Price determination in a competitive market

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Demand
The quantity of a good or service that consumers are able and willing to buy at a given price price during a given period of time, changes in price causes movements along the demand curve which slopes downwards
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Expansion of demand
Price level falls - larger quantity is demanded
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Contraction of demand
Price level increases - lower quantity is demanded
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Factors that shift the demand curve (PIRATES)
P-Population, I-Income, R-Related goods, A-Advertising, T-Tastes and Fashions, E-Expectations, S-Seasons
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How can a change in population cause a shift in the demand curve?
Larger population - higher demand, the structure of the population (distribution of different age groups) also affects demand
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How can a change in income cause a shift in the demand curve?
More disposable income - increase in demand - consumers generally spend more when they perceive their wealth to increase
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How can a change in related goods cause a shift in the demand curve?
Substitutes - can replace another good - as £ falls of substitute - demand for og good falls, Compliment - goes with another goods - price of one good increases the demand for a compliment will fall
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How can a change in advertising cause a shift in the demand curve?
Advertising - Increases consumer loyalty - Increase in demand
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How can a change in tastes and fashions cause a shift in the demand curve?
Demand for a 'old' good can fall if a 'new' good is introduced
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How can a change in expectations cause a shift in the demand curve?
If speculators expect price to increase - demand is likely to increase in the present
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How can a change in seasons cause a shift in the demand curve?
Demand changes according to the season - eg demand for ice cream and sun lotion increases in the summer
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Why does the demand curve slope downwards?
There is an inverse relationship between price and quantity because of the law of diminishing marginal utility - as an extra unit of good is consumed the benefit derived from consumption falls therefore consumers willing to pay less
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Price elasticity of demand
Responsiveness of a change in demand to a change in price
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PED formula
PED = %^QD / %^P
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Price elastic
Very responsive to a change in price - change in price leads to an even bigger change in demand - PED>1
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Relatively price elastic graph
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Price inelastic
Relatively unresponsive to a change in price - PED
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Relatively price inelastic graph
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Unitary price elastic
Change in demand is equal to change in price - PED=1
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Unitary price elastic graph
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Perfectly price inelastic
Demand does not change when price changes - PED=0
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Perfectly price inelastic graph
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Perfectly price elastic
Demand falls to zero when price changes - PED=Infinity
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Perfectly price elastic graph
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Factors influencing PED for a good
Necessity, substitutes, addictiveness or habitual consumption, proportion of income spent on the good, durability of the good, peak and off-peak demand
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How does necessity influence demand for a good?
Necessary good - relatively inelastic demand, Luxury goods - elastic
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How do substitutes influence demand for a good?
Several substitutes - demand more price elastic - the closer and more available the substitutes are, the more price elastic the demand
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How does addictiveness or habitual consumption influence demand for a good?
Not sensitive to a change in price - if addicted - continue demand even if price increases
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How does the proportion of income spent on a good influence the demand for that good?
If takes up small proportion of income - demand is likely to be relatively inelastic, if significant proportion of income - demand likely to be more price elastic
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How does the durability of a good influence the demand for a it?
Good that lasts a long time - more elastic demand - consumers wait to buy another one
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How do peak and off-peak demand influence the demand for a good?
Peak times - demand is more price inelastic
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Firms selling goods with inelastic demands that have indirect tax are likely to......
put the burden on the consumer - price increase will not cause demand to fall significantly - effective for raising government revenue
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Indirect tax on a good with inelastic demand graph
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Firms selling goods with elastic demands that have indirect tax are likely to......
Take most of the tax burden upon themselves - price of the good increases - demand likely to fall - lower overall revenue - not effective at raising government revenue, however can reduce the demand of a particular good
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Indirect tax on a good with elastic demand graph
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Subsidy
A payment from the government to encourage production and to lower firms average costs - increases supply, benefits producer due to increased rev, benefits consumer due to lower prices
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Elasticity of demand and subsidies graph
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Total revenue
TR = P * Q
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Effect of inelastic demand on total revenue
Inelastic demand - firms can raise the price - quantity sold will not fall significantly - increase total revenue
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Effect of elastic demand on total revenue
Firm raises price - quantity sold will fall - reduces total revenue
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Income elasticity of demand
Responsiveness of a change in demand to a change in income
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Income elasticity of demand formula
YED = %^QD / %^Y
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Inferior goods
Demand falls as income increases - YED
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Normal goods
Demand increases as income increases - YED>0
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Luxury goods
Increase in income causes an even bigger increase in demand - YED>1 - During periods of economic prosperity real incomes rise so firms produce more luxury goods as demand for luxury goods increases
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Cross elasticity of demand
Responsiveness of a change in demand of one good, X, to a change in price of another good, Y
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Cross elasticity of demand formula
XED = %^QD of X / %^P of Y
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Complementary goods
Have a negative XED - if one good becomes more expensive the quantity demanded for both falls
