Elasticity and Market Structures - Vocabulary Flashcards

Price Elasticity of Demand

• Measures how responsive consumers are to price changes; elasticity = responsiveness.

• Formula: PED = \frac{\% \Delta Q_d}{\% \Delta P}

• Midpoint/arc elasticity (base is the average of initial and new values) to get consistent results for price moves in either direction:

  • \%\Delta Qd = \frac{Q2 - Q1}{(Q1+Q_2)/2} \times 100

  • \%\Delta P = \frac{P2 - P1}{(P1+P2)/2} \times 100

• Property: elasticity results are the same whether the price goes from a to b or b to a when using the midpoint base.

• Focus is on percent changes; the measurement does not depend on the units of output or price.

• Elasticity categories:

  • Elastic demand: |PED| > 1 — a small price change leads to a relatively large change in quantity demanded (e.g., luxury goods or goods with close substitutes like smartphones).

  • Inelastic demand: |PED| < 1 — a price change leads to a proportionally smaller change in quantity demanded (e.g., essential goods like food).

  • Unitary elastic demand: |PED| = 1 — the percentage change in quantity demanded equals the percentage change in price.

• Example from notes:

  • Coffee price increases by 10%; quantity demanded decreases by 15%.

  • PED = \frac{-15\%}{10\%} = -1.5

• Note on signs: PED is typically negative due to the inverse relationship between price and quantity demanded; sometimes only the absolute value is reported.

Price Elasticity of Demand - Worked Example (from notes)

• If price changes by +10% and quantity demanded changes by -15%, then as above, PED = -1.5 (elastic demand).

Price Elasticity of Supply

• Measures how responsive quantity supplied is to changes in price or other factors (e.g., production costs).

• Formula: PES = \frac{\% \Delta Q_s}{\% \Delta \text{Price or Other Relevant Factor}}

• Elastic supply: PES > 1 — a small price or cost change leads to a relatively larger change in quantity supplied.

• Inelastic supply: PES < 1 — a price or cost change results in a proportionally smaller change in quantity supplied.

• Examples: goods that are easy to produce or where production can be quickly increased tend to have elastic supply; unique or specialized goods with limited production capacity tend to have inelastic supply.

• Example: Oil price increases by 20%; quantity supplied increases by 5%.

  • PES = \frac{5\%}{20\%} = 0.25

Market Structures (Overview)

• Market structure = characteristics of a market that affect the nature of competition and pricing.

Perfect Competition

• Main features:

  • Large number of buyers and sellers

  • Each seller sells a small portion of total output

  • Individual sellers have no influence on the market price

  • Sellers are price takers

  • Homogeneous product (identical product)

  • Same price and cost across sellers

  • Free entry and exit

  • No government or other control (no artificial barriers)

• Additional notes:

  • Perfect knowledge about the market

  • Absence of selling costs and advertising costs

  • A single price for the product, price determined in the industry

  • Example: Agricultural products

Monopoly

• Literally means one seller: 'Mono' = one, 'poly' = seller.

• One firm is the sole producer or seller of a product with no close substitutes.

• This is the negation of competition.

• Features:

  • Single producer or seller

  • No close substitute for the product

  • No freedom of entry

  • The monopolist is a price maker

  • The monopolist aims at profit maximisation

• Summary visual: “Just One Supplier — No Competition — Monopolist Controls Price — Very Hard to Enter the Market.”

Price Discrimination

• A monopoly firm might charge different prices to different groups of buyers.

• This pricing technique is called price discrimination.

• Degrees (as distinguished by Pigou):

  • First degree price discrimination: different price to each of its customers

  • Second degree price discrimination: discriminate according to quantities consumed

  • Third degree price discrimination: different prices to each sub-market

Monopolistic Competition

• Definition: market with large numbers of sellers selling differentiated (not identical) products that are similar but not homogeneous.

  • Examples: Car brands; Uber; Pret à Manger; shoe repairs and key makers; taxi and minibus companies; hairdressing salons; dry-cleaning; sandwich bars and coffee stores; dry-cleaners and launderettes; bars and nightclubs.

• It is a blend of perfect competition and monopoly.

• Features:

  • Free entry and exit

  • Large number of buyers and sellers

  • Product differentiation

  • Selling costs

  • Non-price competition

  • Some influence over price due to differentiation

Oligopoly

• Meaning: a market with a small number of large firms; each firm is affected by the actions of the others.

• Definition: An oligopoly is a market model in which a market for specific goods or services is divided among a small number of large producers. (Lewis, 2020)

• Examples: Automobile industry; Telecommunications industry.

• Type of market (summary table):

  • Perfect Competition

  • Number of firms: Very many

  • Freedom of entry: Unrestricted

  • Nature of product: Homogeneous (undifferentiated)

  • Examples: Cabbages, carrots (approximately)

  • Implications for demand faced by firm: Horizontal; firm is a price taker

  • Monopolistic Competition

  • Number of firms: Many / several

  • Freedom of entry: Unrestricted

  • Nature of product: Differentiated

  • Examples: Builders, restaurants

  • Implications for demand faced by firm: Downward sloping, but relatively elastic

  • Oligopoly

  • Number of firms: Few

  • Freedom of entry: Restricted

  • Nature of product: Undifferentiated or differentiated

  • Examples: Cement, cars, electrical appliances; Local water company, train operators (over particular routes)

  • Implications for demand faced by firm: Downward sloping; relatively inelastic (shape depends on reactions of rivals)

  • Monopoly

  • Number of firms: One

  • Freedom of entry: Blocked

  • Nature of product: Completely unique

  • Examples: Cement; cars; electrical appliances; Local water company; train operators (over particular routes)

  • Implications for demand faced by firm: Downward sloping; more inelastic than oligopoly; firm has considerable control over price

Note: The above notes summarize the key points from the provided transcript, including definitions, formulas, and real-world examples for elasticity and market structures. Where applicable, formulas are shown in LaTeX, and examples illustrate how the concepts apply in practice.