How Markets Work

T1 CC2 (keywords)

Demand

The quantity of a good or service that consumers are willing and able to buy at a given price. To be ‘effective’ demand consumers must have the ability to buy (i.e. have sufficient money).

Equilibrium price

The price at which a good/service is being offered for sale is being bought so the market is said to be clear.

Excess demand

Where there is unfulfilled demand at the market price – demand is greater than supply

Excess supply

Where there are unsold goods/services at the market price – supply is greater than demand

Price mechanism

The mechanism through which price is determined in a free market system. The forces of demand and supply are needed to reach equilibrium.

Law of demand

As price decreases demand will increase and vice versa

Extension of demand

A movement down the demand curve due to a fall in price

Contraction of demand

A movement up the demand curve due to an increase in price

Substitutes

Goods that can be used in place of other goods

Complements

Goods that are usually bought together e.g. X-Box and X-Box games

Shift of the demand curve

Where the whole demand curve shifts left or right due to a factor other than a change in price

Derived demand

Where demand for one good is derived from the demand for another e.g. the increase in demand for taxi rides will cause an increase in demand for taxi drivers

Supply

The amount that suppliers are willing and able to sell at any given market price

Supply curve

A line showing the quantity that suppliers are willing to sell at a given price

Total revenue

Price x Quantity. How much suppliers get for selling their goods/services

Production costs

The firm’s costs involved in producing goods/services such as raw materials, wages and rent

Profit

Revenue - Costs

Loss

Where costs are higher than revenue

Extension of supply

When there is a movement up the supply curve caused by an increase in price

Contraction of supply

When there is a movement down the supply curve caused by a fall in price

Shifts of the supply curve

Where the whole curve shifts due to a change in variable other than price e.g. season or fashion

Joint supply

When two goods are produced together from the same origin / raw material e.g. beef and leather

Composite demand (competitive supply)

Where there are multiple uses for a single product e.g. apples can be used for juice or pies

The invisible hand

Term used by economic thinker Adam Smith to describe the way in which resources are allocated in a market economy to the advantage of everyone – free market forces of demand and supply.

Consumer surplus

The difference between what a customer is willing to pay and what they actually pay

Producer surplus

The difference between what a producer is willing to sell their goods/services for and what they actually sell for

Price elasticity of demand (PED)

The responsiveness of demand to a change in price

Price elasticity of supply (PES)

The responsiveness of supply to a change in market price

Income elasticity of demand (YED)

The responsiveness of demand to a change in disposable income

Cross price elasticity of demand (XED)

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

Elastic

Where one variable is sensitive to changes in another 1 to infinity

Inelastic

Where one variable is insensitive to changes in another 0 to 1

Unitary Elastic

Where one variable changes in the same proportion given changes in another =1

Perfectly Elastic

Demand or supply is infinite at a given price/income = ∞

Perfectly Inelastic

Demand or supply is fixed regardless of the price/income = 0

Short Run

At least one factor of production is fixed

Long Run

All factors of production are variable

Normal Goods

Demand rises when income rises and vice versa, Positive YED

Necessities

Demand changes by a smaller proportion to a change in income, Positive YED < 1

Luxury Goods

Demand changes by a larger proportion to a change in income, Positive YED > 1

Inferior Goods

Demand falls when income rises and vice versa, Negative YED

Income Effect

Change in quantity demanded of a good or service resulting from a change in consumer’s real purchasing power due to a price change.

Substitution Effect

Change in quantity demanded of a good or service as a consumer switches to or from cheaper alternatives when its relative price changes.

Diminishing Marginal Utility

Principle that as a consumer increases consumption of a good or service, the marginal utility (satisfaction) gained from each additional unit decreases.

Conditions of demand/supply

Factors that cause the supply/demand curve to shift

Real income

Income relative to rates of inflation

Disposable income

Income after taxes have been paid and benefits received

Discretionary income

Disposable income less bills

Joint demand

Occurs when two or more goods or services are consumed together. A fall in the price of one good (printers) leads to an increase in the demand for another (ink cartridges.)

Indirect tax

Taxes on expenditure that are collected by a firm and paid directly to the government on behalf of the consumer, i.e. VAT and excise duty.

Subsidy

A government grant given to firms, designed to lower production costs and encourage supply.

Elasticity

The sensitivity/responsiveness of demand or supply to changes in another variable.

Coefficient

A numerical measure used to express degree of responsiveness of one variable to a change in another.

Business cycle

Periodic but irregular fluctuations in levels of economic activity over time, measured by changes in real GDP.