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1.2 - How markets work Flashcards

Introduction to Markets and Market Failure - Microeconomics (86 cards)

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1
Q

What is the assumption behind consumer behaviour in economics?

A

Consumers aim to maximise utility (satisfaction) from their choices

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2
Q

What is the assumption behind firm behaviour in economics?

A

Firms aim to maximise profits by increasing revenue and reducing costs.

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3
Q

What is the assumption behind government behaviour in economics?

A

Governments aim to maximise social welfare by making policies that promote economic efficiency and fairness.

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4
Q

Utility/Economic welfare

A

Total satisfaction received from consuming a good or service

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5
Q

Law of diminishing marginal utility

A

For each additional unit of a good that’s consumed, the marginal utility gained decreases.

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6
Q

Limitations of rational decision making?

A

Takes longer despite possibly being fairer.

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7
Q

What are the assumptions of the bounded rationality model?

A
  1. The first satisfactory alternative is selected.
  2. The decision-maker recognises they perceive the world as simple. 3. The decision maker recognises the need to be comfortable without considering every alternative.
  3. Decisions could be made by heuristics.
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8
Q

Demand

A

The quantity of a product consumers are willing and able to buy at different prices in a specified time period.

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9
Q

Derived demand

A

The demand for one good or service arises from the demand for another good or service.

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10
Q

Composite demand

A

When the good demanded has more than one use, so assuming supply stays the same, an increase in one good leads to a decrease in supply of another.

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11
Q

What causes a movement along the demand curve?

A

A change in the price of the good or service.

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12
Q

Expansion of demand

A

A rise in quantity demanded or downward movement along the curve

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13
Q

Contraction of demand

A

A fall in quantity demanded or upward movement along the curve

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14
Q

How does diminishing marginal utility shape the demand curve?

A

It leads to a downward-sloping demand curve, as consumers are willing to pay less for additional units.

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15
Q

What causes a shift of the demand curve?

A

Non-price determinants:
*Consumer preference
* Income
*Interest rates
*Events
*Weather
*Prices of other goods and services (Substitutes and Compliments)
*State of the economy
*Advertising and Marketing
*Population
*Expectations of future prices
*Government policy

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16
Q

Law of demand

A

There is an inverse relationship between the price of a good and the quantity demanded of it. This means if the price of a good increases/decreases, the quantity of that good decreases/increases.

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17
Q

Effective demand

A

When a consumer’s desire to buy a product is backed up by an ability to pay for it.
They must have sufficient real purchasing power.

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18
Q

Latent demand

A

This exists when there is a willingness to purchase a good, but where the consumer lacks the real purchasing power to be able to afford the product.
It is affected by persuasive advertising – where the producer is seeking to influence consumer tastes and preferences.

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19
Q

Price Elasticity of demand (PED)

A

Price elasticity of demand is the measure of the responsiveness of demand to a change in price.

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20
Q

equation for price elasticity of demand

A

% change in quantity demanded / % change in price

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21
Q

Total Revenue

A

Price x Quantity sold

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22
Q

Total Expenditure

A

Price x Quantity Purchased

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23
Q

Unitary Elasticity

A

PED = 1
* Percentage change in quantity demanded is equal to the percentage change in price.
*As price rises, changes in total expenditure/revenue remains constant.

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24
Q

Relatively elastic demand

A

PED > 1
* Demand is highly responsive to price changes.
*A 1% change in price will bring about a greater than 1% change in quantity demanded.
*As prices rise, changes in total expenditure/revenue decrease.

