economics theme 1.2 Flashcards
(147 cards)
1
Q
What is the definition of demand?
A
Demand for a good refers to the quantities of a good a buyer is willing and able to buy at different prices over a period of time, other factors being constant.
2
Q
When does demand become effective?
A
Only if it’s backed up by a willingness and ability to pay the market price.
3
Q
What causes an extension of demand?
A
A fall in market price.
4
Q
What causes a contraction in demand?
A
A rise in market price.
5
Q
What is effective demand?
A
Effective demand is demand for a good or service from consumers that is backed up with an ability to pay.
6
Q
What is potential (latent) demand?
A
Potential (latent) demand is not yet expressed in the marketplace because consumers do not have the ability to pay.
7
Q
Demand definition
A
Demand is wants supported by purchasing power.
8
Q
What are the features of demand?
A
Demand is wants supported by purchasing power: Wants concern only willingness to pay while demand concerns both willingness and ability to pay. Quantity demanded is a planned quantity: The quantity demanded shows the quantity a buyer plans to buy at a particular price, which may not be what he actually buys. Period of time: When talking about a person’s demand for a good, we need to specify the time period.
9
Q
What is the law of demand?
A
The law of demand states that the lower (higher) the price of a good, the greater (smaller) its quantity demanded, other factors being constant.
10
Q
What are the explanations that justify why the demand curve slopes downward?
A
• Substitution Effect: As the price of a product decreases, it becomes more attractive compared to other similar products. Consumers are more likely to switch to the cheaper option, leading to an increase in the quantity demanded.
• Income Effect: When the price of a product falls, consumers effectively have more real purchasing power. This allows them to buy more of the product, which leads to an increase in the quantity demanded. (doesn’t happen for inferior goods)
• Diminishing Marginal Utility: As people consume more of a particular product, the additional satisfaction or utility they derive from each additional unit starts to diminish. This means they are willing to pay less for each successive unit, which contributes to the downward-sloping demand curve.
11
Q
What is the difference between shifts of and movements along the demand curve?
A
Price causes a movement along the demand curve and any other factor causes a shift.
12
Q
What are substitutes?
A
They are goods that can replace each other as they can satisfy the similar want of a consumer.
13
Q
How do the prices of substitutes affect each other?
A
If the price of Good A rises, the demand for Good B rises as well. If the price of Good A decreases, the demand for Good B decreases as well.
14
Q
What are complements?
A
Two goods are complements for each other if they are used together to satisfy a particular want. And these goods are in complementary/joint demand.
15
Q
How do the prices of complements affect each other?
A
If the price of Good A rises, the demand for Good B decreases. If the price of Good A decreases, the demand for Good B rises.
16
Q
What are examples of goods that are in joint demand/complements?
A
Fish and chips, smartphones and apps, pasta and pasta sauces.
17
Q
What is derived demand?
A
Derived demand is the demand for a factor of production that is used to produce another good or service.
18
Q
How does the demand for certain goods affect its factors of production?
A
If the demand for a good rises, so does the demand for its factors of production. If the demand for a good decreases, so does the demand for its factors of production.
19
Q
What are examples of goods in derived demand?
A
Home and steel/wood/construction workers.
20
Q
What does composite demand mean?
A
Composite demand is where goods have more than one use e.g milk.
21
Q
What is an example of a good that has composite demand?
A
An example is milk which can be used for cheese, yoghurts, cream, butter and other products including fertilizer.
22
Q
What’s the relationship between real income and demand?
A
Normally, a rise in consumers’ real income will give them more purchasing power to buy goods and services. For normal goods, increased real income will lead to an outward shift of demand. However, for inferior goods, a rise in real income causes a fall in demand.
23
Q
How does an expected increase of the future price affect the current demand?
A
When people expect the price of a good to increase, they avoid buying it later at a higher price and buy more of it now, so current demand will increase.
24
Q
What happens to current demand when people expect the future price to decrease?
A
When people expect the price of a good to decrease, they know they can buy it later at a lower price and so will avoid buying it now, so current demand will decrease.
25
Explain the other factors that can affect demand.
Number of buyers: example - if the population is mostly made of aged people, then there will be an increased demand for healthcare services.
Interest rates: A rise in interest rate will increase the cost of borrowing and a decrease in demand for car/ property.
Seasonal factors: Some goods only have high demand during certain seasons e.g. Christmas.
26
What's the definition of supply?
Supply for a good refers to the quantities of a good a seller is willing and able to sell at different prices over a period of time, other factors being constant.
27
What's the law of supply?
The law of supply is that as the price of a product rises, so businesses expand supply. Higher prices provide a profit incentive for firms to expand production.
28
What are the features of supply?
