The quantity of a good or service consumers are willing and able to buy at a given price in a given time period.
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Why is the demand slope downwards?
1) Income effect (as price increases, purchasing power decreases)
2) Substitution effect (as price increases, other substitutes become less competitive)
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What causes shifts in demand?
Population
Advertising
Substitute's prices
Income
Fashion/trends
Interest rates
Complements price
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What is supply?
The quantity of a good or service that producers are willing and able to produce at a given price in a given time period.
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Why is there a direct relationship?
Profit motive - when quantity increases, suppliers want to charge a higher price because their costs of production increases, so they want to increase prices to maintain profit margins.
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What causes a shift in supply?
Productivity
Indirect taxes
No. of firms
Technology
Subsidies
Weather
Costs of production (price of raw materials / imported goods, utility costs, bills, rent, govt regulations, wages)
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What is the price mechanism?
1) Signals that says price is too high or too low (e.g. empty restaurant)
2) Incentives to change prices to make more profit
3) Rations excess supply and demand
4) Allocates scarce resources efficiently.
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What is price elasticity of demand?
It measures the responsiveness to a change in quantity demanded given a change in price.
>1 = elastic (change in price leads to an even bigger % change in demand)
< = inelastic (change in price leads to a smaller % change in demand)
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What determines price elasticity of demand?
Substitutes (goods with many substitutes will have elastic demand)
Percentage of income
Luxury / necessity (inelastic)
Addictive? e.g. cigarettes inelastic
Time period (short run is more inelastic)
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What is price elasticity of supply?
It measures the responsiveness of quantity supplied given a change in price.
Production lag (in the short run capital is fixed)
Stocks (low level is inelastic)
Spare capacity = elastic
Substitutability of FoPs
Time lag - e.g. crops - the supply is inelast
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What is income elasticity of demand?
It measures the responsiveness in quantity demanded given a change in income.
(+) = normal good
>1 = luxury (elastic)
< 1 = necessity (inelastic)
(-) = inferior good
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What is cross price elasticity of demand?
It measures the responsiveness of quantity demanded given a change in price of another.
(+)= substitutes
(-) = complements
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What is consumer surplus?
The difference between the price consumers are willing and able to pay vs the price they actually pay.
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What is producer surplus?
The difference between the price producers are willing and able to supply a good/ service for vs the price they actually receive.
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What are indirect taxes?
They used when there is over consumption or over production and are charged on the producer and paid by consumer indirectly.
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Incidence of tax
If demand for good is inelastic, consumers will take the burden of the tax, as firms can pass majority of tax on to consumer.
If demand is price elastic, firms will have to absorb most of the tax in reduced profit margins.
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What is a specific tax and what is an ad valorem tax?
Specific - fixed amount per unit sold
Ad valorem - % of the price (e.g. VAT, stamp duty)
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What is a price floor and its problems?
It is used to discourage the consumption of demerit goods e.g. alcohol or when the price is deemed to be low by the govt e.g. minimum wage.
Problems:
- Regressive
-Depends on elasticity of demand
-Black markets
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What is a price ceiling and its problems?
It is used when the price level is deemed to be too high by the government e.g. rent control. However, it causes excess demand.
Problems:
-Can create a shortage so people may turn to black markets
-Enforcement?
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What is deadweight loss?
A decrease in consumer or producer surplus that results from an inefficient allocation of resources. This is because goods are being over or under valued and firms are not producing at market equilibrium.
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Other cards in this set
Card 2
Front
Why is the demand slope downwards?
Back
1) Income effect (as price increases, purchasing power decreases)
2) Substitution effect (as price increases, other substitutes become less competitive)
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