Topic 2 Flashcards
Market Definition
The voluntary meeting of buyers and sellers willing to exchange.
Competitive Market Definition
A market in which the large numbers of buyers and sellers possess good market information and can easily enter or leave the market.
Demand Definition
The quantity of a good or service that consumers are willing and able to buy at given prices in a given period of time.
Supply Definition
The quantity of a good or service that firms are willing and able to sell at given prices in a period of time.
The Law of Demand
There is an inverse relationship between the price of a good and demand.
Effective Demand Definition
The desire for a good or service backed up by an ability to pay.
Market Demand Definition
The quantity of a good or service that all the consumers in a market are willing and able to buy at different market prices.
Individual Demand Definition
The quantity that a particular individual would like to buy.
What causes movement along the demand curve?
A change in price.
What causes extension of demand?
A fall in price which leads to more goods being demanded.
What causes contraction of demand?
A rise in price leads to less being demanded.
The Conditions of Demand
Collectively the variables(except price) which do determine changes in planned demand.
Causes of Rightwards Shift of Demand Curve
A fall in price of a complementary good or good in joint demand or a successful advertising campaign making people think more favorably of a good.
Causes of Leftwards Shift of Demand Curve
A decrease in the price of a substitute good or goods in competing demand, decrease in population size or a decrease in personal disposable income.
Normal Goods Definition
When income rises, so does demand and vice versa.
Inferior Goods Definition
Demand decreases as income increases and an increase in income shifts the demand curve leftwards.
What factors determine the demand for a good or service?
Income, wealth, price of substitutes, price, individual preferences or social and emotional factors.
Speculative Demand Definition
When prices rise people might speculate that they will rise further in the future, so demand is likely to increase.
Goods with Indicator of Quality Definition
Consumers may lack accurate information about quality so choose to buy a more expensive good.
Elasticity Definition
The proportionate responsiveness of a second variable to an initial change in the first variable.
Price Elasticity of Demand Definition
Measures the extent to which the demand for a good changes in response to a change in the price of that good.
Price Elasticity of Demand Equation
percentage change in quantity demanded/ percentage change in price
Inelastic Demand
Total consumer expenditure decreases in response to price fall, PED<1, unresponsive to change in price.
Elastic Demand
Total consumer expenditure increases in response to price fall, PED>1.
Perfectly Inelastic Demand
PED=0, demand does not change at all when the price changes, the demand curve will be drawn vertical.
Unit Elastic Demand
PED=1, the percentage change in demand is exactly the same as the percentage change in price.
Perfectly Elastic Demand
PED=infinity, there is one price at which consumers are willing to pay, the demand curve will be drawn horizontal.
Factors determining price elasticity of demand
Number of close substitutes, cost of switching between products, degree of necessity, proportion of a consumer’s income allocated to spending on the good, time period allowed following a price change, whether the good is subject to habitual consumption, peak and off-peak demand, breadth of definition of a good or service.
Number of close substitutes
The more close substitutes there are in the market, the more elastic is demand because consumers find it easy to switch.
Cost of switching between products
There may be significant costs involved in switching in this case demand tends to be relatively inelastic.
Degree of necessity
Necessities tend to have an inelastic demand whereas luxuries tend to have a more elastic demand.
Proportion of a consumer’s income allocated to spending on the good
Products that take up a high percentage of income will tend to have a more elastic demand.
Time period allowed following a price change
Demand tends to be more price elastic the longer that consumers have to respond to a price change
Whether the good is subject to habitual consumption
Consumers become less sensitive to the price of the good if they buy something out of habit.
Peak and off-peak demand
Demand tends to be price inelastic at peak times and more elastic at off-peak times.
Breadth of definition of a good or service
If a good is broadly defined demand is often inelastic, but specific brands are likely to be more elastic following a price change.
Limitations of Elasticities
Problems with inaccurate or incomplete data collection, consumer price sensitivity changes over time, elasticity of demand varies by region/time, not all businesses are profit maximisers, elasticity will vary within product ranges and rival producers will change their market strategies occasionally.
Income Elasticity of Demand Definition
Measures the extent to which the demand for a good changes in response to a change in income.
Income Elasticity of Demand Equation
percentage change in quantity demanded/ percentage change in income
Superior Good
Has an income elasticity of demand >1.
Basic Good
Has an income elasticity of demand between 0 and 1.
Cross Elasticity of Demand Definition
Measures the extent to which the demand for a good changes in response to a change in price of another good.
Cross Elasticity of Demand Equation
percentage change in quantity of A demanded/ percentage change in price of B
Close Complements
A small fall in price of A causes a large rise in demand for B.
Weak Complements
A large drop in price of E only causes a small rise in demand for F.
