Unit 3: Price determination in a competitive market Flashcards
Equation for income elasticity of demand (YED):
% change in quantity demanded ➗% change in income
What is an inferior good?
A good that has a negative YED.
What is a normal good?
A good that has a YED of between 0 and 1.
What is a luxury good?
A good that has a YED greater than 1.
What is a saturated good?
A good that has a YED of 0
When is a good elastic/in-elastic?
Elastic when good has elasticity of more than 1 and less than -1.
Inelastic when good has elasticity of between 1 and -1.
Ad valorem tax definition (with example):
A levy or tax charged as a proportion of the price. E.g. Value Added Tax is an ad valorem tax charged at 17.5% in the U.K.
By-product definition (with example):
A good not made as the prime objective of the production process e.g. brewers yeast is the by-product of beer.
Ceteris paribus definition:
everything else remaining constant.
Commodity definition (with example):
Any good. Sometimes it refers more specifically to basic raw materials that cannot be differentiated e.g. copper, tea.
Competitive demand definition (with example):
When one good may be bought as a substitute for another e.g bic biro or staedtler biro.
Complimentary good definition (with example):
A good that tends to be purchased when another is bought. One good adds to the enjoyment or usefulness of the other E.g. strawberries and cream.
Composite demand definition (with example):
Demand for a product that has more than one use. E.g. oil is used for fuel and plastic.
Contraction of demand definition:
A fall in demand due to the price rising. It involves a movement down the demand curve and not a shift.
Contraction of supply definition:
A fall in supply due to a drop in price. It involves a movement down the supply curve not a shift.
Cross elasticity of demand definition:
Measures responsiveness of demand of one product to the change in the price of another. A positive figure indicates the two goods are substitutes and a negative figure indicates compliments.
Cross elasticity of demand equation:
% change in quantity demanded of X ➗ % change in price of Y.
What does a positive and negative result for cross elasticity of demand indicate?
A positive figure indicates the two goods are substitutes and a negative figure indicates complements.
Demand definition:
quantity of goods consumers are willing and able to buy at a given price per period of time.
Derived demand definition (with examples):
Demand for a good wanted not for its own sake but for the goods Derived. E.g. demand for cotton in order to make clothes. Producers purchase of raw materials or labour is a derived demand.
Direct tax definition (with example):
A levy on income or wealth e.g. income tax, which goes directly from the payer to govt.
Disequilibrium definition:
A combination of price and quantity that is likely to change usually due to excess demand or excess supply.
Dividend definition:
The annual payment to shareholders and is a proportion of the profit earned by the firm.
Dynamic market definition:
Occurs when demand and supply changing very quickly so prices fluctuate greatly.
Effective demand definition:
Actual demand supported by the consumers’ capacity to pay, as opposed to the notional demand.
Elastic definition:
Demand or supply is sensitive (responsive) to changes in price or income. The % change in quantity is greater than the percentage change in price or income. Elasticity is more than 1 or less than -1.
Equilibrium definition (with example):
Having no pressure to alter the current state. E.g. equilibrium price exists where forces of demand and supply are equal and balanced.
Equilibrium price definition:
The price at which quantity demanded and quantity supplied are equal i.e. the price at which the market clears.
Excess demand definition:
More demand than supply which means that price will tend to rise.
Excess supply definition:
More supply than demand, which means that price will tend to fall.
Extension of demand definition:
A rise in demand due to the price falling. It involves a movement up the demand curve and not a shift.
Extension of supply definition:
A rise in quantity supplied due to a rise in price. It involves a movement up the supply curve not a shift.
Extension of demand definition:
A rise in demand due to the price falling. It involves a movement up the demand curve and not a shift.
Extension of supply definition:
A rise in quantity supplied due to a rise in price. It involves a movement up the supply curve not a shift.
Income elasticity of demand definition:
Measures the responsiveness on consumer demand to changes in income. It shows whether goods are normal or inferior. If income elasticity of demand is positive then goods are normal, if negative they are inferior
Income elasticity of demand equation:
% change in quantity demanded ➗ % change in income
If income elasticity of demand is positive or negative, then what does it tell us?
If positive, then goods are normal.
If negative, goods are inferior.
Indirect tax definition:
Expenditure taxes included in the price of the product. E.g. VAT, excise duty.
In-elastic definition:
Demand or supply do not change much when price or income changes. It is unresponsive. Elasticity is less than 1 or more than -1.
Inferior good definition (with example):
A product for which demand falls as incomes rise. E.g. Tesco value Baked beans. Inferior goods have negative income elasticity of demand.
Joint demand definition (with example):
Two items are consumed together so they are complements e.g. cars and fuel.
Joint supply definition (with example):
Production of one good also leads to another being made. E.g. honey and bees wax. The production process creates a by-product
Law of demand definition:
If price is raised then quantity demanded falls ceteris paribus.
Market capitalisation definition (with example):
The value of a company as measured by: share price x number of shares issued.
Market clearing definition:
Occurs when demand equals supply at the ruling price. All the produce is sold.
