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How prices are decided Cheat Sheet (DRAFT) by

Demand, supply, elasticity

This is a draft cheat sheet. It is a work in progress and is not finished yet.

Price mechanism

Price machanism
Higher prices indicate higher demand and vice versa
Rising prices indicate to producers to allocate their resources into that product


for consumers is the want or willin­gness of consumers to buy Gs or Ss
for demand to be effective consumers must have enough money to buy what they want and need
Effective demand
real intention of consumers to purchase and to pay with the means available
Quantity dimanded
the amount of a good or service consumers are willing and able to buy
Individual demand
D of just one consumer
Market demand
the total D for that product from all its consumers willing and able to buy it
Aggregate demand
the total demand for all Gs&Ss in the economy
Demand curve
displays the D of all the consumers of that commodity given a set of possible prices
following mostly applies: as price rises QD falls and vice versa, roughly downward sloping, P and QD move in opposite directions
market D curve shows the relati­onship between the total QD by consumers each period and the price of that product
Change in price
movement along the curve and extens­ion­/co­ntr­action of D
the satisf­action consumers have after buying and using Gs&Ss the wanted, they assume it is rational
Marginal utility
the extra unit gained from the consum­ption of one more product, usually goes down at some point
The law of dimini­shing returns
the more of a commodity consumers have, the less utility they get from consuming one more unit of it

Shifts in demand

Ceteris paribus
all other things remaining unchanged, so no other factor that affects consumer's D changes
Increa­se/rise in D
consumers D more of a product at every price than they did before
the DC moves outwards (to the right)
Fall in the D
consumers now demand less of a product at every price than they did before
the DC moves inwards (to the left)
Changes in D
other factors like changes in people's income (normal or inferial Gs, changes in income tax, changes in the popula­tion, changes in the prices of other Gs (compl­eme­ntary GS - comple­men­ts/­sub­sti­tutes), changes in tastes and fashion, advert­ising, etc.


the willin­gness of producers to make and sell Gs&Ss at different prices
Quantity supplied
the amount of Gs&Ss producers are willing and able to make and sell to consumers in a market
Market supply
the sum of all the individual supply curves of producers vompeting to supply that product
Supply curve
expresses the amount of a good or service firms or producers are willing to make and sell at a given price
opposit of DC
Change in price
movement along the curve
and extens­ion­/co­ntr­action of supply
Other factors
increa­se/fall in supply

Changes in supply

Changes in the cost of factors of production
fall in costs will increase profits and the SC will shift outwards and vice versa
Changes in the price and profit­ability of other Gs & SS
may cause different ammount of S of different products
Technical progress
new technology may be able to increase its production and vice versa
Business optimism and expect­ations
firms allocate resources based on what they think will be the most profitable
Other factors
natural disasters, sudden changes in weather, intern­ational trade sanctions, wars and political factors

Market price

Market price
QD and QS is the same
Equili­brium price
another name for market price
Excess supply
at higher prices firms supply more products above the D
Excess demand
at low prices low amount of products is supplied
D doesn't equal S

Changes in market prices

A shift in the market D
higher QD = higher P = higher S
A shift in the market S curve
higher S = lower P = higher D
Market price increases if
market D rises or market S falls

Price elasticity of demand

the respon­sivness of consumer D to changes in the price of a good or service
change in price affects the QD (more shallow)
PED > 1
change in price doesn't affet the QD, if so only in small amount (steeper)
PED < 1
How to calculate PED?
PED = % change in QD/% change in P
% change in QD = (change in Q/original Q) x 100
% change in P = (change in P/original P) x 100
Determ­inants of PED
factors that affect PED
if the product is a necessity - inelastic
the number of close substi­tutes a product has - more = elastic, less = inelastic
the amount of time consumers have to search for subsitutes - more time = inelastic, less time = elastic
the cost of switching to a different supplier - high = inelastic, low = elastic
the proportion of consumer's income spent on the product - higher = elastic, lower = inelastic
Why is knowleadge of PED useful?
e. g. while government is placing taxes (cigar­ettes, alcohol, etc.)

Special demand curves

Perfectly price inelastic E = 0
a straight vertical line, rise/fall in the P of commodity causes no change in S (insuline)
Infinitely price elastic E = ∞
a straight horizontal line, any change in D will cause S to fall to zero, unreal­istic
Unitary elasticity E = 1
a % change in P will cause an equal change in the QD (looks line a DC)

Other measures of elasticity of demand

Income elasticity of D
by how much a change in income causes the QD of G/S to change
IED = % change in QD/%i change n income
positive number - rise in income = rise in D, normal Gs
negative number - rise in income = fall in QD, inferior Gs
Cross elasticity of D
by how much QD will rise/fall given the change in the price of another product
CED = % change in Q of good X/% change in P of good Y
positive number - rise in P = rise in D, substi­tutes
negative number - rise in P = fall in D, comple­ments
Price elasticity of supply
respon­sivness of QS to a change in P
PES = % change in QS/% change in P
ES > 1 - price elastic - small increase in P = large extension in S
ES < 1 - price inelastic - rise in P = littel extention in S
change in P>c­hange in D = price inelastic
change in P<c­hange in D = price elastic
Determ­inants of PES
the avalia­bility of stock of finished Gs and components - higher availa­bility = elastic, low availa­bility = inelastic
degree of unused or spare production capacity - higher = elastic, lower = inelastic
availa­bbility of resources - higher availa­bility = elastic, lower availa­bility = inelastic
time - momentary run (all FoP fixed - inelas­tic), short run (1 FoP variable, other 2 fixed), long run (all FoP variable - elastic)

Special supply curves

Perfectly price inelastic PES = 0
straight horizontal line, the QS remains the same whatever the P is
Infinitely price elastic PES = ∞
straight horizontal line, producers are willing to S as much as they can at one particular price, theory
Unitary elasticity PES = 1
a % change in price will cause an equal % change in QS

Taxes and subsidies

imposed on Gs & Ss are known as indirect taxes (VAT, excise duties placed on cigarettes and alcohol, etc.)
indirect taxes have an effect of increasing the market price and reducing the Q traded in a market
payment made to producers to help to reduce their costs of production
producers tend to increase their S at every given P, higher S = fall in MP = benefit to the consumers