Price determination

• Demand


  The amount of goods and services that consumers are willing and able to buy at a given price at a given period of time
• What's the law of demand

  When the price of a good rises, the quantity demanded will fall
• Income effect?

  As the price increases, consumers have less real income so they demand less
• Substitution effect

  As the price of goods increases, consumers substitute for another product with the same/more satisfaction
• What causes the movement along the demand curve?


  Change in price. A rise in price results in a contraction in demand whereas a fall in price results in an expansion in demand.
• Contraction and expansion in demand


  • contraction - an increase in price causes quantity demanded to decrease (inward shift)
  • expansion - a decrease in price causes quantity demanded to increase (outward shift)
• Factors affecting demand

  • changes in income
  • uncertainty of future prices
  • advertising and publicity
  • prices of substitute and complimentary goods
  • consumer taste
  • changes in quality
  • competition level
• Inferior good


  A good whose demand decreases when people's incomes rise. Inferior goods are cheaper or lower quality products to make ends meet.
• Normal good


  Items purchased by consumers, such as clothing or food, that demonstrate a proportional connection between demand and income e.g. food and clothing
• Supply

  the quantity of a good or service that producers are willing and able to sell at any given price
• Joint Supply


  When one good is produced, another good is also produced from the same raw material.
• Law of Supply

  When the price of a good rises, the quantity supplied will also rise – others things remaining the same.  There are three reasons for this:

  • As firms supply more, they are likely to find that beyond a certain level of output costs rise more and more rapidly. ​
  • The higher the price of a good the more profitable it is likely to be.  Firms will switch to the production of profitable goods. ​
  • If the price of a good remains high, more producers will be attracted to producing this product, thus market supply will increase.
• Profit

  For a firm, profit is the difference between the sales revenue the firm receives when selling the G/S and the costs of producing the goods.​
• Factors affecting Supply

  • changing costs of production
  • prices of other goods and services
  • changes to raw materials ​
  • technology improvements​
  • increases in labour productivity​
  • regulation and bureaucracy​
  • wage rates​
  • expectations about future prices​
  • objectives of the firm​
  • the number of sellers in the market
• Taxation


  A charge placed on individuals or firms
• Governments use taxation


  To finance their spending
• Taxation


  Can be used to reduce consumption
• Indirect taxes


  Those placed on goods and services produced by individuals and firms
• Subsidies


  Finance provided to producers to encourage them to produce goods and services - increasing supply
• Elasticity


  Elasticity is the measure of responsiveness of one variable to changes in another.  
• PED Formula

  
  

  % change in quantity demanded​ / % change in price 
• PED Values explained

  
• What does a PED of 0 show?

  Perfect inelasticity, price doesn't affect demand
• What does a PED of 0-1 show?

  Inelasticity, price has a less than proportionate effect on demand
• YED Formula


  % change in quantity demanded​ / % change in income
• What does a PED above 1 show?

  Elastic demand, price changes result in a significant change in demand
• What does PED of 0 show?

  Perfect inelasticity (vertical line)
• What does an infinite PED show?

  Perfectly elastic demand (horizontal line)
• Equilibrium


  A situation in which the price has reached the level where quantity supplied equals quantity demanded
• Equilibrium Price (PE)


  The price that balances quantity supplied and quantity demanded
• Equilibrium Quantity (QE)


  The quantity supplied and quantity demanded at the equilibrium price
• If price is set above equilibrium price...

  the quantity supplied of a product exceeds the quantity demanded (called a surplus)
• What do producers do when there is a surplus?

  Cut their prices until the market reaches an equilibrium
• If price is set below equilibrium price...


  the quantity of goods demanded exceeds the quantity supplied (called a shortage)
• What do producers do when there is a shortage?

  Increase prices until the market moves to an equilibrium
• XED Formula

  % change in QD for good A​ / % change in price for good B
• Complimentary goods


  a good that you buy alongside another good to add value e.g a screen protector with a phone
• Goods that are complements are said to be in joint demand.
• An increase in demand for one good will see an increase in demand for a complementary good 
• • Complements have a negative cross elasticity of demand​
  • As the price of good Y increases (positive) the demand for good X will decrease (negative)