Price determination in a competitive market

What causes a shift in the demand curve? (PIRATES)

Population - larger population = higher demand

income - increase in disposable income, wealth of consumer

related goods - fall in price of substitutes (decreases demand), increase in price of complementary goods (decreases demand)

advertising - increases consumer loyalty and demand

tastes - individual preferences

expectations - quality of the product

seasons - changes according to season

What does movement along a demand curve show?

a change in the price of the good

What factors determine demand for a good or a service?

• the prices of substitute goods

• the prices of complementary goods

• personal income

• individual preferences

• population size

What does the demand curve show?

relationship between price and quantity demanded

What factors influence spending decisions of consumers?

Price, income, wealth, the price of substitutes, complementary goods, individual preferences

What are the factors that determine price elasticity of demand

• substitutability

• percentage of income

• necessities or luxuries

• the width of the market definition

• time

Which factors determine the supply of a good or service

• cost of production

• the number of producers

• capacity e.g. factories

• supply of related goods

• technology costs

• taxes

• govt. subsidies

What are the causes of shifts in the supply curve?

• a right shift is an increase in supply

What is the PED equation?

% change in quantity demanded / % change in price

What is unitary elasticity?

• demand is said to have unitary elasticity if a change in price causes quantity to change by equal proportion

• the value of PED would be -1

What is perfectly inelastic demand?

• if a change in price causes no change in quantity demand

• PED value is 0 e.g. insulin

What is perfectly elastic demand?

• where a change in price will cause an infinite change in the quantity demanded

• PED value is infinity e.g. foreign currency

What is elasticity?

A numeric measure of the responsiveness of one economic variable (the dependent variable) following a change in other influencing variable (the independent variable. Ceteris paribus

What are factors that influence PED?

• brand strength (loyalty, reputation)

• necessity

• habit

• availability of substances (competitors, alternatives)

• time (short-run v long-run)

What is income elasticity of demand? (YED)

Shows the effect of a change in income on quantity demanded. (Responsiveness)

What is the YED equation?

% change in quantity demanded / % change in income

What is a normal good?

a good for which demand increases as income rises and demand decreases as income falls.

they have positive income elasticity of demand

i.e. there is an outward shift of the demand curve

What are normal necessities in relation to YED?

They have an income elasticity of demand between 0 and +1

e.g. if income increases bu 4% then income elasticity is +0.4

demand is rising less than proportionality to income

What are luxury goods and services in relation to YED?

They have an income elasticity of demand > +1

I.e. demand rises more than proportionately to a change in income

E.g. an 8% increase in income might lead to a 10% rise in the demand for new kitchens

what is an inferior good?

a good for which demand decreases as income rises and demand increases as income falls.

They have a negative income elasticity of demand

e.x. cigarettes, low-priced own label foods, the demand for council owned properties

What is cross elasticity of demand? (XED)

measures the responsiveness of demand for 'good a' following a change in the price of a related 'good b'

What is the equation for CPED (cross elasticity of demand)

% change in quantity demanded for 'good a' / % change in price for 'good b'

What are close substitutes?

Small rise in price of x causes large demand rise for y

What are weak substitute?

Large rise in price of x leaves to small increase in demand for y

What is a close component?

Small fall in price of x causes large rise in demand for y

What is weak component?

Large fall in price of x causes small rise in demand for y

What is the relevance of PED to a firm?

• data on PED can help a firm with its pricing decisions

• PED allows a firm to understand how demand will respond to a given change in price

• a firm with price elastic demand should drop prices to increase total revenue

What are some factors that make PED not relevant to a firm?

• the data is estimated & thus liable to inaccuracy particularly given the nature of how they are calculated (e.g. customer surveys)

• the data may not hold true over time

• other external factors must be considered

• a firm must consider other internal factors in its decision making

What is PES? (Price elasticity of supply)

Measuring the responsiveness of the supply of a good to a change in price

It shows the speed at which a producer is able to change the factors of production and adjust production when price changes

What is the PES equation?

% change in quantity supplied / % change in price

If supply is elastic (PES >1) ...

... then producers can increase output without a rise in cost or a time delay

E.g. a PES of 3 would be very responsible so rapid increase in supply

If supply is inelastic (PES 0 and 1)...

... then firms find it hard to change production in a given time period

E.g. a PES of .5 would not be responsive so supply increases would be slow

how does elastic supply affect a producer?

enables a producer to benefit from a responsive change to price and demand

What factors determine price elasticity of supply? (PES)

• time (market period

• the length of the production period

• availability of spare capacity (labour

raw materials)

• ease of accumulating stocks

• ease of switching to alternative production

• ease of entering market & no. of firms

How does inelastic supply affect producers?

A producer cannot respond quickly to an increase price and/or demand so will require longer to adapt to the new market conditions

What is equilibrium?

A state of equality between supply and demand. Without a shift in demand and/or supply there will be no change in market price

What is a competitive market?

A market in which a large number of buyers and sellers possess good market information and an waist enter or leave the market

What is equilibrium price?

The price at which planned demand for a good or service exactly equals planned supply

What are normal goods?

A good for which demand increases as income rises and demand increases as income falls

What are inferior goods?

a good for which demand decreases as income rise and demand increases as income falls

What is derived demand?

The demand for a factor of production used to produce another good or service

What is joint supply?

Refers to a product or process that can yield 2 or more outputs

E.x. Livestock industry: cows can be utilised for milk

beef and hide

What is competing supply?

• goods and services in competitive supply are alternative products that a business could make with its factor resources of land

E.x. Diversion of land used in supplying food to producing bio-fuels & the impact it has on global food prices

what events would cause a rightward shift on a demand curve?

• an increase in price of a substitute good

• a fall in price of a complementary good or good in joint supply

• an increase in disposable income

• increase in population size

• successful advertising campaign

what is PED?

price elasticity of demand measures the extent to which the demand for a good changes in response to a change in the price of that good

What is disequilibrium?

A situation in a market when there is excess demand or excess supply.

excess supply

when firms wish to sell more than consumers wish to buy

excess demand

When consumers wish to buy more than firms wish to sell

what is competing supply?

when raw materials are used to produce one good they cannot be used to produce another good

what is a complementary good?

A good in joint demand

what is composite demand?

demand for a good which has more that one use

what factors influence demand?

ability and willingness to pay