Price Determination in a Competitive Market

• Market is a voluntary meeting of buyers and sellers
• Demand is the quantity of a good or service that consumers are willing and able to buy at a given price
• supply is the quantity of a good or service that suppliers are willing and able to sell at a given price
• equilibrium price is when supply = demand
• a movement along a demand curve only occurs when the price of a good changes
• determinants of demand:

  • price of substitute goods
  • price of complementary goods
  • personal income
  • tastes and preferences
  • population size
• factors causing a rightward shift in demand:

  • increase in the price of a substitute good
  • fall in the price of a complementary good
  • increase in personal disposable income
  • successful advertising campaign
  • increase in population size
• substitute goods are alternative goods which can be used for the same purpouse
• complementary goods experience joint demand
• normal goods - demand increases as income increases
• normal goods - demand decreases as income decreases
• inferior goods - demand decreases as income increases
• elasticity is the proportionate responsiveness of a second variable to an initial change in the first variable
• PED = percentage change in quantity demanded / percentage change in price
• YED = percentage change in quantity demanded / percentage change in income
• XED = percentage change in quantity demanded of good A / percentage change in price of good B
• Infinitely elastic demand line goes horizontally straight
• zero elasticity of demand goes vertically straight
• factors determining PED

  • Sustainability
  • Percentage change of income
  • Necessities or luxuries
  • Width of the market
• income elasticity of demand measures the extent to which the demand for a good changes in response to income
• cross elasticity of demand measure the extent to which the demand for a good changes in response to the price of another good
• Market supply is the quantity of a good or service that all firms in a market plan to sell at a given price in a given period of time
• Conditions of supply:

  • Costs of production
  • Technical progress
  • Taxes
  • Subsidies
• increase in supply or demand = rightward shift
• decrease in supply or demand = leftward shift
• price elasticity of supply measures the extent to which the supply of a good changes in response to a change in price of that good
• PES = percentage change in quantity supplied / percentage change in price
• completely inelastic supply is a vertical straight line
• elastic supply is a diagonal line with a shallow gradient
• inelastic supply is a diagonal line with a steep gradient
• unitary elastic supply is a perfect line through the axis
• perfectly elastic supply is a horizontal line straight across
• factors determining price elasticity of supply:

  • length of production period
  • ease of accumulating stock
  • ease of switching methods of production
  • number of firms and ease of entry into the market
  • time