1.2 How markets work

• What is utility?

  The level of satisfaction a consumer receives from the consumption of a product or service
• What is demand?

  The quantity of a good or service that a consumer is able and willing to buy
• What causes movement along the demand curve?

  Price changes
• What causes shifts in the demand curve?

  Real incomes, Size or age distribution of the population, Trends/fashion

  Prices of substitutes or complements, The amounts of advertisement or promotion, Interest rates
• What is total utility?

  The amount of satisfaction a person derives from the total amount of a product consumed
• What is marginal utility?

  The change in total utility from consuming a unit of a product
• What is diminishing marginal utility?

  A decline in the additional satisfaction a person derives from consuming an additional unit of that product
• What is price elasticity of demand?

  Measures the responsiveness of the quantity demanded of a product to a change in its own price
• What's the equation for the PED?

  Price elasticity of demand = % change in quantity demanded % change in price
• What factors determine the PED of a product?

  Number of close substitutes available for consumers, price of the product in relation to total income, cost of substituting between different products, brand loyalty and habitual consumption, degree of necessity/luxury
• What are characteristics of inelastic demand?

  PED <1, Demand responds more than proportionately to a change in price, Increasing the price only decreases the quantity of demand by a small amount increasing revenue
• What are the characteristics of elastic demand?

  PED >1, Change in demand is smaller than the percentage change in price, Increasing the price decreases the quantity of demand by a large amount decreasing revenue, Decreasing the price increases the quality of demand increasing revenue
• What are characteristics of perfectly inelastic demand?

  PED = 0, It implies that consumers are willing and able to pay any price for the product., If supply falls, equilibrium market price can rise without any contraction in quantity demanded
• What are characteristics of perfectly elastic demand?

  PED = infinity, A change in market supply will not lead to any change in the equilibrium price, This demand curve applies to highly competitive markets where no supplier has any "pricing power"
• What are characteristics of unitary demand:?

  PED = 1, A change in price is met with a proportionate change in demand, Total spending by consumers on the product will remain the same at each price level
• What is total revenue?

  The value of goods sold by a firm
• What is the equation for total revenue?

  Total revenue = Price X Quantity sold
• What is the relationship between inelastic demand and total revenue?

  Change in the same direction
• What is the relationship between elastic demand and total revenue?

  Change in the opposite direction
• What is the relationship between unitary demand and total revenue?

  Remain unchanged
• What is the relationship between perfectly inelastic demand and total revenue?

  Change in the same direction by the same proportion
• What is the relationship between perfectly elastic demand and total revenue?

  Fall to zero
• What is cross elastic demand?

  Measures how much demand for a product changes when there is a change in price of another product
• What is the equation for cross elasticity of demand?

  Cross elastic demand = % change in quantity of product Y % change in price of product X
• What is a substitute?

  A good that can be replaced with another good
• What is a close substitute?

  Where a small rise in the price of a product causes a large rise in demand for another
• What is a weak substitute?

  Where a large rise in the price will lead to a small increase in demand for another
• What are complements?

  A good that is demanded because it is used with another good
• What is a close complement?

  Where a small fall in price of a product causes a large rise in demand for another
• What is a weak complement?

  Where a large drop in price of a product causes only a small rise in demand for another
• What does the cross elasticity of demand explain?

  The relationship between products
• What does it mean if the XED is positive?

  The two goods are substitutes, A rise in price of product X will cause an increase in demand for product Y, If they are very close substitutes, the positive value will be higher
• What does it mean if the XED is negative?

  The two goods are complements, A rise in the price of product X will cause the demand of product Y to fall, If they are very close complements, they will have a lower negative value
• What does it mean if the XED is zero?

  The two products are unrelated
• What is income elasticity of demand?

  The responsiveness of demand for a product to change in real income
• What is the equation for income elasticity of demand?

  Income elasticity of demand = % change in quantity demanded % change in real income
• What is an inferior good:?

  Those which consumption declines as real incomes increase because consumers can now afford better higher-quality alternatives
• What does a positive YED mean?

  Indicates the product is a normal good
• What does a negative YED mean?

  Indicates the product is an inferior good
• What is supply?

  The quantity of a product that a producer is willing and able to supply onto the market at a given price in a given time