Close Substitutes
A small rise in price of X causes a large rise in demand for Y.
Weak Substitutes
A large rise in price of S leads to a small increase in demand for T.
Market Supply Definition
The quantity of a good or service that all firms plan to sell at given prices in a given period of time.
Cause of an expansion of supply
A rise in market price.
Cause of movement along the supply curve
A change in price.
Cause of a contraction of supply
A fall in market price.
Cause of the supply curve shifting leftwards
Occurs when the government imposes an expenditure tax such as VAT. Firms try to pass the tax onto consumers by increasing prices.
Cause of the supply curve shifting rightwards
Occurs when subsidies are given by the government
Law of Supply
Economists assume firms main objective is to profit maximise. Firms are only willing to produce more if it is profitable to do so as there are extra costs of production.
Reasons why there is a positive relationship for supply
The profit motive, production and costs and new entrants coming into the market.
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 rise, therefore a higher price is needed to cover extra costs.
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.
Costs of Production
Wages, raw materials, energy, costs of borrowing, technical progress, taxes and subsidies.
Cause of an increase in supply
Technological progress and a decrease in taxes.
Cause of a decrease in supply
Decrease in labour and an increase in wage costs.
Price Elasticity of Supply Definition
The responsiveness of supply to changes in price.
Price Elasticity of Supply Equation
percentage change in quantity supplied/ percentage change in price
Elastic Supply
If the supply curve intersects the price axis, the curve is elastic at all points, though elasticity falls towards unity moving from point to point up the curve. An increase in price is less of an incentive for firms to produce more. Diverting resources to increase supply is likely to cause a proportionally greater rise in price.
Inelastic Supply
If the supply curve intersects the quantity axis, the curve is inelastic at all points, though elasticity rises towards unity moving from point to point up the curve. A small increase in encourages firms to produce more than the proportionate increase in price. factors of production are easily converted to make increase in supply possible
Perfectly Elastic Supply
The supply curve is drawn horizontal, a change in demand can easily be responded to by an increase in supply without creating a greater increase in price, there is an infinite amount of suppliers willing and able to supply at that price, attractive situation for suppliers.
Perfectly Inelastic Supply
The supply curve is unresponsive to changes in price, a increase in price is no incentive for firms to produce more because it is affordable and unattractive, diverting resources to increase supply is likely to cause a greater increase in price for the producer.
Unit Elastic Supply
If the supply curve passes through the origin, elasticity equals unity at all points on the curve.
Factors that determine price elasticity of supply
The length of production period, the availability of spare capacity, the ease or accumulating stocks, the number of firms in the market and the ease of entering the market, the ease of switching between alternative methods of production, time.
The length of production period
If raw materials are converted into finished goods quickly, supply is more elastic.
The availability of spare capacity
If a firm had spare capacity and labour/ raw materials are readily available, then production can generally be increased quickly in the short run.
The ease of accumulating stocks
When stocks of unsold, finished goods, or stocks bought from suppliers are stored at low costs, firms can respond quickly to a sudden increase in demand.
The number of firms in the market and the ease of entering the market
The more firms there are, the greater the ease with which a firm can enter or leave, the greater the elasticity of supply.
The ease of switching between alternative methods of production
Supply is more elastic when firms can quickly alter the way they produce
Market Supply Period
Market supply period shown by a vertical line, shows the situation facing firms following a sudden and unexpected rightward shift in demand, when surprised firms can’t immediately increase output, supply is completely inelastic, price rises to eliminate excessive demand.
Short Run Supply
Higher price means higher profits can be made creating an incentive to increase output, firms increase output by hiring more variable factors of production, price falls, more elastic than market supply period, at least one factor of production remains fixed.
Long Run Supply
Firms believe increase in demand will be long lasting and not just temporary, may increase scale of production by employing more factors of production that are fixed in the short run but variable in long run causes firms to move along long run supply curve, output rises and price falls, all factors are variable.
Equilibrium Price
A market is in equilibrium when planned demand equals planned supply and the demand curve crosses the supply curve. There is no excess demand or supply, unless an event disturbs the equilibrium, there is no need for a change in price.
Market Disequilibrium
A market disequilibrium is when planned demandplanned supply causing price to rise.
Excess Supply Definition
When firms wish to sell more than consumers wish to buy, with the price above the equilibrium price.
Excess Demand Definition
When consumers wish to buy more than firms wish to sell, with the price below the equilibrium price.
Derived Demand Defintion
Where the demand for one good is the result of the demand for another good.
Composite Demand Definition
Where a good is demanded for 2 or more distinct uses.
Joint Supply Definition
Where 2 goods are produced together, so that a change in supply for 1 will change the supply of the other.
Competing Supply Definition
When raw materials are used to produce 1 good they cannot be used to produce another good.