Supply is the willingness to sell supported by the ability to sell. Quantity supplied is a planned quantity - The quantity supplied shows the quantity a seller plans to sell at a particular price, which may not be what he actually sells. Period of time: When talking about a person's supply of a good, we need to specify the time period.
29
Why is the supply curve upward sloping?
The law of supply states that the higher price of a good, the greater its quantity supplied, other factors being constant. This makes it upward sloping so as the price increases so does the profit motive. This makes there to be even new entrants coming into the market.
30
What is the profit motive?
The profit motive describes the driving force behind most private-sector businesses engaging different markets and industries. The pursuit of profit serves an incentive for businesses to innovate.
31
Why are there new entrants into the market?
Higher prices create an incentive for other businesses to enter a market leading to an increase in total supply. Also, as prices fall, some firms might leave the market.
32
What's the difference between a shift of and movement along the supply curve?
A change in price is always shown by a movement along the supply curve and a shift is caused by other factors.
33
What is joint supply?
Joint supply is where an increase or decrease in the supply of one good leads to an increase or decrease in supply of a by-product. It occurs when a production process yields 2 or more outputs.
34
Give an example of goods that are in joint supply.
An example is beef and leather. Roast goose and goose down. An expansion/contraction in supply will lead to the same effect for the by-products.
35
How do the prices of goods in joint supply affect each other?
If the price of Good A (lamb) increases, then the supply of Good B (wool) will increase. (and vice versa)
36
What's the definition of competitive supply?
Two goods are in competitive supply if they require similar factors of production - CELL.
37
How do the prices of goods in competitive supply affect each other?
Price of Good A increases, then the supply of Good B will decrease as producers have more profit incentive to supply Good A. Price of Good A decreases, then the supply of Good B will increase as producers have less profit incentive to supply Good A.
38
Give examples of goods in competitive supply.
Bread and Cake (both use flour). French fries and jacket potatoes (both use potatoes).
39
How can a change in the cost of production affect supply?
• Lower unit costs mean a business can supply more at each price.
• Higher unit costs cause an inward shift of supply perhaps due to a rise in wage rates or an increase in prices of raw materials.
• A fall (depreciation) in the exchange rate causes an increase in the prices of imported components and raw materials.
• Advances in production technologies – causes outward shift of supply.
40
How does the price of an input affect supply?
If the price of an input of a good increases, the supply decreases. If the price of an input of a good decreases, the supply increases.
41
What are the other factors that affect the shift of supply?
• The entry of new producers into the market – causes outward shift.
• Favourable weather conditions for agricultural products.
• Taxes, subsidies and government regulations:
• Indirect taxes cause an inward shift of supply.
• Subsidies cause an outward shift.
42
What happens when the price of a good increases?
The supply decreases.
43
What happens when the price of an input of a good decreases?
The supply increases.
44
What are the other factors that affect the shift of supply?
• The entry of new producers into the market – causes outward shift
• Favourable weather conditions for agricultural products
• Taxes, subsidies and government regulations:
• Indirect taxes cause an inward shift of supply
• Subsidies cause an outward shift of supply
• Regulations usually increase costs – causing an inward shift of supply
45
What are indirect taxes?
They are taxes imposed on the consumption, sale, or use of goods and services. They increase supply costs (marginal costs) of producers so less can be supplied to the market.
46
What are subsidies?
Subsidies involve finance provided to producers by the government to encourage them to produce goods and services. They make it cheaper to produce a product, therefore the supply of that product will increase.
47
What are factors that cause an outward shift in supply?
• An industry-wide fall in supply costs such as falling prices for energy & component parts
• The entry of new suppliers into a market or industry
• Impact of widely-adopted process innovations that lower supply costs
• Government subsidies / financial support to producers
• Favourable climatic conditions improving yields for farmers
• Impact of existing firms scaling up production in the long run
• Effects of a market being opened to trade with lower cost imports
48
What are factors that cause an inward shift in supply?
• Rise in the cost of raw materials, components and energy
• Government imposing an indirect tax on suppliers
• Government withdrawing a subsidy to producers
• Unfavourable weather conditions reducing farm yields / delaying production
• A rise in unit wage costs perhaps caused by labour shortages
• The exit of some suppliers from an industry
49
What is disutility?
Disutility refers to the negative feelings, discomfort or displeasure associated with certain activities, goods, or services.
50
What is marginal utility?
This refers to the additional satisfaction or utility gained from consuming one more unit of a good or service.
51
What is the law of diminishing marginal utility?
This law states that as a person consumes more units of a particular good or service while keeping the consumption of other goods constant, the additional satisfaction (marginal utility) gained from each additional unit will decrease.
52
When is total utility maximised?
Total utility maximised occurs when a consumer consumes the quantity of that product where the marginal utility is zero.
