Unit 3:Price determination in a competitive market

What does a demand curve show?

The relationship between price and quantity demanded

What causes a shift in the demand curve?

-Population

-Advertising

-Substitute’s price

-Incomes

-Fashion/tastes

-Interest rates

-Complement’s price

What is price elasticity of demand (PED)?

PED measures responsiveness of demand to a change in price

What is the formula for PED?

PED = % change in quantity demanded ÷ % change in price

Price Elastic

-Percentage change in demand will be greater than percentage change in price

-Very responsive to price changes

-Increases in price will lead to fall in total revenue

Price Inelastic

-Percentage change in price will be greater than percentage change in demand

-Less responsive to price changes

-Increases in price will lead to a raise in total revenue

Perfectly Elastic

-Price is fixed; demand can take any value

-Any change in price will kill demand

Perfectly Inelastic

Demand is not affected by price changes

Unitary Price Elasticity

-When price increases, demand will fall by the same percentage (and vice versa)

What factors influence PED?

-Substitutes

-Percentage of income

-Luxuries/necessities

-Addictive/habit-forming

-Time period

What is income elasticity of demand (YED)?

YED measures responsiveness of demand to a change in income

What is the formula for YED?

YED = % change in quantity demanded ÷ % change in income

Normal goods

-Positive YED

-When income increases, demand increaeses

Inferior goods

-Negative YED

-When income increases, demand decreases

Normal luxury goods

-YED>1

Normal necessity goods

0<YED<1

What factors influence YED?

-Income level

-Type of good

-Necessity or luxury

What is cross elasticity of demand (XED)?

XED measures responsiveness of demand for one good to a change in the price of another

What is the formula for XED?

XED = % change in quantity demanded of good A ÷ % change in price of good B

What does a positive XED indicate?

Substitute goods

What does a negative XED indicate?

Complementary goods

What factors influence XED?

-Strength of relationship

-Substitutability or complementarity

What does a supply curve show?

A supply curve shows the relationship between price and quantity supplied

Why do higher prices increase supply?

Higher prices imply higher profits, incentivising producers to supply more

What causes a shift in the supply curve?

-Changes in production costs

-Technology

-Taxes and subsidies

-Weather

-Number of sellers

What is the shape of the supply curve under perfect competition?

The marginal cost curve

What is PES?

PES measures responsiveness of quantity supplied to a change in price

What is the formula for PES?

PES = % change in quantity supplied ÷ % change in price

What factors influence PES?

-Spare capacity

-Stock levels

-Production time

-Time period

-Mobility of factors

What determines equilibrium market prices?

The interaction of demand and supply

What is market disequilibrium?

Disequilibrium is when demand does not equal supply

What causes excess demand?

Quantity demanded exceeds quantity supplied

What causes excess supply?

Quantity supplied exceeds quantity demanded

How does excess demand affect prices?

Excess demand causes prices to rise

How does excess supply affect prices?

Excess supply causes prices to fall

What is joint demand?

Joint demand is when goods are used together e.g. printers and ink

What is competitive demand?

Competitive demand is when goods are substitutes e.g. butter and margarine

What is composite demand?

Composite demand is when one good is demanded for multiple uses e.g. milk

What is derived demand?

Derived demand is when demand for one good is linked to another e.g. labour for products

What is joint supply?

Joint supply is when producing one good also produces another e.g. beef and leather