Test 2 Flashcards
PED formula
% change in Q demanded
/ % change in price
Demand curve for price elastic good
Flatter
Demand curve for price inelastic good
Steeper
Demand curve for unitary good
Proportional
> (-) 1 PED means
- Demand for good is relatively elastic (i.e. if price increases by 10%, quantity demanded would price decrease by more than 10%)
- So a decrease in price leads to an increase in revenue, and an increase in price leads to a decrease in revenue
- More of a luxury e.g. holidays
< (-) 1 PED means
- Demand for good is relatively inelastic (i.e for a 10% increase in price, quantity demanded would decrease less than 10%)
- So a decrease in price leads to a fall in total revenue, and an increase in price leads to a rise in total revenue
- More of a necessity e.g. toothpaste
0 PED means
- Demand for good is perfectly price inelastic (i.e. however much the price is increased by, quantity demanded will remain the same)
- Absolute necessity e.g. water
(-) 1 PED means
- Demand for good is unitary (i.e. if there is a 10% increase in price, there will be a 10% decrease in quantity demanded - so Q changes proportional to P)
{ (-) infinity PED means ) }
{ - Demand for good is perfectly price elastic (i.e. the firm can sell any quantity at a given price, but any rise in price will cause demand to fall to zero) }
Total revenue and Quantity demanded graph
- Starts and ends at 0 (as when P is so high no Q is demanded, PQ = 0, and when P is 0, PQ = 0, so no revenue created)
- Curve in between that reaches a peak at the point PED is unitary (middle point of demand curve)
Conditions of demand
= Factors that could cause an inwards/outwards shift in the demand curve for a particular good/service
- Income of consumers
- Population
- If the good/service provides credit
- Tastes (and therefore things which affect these such as advertising)
- Price of complements
- Price of substitutes
The law of diminishing marginal utility
As the amount consumed of a commodity increases, the marginal utility received by the consumer decreases. (This explains downward sloping demand curve)
E.g. Percy and Minstrels
Assumptions for law of diminishing rational utility
- All units of good must be the same in all respects
- Unit of good must be standard
- Must be continuity in consumption, no change in price of substitutes or in taste during process of consumption
Total Utility / Quantity Graph
- Upwards sloping curve which levels off as Q increases until max. TU and 0 MU is reached, then begins to slope downwards
Marginal Utility Graph
- Downwards sloping line, which continues just the same after crossing the x axis at 0 MU and max. TU
Reasons for consumers not acting rationally
- Cognitive limitations (can only process a limited level of information / number of options at a given time)
- Defaults/habits (people tend to stick to what they currently do, the status quo)
- Present bias (people overvalue immediate effects and undervalue future ones)
- Loss aversion (people feel losses more keenly than they feel equal gains - e.g. resentment towards paying taxes)
- Herd behaviour (people are both consciously and subconsciously subconsciously affected by others, which creates social norms that can be both positive and negative)
- Anchoring (arbitrary reference points can influence people e.g. reduced prices)
Effective demand
- How much of a good/service consumers are willing and able to buy at a given price
- Illustrated by the demand curve
Law of demand
As the price of a good/service decreases, the quantity of it demanded will increase.
Exceptions to the law of demand
- Veblen goods
- Giffen goods
Change in conditions of demand on demand curve
Shift in the demand curve either:
In > DECREASE in Qd
Out > INCREASE in Qd
Change of price on demand curve
Movement along the demand curve either:
Left (i.e. from increase in price) > CONTRACTION in Qd
Right (i.e. from decrease in price) > EXTENSION in Qd
Change in conditions of supply on supply curve
Shift in the supply curve either:
In > DECREASE in Qs
Out > INCREASE in Qs
Change of price on supply curve
Movement along the supply curve either:
Left (i.e. from decrease in price) > CONTRACTION in Qs
Right (i.e. from increase in price) > EXTENSION in Qs
Conditions of supply
= Factors that could cause an inwards/outwards shift in the supply curve for a particular good/service
- Costs of production
- Technology available
- If subsidies are provided
- Taxes
- Government legislation
- Weather (only affects agricultural commodities)
When price is above the equilibrium
Surplus of the difference between Q at equilibrium and Q at new price
When price is below that of the equilibrium
Shortage of the difference between Q at equilibrium and Q at new price
Changes in equilibrium occur when
There is a change in one of the factors of demand or supply, causing the curves to shift
Consumer surplus represented by
Area of right angled triangle between top of demand curve and equilibrium price
- Inwards shift of D curve will decrease this, outwards shift increase it
Produced surplus represented by
Area of right angled triangle between bottom of supply curve and equilibrium price
- Inwards shift of supply curve will decrease this, outwards shift increase it
Total revenue =
= Price x Quantity
- Represented by area underneath demand curve
Elasticities along demand curve
First half - Elastic (i.e. > (-) 1 ) because as you move along the 1st half of the D curve, price falls creating an INCREASE in revenue as the area under the curve is getting bigger
Middle point - Unitary (i.e. 1)
Second half - Inelastic (i.e. (< (-) 1) because as you move along the 2nd half of the D curve, price falls creating a DECREASE in revenue as the (marginal?) area under the curve is getting smaller.
Factors affecting PED
- Number and closeness of substitutes (as increases, PED becomes more elastic)
- Proportion of income for which good accounts (as increases, PED becomes more inelastic)
- Influence of habit (if good is addictive, PED becomes more inelastic)
Firms use PED to predict
- Effect of change in price on TR and expenditure of a product
- Whether / How best to use price discrimination (where supplier charges different segments of market different prices for same product e.g. peak + off peak rail travel)
- Price volatility in a market following changes in supply
