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# Economic Terms

### Price elasticity of supply

The proportionate change of the quantity supplied of a good in response to a proportionate change in price.

A good is classified as inelastic if it has a PES value that it less than 1.

A good is classified as elastic if it has a PES value that is greater than 1.

A good is classified as unit elastic if it has a PES value that is equal to 1.

The value of the PES for a good determines the type (slope and position) of supply curve in the market.

### Price inflation

When the prices of goods and services rise over a period of time. The rate of inflation is positive.

### Price level

The average price of goods and services in an economy. This is normally determined by measuring the price changes relating to a representative sample of goods and services

### Price Maker

A firm that has a very strong market position and is able to dictate the price that consumers pay for its goods and services. This is normally associated with a firm that possesses monopoly power.

Below is a diagram to show how monopolistic firms can restrict output and charge whatever price they wish to do so to maximise profits. This is not the case in perfectly competitive markets where all firms have to take the market price as given and are price takers as they are all competing over a homogeneous good.

### Price mechanism

How the interaction of demand and supply determine the price and quantities of the goods that get produced.

This price mechanism has three individual functions that it performs:

• The first is the rationing function which enables prices to change in order to curb or encourage demand in order to cope with limited or excess supply. This often happens for the demand for sporting event tickets.
• Then there is the signalling function which means that prices are there to inform economic agents about market fluctuations i.e. if the price of a good is high this signals to producers that this good is in high demand and therefore they should produce more.
• Finally, prices have an incentive function which provides agents with the incentives to change their behaviour i.e. firms are incentivised to produce more goods if the price is high due to higher margins and profit incentives.

Below is a brief summary of these functions of the price mechanism.

### Price Taker

When firms in a market do not have sufficient market power to be able to influence the market price and as a result charge the optimal price in order to maximise profits. All firms in a perfectly competitive market are classified as price takers due to size of the market and close substitutes available to each firm's product.

Below is a diagram to illustrate price takers in a perfectly competitive market. These firms have to accept the market price as given due to the fact that they are in a market with hundreds of firms all producing a homogeneous product and therefore no firm has sufficient market power or control to set their own prices.

### Price War

Occur where firms compete with each other to charge lower prices and thereby force the market price down. This has occured most recently in the UK Supermarket Industry with discount stores such as Aldi and Lidl relentlessly slashing prices of popular products below that of the Big 4 supermarkets.

Below is the logical chain of reasoning to emphasise the main features of a price war.

### Primary Products

Raw materials that are either extracted or farmed from land and the sea.

### Principal

The individual that authorises an agent to act on their behalf in personal and business transactions.

### Principal agent problem

Scenarios in which economic outcomes are distorted because economic agents (principal) rely on the services of and are influenced by an agent that may have different objectives/incentives.

The most common example of this is the differing objectives between shareholders and managers. Shareholders wish to maximise profits and managers have internal goals relating to self-interest, but due to asymmetrical information it is difficult for shareholders to detect this.

Below is a breakdown of this type of problem relating to shareholders and managers. In this case the manager has three main objectives to achieve alongside maximising return for shareholders. For instance it may be that managers try to help the firm acquire as much market share as possible in order to make the firm grow and expand to meet those customers. This is becaue firms that have exponentially grown are often the firms that are most impressive from a manager's performance persepctive and therefore it will put the manager's value higher from not just within the company but from external companies. Therefore they may decide to reinvest majority of the profits the company makes to help fuel expansion rather than paying higher dividends to shareholders.

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