B: Price Determination In A Competitive Market

Question 1

There is an ___ relationship between price and demand.

Answer 1

There is an INVERSE relationship between price and demand

Question 2

Define Demand

Answer 2

Demand refers to the quantity of a good or service that consumers are willing and able to buy at given prices in a particular time period

Question 3

How is ‘ceteris Paribus’ relevant when we discuss the demand schedule?

Answer 3

CETERIS PARIBUS is the assumption we make when we consider the law of demand (involving price). Here we are assuming all other possible determinants of demand are held constant

Question 4

What is the econplusdal pneumonic for factors that shift demand?

Answer 4

PASIFIC

Question 5

What are the terms in the mnemonic for factors that shift demand?

Answer 5

Population, Advertising, Substitute’s price, Income, Fashion/tastes, Interest rates, Complement’s price

Question 6

What is a joint demand?

Answer 6

Complementary goods, demanded together

Question 7

What are goods in competitive demand?

Answer 7

This is where one good can be used as an alternative to the other

Question 8

What are goods in composite demand?

Answer 8

This is where goods are demanded for more than one distinct use so an increase in demand for one use means a decrease in supply for another use

Question 9

What does it mean for goods to be in derived demand?

Answer 9

When a good or factor of production is necessary for the provision of another good/service.

Question 10

What is the definition for price elasticity of supply?

Answer 10

Price elasticity of supply measures the responsiveness of the quantity supplied of a good or service to a change in price

Question 11

What is the equation for PES?

Answer 11

PES = %change in Quantity Supplied / %change in price

Question 12

What type of elasticity does barley have from this example:

A 20% increase in the price of barley leads to a 5% increase in quantity supplied.

Answer 12

PES = +5/+20 = +0.25
It has price INELASTIC supply because the change in price has led to a smaller percentage change in quantity supplied. The supply curve will be relatively steep (between 0 and 1)

Question 13

What type of price elasticity of supply do carpets have in this example?

A 5% fall in the price of carpets leads to a 10% fall in quantity supplied.

Answer 13

PES = -10/-5 = +2.0
The change in price has led to a greater percentage change in quantity supplied. The supply curve will be relatively shallow (greater than 1)

Question 14

What is unitary elastic supply?

Answer 14

When the PES is exactly one. A change in price leads to the exact same change in quantity supplied.

Question 15

What is the acronym for the determinants of price elasticity of supply (and what each word stands for)?

Answer 15

P- production lag
S- stocks
S- spare capacity
S- substitutability of factors of production
T- time

Question 16

How does Time affect the price elasticity of supply?

Answer 16

In the short run, supply is price inelastic whereas in the long run, supply is price elasticity. This is because in the Short run there is at least one fixed factor of production (land and capital) so it is difficult to expand supply. In the long run, all factors of production are variable so it easier to increase or decrease production.

Question 17

How do production lags (how long it takes to expand supply) affect price elasticity of supply?

Answer 17

If it is difficult or time consuming to increase production, e.g. building a new oil refinery, then supply will tend to be more price inelastic?

Question 18

How does the size of spare capacity determine the price elasticity of supply?

Answer 18

Firms with machinery, factory space or labour that is not fully utilised will be more able to expand production in the short run. Supply will therefore tend to be more price elastic.

Question 19

How does the substitutability of factors of production affect price elasticity of supply?

Answer 19

If firms can easily adjust the way they use their factors of production such as capital and labour to respond to changes in firms, then supply will tend to be relatively price elastic. However, if a firm has highly specialised equipment and employees, then supply will tend to be relatively price inelastic.

Question 20

How does the availability of stocks affect the price elasticity of supply of goods?

Answer 20

Firms with stocks of finished or partly finished goods will be able to respond relatively quickly to a price increase and so supply will tend to be more price elastic.

Question 21

Define price elasticity of demand

Answer 21

A measure of the responsiveness of quantity demanded of a good to a change in its price.

Question 22

What do we have to ignore in PED calculations and why?

Answer 22

The negative sign. Apart from a few cases, the value for PED is negative because of the inverse relationship between price and quantity demanded. In practice, we ignore the sign when presenting the results of calculations

Question 23

What type of PED is this?

A 50% increase in the price of petrol leads to a 10% fall in quantity demanded.

Answer 23

PED = -10/+50 = - 0.2
Price inelastic demand since a change in price has led to a smaller percentage change in the quantity demanded

Question 24

What type of PED is this?

10% reduction in price of cars leads to a 15% increase in quantity demanded

Answer 24

PED = -10/15 = -1.5
Price elastic demand because change in price has led to a larger percentage change in quantity demanded.

Question 25

What type of PED is this? An extremely small increase in the price of a product leads to the quantity demanded falling to zero

Answer 25

Perfectly elastic demand. The change in price has led to an infinitely large change in quantity demanded

Question 26

If demand is price elastic, a reduction in price leads to ______ in total revenue

Answer 26

AN INCREASE

Question 27

If demand is price inelastic, a price increase leads to _______ in total revenue

Answer 27

If demand is price inelastic, a price increase leads to AN INCREASE in total revenue

Question 28

What is the mnemonic (and what each letter stands for) for the determinants of price elasticity of demand?

Answer 28

S - substitutes (close) P - percentage of income L - luxury or necessity A - addiction (habit forming) T- time period

Question 29

How can percentage of income spent on the product be a determinant of PED?

Answer 29

If a product accounts for a relatively large percentage of a consumer’s income such as a new car, a change in price is most likely to have have a significant effect on disposable income. Opposite for less expensive products.

Question 30

Define income elasticity of demand

Answer 30

A measure of the responsiveness of quantity demanded to a change in income

Question 31

What type of goods have a negative income elasticity of demand and why?

Answer 31

Inferior goods. Because an increase in income has led to a fall in demand.

Question 32

What type of YED is this and what type of good is this: A 10% increase in real income leads to a 20% increase in demand for foreign holidays.

Answer 32

YED = 20/10= 2 Income elastic demand. The increase in real income has led to a greater percentage increase in demand. Income elastic products are often referred to as luxury goods.

Question 33

What type of goods have income inelastic demand

Answer 33

Basic goods or necessities

Question 34

Define Cross elasticity of demand

Answer 34

A measure of the responsiveness of demand for a product following a change in price of another product

Question 35

What is the equation for XED ?

Answer 35

XED = percentage change in quantity demanded of A / percentage change in price of B

Question 36

What do the signs mean for XED products?

Answer 36

If it is positive (S+) then they are substitutes If it negative then they are complements

Question 37

How do we know from the XED value whether we have strong complements or weak complements?

Answer 37

If they are complements, the value will be negative. If it is less than -1 (so bigger than one but with a negative in front of it), then they are strong complements

Question 38

Define supply

Answer 38

The quantity of a good or service that firms plan to sell at given prices in a particular time period

Question 39

What is the mnemonic for the things that shift a supply curve?

Answer 39

Population Indirect taxes No of firms Technology Subsidies Weather Costs of production