1.2 Price Determination in a Competitive Market

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  • Created by: Sam19
  • Created on: 04-01-17 15:46
Demand
Is the amount of a product that consumers are willing and able to purchase at a given price.
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Effective Demand
The desire for a good or service backed by the ability to pay.
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What does a demand curve show and what does it look like?
Relationship between price and quantity and inverse relationship shown by a negative curve.
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Individual demand curve
Each persons preference and income. Drawn based on satisfaction or utility they get from each unit of product.
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Market demand curve
Calculated from the sum of all individuals together.
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What shifts a demand curve?
Anything but price will shift a demand curve.
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Reasons for a shift in demand:
Income: goes up- shift outwards, goes down- shift inwards. Price of other goods: Substitute and Complementary goods- the demand for one good often depends on the price of another. Changes in tastes and fashion. Population- ageing population.
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What is labeled on the axis of a demand and supply curve?
Y axis- Price and X axis - Quantity
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Who are elasticities important for?
Economists, Business people, Politicians
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What factors affect demand?
Change in the price of the product, the price of related products and Income.
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Price Elasticity of Demand (PED)
Is a measure used in economics to show the responsiveness or elasticity, of the quantity demanded of a good/service to a change in its price. It is usually negative but you ignore the sign.
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PED formula
= % change in quantity demanded/ % change in price
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How can demand be described?
Elastic, Inelastic, Perfectly elastic, Perfectly inelastic and Unit elastic.
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If PED =0 what is it called?
Perfectly inelastic
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If PED is between 0 and 1 what is it called?
Inelastic
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If PED = 1 what is it called?
Unit elastic
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If PED > 1 what is it called?
Elastic
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What are the factors influencing elasticity?
Number of close substitutes, Price in relation to total income, Cost of substituting between products, Brand loyalty and the degree of necessity/ luxury.
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What happens to quantity demand for normal and inferior goods when the price is increased?
Normal goods- quantity demanded goes up. Inferior goods- Quantity demanded goes down.
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What does it mean if a product is inelastic?
It is unresponsive to a change in price.
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What does it mean if a product is elastic?
Demand is said to be price elastic i.e. highly responsive to a change in price. The change in quantity demanded will be proportional higher than the reduction price.
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What does it mean if a product is perfectly inelastic?
It means that demand does not change with price. It is a very extreme case and implies all consumers are willing and able to pay any price for the product.
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What does it mean if a product is perfectly elastic?
A change in market supply will not lead to a change in equilibrium price. Applies to highly competitive markets where no supplier has any pricing power.
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What does it mean if a product is unit elastic?
A change in price is met with a proportionate change in quantity demanded. This means total spending by customers on the product will remain the same at each price level.
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Why is PED useful?
Shows change in total revenue, price volatility in a market following changes in supply, ca
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What are the limitations with PED?
Accuracy, Consumer price sensitivity changes over time, Elasticities varies by region and time, Not all businesses are profit maximisers, Varies within product ranges and Rivals will change their strategies from time to time.
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Cross elasticity of demand formula
% change in quantity demanded of good X / % change in price of good Y (The more positive it is the closer5 the substitution)
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What type of demand is there for substitute goods?
Competitive demand
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What type of demand is there for complement goods?
Joint demand
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Is XED positive or negative for substitute goods?
Positive always
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Is XED positive or negative for complementary goods?
Negative always.
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What does Income Elastic Demand show?
It shows how responsive the demand for a product is to a change in (real) income
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What is the formula for YED?
% change in quantity demanded / % change in income KEEP THE SIGN +/-
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What type of elasticity does a Normal good have?
Positive Income elasticity.
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What type of elasticity does a Luxury good have?
Elasticity > 1
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What type of elasticity does a Necessity have?
Income elastic >0
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What type of elasticity does a Inferior good have?
Negative income elasticity
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Counter cyclical goods
Products whose demand varies inversely to the macroeconomic cycle- demand rise in a turndown (Inferior good)
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Give 2 examples of Normal necessities
Milk and Fruit
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What type of elasticity do Normal luxuries have?
These products have a high positive YED, typically high end considered as a luxury by the relevant groups of people.
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Weak substitutes XED
Large rise in price of X leads to a small increase in demand for Y. (Graph is more vertical- Positive)
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Close substitutes XED
A small rise in price of X causes a large rise in demand for Y. ( Graph is more horizontal- Positive)
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Close complements XED
Small fall in price of X causes large increase in demand of Y. ( Graph is more horizontal- Negative)
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Weak complements XED
A large drop in price of X causes only a small rise in the demand in Y. (Graph is more horizontal - Negative)
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How to work out percentage change
Change in value/ original
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What happens if XED = 0?
The products are unrelated. E.G: Taxi fares and demand for cheese.
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Joint Supply
Is where an increase or decrease in the supply for one good leads to increase or decrease of byproduct.
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Supply
Is the quantity of a good or service that a producer is willing and able to supply into the market at a given price in a given time period. It is not necessarily the amount sold.
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Basic law of supply (positive curve)
Price increases of a product, so the business expands supply to the market - profit motive.
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What does a supply curve show?
A relationship between market price and how much a firm is willing and able to sell.
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Why are supply curves positive?
Profit motive, Production and Costs- when output expands a firms production costs tend to rise therefore a higher price is needed to cover costs, New entrants into the market- increase prices may create incentive for other firms to enter the market.
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Profit Motive
If the market price rises following a increase in quantity demanded, it becomes more profitable for businesses to increase output.
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What causes a movement along the supply curve?
A change in price- lower prices and supply contractions.
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Market Supply
Total supply brought to the market by producers at each price. To calculate, sum of the individual supply schedules.
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What causes a shif† in supply?
Change in cost of production, A fall in exchange rates, Advances in production technology, Entry of new producers into the market, Favourable weather conditions & Taxes, subsidies and government regulations.
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What does price elasticity of supply PES show?
Measures the relationship between change in quantity supplied and a change in price.
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If supply is elastic what can producers do?
They can increase there output without a rise in cost or delay. Spare capacity.
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Formula for PES
% change in quantity supplied / % change in price
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What does a PES of >1 show? What does the curve look like?
Supply is elastic. The graph is more horizontal- they are able to supply.
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What does a PES of
Supply is inelastic. The graph is more vertical as the suppliers can't really respond.
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What does a PES of 0 show? What does the curve look like?
Supply is perfectly inelastic.The graph is completely vertical- supply is fixed.
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What does a PES of infinity show? What does the curve look like?
Supply is perfectly elastic. The graph is completely horizontal- a change in demand can be met without any change in market price.
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What factors effect PES?
Spare production capacity, Stocks of finished products and components, Ease and cost of factor substitution/ factor mobility, Time period and production speed.
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Equilibrium
A state of rest or balance between opposite forces. No excess demand or supply.
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A change in equilibrium price - What happens if there is increased demand?
An outward shift of market demand leads to a rise in equilibrium price and an expansion in market supply.
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A change in equilibrium price - What happens if there is increased supply?
An outward shift of marker supply will lead to a fall in equilibrium price and an expansion in demand.
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A change in equilibrium price - What happens if there is decreasing demand?
An inward shift of the market demand leads to a fall in equilibrium price and a contraction of market supply.
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A change in equilibrium price - What happens if there is decreasing supply?
An inward shift of market supply leads to a rise in equilibrium price and a contraction of market demand.
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Effective Demand

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The desire for a good or service backed by the ability to pay.

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What does a demand curve show and what does it look like?

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Card 4

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Individual demand curve

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Card 5

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Market demand curve

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