Price Determination in a Competitive Market

Question 1

What is demand?

Answer 1

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

Question 2

How does demand vary with price?

Answer 2

Generally, the lower the price, the more affordable the good and consumer demand increases.

Question 3

What causes movements along the demand curve?

Answer 3

Only changes in price.

Question 4

What mnemonic is used to remember the factors that shift the demand curve and what does each letter stand for?

Answer 4

Population
Income
Related Goods
Advertisement
Tastes and Fashion
Expectations of future price
Seasons

Question 5

What are substitutes in the context of related goods?

Answer 5

Goods that can replace another good, such as two different brands of TV.

Question 6

What is the effect of a price decrease in a substitute good on demand?

Answer 6

The quantity demanded of the original good will fall.

Question 7

How do expectations of future price changes affect demand?

Answer 7

If speculators expect prices to increase, current demand is likely to increase.

Question 8

What does the law of diminishing marginal utility state?

Answer 8

As an extra unit of the good is consumed, the marginal utility falls.

Question 9

What does the downward sloping demand curve indicate?

Answer 9

The inverse relationship between price and quantity.

Question 10

Why are consumers willing to pay less for additional units of a good?

Answer 10

Because the marginal utility derived from consuming the good decreases.

Question 11

When does the utility derived from a good become zero?

Answer 11

Eventually, as more units are consumed.

Question 12

What is PED and the formula

Answer 12

Price Elasticity of Demand - the responiveness of a change in demand to a change in price
PED = %change QD/%change P

Question 13

what do each PED values show, + perfect values

Answer 13

PED=infinity = perfectly elastic
PED=0 = perfectly inelastic
PED=1 = unitary elastic
PED<1 = inelastic
PED>1 = elastic

Question 14

What is YED, + formula

Answer 14

YED = %change QD/ %change Y
Income elasticity of demand, the resposiveness of a change in demand to a change in income

Question 15

What does each YED value mean

Answer 15

YED<0 = inferior good
<0YED<1 = normal good
YED>1 = luxury good

Question 16

What is XED

Answer 16

Cross elasticity of demand is the responsiveness of a change in demand of one good

Question 17

What does each XED value mean

Answer 17

XED>0 = substitute good
XED<0 = compliment good

Question 19

What is supply?

Answer 19

Supply is the quantity of a good or service that a producer is able and willing to supply at a given price during a given period of time.

Question 20

Why are supply curves upward sloping?

Answer 20

Supply curves are upward sloping because:
* If price increases, it is more profitable for firms to supply the good, so supply increases.
* High prices encourage new firms to enter the market, because it seems profitable, so supply increases.
* With larger outputs, firm’s costs increase, so they need to charge a higher price to cover the costs.

Question 21

What is an expansion of supply?

Answer 21

If price increases from P2 to P1, QS increases from Q2 to Q1. This is an expansion of supply.

Question 22

What causes movements along the supply curve?

Answer 22

Only changes in price will cause movements along the supply curve.

Question 23

What drives firms according to the theory of the profit motive?

Answer 23

Firms are driven by the desire to make large profits.

Question 24

Do price changes shift the supply curve?

Answer 24

Price changes do not shift the supply curve.

Question 25

What mnemonic can be used to remember the factors that shift the supply curve and what does each letter stand for?

Answer 25

Productivity Indiirect taxes Number of firms Technology Subsidies Weather Costs of production

Question 26

How does depreciation in the exchange rate affect supply?

Answer 26

Depreciation in the exchange rate will increase the cost of imports, causing an inward shift in supply.

Question 27

What is the price elasticity of supply?

Answer 27

The responsiveness of a change in supply to a change in price.

Question 28

What is the formula for price elasticity of supply (PES)?

Answer 28

PES = % change in quantity supplied / % change in price.

Question 29

What does it mean if supply is elastic?

Answer 29

Firms can increase supply quickly at little cost. PES > 1.

Question 30

What does it mean if supply is inelastic?

Answer 30

An increase in supply will be expensive for firms and take a long time. PES < 1.

Question 31

What is the PES value for perfectly inelastic supply?

Answer 31

PES = 0.

Question 32

What is the PES value for perfectly elastic supply?

Answer 32

PES = infinity.

Question 33

What is the impact of time scale on PES?

Answer 33

In the short run, supply is more price inelastic; in the long run, it becomes more price elastic.

Question 34

How does spare capacity affect PES?

Answer 34

Full capacity means no increase in supply; spare resources allow for quick supply increase.

Question 35

How does the level of stocks influence PES?

Answer 35

Goods that can be stored (like CDs) allow for easy increase in supply; perishable goods (like apples) make supply more inelastic.

Question 36

What is the effect of substitutable factors on PES?

Answer 36

If labor and capital are mobile, supply is more price elastic.

Question 37

How do barriers to entry affect PES?

Answer 37

Higher barriers to entry mean supply is more price inelastic.

Question 38

What is the equilibrium price and quantity?

Answer 38

This is when supply meets demand, shown by P1 and Q1. ## Footnote At market equilibrium, price has no tendency to change, and it is known as the market clearing price.

Question 39

What occurs when there is excess demand?

Answer 39

At Q2, price is at P2, which is below market equilibrium. Demand is greater than supply. ## Footnote This results in a shortage in the market, pushing prices up and causing firms to supply more.

Question 40

What happens to prices when there is excess demand?

Answer 40

Prices will increase, leading to a contraction in demand. ## Footnote This continues until supply meets demand again at the market clearing price P1.

Question 41

What happens to prices when there is excess supply?

Answer 41

Price will fall back to P1 as firms lower their prices to sell their goods. ## Footnote The market will clear and return to equilibrium.

Question 42

What causes new market equilibriums to be established?

Answer 42

New market equilibriums are established when the demand or supply curves shift due to PIRATES or PINTSWC reasons. ## Footnote PIRATES refers to factors like population, income, related goods, advertising, tastes, expectations, and substitutes.

Question 43

What happens if there is an increase in the population regarding demand?

Answer 43

Demand shifts from D1 to D2, leading to an increase in price to P2 and a larger quantity supplied of Q2. ## Footnote This results in a new market equilibrium at P2 Q2.

Question 44

What is derived demand?

Answer 44

Derived demand is when the demand for one good is linked to the demand for a related good, such as the demand for bricks being linked to the demand for building houses, or the demand for labour being linked to the goods it produces.

Question 45

What is composite demand?

Answer 45

Composite demand occurs when a good has more than one use, so an increase in demand for one use (like cheese) reduces the supply available for another use (like butter).

Question 46

What is joint demand?

Answer 46

Joint demand is when goods are bought together, such as a digital camera and a memory card, so an increase in demand for one leads to an increase in demand for the other.

Question 47

How does demanding substitute goods affect supply and prices?

Answer 47

Demanding substitute goods, like Samsung TVs over Panasonic TVs, reduces the quantity supplied of the substitutes and can also lead to a decrease in their prices.

Question 48

What is joint supply?

Answer 48

Joint supply occurs when increasing the supply of one good causes an increase or decrease in the supply of another, such as producing more lamb increasing the supply of wool.