2 The Price system & the Microeconomy Flashcards
(26 cards)
Effective demand
The total demand for goods/ services in an economy that is backed up by people’s ability & willingness to pay
Factors affecting demand
- Price
- Income
- Tastes & preferences
- Substitutes/ complements
- Future expectations
Individual demand
Quantity a single consumer is willing to buy at different price levels
Individual supply
Quantity a single producer is willing to offer at different price levels
Determinants of demand
- Price
- Elasticity of the good
- Income
- Taste & preferences
Supply
The total quantity of goods/ services that producers are willing & able to offer for sale at various prices
Determinants of supply
- Production cost
- Subsidies, taxes
- Technological advancements
- Expectations of producers
Movement in a curve
Due to price related factors
Shift in a curve
Due to non-price related factors
Price elasticity of demand + calculation
Measures the responsiveness of demand to changes in price
PED > 1 = Elastic
PED < 1 = Inelastic
PED = 0 = Unit elastic
% Change in Q.D/ % Change in price x 100
Income elasticity of demand + calculation
Measures the responsiveness of demand in relation to changes in income
Positive YED = Normal goods
Negative YED = Inferior goods
% Change in Q.D/ % Change in income x 100
Cross elasticity of demand + calculation
Measures the responsiveness of demand for one good in relation to a change in price of another good
Positive XED = Substitutes
Negative XED = Complements
% Change in Q.D of Good A/ % Change in price of Good B x 100
Substitutes
Goods that replace each other in consumption/ alternatives
(Coke & Pepsi, Butter & margarine)
Complements
Goods that are consumed together (E.g Car & petrol)
Price Elasticity of Supply (PES)
Measures the responsiveness of quantity supplied to price changes
Usefulness of PED in firms
- Pricing decisions for total revenue
- Price inelastic, increase price, increase TR
- Price elastic, decrease price, increase TR
- Helps forecast impact of price changes on sales & revenue
- Firms can try and make a good inelastic through advertisements, branding
Usefulness of YED in firms
- Pricing decisions
- Increase in income, increase demand
- Can increase price without loss of consumer
- Employment decisions
- High YED = increase employment in growth/ booms, decrease employment in recessions
- Inferior goods = decrease employment in booms/ increase employment in recessions
- Allows prevention of understaffing/ overstaffing, managing labour costs accordingly
- Stock management
- Firms can see the pattern of changes due to increase/ decrease of income
- Income increase, likely reduce demand for inferior good, so they can reduce stock
- Luxury good: higher stock during income increase/ economic growth (vice versa)
Usefulness of XED in firms
- To estimate the impact of a competitior’s price cut
- To estimate the impact of a price cut on a complement
- To estimate the impact of a change in price of a firm’s product on its other products
Drawbacks of using PED
- Can change over time as consumer behaviour changes
- PED is based on ceteris paribus. Assumes that price is the only changing variable. Not true, eg income can change and impact demand
Drawbacks of using YED
Doesn’t consider other factors such as consumer taste/ preferences, new competitors or product reputation
Producer surplus
The difference between what the producers receive compared to the minimum price they are willing to accept
Drawbacks of using XED
- XED values not constant, consumer preferences, technology, & income levels can shift the relationship between goods.
- A product that was once a close substitute may no longer be, making XED values unreliable for long-term decisions
- Can be hard to determine whether two goods are truly substitutes or complements, especially in complex markets.
- Some goods might be weak substitutes or have a mixed relationship, making XED less meaningful
- Assumes all other factors remain constant (e.g. income, preferences, trends).
- In the real world, multiple factors change at once, so isolating the effect of one good’s price is difficult
Consumer surplus
The difference between the price the consumer is willing to pay compared to what they actually pay
Economic transition
When a country changes its economy
Usually from planned to market
