Topic 1 - Price Mechanism Flashcards
What is meant by demand?
Demand is the quantity of a product that consumers are willing to buy at a given price at a set period.
Utility definition
The enjoyment and usefulness that we see with a product.
Effective demand
The desire to buy a product and the ability to pay for it.
Derived demand
Derived demand is the demand for a factor of production used to produce another good or service
The law of demand?
There is an inverse relationship between the price of a good and demand.
As prices rise we see a contraction in demand however if prices were to decrease the demand would expand
Ceteris Paribus assumption
Allows us to isolate the effect of one value
The demand curve and the two reasons why more is demanded when prices decrease
A demand curve shows the relationship between the price of an item and the quantity demanded over a
period of time. There are two reasons why more is demanded as price falls:
1. The Income Effect: There is an income effect when the price of a good falls because the consumer
can maintain the same consumption for less expenditure. Provided that the good is normal, some
of the resulting increase in real income is used to buy more of this product.
2. The Substitution Effect: There is a substitution effect when the price of a good falls because the
product is now relatively cheaper than an alternative item and some consumers switch their
spending from the alternative good or service.
What causes the demand curve to shift
factors such as income and preference will cause the demand curve to shift.
Supply definition
Supply is the quantity of a product that a producer is willing and able to supply onto the market at
a given price in a given time period
law of supply
as the price of a product rises, so businesses expand supply to the market. A
supply curve shows a relationship between price and how much a firm is willing and able to sell
Why a positive correlation with the supply curve
- The profit motive: When the market price rises following an increase in demand, it becomes more
profitable for businesses to increase their output - Production and costs: When output expands, a firm’s production costs tend to rise; therefore a
higher price is needed to cover these extra costs of production. This may be due to the effects of
diminishing returns as more factor inputs are added to production. - New entrants coming into the market: Higher prices may create an incentive for other businesses
to enter the market leading to an increase in total supply.
How exchange rates effect supply
If the exchange rate causes the currency to become weaker then it will cause imports to become more expensive whereas if the exchange rate causes the currency to become stronger then it was cause imports to become cheaper which means the exports will become more expensive. A stronger currency will cause the price to increase which means the supply will also increase.
How advances in production technology effects supply
An advance in production technology will cause an increase in the efficiency of the production process which means cost of production will decrease. This means the pricce sold to retailers will increase which means they will make profit. This means the supply will shift to the right( increase)
How the entry of new producers into the market effects supply
If more producers are supplying the product, there will be a higher quantity supplied into the markets. The market curve will shift rightwards with quantity supplied increasing.
How the favourable weather conditions effects supply
There will most likely be an increase in output from good harvest. This means that the quantity produced will increase which will cause the supply curve to shift to the right.
How taxes, subsidies and government regulations effect supply
If taxes are imposed then the profit motivated suppliers will have to increase the prices. This means the supply curve will shift upwards.
Explain how equilibrium occurs?
Means a state of equality or balance between market demand and supply. An “equilibrium” price in a market is the price which makes the planned demand of consumers and the planned supply of firms equal the market clearing price. But at most prices, planned demand does not equal planned supply. This is a state of disequilibrium because there is either a shortage or surplus and firms have an incentive to change the price.
Producer surplus
is the difference between the price producers are willing and able to supply a good or service for and the price they actually receive.
Consumer surplus
is the difference between the price they receive and the price that they are willing to pay.
Composite demand
This is when the use of a good has more than one use for example like milk. If there is an increase in demand for cheese then the supply of butter will decrease.
Joint demand
Is when goods are bought together such as a digital camera and a memory card
Price mechanism
is the interaction of demand and supply in a free market -> this interaction determines prices which are the means by which scarse resources are allocated between competing wants and needs. The price moves resources to where they are demanded or where there is a shortage and removes resources to where there is a surplus.
Rationing
When demand is greater than supply the price is increased so that the quantity demanded will decrease again and those who are able to pay the new price will be able to buy the product.
Signaling
The price changes show where the resources are needed in the market. A high price provides a signal to suppliers to expand production to meet higher demand. But also signals firms to enter the market because it is profitable. Occurs when there is excess supply allowing price to fall down.I
Incentive
Throught their choices consumers send information to producers. This encourages a change in behaviour of a consumer or producer.
