ExpertExternal Influences – Micro-economic Factors
Learning outcomes
- Understand the laws of supply and demand.
- Apply price elasticity of demand to business pricing strategies.
Supply and Demand
Micro-economics looks at individual markets.
- Demand: As price falls, consumers demand more.
- Supply: As price rises, producers want to supply more.
- Equilibrium: The price where quantity demanded equals quantity supplied.
Price Elasticity of Demand (PED)
PED measures how sensitive demand is to a change in price.
PED = % change in quantity demanded / % change in price
- Elastic (>1): Demand is highly sensitive. (e.g., luxury holidays). A small price increase leads to a massive drop in sales.
- Inelastic (<1): Demand is insensitive. (e.g., life-saving biotech drugs). A price increase barely affects sales because people need it.
If a 10% increase in the price of a product leads to a 2% drop in quantity demanded, the demand is:
Revenue and Elasticity
If demand is inelastic, raising prices will increase total revenue (you lose a few customers, but make much more per unit). If demand is elastic, raising prices will decrease total revenue.
Market Structures
- Perfect Competition: Many small firms, identical products, price takers.
- Monopoly: One dominant firm, price maker.
- Oligopoly: A few large firms dominating the market (e.g., supermarkets).
Which market structure is characterized by a few large firms whose decisions are highly interdependent?
Exam Focus
Expect questions asking what a firm should do with its pricing based on its PED. Remember the rule: Inelastic = raise price to boost revenue. Elastic = lower price to boost revenue.
A product has many close substitutes available. Its price elasticity of demand is likely to be:
What happens to the equilibrium price if supply decreases while demand remains constant?
A firm operates in a perfectly competitive market. Which of the following is true?
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