Price Determination in a competitive market

• Demand: quantity of a good/service consumers are willing and able to buy at a given price in a given period
• Law of Demand: inverse relationship between price and demand assuming ceteris paribus
• Demand had a downward slope due to:

  income effect- prices increase less able to buy as income not able to stretch as much, demand contracts

  substitution effect- prices increase other goods are cheaper, switching goods, demand contracts
• Factors Affecting Demand:

  Population

  Advertising

  Substitute prices

  Income

  Fashion trends

  Interest rates

  Conplement Prices
• Price Elasticity of Demand (PED):

  Measures responsiveness of quantity demanded given a price change.

  Always negative due to Law of Demand
• PED:

  >1: demand price elastic

  <1: demand price inelastic
• When is a good elastic / inelastic:

  Number of subs- more then it is price elastic

  % of income- greater % more price elastic

  Luxury/ Necessity- lux is elastic necessity is inelastic

  Time period- SR less subs so inelastic and LR more elastic
• Income Elasticity of Demand (YED):

  Measures responsiveness of quantity demanded given a change in income.
• YED + : normal good

  YED - : inferior good

  If YED is:

  >1: demand income elastic- normal luxury

  <1: demand income inelastic- normal necessity
• Cross elasticity of demand (XED):

  Measures responsiveness of quantity demanded given a change in price of an other good.
• XED - : complement good

  XED + : substitute good

  >1: demand between the prices of the goods- price elastic (strongly relate)

  <1: demand between the prices of the goods-price inelastic (weakly relate)
• Law of Supply:

  a direct link between price and quantity supplied due to firms profit motive.
• Factors affecting supply:

  Productivity

  Indirect Tax

  Number of firms

  Subsidy

  Weather

  Costs of Production
• Price elasticity of supply (PES):

  Measures responsiveness of quantity supplied given a change in price.
• PES always negative due to law of supply:

  >1: supply price elastic

  <1: supply price inelastic
• Factors affecting PES:

  Production Lags

  Stocks

  Spare capacity

  Subs for FOP

  Time
• Market Equilibrium


  Where demand and supply in a market are in balance
• Excess demand in a market

  Firms will see large queues, prices will rise (upward pressure)
• Excess supply in a market

  Prices will fall (downward pressure)
• How higher prices affect a market

  1. Signal there is excess demand and need for more resources

  2. Incentivise firms to increase output due to profit motive

  3. Ration scarce resources by discouraging consumption

  4. Create a new equilibrium that allocates resources efficiently
• How lower prices affect a market

  1. Signal there is excess supply and need for fewer resources

  2. Incentivise firms to decrease output

  3. Encourage more consumption

  4. Create a new equilibrium that allocates resources efficiently
• Equilibrium is where demand and supply in a market are in balance