Competitive Markets

• Demand


  The quantity of a good or service that consumers are willing and able to buy at a given price
• Market

  • Where goods and services are bought and sold
• Determining price and quantity in a market


  Determined by the laws of demand and supply
• Demand curves usually slope downwards
• Consumers aim to pay the lowest price possible for goods and services
• As price decreases


  Demand increases
• As price increases


  Demand decreases
• Movement along the demand curve


  Caused by changes in price
• Shift in the demand curve

  Caused by factors other than price
• Factors that can cause a shift in the demand curve

  • Changes in consumer tastes and preferences
  • Changes in consumer income
  • Changes in the prices of related goods
• Normal goods

  Goods for which demand increases as income increases
• Complementary goods


  • Beef and gravy
  • Strawberries and cream
  • Tennis rackets and tennis balls
• Derived demand


  The demand for a good or factor of production used in making another good or service
• Composite demand


  When a good has more than one use, so changes in the demand for one use can affect the supply curve for another use
• Price elasticity of demand (PED)


  A measure of how the quantity demanded of a good responds to a change in its price
• Elastic demand


  • PED > 1, a percentage change in price causes a larger percentage change in quantity demanded
• Inelastic demand


  • PED < 1, a percentage change in price causes a smaller percentage change in quantity demanded
• Unit elastic demand


  • PED = 1, the percentage change in price is equal to the percentage change in quantity demanded
• Income elasticity of demand (YED)


  A measure of how much the demand for a good changes when consumer income changes
• Cross elasticity of demand (XED)


  A measure of how the quantity demanded of one good responds to a change in the price of another good
• Substitutes have a positive XED, complements have a negative XED
• Price Elasticity of Demand


  Measures how responsive the quantity demanded of a good is to a change in its price
• Factors that influence Price Elasticity of Demand

  • The rarity of the good
  • The availability of close substitutes
  • The proportion of income spent on the good
  • Whether the good is a necessity or a luxury
• Demand for essential goods like toilet paper is price inelastic, but demand for non-essential goods like tablet computers tends to be price elastic
• Demand for goods that are habit-forming like alcohol and tobacco tends to be price inelastic
• Demand for purchases that cannot be postponed in an emergency like plumbing services tends to be price inelastic
• Demand for products with several different uses like water tends to be price inelastic
• Proportion of income spent on a good

  The more of a consumer's income a good takes up, the more price elastic the demand
• Demand for products that need a large proportion of the consumer's income like a fridge is more price elastic than demand for products that only need a small proportion of income like toothpaste
• Consumers are more likely to shop around for the best price for an expensive good
• In the long run, demand becomes more price elastic as it becomes easier to change to alternatives because consumers have had the time to shop around. Also, in the long run, habits and loyalties can change
• Total Revenue


  Price per unit x Quantity sold
• Elasticity changes along a straight-line demand curve: PED changes from minus infinity at high price/zero demand, through an elasticity of minus one at the midpoint, to an elasticity of zero at zero price/high quantity demanded
• Total revenue is maximised when PED=-1, the nearer a firm sets a product's price to the midpoint of the demand curve, the higher its total revenue will be
• For a good with elastic demand (PED>1)

  A reduction in price will increase the firm's total revenue, an increase in price will reduce the firm's total revenue
• For a good with inelastic demand (PED<1)

  A reduction in price will reduce the firm's total revenue, an increase in price will increase the firm's total revenue
• Income Elasticity of Demand (YED)

  Measures how responsive the quantity demanded of a good is to a change in consumer income
• Normal Goods


  Goods with a positive YED - as income rises, demand rises
• Inferior Goods


  Goods with a negative YED - as income rises, demand falls
• Cross Elasticity of Demand (XED)


  Measures how responsive the quantity demanded of one good is to a change in the price of another good