How markets work Flashcards
Define
price mechanism
The market mechanism that guides decisions taken by different producers and consumers about how scarce resources should be allocated between competing uses.
Define
demand
The want or willingness of a consumer or group of consumers to buy a good or service.
For demand to be effective, this want must be backed by an ability to pay for it.
The quantity demanded of a product is the amount of a good or service consumers are willing and able to buy. Individual demand is the demand of just one consumer, while the market demand is the total demand from all consumers.
Define
supply
The willingness of a producer or group of producers to make a product available.
The quantity supplied of a product is the amount that producers are willing and able to make and sell to consumers, measured per period of time. The market supply is the total volume or value of a product supplied to a market by all its producers.
What is meant by a expansion or contraction in supply or demand?
Extension: demand/supply increases due to price changes, given that no other factor is affecting demand/supply
Contraction: demand/supply decreases due to price changes, given that no other factor is affecting demand/supply
This is called the ceteris paribus assumption, meaning ‘all other things remaining unchanged’.
Define
complements
(as in complementary goods and services)
A good or service that is in joint demand with another, for example, cars and petrol, or milk and coffee.
Define
substitutes
(as in substitute goods and services)
Products that compete to satisfy the same consumer demand, such as butter and margarine.
Define
- normal goods
- inferior goods
- Products for which demand rises as consumer incomes rise.
- Products for which demand tends to fall as consumers’ incomes rise.
What factors are likely to cause shifts in demand?
- Changes in consumers’ incomes
- Changes in taxes on incomes
- Prices and availability of complements and substitutes
- Changes in tastes, habits and fashion
- Population change
- Other factors, e.g. weather, season, interest rates and laws
What factors are likely to cause shifts in supply?
- Changes in the cost of factors of production
- Changes in the price and profitability of other goods and services
- Techonological advance
- Business optimism and expectations
- Global factors, e.g. climatic change, trade sanctions, wars, natural disasters and political factors
Define
market price
The equilibrium price for a product in a market, determined where market demand exactly matches market supply.
Define
market disequilibrium
A market outcome, in terms of price and total quantity traded, which is unstable and liable to change because market demand and market supply are not in balance, i.e. there is excess demand or excess supply.
Define
price elasticity of demand (PED)
and state its formula
The responsiveness of consumer demand for a product to a change in its price.
Consumer demand for a product is described as price elastic if a small change in its price causes a larger proportionate demand response, i.e. PED > 1.
Consumer demand for a product is described as price inelastic if a small change in its price causes a less than proportionate demand response, i.e. PED < 1.
PED = %change in quantity / %change in price
What is the link between PED and revenue?
If PED is elastic, an increase in price will cause a proportionately larger decrease in demand, so revenue increases. Therefore, it is advisable for the firm to lower prices.
If PED is inelastic, an increase in price will cause a proportionately smaller decrease in demand, so revenue increases. Therefore, it is advisable for the firm to increase prices.
What 3 factors affect the PED?
- The number of substitutes
- elastic if many substitutes, inelastic if not many
- The period of time
- demand is more price elastic in the long run as consumers have more time to search for substitutes
- The proportion of income spent on a commodity
- cheap products are price inelastic as they only take a bit out of a person’s income, expensive products are more price elastic
Define
price elasticity of supply (PES)
and state its formula
The responsiveness of producer supply of a product to a change in its price.
Producer supply of a product is described as price elastic if a small change in its price causes a larger proportionate supply response, i.e. PES > 1 .
Producer suppy of a product is described as price inelastic if a small change in its price causes a less than proportionate supply response, i.e. PES > 1 .
PES = %change in quantity / %change in price
What is the effect of an indirect tax on market price?
- market price increases, but not by the full amount of the indirect tax
- this is because demand contracts as price rises, so the producer has to pay some of the tax to the government
- the increase in market price depends on the PED
What is the effect of a subsidy on market price?
- market price decreases, but not by the full amount of the subsidy
- this is because demand extends as price falls, so the producer does not have to pass on the full amount of the subsidy
- the decrease in market price depends on the PED
