Price determination in a competitive market

Question 1

What is a market?

Answer 1

A market is created when there is a voluntary exchange of goods or services between buyers and sellers.

Question 2

What are the three characteristics of a competitive market?

Answer 2

-there is a large number of buyers and sellers
-all possess good market information
-can easily enter or leave the market

Question 3

How is the price of a good in a competitive market determined?

Answer 3

The price of a good in a competitive market is determined by the market forces of demand and supply and how they interact.

Question 4

What is the definition of demand?

Answer 4

Demand is the quantity of a good or service that consumers are willing and able to buy at a given price in a given time period.

Question 5

What is individual demand?

Answer 5

Individual demand is the quantity of a good or service that a particular individual is willing and able to pay.

Question 6

What is market demand?

Answer 6

Market demand is the quantity of a good or service that all consumers in a market are willing and able to buy.

Question 7

What is the law of demand and what can be said about it?

Answer 7

The law of demand is that as the price of a good or service increases, the quantity demanded decreases. The relationship between price and quantity is inverse.

Question 8

What causes a movement along the demand curve?

Answer 8

any change in price of a good or service

Question 9

What is a movement up/down the demand curve called?

Answer 9

extension/contraction

Question 10

What are the conditions of demand?

Answer 10

-price of substitute goods
-customer’s taste and preference
-customer’s future expectation
-income
-price of complementary goods

Question 11

What are the exceptions to the law of demand?

Answer 11

-veblen goods
-speculative demand
-goods for which price is an indicator of quality

Question 12

What does price elasticity of demand mean?

Answer 12

the responsiveness of quantity demanded to a change in price

Question 13

What is the equation for PED?

Answer 13

% change in quantity demanded
————————————————
% change in price

Question 14

What does it mean when a good or service has elastic demand?

Answer 14

A change in price causes a larger than proportional change in quantity demanded (PED = greater than 1)

Question 15

What does it mean when a good or service is price inelastic?

Answer 15

A change in price causes a smaller than proportional change in quantity demanded (PED = less than 1)

Question 16

What is the equation for revenue?

Answer 16

revenue = price x quantity sold

Question 17

What are the factors determining PED?

Answer 17

-availability of substitutes
-cost of switching
-breadth of definition
-degree of necessity
-time frame
-brand loyalty
-percentage of income
-habit-forming products

Question 18

What are the values for PED for different graphs?

Answer 18

-inelastic = less than 1
-elastic = more than 1
-perfectly elastic = infinity
-perfectly inelastic = 0
-unitary elastic = 1

Question 19

What is income elasticity of demand?

Answer 19

The responsiveness of quantity demanded to a change in income.

Question 20

What is the equation for YED?

Answer 20

% change in quantity demanded
————————————————
% change in income

Question 21

What is a normal and inferior good?

Answer 21

-An inferior good is a good for which demand decreases as income increases
-A normal good is a good for which demand rises as income rises

Question 22

What are the values for YED for normal goods, luxury goods and inferior goods?

Answer 22

-normal goods (necessity) = 0 < YED <1
-normal good (luxury) = YED > 1
-inferior good = YED < 0

Question 23

What is cross elasticity of demand?

Answer 23

the responsiveness of quantity demanded of one good (good A) to a change in the price of another good (good B)

Question 24

What is the equation for XED?

Answer 24

% change in quantity demanded of good A
———————————————————
% change in price of good B

Question 25

What does an XED value greater than 0 signify?

Answer 25

the two goods are substitutes and so an increase in the price of one good (good A) will lead to a rise in demand for a substitute good (good B)

Question 26

What does an XED value less than 0 signify?

Answer 26

the two goods are complements and so an increase in the price of one good (good A) will lead to a fall in demand for a complementary good (good B)

Question 27

What does an XED value of 0 signify?

Answer 27

that there is no apparent demand relationship and so an increase in the price of one good (good A) has no effect on the quantity demanded of another good (good B)

Question 28

What is the definition of supply?

Answer 28

Supply is the quantity of a good or service that producers are willing and able to produce at a given price in a given time period.

Question 29

What is the law of supply?

Answer 29

The law of supply states that as the price of a good or service increases, quantity supplied increases (a positive relationship)

Question 30

What are the conditions of supply?

Answer 30

-costs of production -state of technology -price of related goods -government policies -climate conditions

Question 31

What is the equation for PES?

Answer 31

% change in quantity supplied —————————————— % change in price

Question 32

What does it mean when a good or service has elastic supply?

Answer 32

A change in the price of a good causes a larger than proportional change in quantity supplied (PES = greater than 1)

Question 33

What does it mean when a good or service has inelastic supply?

Answer 33

A change in the price of a good causes a smaller than proportional change in quantity supplied (PES = less than 1)

Question 34

What are the factors determining PES?

Answer 34

-are resource inputs readily available? -are factors mobile (eg are workers prepared to move to where they are needed?) -can finished products be easily stored, and are there existing stocks? -is production running at full capacity? -how long and complex is the production cycle or production process?

Question 35

When will supply tend to be more price elastic?

Answer 35

-supplier has plenty of spare capacity to increase output -high stock levels are immediately available to meet rising demand -there is a short production time frame to get extra products to the market -ease of factor substitution is high i.e. resources can be reallocated easily

Question 36

What is market equilibrium?

Answer 36

Market equilibrium occurs where market supply equals market demand. At market demand, the market has cleared and there is no excess demand or excess supply.

Question 37

What is achieved at market equilibrium?

Answer 37

Allocative efficiency where supply meets demand, indicating that production is aligned with consumer preferences.

Question 38

When is a market in disequilibrium?

Answer 38

-when there is excess supply (firms wish to sell more than consumers wish to buy, with the price above the equilibrium price) -where there is excess demand (consumers wish to buy more than firms wish to sell, with the price below the equilibrium price)