1.2. Price Determination in a Competitive Market

• Factors which influence demand are;

  • price
  • income
  • wealth
  • price of substitutes
  • price of complements
  • individual preference
• • Demand - the amount of a good or service one is willing and able to buy at a particular price in a given period of time
  • Supply - the amount of a good or service one is willing and able to sell at a particular price in a given period of time
• PED = % change in quantity demanded / % change in price

  YED = % change in quantity demanded / % change in income

  XED = % change in quantity demanded of good X / % change in price of good Y
• A normal good is a good which if income increases, the quantity demanded increases

  an inferior good is a good which if income increases, the quantity demanded decreases

  this causes normal goods to have a positive income elasticity of demand but inferior goods to have a negative elasticity of demand.

  luxury goods have a YED > 1
• • complements are goods which are used in conjunction with eachother
  • substitutes are goods which can replace eachother

  This causes the cross elasticity of demand of substitutes to be positive, and the cross elasticity of demand of complements to be negative

  • if XED = 0, the two goods have no relationship with eachother
• Price elasticity of demand is a measure of how sensitive a change in price is to a change in demand of a particular good or service

  For an elastic good, when price increases, demand increases by a large percent

  For an inelastic good, when price increases, demand increases by a smaller percentage

  A) price

  B) quantity

  C) price

  D) quantity

  E) Inelastic demand

  F) elastic demand

  
• Factors that influence price elasticity of demand (FADPOW):

  • Frequency of buying
  • Availability of substitutes
  • Degree of necessity
  • Proportion of income spent
  • Original price of good
  • Width of definition
• factors affecting income elasticity of demand:

  • level of income of a consumer
  • standards of living
  • whether a good is a necessity or a luxury
  • the economic cycle
• factors affecting cross elasticity of demand:

  • whether goods are substitutes, complements or neither
• • Price elastic: PED > 1
  • Unitary elastic: PED = 0
  • Price inelastic: 0 < PED < 1
  • Luxury goods: YED > 1
  • Normal goods: YED > 0
  • Inferior goods: YED < 0
  • Substitutes: XED > 0
  • No relationship: XED = 0
  • Complements: XED < 0
• Determinants of Supply:

  • price of other goods and services
  • technological progress
  • impact of changing costs of production
  • government policy (taxation and subsidies)
  • the price of a good
• a supply curve shows the relationship between price and quantity supplied as; higher prices imply higher profits and that provides an incentive to expand production

  • movements are caused by the change in price of the good itself
  • shifts are caused by all other factors

  A) price

  B) quantity

  C) S

  
• the demand curve is the relationship between price and quantity demanded because;

  • as price rises, quantity demanded falls
  • this can be due to the income effect, substitution effect or diminishing marginal unity
  • a movement is caused by the change in price of the good itself
  • a shift is caused by a change in any other factor

  A) price

  B) quantity

  C) D

  
• price elasticity of supply is a measure of the responsiveness of supply to a change in price

  For an elastic good - a change in price causes a change in supply by a large percent

  For an inelastic good - a change in price causes a change in supply by a smaller percent

  A) price

  B) quantity

  C) inelastic supply

  D) price

  E) quantity

  F) elastic supply

  
• PES = % change of quantity supplied / % change of price

  price elasticity of supply is affected by:

  • price
  • substitutes
  • timescale - i.e. long run (elastic) and short run (inelastic)
• this diagram shows excess demand:

  A) price

  B) quantity

  C) demand

  D) supply

  
• Demand-Supply curve:

  • market clearing price: supply = demand
  • movement - disequilibrium
  • shift - equilibrium point shifts
  • market forces push prices towards market equilibrium

  A) price

  B) quantity

  C) demand

  D) supply

  E) market equilibrium

  
• How markets are connected:

  • joint demand (demand for goods are interlinked e.g. fish and chips)
  • demand for substitutes (demand is inversely proportional)
  • composite demand (increase in demand of one good restricts the resources' availability for another use e.g. milk - yoghurt and ice-cream)
  • derived demand (demand for another good/service influences the demand of another e.g tinned tomatoes and metal)
  • joint supply (the production of a product creates a by-product that can also be supplied e.g cow - beef and leather)