3.0 Price Determination (All in 1)

What is the relationship between income elasticity of demand and normal and inferior goods

Normal goods have a positive income elasticity, meaning demand increases as income rises

Inferior goods have a negative income elasticity, indicating demand decreases as income increases

How is income elasticity of demand calculated?

%change in quantity/

%change in income

What factors influence the elasticities of demand

Factors include -

• the availability of substitutes

• the proportion of income spent on the good

• the necessity of the product

• time period

• consumer habits

How does price elasticity of demand relate to a firm's total revenue?

If demand is elastic, a price decrease will lead to an increase in total revenue, while a price increase reduces total revenue

If demand is inelastic, a price increase raises total revenue, a price decrease lowers it

How is price elasticity of demand calculated (PED)? 

%change in quantity demanded/

%change in price

How is cross elasticity of demand calculated?

%change in quantity demanded of B/

%change in price of A

What is the relationship between cross elasticity of demand and substitute and complementary goods

Substitute goods have a positive cross elasticity of demand; an increase in the price of one leads to and increase in the demand for the other

Complementary goods have a negative cross elasticity; an increase in the price of one leads to a decrease in demand for the other

How should numerical values of elasticities of demand be interpreted?

PED 

• 1> Elastic

• 1< Inelastic

YED

• 1> Luxury good

• 0-1 Necessity 

• <0 Inferior good

XED

• Posititve = substitute

• Negative = complements

Why do higher prices imply higher profits and incentivise production expansion?

Higher prices can lead to higher revenues for firms, increasing potential profits

What causes shifts in the supply curve?

Result from factors like - 

• changes in production costs

• technological advancements

• taxes and subsidies

• number of sellers in a market

Under perfect competition, why is the supply curve the marginal cost curve?

In perfect competition, firms are price takers and produce where price equals marginal cost. Therefore, the supply curve reflects the marginal cost of production

What does a supply curve represent?

A supply curve shows the relationship between the price of a good or service and the quantity supplied by producers

How should numerical values of price elasticity supply of be interpreted?

A PES >1 is elastic supply

A PES <1 is inelastic supply

How is price elasticity of supply calculated?

%Change in quantity supplied/

%Change in price

What factors influence price elasticity of supply?

Factors include - 

• time period

• availability of spare capacity

• flexibility if production processes

• avaiabiliy of raw materials

• the ability to store stock

Example of Elastic and Inelastic supply

Elastic: T-shirt

Inelastic supply: Pharmaceutical drugs

What is the difference between equilibrium and disequilibrium in a market?

Equilibrium occurs when market supply equals market demand

Disequilibrium when there is either excess supply of excess demand 

Why do excess demand and supply lead to change in price?

Excess demand leads to upward pressure on price, because consumers compete to purchase the limited goods available

Excess supply lead to downward pressure on price, because producers want to sell excess stock, often by lowering prices

How is the equilibrium price determined in a market economy?

The equilibrium price is determined through the interaction of demand and supply

What is it meant by "equilibrium price" in a market?

When the quantity of a good or service demanded is equal to the quantity of a good service supplied 

What is joint supply?

Joint supply occurs when the production of one good also results in another good being produced e.g. beef and leather from cattle

What is composite demand?

Composite demand is when a good is demanded for multiple uses e.g. milk being used for butter, cheese and drinking

What is competitive demand?

Competitive demand refers to goods that are substitutes for each other e.g tea and coffee. An increase in demand for one typically lowers demand for the other

What is derived demand?

Derived demand is when the demand for one good depends on the demand for another good e.g. demand for steel depends on car production

How can changes in one market affect other markets?

Changes in price, demand, or supply in one market can have ripple effects on others. For example, rise in price for petrol can affect car usage and public transport demand. This is due to interlinked relationships like joint demand and derived demand

What is joint demand?

Joint demand occurs when goods are used together e.g. printers and ink. A rise in demand for one increases demand for the other.