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25
Relatively inelastic demand
PED < 1 * Demand is not very responsive to price changes. * A 1% change in price will bring about a less than 1% change in quantity demanded. * As prices rise, changes in total expenditure/revenue increase.
26
Perfectly elastic demand
PED = ∞ * Demand is completely sensitive to price. * A tiny change in price causes an infinite change in quantity demanded. * As prices rise, changes in total expenditure/revenue decrease to zero.
27
Perfectly inelastic demand
PED = 0 * Quantity demanded does not change at all with price changes. * As prices rise, changes in total expenditure/revenue increase.
28
Factors effecting PED
* Availability of substitutes * Degree of necessity of consumption * Proportion of income * Time period * Addictiveness or habitual consumption * Peak or off-peak demand * The breadth of definition of a good or service
29
If a firm sells a good with an inelastic demand, they are likely to put most of the tax burden on ……………
consumer
30
If a firm sells a good with an elastic demand, they are likely to put most of the tax burden on ……………
themselves (the firm)
31
PED Unit
PED is usually negative because demand falls as price increases
32
Income Elasticity of demand (YED)
Measures how the quantity demanded of a good changes in response to a change in consumers' income.
33
Equation for income elasticity of demand
% change in quantity demanded / % change in income
34
Normal goods
* Normal goods have a positive (+) income elasticity of demand, so as consumers’ income rises, demand increases. * A positive relationship. * A normal good has an upward-sloping curve. There are two types: necessities and luxuries.
35
Luxuries/income elastic
YED > 1 * Luxuries are non-essential goods for which demand increases more than proportionally as income rises. * They have a high positive income elasticity of demand
36
Necessity/income inelastic
YED < 1 * Necessities are essential goods that people continue to buy, but the increase in demand is less than proportional to the increase in income. * They have a low positive income elasticity
37
Inferior goods
YED < 0 * Inferior goods have a negative (-) income elasticity of demand, so as consumers’ income rises, demand falls. * An inverse/negative relationship. * An inferior good has a downward-sloping curve.
38
What does D3 show
D3 shows a good which is normal at low levels of income but is inferior at high levels of income.
39
Cross elasticity of demand (XED)
Measures the proportionate response of the quantity demanded of one good (good X) to the proportionate change in the price of another (good Y).
40
Equation for cross elasticity of demand
% change in quantity demanded of good X / % change in price of good Y
41
Substitute goods
XED > 0 * A good which can be replaced by another good. * If the price of one good rises, consumers are likely to switch to the other good, increasing its demand, so there is a positive relationship between goods.
42
Complement goods
XED < 0 * A good which is demanded because it is used with another good. * If the price of one good increases, the demand for both goods usually decreases, so there is an inverse relationship between goods.
43
Unrelated goods
XED = 0 * These are goods that have no relationship with each other. * A change in the price of one good does not affect the demand for the other.
44
Why is elasticity important for firms and governments?
Firms: To predict how price changes affect revenue Government: To assess effects of taxes/subsidies, income changes, and price changes on demand
45
Supply
Supply is the quantity of a good or service that a producer is willing and able to supply onto the market at a given price in a given time period.
46
Law of supply
As the market price of a product or service rises, the quantity supplied also rises and vice versa. There is a positive relationship between the two.
47
What does a supply curve show?
The relationship between price and qauntity supplied
48
What causes a movement along the supply curve?
A change in the price of the good or service.
49
What causes a shift of the supply curve?
Non price determinants: * Technology * Weather * Subsidies * Productivity * Number of firms * Exchange rates * Indirect taxes * Production costs * Government intervention and international trade * Natural resource availability * Government policies and regulations
50
Price Elasticity of Supply (PES)?
Measures how much the quantity supplied responds to a change in price.
51
Equation for price elasticity of supply
% change in quantity supplied / % change in price
52
Unitary Supply
PES = 1 * A percentage change in price results in an equal percentage change in supply.
53
Relatively elastic supply
PES > 1 * A percentage change in price will result in a greater percentage change in quantity supplied. * Producers are unable or unwilling to adjust supply in response to fluctuations.
54
Relatively inelastic Supply
