Economics and Business, edexcel AS unit 2B
Allocation of Resources
The resources are the factors of production;
In a free market economy (one without influence from the government) resources are allocated by the amount of profit to be gained. It starts with demand, the amount of a product consumers are willing to buy will affect the amount of production. This is consumer sovereignty, which means the consumer has the power to decide what is produced. However consumer sovereignty relies on healthy competition.
Supply and Demand
The supply and demand curves are plotted against a y axis of price and an x axis of quantity.
A change in the conditions of demand shifts the demand curve to the right or left. A change in the conditions of supply shifts the supply curve to the right or left.
The equilibrium point is where supply meets demand, this is the market price.
This is how much one variable changes in response to a change in another related variable. There is price elasticity of demand and income elasticity of demand.
To calculate PED we do %change in quantity demanded / %change in price
If the answer is
- beyond -1 it means the product is price elastic, so demand is affected by changes in price
- -1 it means there is price unity, so a price change causes the same proportional change in demand
- between 0 and -1 it means the product is relatively price inelastic
PED is important to businesses because of marketing (price changes can be good promotional strategies, increase demand etc), branding (if the brand is successful their products will hopefully be price inelastic, since that is what most businesses desire) and total revenue (changing price can dramatically effect total revenue).
An elastic demand curve will be a gentle slope, not very steep. But an inelastic demand curve will be very steep.
High price elasticity usually occurs in a very competitive market, where there are many substitutes so businesses compete on price. Businesses will use differentiation and branding to make their products.
Factors affecting price elasticity;
- Number and closeness of substitutes (the more there are the more elasticity)
- Whether it is a luxury or neccessity (luxury's are less price elastic)
- The proportion of income spent on good
- Time scale (in the short term many goods will be more price inelastic than in the long term
To calculate YED (income elasticity) we do
%change in quantity demanded / %change in price
If the answer is
- Greater than 1 it means the product is income elastic
- 1 it means there is income unity
- Between 0 and 1 it means the product is income inelastic
For most products, as income rises demand rises. But for inferior goods demand falls as income rises. This means inferior goods will have a negative YED value.
Whether the product is luxury or necessity will affect the degree of elasticity. Luxury goods will be income elastic, but necessities will…