Price determination in a competitive market

• demand 


  quantity of a good or service that consumers are able and willing to buy at a given price during a given time period
• factors affecting demand (PIRATES)


  • population
  • income
  • related goods ( substitutes and compliments)
  • advertising
  • tastes and fashion
  • expectations
  • seasons
• The law of diminishing marginal utility


  as an extra unit of the good is consumed, the marginal utility (the benefit derived from consuming the good) falls

  consumers are willing to pay less for the good
• price elasticity of demand

  responsiveness of a change in demand to a change in price
• PED formula


  %△QD/ %△P
• price elastic good 


  very responsive to a change in price
• price inelastic good 


  demand is relatively unresponsive to a change in price
• PED value of >1

  elastic
• PED value of <1

  inelastic
• unitary elastic good 


  change in demand is equal to the change in price

  • PED= 1
• perfectly inelastic good


  demand does not change when price changes

  PED = 0
• perfectly elastic good 


  demand falls to zero when price changes

  • PED = ∞
• factors affecting PED


  necessity

  • necessity
  • substitutes
  • addictiveness
  • proportion on income (spent on good)
  • durability of the good
  • peak and off-peak demand
  • elasticity of demand and tax revenue
• total revenue 


  TR = P x Q
• income elasticity

  YED = %△QD/ %△Y

  (Y = income)
• income elasticity of demand

  the responsiveness of a change in demand to a change in income
• inferior goods 


  fall in demand as income increases

  • eg: un-branded goods
• normal goods 


  demand increases as income increases
• luxury goods


  increase in income causes a greater increase in demand
• cross elasticity of demand 


  responsiveness of a change in demand of one good, X, to a change in price of another good, Y
• cross elasticity formula 


  XED = %△QD of X/ %△P of Y
• complementary goods


  
  

  • negative XED