The Economic Environment Of Business And Finance Flashcards
What is a market?
Where potential buyers and sellers come together for the purpose of exchange
What is the market mechanism?
The interaction of supply and demand for a particular item
Demand definition
The quantity consumers are willing and able to buy at a given price
Usual demand curve
Quantity demanded goes up as price goes down
Determinants of demand
- Price of the good itself
- Price of other goods
- Substitutes (e.g. different brands)
- Complements (e.g. shirts and ties)
- National income effect on demand for normal/inferior goods
- Fashion
- Population size
- Credit terms
Causes of a shift of a demand curve to the right
- Increase in household income
- Increase in price of substitutes
- Decrease in price of compliments
- Good becoming more fashionable
- Expectation good will increase in price
Price elasticity of demand equation
PED = change in demand/change in price
Convention to ignore sign as usually negative
Inelastic PED =
PED < 1
Elastic PED =
PED > 1
Perfectly inelastic PED =
PED = 0
Perfectly elastic PED =
PED = infinity
Unitary elasticity PED
PED = 1
Factors affecting PED
- Availability and closeness of substitutes (generally increases elasticity)
- Time (generally demand is les elastic in short term)
- Competitors pricing (copying price cut = same demand = inelastic. Not copying = fall in demand = elastic)
(Can create ‘price stickiness’) - Nature of the product (generally demand for luxuries is more elastic, necessities less elastic, habit-forming products are inelastic)
- Proportion of income accounted for by a good. (Large = elastic)
Significance of price elasticity
Prediction: Allows managers to predict effect of price changes on demand and revenue
What will happen when increasing the price of inelastic products?
Total revenue will increase even though fewer units are sold
What will happen when increasing the price of elastic products?
Revenue will decrease if fewer units sold
Price must be due to increase revenue
Similarities of Giffen and Veblen goods
Upward sloping demand curves
Positive price elasticity of demand
Giffen goods
Price increase causes people to buy more
E.g. bread
Veblen goods
Bought for ostentation
So higher price makes them more exclusive and desirable
Income elasticity of demand looks at
The degree demand is affected by changes in household income
Income elasticity of demand formula
YED = (%ΔDemand)/(%ΔHousehold income)
YED > 0 for
Normal goods
YED > 0 for
Inferior goods
YED > 1 for
Luxury goods