topic 3 : price determination in a competitive market Flashcards
what does the demand curve illustrate
the relationship between quantity demanded and price
what are the two main theories that explain the relationship between price and quantity
- income effect- when prices fall consumers can afford a greater quantity of good and services so the demand foe these increase
- substitution effect- when the price of one good falls consumers will buy more of the cheaper good so demand foe the cheaper good increases and the demand for the costlier good decreases
what are substitute goods
goods that can replace each other because they satisfy the same need. If the price of one increases, demand for the other rises.
what are complement goods
goods that are used together, so demand for one increases the demand for the other.
what is price and quantity demanded
-price is what the buyer pays for a specific good or service
-quantity demanded is the total number of units purchased at that price
What does the demand curve show and look like?
The demand curve is downward sloping, and shows the relationship between price and quantity
what does the law of demand show?
The inverse relationship between price and quantity, assuming all of the variables are constant
factors that shift the demand curve
- population
-income
-related goods
-advertising
-tastes and fashions
-expectations
-seasons
what does the law of diminishing marginal utility state?
As an extra unit of good is consumed, the marginal utility falls, therefore consumers are willing to pay less for the good
what is the price elasticity of demand?
The price elasticity of demand is the responsiveness of a change in demand to a change in price
What is the formula for PED?
Price elasticity = %change in quantity demanded/ % change in price
what is the PED for a price elastic good
PED is > 1
(very responsive to change in price)
What is the PED of a price inelastic good?
PED is <1
(relatively unresponsive to a change in price)
What is the PED of a unitary elastic good?
PED = 1
(demand is equal to change in price)
what is the PED of a perfectly inelastic good
PED=0
(Demand does not change when price changes )
what is the PED of a perfectly elastic good?
PED = infinity
(Demand forced to zero when price changes )
factors influencing PED
-necessity
-substitutes
-addictiveness or habitual consumption
-proportion of income spent on good
- durability of the good
- peak and off peak demans
total revenue equals
price x quantity sold
what is income elasticity of demand (YED)
the responsiveness of a change in demand to a change in income
what is the formula for YED
income elasticity of demand = %change in quantity demanded/ % change in income
what are inferior goods YED
YED< 0
see a fall in demand as income increases
what are normal goods YED
YED > 0
demand increases as income increases
what are luxury goods YED
YED> 1
increase in income causes an even bigger increase in demand
what is cross elasticity of demand (XED)
the responsiveness of a change in demand of one good X, to a change in price of another good Y
formula for XED
cross price elasticity of demand = % change in quantity demanded of good A / % change in price of good B
what XED do complementary goods have (weak and close complements)
-negative XED
because if one good becomes more expensive the quantity demanded for both goods will fall
-close complements: a small fall in the price of good X leads to large increase in quantity demanded of Y
-weak complements: a large fall in the price of good X leads to only a small increase in quantity demanded of Y
what is XED of substitutes (close and weak substitutes)
-positive XED
-close substitutes- a small increase in the price of a good X leads to a large increase quantity demanded in Y
-weak substitutes- a large increase in the price of good X leads to a smaller increase in quantity demanded of Y
is the demand curve downward sloping or upward sloping for substitutes
upward sloping
is the demand curve downward sloping or upward sloping for complements
downwards sloping
what XED do unrelated goods have
zero
why are firms interested in XED
to see how many competitors they have and how likely they are going to be effected by prices changes by other firms selling substitutes or complementary goods
what is supply
the quantity of a good or service that a producer is able and willing to supply at a given price during a given time
why is the supply curve upwards sloping
- if price increases it is more profitable so supply increases
- higher prices encourage new firms to enter the market because its more profitable so supply increases
- with larger output firms costs increase so they need to charge a higher price to cover the costs
factors that shift the supply curve
-productivity
-indirect taxes
-number of firms
-technology
-subsidies
-weather
costs of production
what is the price elasticity of supply
the responsiveness of a change in supply to a change in price
PES formula
price elasticity of supply = %change in quantity supplied/ % change in price
PES for elastic supply
PES is > 1
PES of inelastic supply
PES is < 1
perfectly elastic PES
PES = 0
perfectly elastic supply
PES= infinity
factors influencing PES
-time scale
- spare capacity
- level of stocks
- how substitutable factors are
- barriers to entry to the market
aasumptions of the equilibrium model
perfect competition
ceteris paribus
independence between supply and demand
types of demand
derived- demand for one good is linked to demand for related good
composite- good demanded has more than one use
joint - bought togetehr
