1.2 How markets work

Utility

The satisfaction gained from consuming a product.

Homo Economicus

The rational consumer who makes decisions based on utility calculations.

Demand

The ability and willingness to buy a particular good at a given price and time.

Contraction in demand

A decrease in quantity demanded due to an increase in price.

Extension in demand

An increase in quantity demanded due to a decrease in price.

Conditions of demand

Factors that cause the demand curve to shift.

PIRATES

A mnemonic for the conditions of demand: Population, Income, Related goods, Advertising, Taste/Fashion, Expectations, and Seasons.

Diminishing marginal utility

The decrease in satisfaction from consuming additional units of a good.

Price Elasticity of Demand (PED)

The responsiveness of demand to a change in the price of the good.

Elastic demand

When PED > 1; quantity demanded changes by a larger percentage than price.

Inelastic demand

When PED < 1; quantity demanded changes by a smaller percentage than price.

Income Elasticity of Demand (YED)

The responsiveness of demand to a change in income.

Inferior good

A good with YED < 0; demand falls as income rises.

Normal good

A good with YED > 0; demand rises as income rises.

Cross Elasticity of Demand (XED)

The responsiveness of demand for one product to the change in price of another product.

Substitutes

Goods with XED > 0; an increase in the price of one increases the demand for the other.

Complements

Goods with XED < 0; an increase in the price of one decreases the demand for the other.

Supply

The ability and willingness to provide a good or service at a particular price.

Conditions of supply

Factors that cause the supply curve to shift.

Price Elasticity of Supply (PES)

The responsiveness of supply to a change in price of the good.

Unitary elastic supply

When PES = 1; quantity supplied changes by exactly the same percentage as price.

Perfectly elastic supply

When PES = infinity; a change in price results in quantity supplied falling to zero.

Perfectly inelastic supply

When PES = 0; a change in price has no effect on output.

Factors influencing PED

Include availability of substitutes, time, necessity, percentage of total expenditure, and addictiveness.

Factors affecting PES

Include time, stocks, working below capacity, availability of factors of production, ease of entry into the market, and availability of substitutes.