Government intervention in the market mechanism
The incentives that consumers and producers have are changes by government intervention.
For example changes in relative prices are brought around by subsidies and taxation.
The government might also intervene with maximum and minimum prices.
Ceteris Paribus
is the effect of one economic variable has on another provided all other variables remain the same.
What is price elasticity of Demand?
Definition
a measure of the percentage (proportionate) changes/ increase/ decrease in the quantity demanded resulting from a given change in the change in price and how this affects the demand for the product.
Price Elasticity of Demand Coefficients
> 1 - Highly responsive, price elastic
=1 - unit elastic
<1 - inelastic
0 - perfectly inelastic
Price inelastic demand
A perfectly inelastic demand curve is an extreme case. It implies that consumers are willing to pay any price for the product.
The demand curve has a constant quantity.
Perfectly elastic demand
If demand is perfectly elastic, a change in market supply will not lead to any changes in the equilibrium.
This type of demand curve applies to highly competitive markets where no suppliers have any “pricing power”.
The demand curve has a constant price.
Unitary Elastic Demand
A change in price is met with a proportionate change in quantity demanded. This means total spending of consumer will remain the same.
Income elasticity of Demand (YED)
shows how responsive the demand for a product is to a change in real income.
The demand for a product may change if there is a change in the consumers income.
Formula for calculating income elasticity of demand
%change in QD/ %change in Real Income
What is a normal good
if following an income in crease, more of the good is demanded then the good is a normal good
Normal necesities
The products have a low but positive income elasticity.
e.g. milk and fruit
Normal Luxuries
The products have a high and positive income elasticity - typically higher end products considered as a luxury by the relevant group of consumers.
Inferior goods
have a negative elasticity of demand. If there is an increase in income and less of the good is consumed (demand falls) then the good is an inferior good.
They have a negative YED
aka counter cyclical goods
when incomes rise - demand falls
when income falls - demand rises.
Cross Price Elasticity
measure the responsiveness of demand for good following a change in the price of a related goods.
Substitutes and compliments and there Xed
Substitutes - products with competitive demand
have a positive Xed because if there is an increase in price of one product then the demand for its substitute goes up.
Competitive - products in joint demand.
Compliments have a negative Xed because if there is an increase in price of one product then a product which is a compliment will have a decrease in demand.
Price elasticity of supply
measure the change in quantity supplied due to a change in price. If there is a change in price then how does this have an affect on the change in supply.
Substitute goods
Alternative goods for each other for example an I-phone or a Samsung.
Complimentary goods
A good which is required whilst using another good for example petroleum is a complimentary good of having a car.
Giffen goods
A product that people will consume more of as the price rises but will consume less of as the price decrease. Eg potatoes
Substitution effect
Consumers switching to cheaper products as the price increases. Eg choosing tea over coffee if the price of coffee shoots up.
Income effect
The change in demand for a good or service caused by a change in the consumers real income. An example of this may be when the income of a person increases and they purchase more luxury goods
PES formula
%change in Quantity supplied/ % change in Price
Elastic supply
PES > 1
change in demand can be met without large rise in priceP
Perfectly elastic supply
An increase in demand can be met without any change in market price.
Supply curve stay constant with price.
Perfectly ineleastic supply.
Supply is fixed and cannot respond to a change in market demand.
Here the supply curve stays constant with quantity.
Unit elastic of supply
PES = 1
Equal % change in quantity supplied as the % change in price.
Factors affecting PES
Time scales
Time scale - in the short run, supply is more price inelastic, because producers cannot quickly increase supply. In the long run supply becomes more price elastic.
Factors affecting PES
Spare capacity
If the firm is operating at full capacity there is no space left to increase supply. If there are spare resources, supply can be increased quickly.
Factors affecting PES
Level of stock
If goods can be stores, such as CD, firms can stock them and increase market supply easily. If the goods are perishable, such as apples, firms cannot stock them for long. So supply is more inelastic.
Factors affect PES
How substitutable the factors of production are.
If labour and capital are mobile, supply is more elastic, because resources can be allocated to where supply is needed. For example, if workers have transferrable skills, they can be allocated to produce a different good and increase the supply of it.
Factors affecting PES
Barriers to entry to the market
Higher barriers to entry means supply is more price inelastic, because it is difficult for new firms to enter and supply the market.