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Close compliments
A small fall in the price of good X leads to a large increase in QD of Y
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Weak compliments
A large fall in the price of a good X leads to only a small increase in QD of Y
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Substitutes
Can replace another good, so the XED is positive and the demand curve is upward sloping
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Close substitutes
A small increase in the price of good X leads to a large increase in QD of Y
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Weak substitutes
A large increase in the price of good X leads to a smaller increase in QD of Y
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Unrelated goods
XED = 0
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Why are firms interested in XED?
To see how many competitors they have - less likely to be affected by price changes by the other firms, if they are selling complementary goods or substitutes
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Supply
Quantity of a good or service that a producer is able and willing to supply at a given price during a given period of time
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Why are supply curves upward sloping?
If price increases, it is more profitable for firms to supply - High prices encourage new firms to enter the market - Larger outputs, firms costs increase so they need to charge a higher price to cover the costs
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Contraction of Supply
Price falls and Quantity supplied falls
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Expansion of supply
Price increases and Quantity supplied increases
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Theory of the profit motive
Firms are driven by the desire to make large profits - explains why only changes in price will cause movements along the supply curve
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Outward shift of supply
A larger quantity of goods is supplied at the market price
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Inward shift of supply
Less goods are supplied at the market price
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Factors that shift the supply curve (PINTSWC)
P-Productivity, I-Indirect taxes, N-Number of firms, T-Technology, S-Subsidies, W-Weather, C-Cost of production
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How does a change in productivity shift the supply curve?
Higher productivity causes an outward shift as average costs fall
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How does a change in indirect taxes shift the supply curve?
If indirect taxes increase supply shifts inwards
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How does a change in the number of firms shift the supply curve?
More firms - larger supply
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How does a change in technology shift the supply curve?
More advanced technology - outward shift in supply
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How does a change in subsidies shift the supply curve?
Increase in subsidies - Outward shift of supply
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How does a change in weather shift the supply curve?
Favourable conditions will increase supply
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How does a change in the costs of production shift the supply curve?
CoP fall - supply more - outward shift of the supply curve
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How does a depreciation in the exchange rate shift the supply curve?
Will increase the cost of imports - inward shift in supply
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Price elasticity of supply
Responsiveness of a change in supply to a change in price
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Price elasticity of supply formula
PES = %^QS / %^P
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Relatively elastic supply
Firms can increase supply quickly at a little cost - PES>1
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Relatively elastic supply graph
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Relatively inelastic supply
An increase in supply will be expensive for firms and take a long time - PES
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Relatively inelastic supply graph
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Perfectly inelastic supply
Supply is fixed, so if there is a change in demand, it cannot be met easily - PES=0
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Perfectly inelastic supply graph
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Perfectly elastic supply
Any quantity demanded can be met without changing price - PES=infinity
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Perfectly elastic supply
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Factors influencing PES
Time scale, Spare capacity, Levels of stocks, How substitutable factors are, Barriers to entry to the market
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How does time scale influence PES?
SR - supply is more price inelastic, LR - supply is more price elastic
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How does spare capacity influence PES?
Full capacity - no space left to increase supply, Spare resources - Supply can be increased quickly
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How do the level of stocks influence PES?
If goods can be stored - stock them and increase market supply easily, If goods are perishable - cannot stock them for long so supply is more inelastic
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How does the substitubility of factors influence PES?
If labour and capital mobile - supply is more price elastic because resources can be allocated to where extra supply is needed
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How do barriers to entry in a market influence PES?
Higher barriers - more price inelastic - difficult for new firms to supply the market
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Equilibrium
Supply = Demand, price has no tendency to change, known as the market clearing price
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Excess demand
Demand>Supply - Price is below equilibrium - shortage in the market - pushes prices up - firms supply more - since prices increase demand contracts
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Excess supply
Supply>Demand- Price is above equilibrium - Surplus - Price will fall to Pe - firms lower their prices and try to sell their goods
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New market equilibriums
When the demand or supply curves shift a new market equilibrium is established at the new point of S=D
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Derived demand
Demand for one good is linked to the demand for a related good
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Composite demand
Good demanded has more than one use
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Joint demand
Goods are bought together
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Joint supply
Increasing the supply of one good causes a change in the supply of another good
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Interrelationship between markets
Changes in one market are likely to affect other markets - relates to the types of demand and supply, and how they link different markets
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Other cards in this set

Card 2

Front

Price level falls - larger quantity is demanded

Back

Expansion of demand

Card 3

Front

Price level increases - lower quantity is demanded

Back

Preview of the back of card 3

Card 4

Front

P-Population, I-Income, R-Related goods, A-Advertising, T-Tastes and Fashions, E-Expectations, S-Seasons

Back

Preview of the back of card 4

Card 5

Front

Larger population - higher demand, the structure of the population (distribution of different age groups) also affects demand

Back

Preview of the back of card 5
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