Price mechanism
Price machanism |
Higher prices indicate higher demand and vice versa |
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Rising prices indicate to producers to allocate their resources into that product |
Demand
Demand |
for consumers is the want or willingness of consumers to buy Gs or Ss |
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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 |
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following mostly applies: as price rises QD falls and vice versa, roughly downward sloping, P and QD move in opposite directions |
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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 |
Utility |
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 |
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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 |
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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. |
Supply
Supply |
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 |
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opposit of DC |
Change in price |
movement along the curve |
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and extension/contraction of supply |
Other factors |
increase/fall in supply |
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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 |
Disequilibrium |
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
PED |
the responsivness of consumer D to changes in the price of a good or service |
Elastic |
change in price affects the QD (more shallow) |
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PED > 1 |
Inelastic |
change in price doesn't affet the QD, if so only in small amount (steeper) |
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PED < 1 |
How to calculate PED? |
PED = % change in QD/% change in P |
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% change in QD = (change in Q/original Q) x 100 |
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% change in P = (change in P/original P) x 100 |
Determinants of PED |
factors that affect PED |
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if the product is a necessity - inelastic |
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the number of close substitutes a product has - more = elastic, less = inelastic |
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the amount of time consumers have to search for subsitutes - more time = inelastic, less time = elastic |
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the cost of switching to a different supplier - high = inelastic, low = elastic |
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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.) |
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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 |
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IED = % change in QD/%i change n income |
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positive number - rise in income = rise in D, normal Gs |
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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 |
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CED = % change in Q of good X/% change in P of good Y |
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positive number - rise in P = rise in D, substitutes |
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negative number - rise in P = fall in D, complements |
Price elasticity of supply |
responsivness of QS to a change in P |
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PES = % change in QS/% change in P |
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ES > 1 - price elastic - small increase in P = large extension in S |
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ES < 1 - price inelastic - rise in P = littel extention in S |
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change in P>change in D = price inelastic |
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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 |
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degree of unused or spare production capacity - higher = elastic, lower = inelastic |
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availabbility of resources - higher availability = elastic, lower availability = inelastic |
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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
Taxes |
imposed on Gs & Ss are known as indirect taxes (VAT, excise duties placed on cigarettes and alcohol, etc.) |
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indirect taxes have an effect of increasing the market price and reducing the Q traded in a market |
Subsidy |
payment made to producers to help to reduce their costs of production |
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producers tend to increase their S at every given P, higher S = fall in MP = benefit to the consumers |
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