of income affect PED
the GREATER PROPORTION of consumers’ income spent on a good or service, the more price ELASTIC demand will be, ceteris paribus
how does luxury/necessities affect PED
ESSENTIAL products (eg. fuel, housing, food) tend to be price INELASTIC as households will continue to purchase them even if price rises
demand for LUXURIES is relatively price ELASTIC
how do addictions and habits affect PED
if a product is habit forming or addictive it tends to be price INELASTIC
how does time period affect PED
SHORT RUN - INELASTIC
- few substitutes available and consumers may not have as much time to look for alternatives
- consumers need time to change their habits and preferences
LONG RUN- ELASTIC
- more substitutes available
- over time consumers can change their demand based on more permanent price changes by switching to alternative products
how would advertising and brand loyalty affect PED
effective advertising shifts demand curve outwards to the right but may reduce PED for the product
how would durability affect PED
more durable (eg. furniture or motor vehicles), more elastic its demand tends to be as there is no urgency to replace if their prices are high
how would the costs of switching affect PED
if there are high costs for customers to switch between brands or products, demand tends to be price inelastic
eg. mobile phone subscribers are bound by lengthly contracts so switching between rival services is less easy
how can firms use the knowledge of PED to increase their revenue
firms that face:
inelastic price demand can increase its prices to earn more total revenue
price elastic demand for products can reduce prices to earn more revenue
why is the PED for many primary commodities low and the PED for many manufactured goods high
These commodities lack real substitutes and are essential products for output. Hence, their PED value is relatively low, i.e. price inelastic or unresponsive to changes in price. By contrast, the PED for manufactured
goods is relatively high because there are far more substitutes available for customers to choose from.
if supply is elastic firms can _____ if there is an increase in the price of a product
such firms can ________
if supply is elastic firms can easily increase supply without a time delay if there is an increase in the price of a product
such firms can gain a competitive advantage
PES > 1
supply is price elastic, responsive to changes in price
When the price rises from P1 to P2 there is PLENTY OF SPARE CAPACITY for the firm, so the quantity supplied can increase by a greater proportion from Q1 to Q2.
Eg. mass produced goods
positive linear slope, shallow gradient
PES < 1
supply is inelastic, not responsive to changes in price
When the price rises form P1 to P2, there is very LITTLE SPARE CAPACITY for the firm, so the quantity supplied can only rise by a smaller proportion from Q1 to Q2
Eg. fresh fruit/veg that take time to grow
positive linear slope, steep gradient
PES = 0
supply is perfectly price inelastic, change in price has NO IMPACT on quantity supplied, there is NO SPARE CAPACITY TO RAISE OUTPUT
irrespective of change in price, firm only supplies a maximum of Qe
eg. stadium that has a maximum seating capacity
PES = 1
supply has unitary price elasticity, the percentage change in quantity supplied MATCHES the proportional change in price
supply curve starts at the origin, any curves that start at at the origin has a PES value =1
PES= ∞
supply is perfectly price elastic
Due to the SPARE CAPACITY, quantity can increase from Q1 to Q2 irrespective of a price change
What are the determinants of price elasticity of supply
TICS
Time (period)
Inventory (level of stocks) (degree of spare productive) Capacity
(ease and cost of) Substitution (of factors
production)
effect of time period on PES
supply is price inelastic in the short run (eg. fresh fruit and veg dependant on harvest time)
long run- firms adjust their levels of production according to changes in the market
effect of the level of stocks on PES
firm with high inventories have relatively price elastic supply -> MORE ABLE TO RESPOND QUICKLY TO A CHANGE IN MARKET PRICE
effect of degree of spare productive capacity on PES
firm with plenty of spare capacity can increase supply with ease without increasing its costs of production, so supply is relatively ELASTIC
opposite applies in the long run
effect of the ease and cost of factor substitution on PES
the easier it is to substitute factors of production, the more price elastic supply tends to be
the more mobile factors of production are, the greater the PES will be, ceteris paribus
why is it beneficial for firms to have a high PES
they are highly responsive to changes in price and other market conditions giving them a competitive advantage
compare the PES for primary sector products with manufactured products
PES for primary products low, takes comparatively long time to increase primary sector output
PES for manufactured products higher, can be mass-produced in shorter periods
how can a company improve PES value
- create spare capacity
- keep large volumes of stocks (inventories)
- improve storage systems to prolong the shelf-life of products
- adopting or upgrading tot the latest tech
- improving distribution systems (how the products get to the customers)
- developing and training employees to improve labour occupational mobility (to perform a range of jobs)
what is the key determinant of PES
the nature of barriers to entry eg. copyrights and patents reduces the number of potential firms in the industry which lowers the value of PES, ceteris paribus
What does the law of supply state?