PES < 1 * A percentage change in price will result in a smaller percentage change in quantity supplied. * Producers have limited flexibility to adjust supply quickly.
55
Perfectly elastic supply
PES = ∞ * A percentage change in prices will result in an infinite change in quantity supplied. * This is rare and usually occurs in markets where producers can instantly and costlessly adjust production.
56
Perfectly inelastic supply
PES = 0 * A percentage change in prices has no effect on the quantity supplied to the market. * Producers are unable or unwilling to adjust supply in response to price fluctuations.
57
Factors effecting PES
* Production time * Availability of spare capacity * Stock levels * Factor substitution possibilities * Time period * Artificial limits on supply, e.g., government regulations, rare products, etc.
58
What’s the difference between the short run and long run in terms of PES?
In the short run, supply is more inelastic due to fixed factors of production. In the long run, supply becomes more elastic as firms can expand capacity.
59
What is an equilibrium price?
The price at which quantity demanded equals quantity supplied.
60
What is excess demand?
When quantity demanded exceeds quantity supplied, it leads to upward pressure on price.
61
What is excess supply?
When quantity supplied exceeds quantity demanded, it leads to downward pressure on price.
62
How do market forces eliminate excess demand/supply?
Prices adjust: rising in response to excess demand, falling in response to excess supply.
63
What happens when demand or supply shifts?
The equilibrium price and quantity change — shown through shifts in the demand/supply curve. Without a shift in demand and/or supply, there will be no change in market price.
64
What is the price mechanism?
The process by which prices adjust to balance supply and demand.
65
What are the three functions of the price mechanism?
*Rationing *Incentive *Signalling: Communicates information about market conditions
66
In what markets does the price mechanism operate?
It works in local, national, and global markets.
67
Consumer surplus
The difference between what a firm is willing to pay and the price they actually pay.
68
Producer surplus
The difference between the price the producer is willing to charge and the price they actually charge.
69
How do changes in demand/supply affect surplus?
An increase in demand or supply typically increases both consumer and producer surplus.
70
Economic welfare
The total benefit society receives from an economic transaction.
71
How is economic welfare calculated?
The area of producer surplus and consumer surplus added together.
72
What is an indirect tax?
A: A tax placed on the sale of goods and services, paid by producers to the government, but often passed on to consumers through higher prices.
73
What are the two types of indirect taxes?
* Specific (unit) tax – a fixed amount per unit (e.g., £0.20 per litre of fuel) * Ad valorem tax – a percentage of the price (e.g., 20% VAT)
74
How does a specific tax affect the supply curve?
It causes a parallel shift to the left (vertical shift upward)
75
How does an ad valorem tax affect the supply curve?
It causes a pivotal shift — the higher the price, the larger the tax amount
76
Who pays more of the tax — the consumer or the producer?
It depends on the price elasticity of demand and supply: * Inelastic demand - consumers bear more of the tax * Elastic demand - producers bear more of the tax
77
What is tax incidence?
The division of the tax burden between consumers and producers.
78
How does an indirect tax affect market outcomes?
* Increases prices for consumers * Reduces quantity traded * Causes deadweight welfare loss * Raises government revenue
79
What are the goals of indirect taxes?
* To raise revenue * To internalise externalities (e.g., reduce pollution or smoking)
80
What is a subsidy?
A payment from the government to firms to lower production costs and encourage supply.
81
How does a subsidy affect the supply curve?
It shifts the supply curve rightward, reducing market prices and increasing quantity.
82
What are the economic effects of a subsidy?
* Reduces prices for consumers * Increases output * Increases producer revenue * May lead to overproduction if misused
83
What are the two components of a subsidy shown on a diagram?
* Consumer subsidy – the price benefit consumers receive * Producer subsidy – the additional revenue received by producers above the new price
84
Who benefits more from a subsidy?
Depends on elasticity: * Inelastic demand - consumers benefit more * Elastic demand - producers benefit more
85
Why do governments give subsidies?
* Encourage positive externalities * Support essential industries (e.g., farming, green energy) * Make goods more affordable
86
What are the 3 reasons why a consumer might not act rationally?
* The influence of other people's behaviour. * The importance of habitual behaviour. * Consumer weakness at computation.

Economics (10 decks)

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