Theme 1, How Markets Work CC2 Flashcards
price mechanism
mechanism through which price is determined in a free market sytem
invisible hand
Adam Smith
describe thway in which resources are allocated in a market economy to the advantage of everyone
market equilibrium
the equilibrium price and quantity is determined by the intersection of the demand and supply curve
QD = QS
excess supply
when price is set above the equilibrium price, there will be too much supply in relation to demand
S > D
excess demand
when price is set below the equilibrium market price leading to a situation where demand > supply
quantity demanded
the quantity of a good or service that consumers are willing and able to buy at a given price
quantity supplied
quantity of a good that suppliers are willing and able to sell at a given price
market definition
any convenient set of arrangements by which buyers and sellers communicate to exchange goods and services
demand curve
a graph showing how much of a good will be demanded by consumers at any given price
law of demand
states that there is an inverse relationship between quantity demanded and the price of a good or service, ceteris paribus
extension of demand
price fall causes an increase in QD, ceteris paribus
movement down the curve
contraction of demand
price rise causes a fall in QD, ceteris paribus
movement up the demand curve
substitutes
two goods that can replace eachother
if the price of Good A rises, the QD of Good B will rise
eg Xbox and Playstation
complements
two goods that are usually bought together
if the price of Good A rises, QD of Good B will decrease
eg cereal and milk
changes that will shift the demand curve
- changes in real income
- changes in tastes and fashions
- substitutes
- complements
- advertising and branding
- changes in size/age distribution of popn.
- expectations of future prices
- derived demand
derived demand
needed to produce another good
eg if QD rises for cars, QD for steel to make the cars will also rise
relationship between price and quantity demanded
inverse, downward sloping
supply curve
graph showing the QS by a firm at any given price
total revenue
the income gained from selling a product
revenue = price x quantity sold
profit/loss
profit/loss = total revenue - total costs
production costs
costs which firms must pay to provide a good/service
they can be fixed or variable costs
extension of supply
a price rise will cause a movement along the supply curve to the right (rise in QS)
contraction of supply
a price fall will cause a movement along the supply curve to the left (fall QS)
relationship between price and quantity supplied
positive
factors causing the supply curve to shift
- change in production costs
- improvement in production methods
- substitutes
- goods in joint supply
- weather or natural disasters
- aims and objectives of producers
- expectations of future prices
- indirect taxes and subsidies
- new firms enter/leave the market
- increase in the factors of production eg labour
shifting of the supply curve - substitutes
alternatives
if the price of Good A increases, supplies may switch from selling Good B to Good A to make more of a profit
shifting of the supply curve - goods in joint supply
a good is in joint supply with another when it is supplied for two different purposes, ofte when one is a by-product of another
if price increases for beef, farmers will rear more cattle and will produce more leather
composite demand
competitive supply
when a good is used for two or more purposes
if more of the good is used for one purpose, less of this good is available for the other purpose
consumer surplus
difference between the amount a consumer is willing to pay and the amount they actually pay
area of under demand curve but above equilibrium price
producer surplus
difference between the price producers are willing to supply a good for and the actual market price
area above supply curve and below the equilibrium price
Price Elasticity of Demand
PED
responsiveness of quantity demanded to a change in price
% change in QD / % change in price
price elastic demand
the % change in price will lead to a greater proportionate change in QD
PED > 1
price inelastic demand
the % change in price will lead to a smaller proportionate change in QD
PED < 1 (between 0 and 1)
unitary elastic demand
a % change in price will lead to the same % change in QD
PED = 1
perfectly inelastic demand
the % change in price will lead to no change in QD
PED = 0
perfectly elastic demand
QD is infinite at a particular price
PED = infinity
determinants of price elasticity of demand
- availability of substitutes
- necessity or luxury?
- proportion of income spent on a good
- habit forming goods
- brand loyalty
- short or long run?
relationship between PED and revenue:
- if elastic and the price falls then ….
- if elastic and the price rises then ….
- if inelastic and the price falls then ….
- if inelastic and the price rises then ….
- revenue rises
- revenue falls
- revenue falls
- revenue rises
if the gradient of the demand curve is relatively steep, what is the PED?
if the gradient of the demand curve is relatively shallow, what is the PED?
- inelastic
- elastic
where will you find these points on a demand curve:
- unit elastic, PED = 1
- perfectly elastic, PED = infinity
- perfectly inelastic, PED = 0
- midpoint of the demand curve
- where demand curve touches y-axis
- where demand curve touches x-axis
Price Elasticity of Supply
PES
measures the responsiveness of supply to a change in price
% change in supply / % change in price
price elastic supply
percentage change in supply is greater than the percentage change in the price of the good
PES > 1
price inelastic supply
percentage change in supply is less than the percentage change in the price of the good
PES < 1
short run
a period in which at least one factor of production is fixed
long run
a period of time in which all factors of production are variable
supply is unitary elastic
% change in price will leade to the same % change in QS
PES = 1
supply is perfectly inelastic
% change in price will have no impact on supply
PES = 0
supply is perfectly elastic
change in price will lead to an infinite amount being supplied
PES = infinity
factors that influence price elasticity of supply
- level of spare capacity
- state of economy
- how easily production can be switched to a different product?
- level of stock
- perishability of goods
- can new firms enter market easily?
- short run and long run
- nature of product (eg agriculture)
Income Elasticity of Demand
YED
responsiveness of quantity demanded to a change in income
% change in demand / % change in income
YED > 1
demand is income elastic
YED < 1
demand is income inelastic
normal good description
normal good YED
if income rises, demand rises
if income falls, demand falls
positive
luxury good description
luxury good YED
as income rises, consumers spend proportionally more on the good
positive and greater than 1
inferior good description
inferior good YED
if income rises, demand will fall
eg mcdonalds, bus journeys
negative
Cross Elasticity of Demand
XED
measures the responsiveness of demand for one good following the change in the price of another good
positive XED
substitutes
negative XED
complements
XED = 0
no relationship
XED > 1
cross elastic
XED < 1
cross inelastic