There is a positive relationship between quantity supplied of a product and its price, coteries paribus
What are the reasons for the relationship between price and supply
- existing firms in the market can earn higher profit margins if they supply more
- more firms enter the market as higher prices allow them to cover production costs
How does price affect the supply curve
There is a movement along the supply curve causing a change in the quantity supplied
The line looks like /
Contraction: fall in price causes contraction in quantity supplied, downwards to the left
Expansion: rise in price causes quantity supplied to expand, upwards to the right
How do non-price factors affect the supply
It causes a shift of the supply curve causing a change in supply
• increase in supply -> rightwards shift
• decrease in supply -> leftwards shift
What are the non-price determinants of supply
PINTS WC JECT
Productivity Indirect Tax No of firms Technology Subsidy
Weather
Costs of Production
Joint supply
Expectations
Competitive supply
Time
Effect of costs of production on supply
A reduction in costs of production will shift the supply curve to the right as producers are more willing and able to produce
Effect of productivity on supply
If productivity, of for example capital or labour; output per worker per time period increases, they are producing more at the same wage
This reduces costs of production and shifts the curve to the right
Effect of indirect tax on supply
Increase of indirect tax imposed on the supplier increases costs of production so they reduce market supply
Effect of barriers to entry (n of firms) on supply
The number of firms in the market, determined by the nature of barriers to entry to the industry, can affect the level of supply
(The more firms that enter the market, the supply curve will shift to the right)
Effect of technology on supply
Advances in technology mean that there can be greater levels of output at every price level
An improvement in tech reduces the costs of production and shifts a supply curve to the right
Effect of subsidies on supply
Subsidies are financial assistance from the government to help encourage output by reducing the costs of production for products that are beneficial to society as a whole (eg. Healthcare, education)
If a subsidy is increased or given, supply curve shifts to the right since costs of production lowered
Effects of weather on supply
The output of some products depends on the weather- for example agriculture output
Good weather will shift supply curve to the right
Effect of joint supply on supply
The output of one product (such as cows) routinely leads to the supply of another (such as milk)
Effect of expectations on supply
Price acts as a signal to producers to move their resources to the provision of products with greater profitability
The expectations of price movements affect supply
If a producer thinks they can make more profit on their product in the future, they’ll hold back supply now and supply more later on
What happens to the supply for a product when the price increases?
Supply stays the same, but quantity supplied increases
Change in price ONLY affects quantity supplied
Effect of competitive supply on supply
The output of a product (such as apples) takes place as an alternative to other products (such as oranges), based on the relative profitability of these products
Effect of time on supply
Supply tends to be lower int he short run but can increase over time
- eg. It is difficult for farmers to increase their supply of crops within a short period of time
Equilibrium
Where demand = supply in a market
Intersection of supply and demand curves
The point where the market is clear from excess demand and excess supply
Disequilibrium
Demand does not equal supply
Eg. The price is above P1 (excess supply) or below P1 (excess demand)
“A market outcome, in terms
of price and total quantity traded, which is unstable
and liable to change because market demand and
market supply are not in balance, i.e. there is excess
demand or excess supply.”
What happens to disequilibrium in a free market
In a free market disequilibrium will never last because the of the price mechanism which takes away problems that exist in the form of excess supply or demand.
4 functions of of price mechanism
ARSI Allocates scarce resources efficiently and effectively Rations excess demand/supply Signals price too high/ too low Incentives to change to change price
market price
The equilibrium price for a product in a market, determined where market demand exactly matches market supply.
PLANNED ECONOMIC SYSTEM
An economic system in which the government determines what goods and services to produce, their prices and how they are allocated.
MARKET ECONOMIC SYSTEM
An economic system in which decisions about how resources are used, what goods and services they produce and how they are allocated, are taken by private sector firms and consumers.
LABOUR MOBILITY
The ease with which workers can move between different occupations or jobs.
LABOUR PRODUCTIVITY .
The average output or revenue per worker per period of time
LAND
Natural resources used in the production of goods and services.
CAPITAL GOODS
Human-made resources that do not satisfy an immediate consumer want because they are to be used in the production of other goods and services.
FACTOR REWARDS
Payments received by the owners of factors of production for use of their services in production. They include wages (labour), rent (land), interest (capital) and profits (enterprise).
FACTOR MOBILITY
The ability or ease with which factors of production can be moved or reallocated between different productive uses without incurring significant costs or a loss of output
FACTOR SUBSTITUTION
Replacing one factor of production with another in a production process, for example, to make production more capital intensive.
FACTORS OF PRODUCTION
Scarce resources (land,
labour and capital) used in the production of
goods and services to satisfy consumer needs and
wants.
LABOUR
Human effort used in the production of goods and services.
ENTERPRISE
The skills and willingness to take the risks required to organize productive activity in a firm.
ENTREPRENEUR
A person with enterprise and the willingness to take the risks and decisions necessary to organize scarce resources into firms to produce goods and services.
EXCESS DEMAND
When the market demand for a product exceeds its market supply so there is upward
pressure on its market price.
EXCESS SUPPLY
When the market supply of a product
exceeds market demand so there is downward
pressure on its market price.
what is the key determinant of PED
the key determinant of the value of PED for a good or service is the degree of substitution- the extent to which consumers have access to close alternatives for the product
how can governments use PED
to determine taxation policies: eg. imposing heavy taxes on demerit goods such as cigarettes knowing demand for these products is inelastic
how can firms with different PED values apply this knowledge
use price discrimination to charge different customers different prices for the same product
eg. theme parks charge adults higher prices and offer discounts for children and families to increase revenue
how will firms benefit if the PED for their firm’s exports is price elastic
it will generally benefit from lower exchange rates
as export prices fall, so the firm becomes more price competitive
firms can ____ on most of the ____ ____ on products that are highly price inelastic eg. ___
firms can pass on most of the incidence on indirect taxes on products that are highly price inelastic eg. alcohol, tobacco, petrol
Why is PES important for consumers
The price elasticity, the ability to charge more entices the producers to produce more. But at some on time, they reach a production output and capability that he can now reduce costs because they are more efficient and produce more which benefits the consumers.
Why is PED important for consumers
If a firm increases the price of its products consumers will change their demand for other substitutes. At some point the producers will improve their productivity such that they can lower the price so consumers are more willing and able to purchase them
