How markets work 1.2

what is a market ?

where consumers and producers come into contact with each other to exchange goods and services

what is utility ?

the amount of satisfaction obtained from consuming a good/ service

what does it mean for consumers to be assumed to make rational decisions

it means consumers will allocate their income to maximise their utility and satisfaction from the goods and services they obtain

what is the equation for maximising consumer utility ?

marginal utility of good A =marginal utility of good B

---

price of good A = price of good B

if a consumers has £100 if he spends £20 on a T-shirt and £80 on shoes what is the marginal utility

40 units of extra utility - T-shirt

160 units of extra utility - shoes

what is rational decision making ?

where consumers allocate their expenditure on goods and services to maximise utility and producers allocate their resources to maximise profits

what does it mean for a producer to make a rational decision

firms will use their resources to maximise profits from the goods and services produced

This is involves producing at the level of output where total revenue exceeds total cost by the largest amount

demand

the quantity of a good/ service purchased at given price over at a given time period

demand curve

shows the quantity of a good or service that would be bought over a range of different price levels in a given time period

why does a demand curve slope downwards from left to right

as price falls the goods become cheaper compared to substitutes so demand increases and more can be purchased with a given level of income

how does movement along a demand curve occur

when their is a change price

fall in price - extension demand

rise in price - contraction demand

marginal utility

the utility / satisfaction obtained from consuming one extra unit of a good/ service

diminishing marginal utility

as successive units of a good is consumed the utility/ satisfaction gained from each extra unit will fall

marginal utility x demand curve

as a someone consumes more of one good the utility x satisfaction gained from each extra units will decrease that’s why it is downward sloping

example using cereal on diminishing marginal utility

total utility from consuming a bowl of cereal will increase but at a diminishing rate until the consumer feels sick then it will drastically fall

what factors could cause a shift in the demand curve (8)

rise in the price of substitute goods

change in fashion taste

increase advertising

increase in real real incomes

decrease in income tax

fall in the price of complementary goods

increase in population / change in average of population

increase in credit facilities

ped

the responsiveness in the demand of a good due to the change in its price

PED formula

percentage change in demand of good A

---

percentage change in the price of good A

most circumstances a minus is produced indicating that the two variables move in opposite direction

PED greater than 1

relatively price elastic

PED is less than 1

relatively price inelastic

PED=1

the good has unit elasticity

PED=0

perfectly inelastic - e.g heroin to a drug addict

PED is infinity

perfectly elastic

what happens to elasticity as you move along the demand curve from the top left to bottom right

elasticity falls

what does the middle of a demand curve signify

demand has unit elasticity

total revenue

the price per unit of a good multiplied by the quantity sold

how does elastic demand effect revenue when there is a cut in the price

increases revenue as it will increase total consumer spending

how does elastic demand effect revenue when there is a rise in the price ?

decrease revenue as consumers total spending will decrease as they are responsive to price

when a good is demand inelastic how will a rise in price effect revenue

it will increase revenue as consumers are not responsive to price so they are still willing to buy the product

when a good is demand inelastic how will a decrease in price effect revenue

decrease revenue for the firm wont effect consumer spending so firm looses revenue

unit price elasticity and revenue

the firms is maximising its total revnue

marginal revenue is 0

demand is unit elastic

marginal revenue is negative

demand inelastic

marginal revenue is positive

demand is elastic

how does availability of substitutes effect PED