1.2 - How Markets Work Content Flashcards
(51 cards)
1.2 - How Markets Work
What are the Underlying Assumption of Rational Economic Decision Making
1.2.1 - Rational Decision Making
- Consumers Aim to Maximize Utility
- Firms Aim to Maximize Profits
- Consumer Decision-Making - Consumers make choices based on their preferences and budget constraints. Utility-maximizing consumers allocate their budgets to maximize satisfaction.
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Firm Decision-Making - Firms produce goods and services to meet consumer demand.
Profit-maximizing firms adjust production levels and pricing to achieve the highest profit
1.2 - How Markets Work
What are some critiques of the assumptions of Rational Economic decision making
1.2.1 - Rational Decision Making
Critics argue that in reality, consumers and firms may not always behave rationally due to bounded rationality, cognitive biases, and imperfect information
Importance of the Assumptions - Despite the critiques, the assumptions of utility maximization for consumers and profit maximization for firms serve as foundational concepts in economics.
They provide a framework for understanding and analyzing economic decision-making in various contexts
1.2 - How Markets Work
What is the different between a Movement and a Shift of the Demand Curve
1.2.2 - Demand
- Movements Along a Demand Curve - Movements along a demand curve occur when the quantity demanded changes due to a change in the price of the good or service, while other factors remain constant. The law of demand states that, all else being equal, as the price of a good or service decreases, the quantity demanded increases, and vice versa.
- Shifts of a Demand Curve - Shifts of a demand curve occur when factors other than price cause a change in the quantity demanded at every price level. A shift indicates a change in overall demand, not just a response to price changes.
1.2 - How Markets Work
Factors that may cause a shift in the demand curve
1.2.2 - Demand
- Population
- Advertising
- Confidence
- Income
- Fashion
- Income Tax
- Complement Prices
- Subsitute Prices
PACIFICS
1.2 - How Markets Work
How does Diminishing Marginal Utility Influence the Demand Curve
1.2.2 - Demand
The law of diminishing marginal utility contributes to the downward-sloping shape of the demand curve. As price decreases, consumers are willing to buy more because the marginal utility of each additional unit exceeds the price. Example: If a consumer enjoys ice cream, the first scoop provides high utility, but by the fifth scoop, the satisfaction gained from each additional scoop decreases.
1.2 - How Markets Work
What is PED
1.2.3 - Price, income and cross elasticities of demand
Price Elasticity of Demand
Measures the responiveness of the quantity demand to changes in the price of a good
Formula: PED = (% Change in Quantity Demanded) / (% Change in Price)
1.2 - How Markets Work
What is YED
1.2.3 - Price, income and cross elasticities of demand
Incomne Elasticity of Demand
YED measures the responsiveness of the quantity demanded to changes in consumer income
Formula: YED = (% Change in Quantity Demanded) / (% Change in Income)
1.2 - How Markets Work
What is XED
1.2.3 - Price, income and cross elasticities of demand
Cross Elasticity of Demand
XED measures the responsiveness of the quantity demanded of one good to changes in the price of another.
Formula: XED = (% Change in Quantity Demanded of Good A) / (% Change in Price of Good B)
1.2 - How Markets Work
Values for PED
1.2.3 - Price, income and cross elasticities of demand
Perfectly Elastic (PED = ∞): Quantity demanded is extremely responsive to price changes, demand is perfectly elastic.
Relatively Elastic (PED > 1): Demand is responsive to price changes.
Unitary Elastic (PED = 1): Percentage change in quantity demanded is exactly proportional to the percentage change in price.
Relatively Inelastic (0 < PED < 1): Demand is less responsive to price changes
Perfectly Inelastic (PED = 0): Quantity demanded does not respond to price changes, demand is perfectly inelastic.
1.2 - How Markets Work
Values for YED
1.2.3 - Price, income and cross elasticities of demand
Inferior Goods (YED < 0): Demand decreases as income increases (e.g., low-quality goods).
Normal Goods (0 < YED < 1): Demand increases with income but at a decreasing rate.
Luxury Goods (YED > 1): Demand increases significantly with income (e.g., luxury cars).
1.2 - How Markets Work
Values for XED
1.2.3 - Price, income and cross elasticities of demand
Substitutes (XED > 0): An increase in the price of one good leads to an increase in the quantity demanded of the other (e.g., Coke and Pepsi).
Complementary Goods (XED < 0): An increase in the price of one good leads to a decrease in the quantity demanded of the other (e.g., cars and gasoline).
Unrelated Goods (XED = 0): The price change of one good has no effect on the other.
