Price determination in a competitive market

• Demand for a good or service is the quantity that purchasers are willing and able to buy at a given price
• effective demand is the demand that is actually purchased by consumers in a given period of time
• the basic law of demand is that demand varies inversely with price - lower prices make products more affordable
• effective demand is backed up with an ability to pay
• potential (latent) demand is not yet expressed in the market
• only changes in market price cause a movement along the demand curve
• a higher price leads to a contraction of quantity demanded
• a lower price leads to an expansion of quantity demanded
• income effect - a fall in price increases the real purchasing power of consumers
• the income effect allows people to buy more with a given budget
• substitution effect - a fall in the price of good X makes it relatively cheaper compared to substitutes
• the substitution effect means some consumers will switch to good X leading to a higher demand
• determinants of demand:

  • advertising
  • price of a good
  • expectations of future prices
  • legislation
  • real income
  • price of other goods
  • interest rates / credit conditions
  • population
  • tastes and preference
• utility is a measure of the satisfaction that we get from purchasing and consuming a good or service
• total utility is the total satisfaction from a given level of consumption
• marginal utility is the change in satisfaction from consuming an extra unit
• consumer surplus is the excess of what a consumer would have been prepared to pay compared to what they actually pay
• derived demand is the demand for a factor of production used to produce another good or service
• in factor markets, the demand for labour is derived
• social factors influencing demand:

  • social awareness
  • social norms
  • social pressures
• emotional factors influencing demand:

  • emotional arousal
  • binge drinking
  • demand for products
• the basic law of demand states that when the price goes up quantity demanded will decrease and when price goes down quantity demanded will increase
• PED measures the responsiveness of quantity demanded given a change in price
• PED = % change in quantity demanded / % change in price
• if PED is greater than 1 demand is price elastic
• PED is less than 1 demand is price inelastic
• if PED is 0 demand is perfectly price inelastic
• PED infinity means demand is perfectly price elastic
• if PED is 1 demand is unit price
• % change = difference / original X100
• if demand is price elastic you draw the demand curve shallow
• if demand is price inelastic the curve is steep
• the less substitutes the more price inelastic demand will be, the more substitutes the more price elastic demand will be
• demand is the quantity of a good or service consumers are willing and able to buy at a given price in a given time period
• the law of demand states there is an inverse relationship between price and quantity demanded
• PED for a normal good should be negative. This is because there is an inverse relationship between price and quantity demanded.
• A steep demand curve suggests that the good is inelastic - relatively unresponsive to change in price
• Shallow PED gradient for elastic
• For a good which is elastic in nature, the percentage change in quantity demanded is more than the percentage change in price