Price Determination in a Competitive Market
3.1 The Determinants of the demand for goods and services
● Demand is the quantity of good or service that consumers are able and willing to buy
at a given price during a given period of time
● Demand varies with price. Generally the lower the price, the more affordable the
good and so consumer demand increases. This can be illustrated with the demand
curve.
Movements along the Demand Curve:
Diagram
● At price P1 a quantity of Q1 is demanded. At the lower price of P2, a larger quantity
of Q2 is demanded. This is an expansion of demand. At the higher price of P3, a
lower quantity of Q3 is demanded. This is a contraction of demand. Only changes in
price will cause these movements along the demand curve.
Shifting the Demand Curve:
Diagram
● Price changes do not shift the demand curve. A shift from D1 to D2 is an inward shift
in demand, so a lower quantity of goods is demanded at the market price at P1. A
shift from D1 to D3 is an outward shift in demand. More goods are demanded at the
market price at P1.
● The factors that shift the demand curve can be remembered using the mnemonic
PIRATES:
- P- Population. The larger the population the higher the demand. CHanging
the structure of the population also affects demand, such as the distribution of
different age groups.
- I- income. If consumers have more disposable income, they are able to afford
more goods, so demand increases. Also, a consumer's wealth affects their
demand. Consumers generally spend more as they perceive their wealth to
increase. Likewise, consumers speed less when they believe their wealth will
decrease.
- R-Related goods. Related goods are substitutes or complements. A substitute
can replace another good, such as two different brands of TV. If the price of
the substitute falls, the quantity demanded of the original good will fall
because consumers will switch to the cheaper option. A complement goes
with another good, such as strawberries and cream. If the price of
strawberries increase, the demand for cream will fall because fewer people
will be buying strawberries and hence fewer people will be buying cream.
- A-advertising. This will increase consumer loyalty to the good and increase
demand.
- T- Tastes and fashions. The demand curve will also shift if consumers' tastes
change. For example, the demand for physical books might fall, if consumers
start preferring to read e-books.
, - E-expectations. This is of future price changes. If speculators expect the price
shares in a company to increase in the future, demand is likely to increase in
the present.
- S-Seasons. Demand changes according to the season. For example, in the
summer. The demand for ice cream and sun lotions increases.
Diminishing Marginal Utility:
● The demand curve is downward sloping showing the inverse relationship between
price and quantity.
● The law of diminishing marginal utility states that as an extra unit of the good is
consumers, the marginal utility is the benefit derived from consuming the good, falls.
Therefore, consumers are willing to pay less for the good.
● This can be explained using the example of chocolates. The first chocolate bar will
benefit the consumer more because it satisfies more of their needs, and so the
consumer is willing to pay more for it. The second bar will satisfy the consumer less
because they have less need for it and the consumer will be willing to pay less for it.
Eventually the utility derived will become zero.
3.2 Price, Income and Cross Elasticities of Demand
Price Elasticity of Demand:
● The price elasticity of demand is the responsiveness of a change in the demand to a
change in the price. The formula for this is
Formula insert
● A Price elastic good is very responsive to change in price. In other words the change
in price leads to an even bigger change in demand. The numerical value for PED is
>1.
Diagram
● A price inelastic good has a demand that is relatively unresponsive to a change in
price. PED is <1
Diagram
● A unitary elastic good has a change in demand which is equal to the change in price
PED =1
Diagram
● A perfectly elastic good has a demand which does not change when price changes
so PED = 0
Digram
● A perfectly elastic good has a demand which falls to zero when price changes. PED
= infinity
3.1 The Determinants of the demand for goods and services
● Demand is the quantity of good or service that consumers are able and willing to buy
at a given price during a given period of time
● Demand varies with price. Generally the lower the price, the more affordable the
good and so consumer demand increases. This can be illustrated with the demand
curve.
Movements along the Demand Curve:
Diagram
● At price P1 a quantity of Q1 is demanded. At the lower price of P2, a larger quantity
of Q2 is demanded. This is an expansion of demand. At the higher price of P3, a
lower quantity of Q3 is demanded. This is a contraction of demand. Only changes in
price will cause these movements along the demand curve.
Shifting the Demand Curve:
Diagram
● Price changes do not shift the demand curve. A shift from D1 to D2 is an inward shift
in demand, so a lower quantity of goods is demanded at the market price at P1. A
shift from D1 to D3 is an outward shift in demand. More goods are demanded at the
market price at P1.
● The factors that shift the demand curve can be remembered using the mnemonic
PIRATES:
- P- Population. The larger the population the higher the demand. CHanging
the structure of the population also affects demand, such as the distribution of
different age groups.
- I- income. If consumers have more disposable income, they are able to afford
more goods, so demand increases. Also, a consumer's wealth affects their
demand. Consumers generally spend more as they perceive their wealth to
increase. Likewise, consumers speed less when they believe their wealth will
decrease.
- R-Related goods. Related goods are substitutes or complements. A substitute
can replace another good, such as two different brands of TV. If the price of
the substitute falls, the quantity demanded of the original good will fall
because consumers will switch to the cheaper option. A complement goes
with another good, such as strawberries and cream. If the price of
strawberries increase, the demand for cream will fall because fewer people
will be buying strawberries and hence fewer people will be buying cream.
- A-advertising. This will increase consumer loyalty to the good and increase
demand.
- T- Tastes and fashions. The demand curve will also shift if consumers' tastes
change. For example, the demand for physical books might fall, if consumers
start preferring to read e-books.
, - E-expectations. This is of future price changes. If speculators expect the price
shares in a company to increase in the future, demand is likely to increase in
the present.
- S-Seasons. Demand changes according to the season. For example, in the
summer. The demand for ice cream and sun lotions increases.
Diminishing Marginal Utility:
● The demand curve is downward sloping showing the inverse relationship between
price and quantity.
● The law of diminishing marginal utility states that as an extra unit of the good is
consumers, the marginal utility is the benefit derived from consuming the good, falls.
Therefore, consumers are willing to pay less for the good.
● This can be explained using the example of chocolates. The first chocolate bar will
benefit the consumer more because it satisfies more of their needs, and so the
consumer is willing to pay more for it. The second bar will satisfy the consumer less
because they have less need for it and the consumer will be willing to pay less for it.
Eventually the utility derived will become zero.
3.2 Price, Income and Cross Elasticities of Demand
Price Elasticity of Demand:
● The price elasticity of demand is the responsiveness of a change in the demand to a
change in the price. The formula for this is
Formula insert
● A Price elastic good is very responsive to change in price. In other words the change
in price leads to an even bigger change in demand. The numerical value for PED is
>1.
Diagram
● A price inelastic good has a demand that is relatively unresponsive to a change in
price. PED is <1
Diagram
● A unitary elastic good has a change in demand which is equal to the change in price
PED =1
Diagram
● A perfectly elastic good has a demand which does not change when price changes
so PED = 0
Digram
● A perfectly elastic good has a demand which falls to zero when price changes. PED
= infinity
