Markets

• Price elasticity of demand (PED)


  The responsiveness of demand to a change in price
• Types of goods based on price elasticity

  • Luxury goods (PED > 1)
  • Normal goods (PED = 1)
  • Inferior goods (PED < 0)
• Luxury goods


  • Demand grows at a faster rate than the increase in real income
• Normal goods


  • As real incomes increase, demand also increases (positive income elasticity less than one)
• Inferior goods


  • Cheap substitutes of products people prefer to buy when their income is reduced (negative income elasticity)
• Examples of goods by income elasticity

  • Luxury: holidays abroad, health club membership, sports cars
  • Normal: matches, lemonade, newspapers
  • Inferior: value line baked beans
• Price elastic: a product where a proportionate increase or decrease in price leads to a proportionately greater increase or decrease in the quantity sold (elasticity > 1)
• Price inelastic: where a proportionate change in a product's price leads to a proportionately smaller change in the quantity sold (elasticity between 0 and 1)
• Examples of price elastic goods: Hovis bread, Heinz soup, Aero chocolate bar
• Examples of price inelastic goods: Petrol, salt, tap water, cigarettes
• Income elasticity of demand (YED)

  Measures how sensitive demand is to a change in income
• As income increases


  Demand for normal goods increases, demand for luxury goods increases more than proportionately, demand for inferior goods decreases
• As income decreases


  Consumers stay with normal goods, buy more luxury goods and less inferior goods
• The theory of income elasticity of demand may be useful to a manufacturer of digital television sets to predict future sales
• However, predictions based on past performance may be unreliable due to new technologies, changing economic circumstances, and loss of market share
• Demand


  The amount of a product that consumers are willing and able to purchase at any given price
• Supply


  The amount of a product that suppliers will offer to the market at a given price
• Factors that cause the demand curve to shift

  • Population
  • Income
  • Advertising
  • Substitutes
  • Complements
  • Fashion and Taste
  • Interest Rates
• Factors that cause the supply curve to shift

  • Productivity
  • Cost of Production
  • Number of Firms
  • Technology
  • Subsidies
  • Weather
  • Indirect Tax
• Earthquake destroys large percentage of Chilean wine


  Supply curve shifts to the left, leading to an increase in price
• Equilibrium price


  The price where quantity demanded is equal to quantity supplied in a free market