Week 2 Flashcards
The invisible hand
Specialised individuals need to exchange. The market developed as the mechanism that organises exchange first through barter then using money as the medium of exchange, store of value and unit of account.
The model of the competitive market
The market is an institution where the buyers and sellers of the same good or service come together to trade
Assumptions of the model of the competitive market
Rational agents
Perfect information
Zero transaction cost
Flexible prices
Property rights defined and enforced
Perfect competition
Variables in the allocation of resources
Price (P)
Quantity (Q)
We analyse the model for equilibrium and efficiency
Are the assumptions unrealistic
While these assumptions are “unrealistic” simplifications, together they tell us what
conditions need to be in place to make the market work well. They serve as a benchmark
for the design and improvement of real markets.
The law of demand
The law of demand states that as the price rises, the quantity demanded falls and vice versa (because consumers are relatively worse off and substitute into other products).
Demand
Demand comprises all those consumers willing and able to buy the product. How much
people buy depends on many variables, we focus on price. Demand shows how much consumers plan to
buy at every conceivable price.
Quantity demanded
Quantity demanded (Qd) refers to purchasing plans at one particular price (P).
Demand curve
Slopes downward
Steepness reflects consumer price sensitivity
Position reflects the volume of demand
Demand curve and function example
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Elasticity
elasticity measures the responsiveness of quantity to one of its determinants. We measure
elasticity in the steepness of the curve concerned. There are many types of demand and supply elasticity to
determinants such as price of the product, price of related products, income etc.
Own price elasticity
own-price elasticity of demand measures the responsiveness
of quantity demanded of a product to its price. It reflects the sensitivity or
responsiveness of consumer purchasing plans to price.
The steepness of the demand curve
The steepness of the demand curve is a measure of own-price
elasticity of demand. Flatter curves mean greater elasticity
(greater change in consumers’ purchasing plans), steeper
curves mean lesser elasticity
A product´s own-price elasticity depends on:
- availability of close substitutes
- proportion of income spent on the good
- necessities versus luxuries
- time horizon
PED =
Photo in favourites 26/7/18
Demand elasticity calculations
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Demand elasticity: PED overview
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Cross price elasticity of demand measures the responsiveness
cross-price elasticity of demand measures the responsiveness
of quantity demanded of a product to changes the price of another good.
CPED =
Photo in favourites 26/7/18
Demand elasticity: cross price example
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Income elasticity of demand
Income elasticity of demand measures the responsiveness of quantity demanded of a product to changes in consumer income
Demand elasticity: income example
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YED =
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Supply
supply shows how much producers plan
to produce at every conceivable price. Quantity
supplied (Qs) refers to one particular price level. Supply comprises all those producers willing and able to produce the product.
How much these firms produce depends on many variables, we focus on price.
The law of supply
the law of supply states that as the price rises, the quantity supplied rises and vice versa (because producers substitute out of other products).
Supply curve
•slopes upward • slope reflects producer price sensitivity • position reflects volume of supply
Supply function and curve example
Photo in favourites 26/7/18
Own price elasticity of supply
own-price elasticity of supply measures the
responsiveness of quantity supplied of a product to its
price. It reflects the sensitivity or responsiveness of
producer purchasing plans to price.
The steepness of the supply curve
The steepness of the supply curve is a measure of own-price
elasticity of supply. Flatter curves mean greater elasticity
(greater change in firms´ producing plans), steeper curves
mean lesser elasticity
A product´s own-price elasticity depends on:
- availability of inputs
- flexibility of sellers
- time horizon
PED
Percentage change in quantity demanded divided by percentage change in price
CPED
Percentage change in quantity demanded divided by percentage change in price of another good
YED
Percentage change in quantity demanded divided by percentage change in income
PES
Percentage change in quantity supplied divided by percentage change in price
Total expenditure example
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What is proportional elasticity equal to
1
When calculating PED do you ignore the minus sign
Yes
Aggregation
Economists refer to the process of adding up the individual demand curves to find the market demand curve as aggregation.
Aggregation consists of fixing the price of the good
and adding up the quantity demanded by each buyer.
The five major factors that shift the demand curve when they change are:
- Tastes and preferences
- Income and wealth
- Availability and prices of related goods
- Number and scale of buyers
- Buyers’ beliefs about the future
Consumer surplus
The value or total benefits one receives from a good in excess of the price paid for it describes the meaning of consumer surplus.
Do all consumers in a competitive market enjoy the same amount of consumer surplus?
No, since considerable variation exists among consumers in terms of tastes and incomes.