1.2 - How Markets Work
Factors Influencing Elasticites of Demand
1.2.3 - Price, income and cross elasticities of demand
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- Degree of Necessity
- Addictiveness
- Availability of Substitutes
- Time - become more elastic over time
- Income (% of)
- Brand Loyalty
1.2 - How Markets Work
Why is Elasticities of Demand Important to Firms
1.2.3 - Price, income and cross elasticities of demand
- Firms use elasticities to set prices and predict revenue changes.
- Elastic demand means price increases reduce total revenue, while inelastic demand means price increases raise total revenue.
1.2 - How Markets Work
Why are Elasticities of Demand Important to the Government
1.2.3 - Price, income and cross elasticities of demand
- Government uses elasticities to make taxation and subsidy decisions.
- Inelastic goods can bear higher taxes, while elastic goods may see reduced consumption due to taxes.
- Subsidies can encourage the consumption of essential goods.
1.2 - How Markets Work
What is the difference between a movement along the supply curve and a shift of the supply curve
1.2.4 - Supply
- Movements Along a Supply Curve - Movements along a supply curve occur when the quantity supplied changes in response to a change in the price of the good or service, while other factors remain constant. The law of supply states that, all else being equal, as the price of a good or service increases, the quantity supplied also increases, and vice versa.
- Shifts of a Supply Curve - Shifts of a supply curve occur when factors other than price cause a change in the quantity supplied at every price level. A shift indicates a change in overall supply, not just a response to price changes.
1.2 - How Markets Work
Conditions of Supply
1.2.4 - Supply
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- Productivity
- Indirect taxes
- Number of firms
- Technology - level of technology or technological advancements
- Subsidies
- Weather
- Costs
- Government policies and regulation
1.2 - How Markets Work
What is PES
1.2.5 - Elasticity of Supply
Price Elasticity of Supply
Measures the responsiveness of the quantity supplied of a good to changes in its prices
Formula: PES = (% Change in Quantity Supplied) / (% Change in Price
1.2 - How Markets Work
Value for PES
1.2.5 - Elasticity of Supply
- Perfectly Inelastic (PES = 0) - Quantity supplied doesn’t respond to price changes. Price are unable or unwilling to change supply
- Relatively Inelastic (0 < PES < 1) - a percentage change in price results in a smaller percentage change in quantity supplied. Producers have limited flexibility to adjust supply quickl
- Relatively Elastic (PES > 1) - a percentage change in price results in a larger percentage change in quantity supplied. Producers can respond to price changes by adjusting production.
- Perfectly Elastic (PES = ∞) - even a slight price change results in an infinite change in quantity supplied. This is rare and usually occurs in markets where producers can instantly and costlessly adjust production.
1.2 - How Markets Work
Factors Influencing PES
1.2.5 - Elasticity of Supply
- Availability of substitutes
- Stocks - shelf life
- Production time
- Availability of factors of production
- Capacity
- Ease of entry into the market
ASPACE
1.2 - How Markets Work
What are the Functions of the Price Mechanism to Allocate Resources
1.2.7 - Price Mechanism
- Rationing Function - Prices allocate scarce resources among competing uses. When demand is higher than supply then price rises, so only people willing to pay get the goods
- Incentive Function - Provides incentive for producers to allocate resources. Higher prices motivate proders to produce more and vice versa
- Signaling Function - Convey information about market conditions allowing consumers and producers to make informed decisions
1.2 - How Markets Work
The Price Mechanism in Local Markets
1.2.7 - Price Mechanism
In local markets, prices are determined by supply and demand conditions within a specific geographic area. Local factors, such as weather or local preferences, can influence prices. Example: The price of fresh produce at a local farmers’ market may vary based on seasonal factors and local supply.
1.2 - How Markets Work
Price Mechanism in National Markets
1.2.7 - Price Mechanism
National markets cover an entire country and consider supply and demand at a broader scale. National policies and regulations, such as taxes and trade policies, can impact prices. Example: The national housing market may be influenced by government policies related to interest rates and mortgage regulations.
1.2 - How Markets Work
Price Mechanism in Global Markets
1.2.7 - Price Mechanism
Global markets involve international trade and can be influenced by factors like currency exchange rates, global supply chains, and geopolitical events. Prices in global markets are interconnected and can impact local and national markets. Example: The price of oil in global markets affects fuel prices around the world, impacting consumers and industries in various countries
1.2 - How Markets Work
What is Consumer Surplus
1.2.8 - Consumer and Producer Surplus
Consumer surplus is the additional benefit or utility that consumers receive when they are able to purchase a good or service at a price lower than what they are willing to pay. It represents the difference between what consumers are willing to pay (their maximum price) and what they actually pay in the market.