Market mechanism definition:
The process through which markets solve the problem of allocating scarce resources between competing uses through the operation of demand and supply to set prices and quantities.
Market period definition:
The time for which supply is fixed (i.e. Supply is vertical)
Mixed economy definition (with example):
Resource allocation occurs partly via state planning and partly by market forces. E.g. UK economy is a mixed economy.
Normal good definition (with example):
A good, which is consumed in greater quantity as income rises.
E.g. restaurant meals. Normal goods have positive income elasticity of demand.
What are OPEC and what are they known for?
ORGANISATION OF PETROLEUM EXPORTING COUNTRIES; A cartel made up of 13 oil producing countries who agree to restrict output in order to boost oil prices.
Planned economy definition:
A country in which resource allocation is determined solely by the government and not by market forces.
Planned supply definition (with example):
The quantity that the producer or producers intend to make. This may differ from actual supply due to unforeseen circumstances e.g. strikes or bad weather.
Price ceiling (price cap) definition:
Government set, maximum limit on the price that can be charged to the consumer. E.g. rent control. It creates shortages if set below equilibrium price.
Price elasticity of demand definition:
A measure of how responsive sales quantity is to price changes. It will always be a negative number. If P.E.D is a fraction between 0 and -1 then demand is inelastic and raising price will increase revenue.
Price elasticity of demand equation:
% change in quantity demanded ➗ % change in price
Price elasticity of supply definition:
Measures the extent to which supply of a good reacts to a change in price. If P.E.S is less than 1, supply is inelastic. If P.E.S os greater than 1, supply is elastic.
Price elasticity of supply equation:
% change in quantity supplied ➗ % change in price
Price floor definition (with example):
A minimum price that the government will guarantee to pay for produce. If set above equilibrium then the government will end up with surplus stocks. E.g. grain prices.
Price mechanism definition:
The interaction of demand and supply to set prices.
Profit margin definition (with example):
Profit as a percentage of sales revenue. e.g. If an item is sold for £1 and cost 70p then the profit margin is 30%.
Saturated demand definition (with example):
Demand does not change as income rises or falls e.g. toilet roll. Its income elasticity of demand is 0.
Spare capacity definition:
A firm’s maximum output is not being achieved.
Specific tax definition (with example):
A levy or tax that is set at a certain value whatever the price of the good. E.g. 52p per pint of beer.
Speculative bubble definition:
Prices go above the long run trend due to expectation of further rises, but then are likely to collapse suddenly.
Subsidy definition:
A government grant given to producers to encourage extra supply and tends to reduce the price of a good or service.
Substitute definition (with example):
Similar but alternative goods. E.g. Galaxy is a substitute for Yorkie.
Supply definition:
The quantity of a good or service that producers are willing and able to sell at a given price, in a set time period.
Surplus definition (with example):
An excess. This may be of supply e.g. excess stock or money coming in over money going out say for balance of payments current account.
Tax incidence definition:
The extent to which an indirect tax falls on the consumer via raising price and the extent to which t falls on the producer by reducing profit margin. (Who pays more of the tax? The consumer or the producer?)
Zero pricing definition (with example):
Goods or services are provides free. e.g. Library use
Difference between left shift of supply curve when ad Valorem tax is imposed and when specific tax is imposed and reason for difference:
. Specific tax shifts supply curve parallel to left since it’s taxed at a certain amount (no matter what the price is).
. Ad valorem tax shifts supply curve to the left with a more vertical angle because it’s taxed as a % of the price.
Name 6 factors that can shift the demand curve (TIPPLE):
Tastes. Income. Population. Price of other goods. Laws. Expectations.
Name 7 factors that can shift the supply curve (CARPETS):
Cost. Acts of God. Regulation. Price of other goods. Expectation. Taxes that are indirect. Subsidies.
Name 7 factors that determine the value of PES:
Availability of stocks.
Availability of spare capacity.
Time.
Ease with which alternate factors of production can be used and different production methods can be used.
Ease of entry into industry.
Number of firms in market.
Ease at which production can be increased.
What is a change along the supply curve called following a price rise?
Extension and contraction of supply curve.
What does SEXPIECE stand for (important for understanding demand and supply diagram)?
. Shift in S or D.
. EXcess supply or demand is created.
. Price change.
. Incentive to boost revenue is the cause of price change.
. Extension and Contraction along one of the curves.
. Equilibrium is restored at a new level where D cuts S.
If there is a shift in the supply or demand curve, how do you present that on the diagram?
Label old and new lines D1 or S1 and D2 or S2.
Label old and new prices and quantities P1, P2,Q1 and Q2 with half filled lines showing where they are.
Have an arrow indicating the direction the curve moved.
How do you show excess supply or excess demand and how it is eliminated on a diagram?
Label the quantity supplied or demanded, following a shift of one of curves and if the price doesn’t change, q3.
Put arrows on curves going from (Q3,P1) to (Q2,P2) and from (Q1,P1) to (Q2,P2).