53
What other curve does the MU show?
Marginal Utility is the demand curve.
54
What is the meaning of homo economicus?
This is based on the idea that people are rational and self-interested and make decisions based on maximising their own utility/satisfaction.
55
What is the rational choice theory?
This assumes that people have perfect information about the options available to them and the consequences of each option.
56
What is price elasticity of demand?
This measures the responsiveness of the quantity demanded of a good or service to changes in its price.
57
What's the formula for calculating price elasticity of demand?
(%Change in Quantity Demanded for X)/(%Change in Price of X)
58
What do the coefficients of price elasticity of demand mean?
• PED = 0, then demand is perfectly price inelastic
• PED < 1, then demand is price inelastic
• PED = 1, then demand is unitarily price elastic
• PED > 1, then demand is price elastic
• PED = infinity, then demand is perfectly price elastic
59
What is price elastic demand?
It means when the coefficient of price elasticity is greater than 1. In this case, a small change in price leads to a relatively larger change in the quantity demanded.
60
What is price inelastic demand?
This occurs when the coefficient of price elasticity of demand is less than 1. This means that the change in price causes a smaller change in the quantity demanded.
61
What is a perfectly inelastic demand curve? (PED=0)
It implies that consumers are willing and able to pay any price for the product. So if supply falls, the price can rise without any contraction in quantity demanded.
62
What is a perfectly elastic demand curve? (PED= infinity)
This means a change in supply will not lead to any change in the equilibrium price and this usually applies to highly competitive markets.
63
What is the relationship between the gradient of demand and the PED?
See diagram.
64
What is the relationship between Elasticity of demand and Total revenue in the case of a price change?
See diagram.
65
What is the interpretation of the relationship between Ed and TR?
See diagram.
66
What's the relationship between PED and total expenditure?
If PED is elastic, a rise in price will cause total expenditure to fall and vice versa. If PED is inelastic, a rise in price will cause total expenditure to rise and vice versa.
67
What are the key factors affecting price elasticity of demand?
• Number of close substitutes (most important factor)
• Cost of switching between products
• Degree of necessity or whether the good is a luxury spend
• Proportion of income (budget) allocated to spending on the good
• Time period allowed for consumers to respond following a price change
• Whether or not the product is subject to habitual consumption
• Peak and off-peak demand
• Breadth of definition of a good or service
• Method of payment (cash versus digital)
68
What is income elasticity of demand?
Income elasticity of demand measures the relationship between a change in quantity demanded for good X and a change in consumers' real disposable income.
69
What is the formula for calculating income elasticity of demand (YED)?
%Change in quantity demanded for X/ %change in real income
70
What do the coefficients of YED mean?
• Normal goods- they have a positive income elasticity
• Luxury goods- where the income elasticity is > 1
• Necessities - here the income elasticity > 0 and < 1
• Inferior goods - have negative income elasticity
71
What are inferior goods?
If, following an increase in real income, less of the good is purchased, then the good is an inferior good. Inferior goods have a negative YED.
72
What is the importance of income elasticity for businesses?
• Knowledge of YED helps firms to predict the effect of changes in the (macro) economic cycle on their sales.
• Luxury products with a high-income elasticity see greater sales volatility over a business cycle than necessities where demand is less sensitive to changes in the economic cycle.
• Important for businesses to have a diversified product range.
• Higher value-added products increase profit margins – this is because they have a high YED and a low PED.
73
What is cross price elasticity of demand?
Cross price elasticity of demand measures the responsiveness of the quantity demanded of one good to a change in the price of another related good.
74
What is the formula for calculating cross price elasticity of demand?
Cross price elasticity of demand (A to B)= (%Change in Quantity demanded of A)/(%Change in price of B)
75
What is the XED of demand for substitutes?
Substitutes have a positive cross price elasticity of demand. An increase in the price of one product will lead to a rise in demand for its substitute.
76
What are the two types of relationships between substitutes?
Strong and weak substitute relationship. The higher the value of the coefficient the closer the two products are as substitutes. Consumers are more likely to switch between competing products when there is a change in relative prices.
77
What is the XED for complements?
If cross-price elasticity is negative, then two goods are complements. An increase in the price of good B results in a decrease in the quantity demanded of good A, and vice versa.
78
What are the 2 types of relationships between complements?
See diagram.
79
What is price elasticity of supply?
Price elasticity of supply (PES) measures the responsiveness of the quantity supplied of a good or service to changes in its price.
80
What's the formula for price elasticity of supply?
PES= (%Change in quantity supplied)/(%Change in price)
81
What do the PES coefficients mean?
0 means that supply is perfectly inelastic
0 < PES < 1 means that it's price inelastic
1 means that supply is unitarily elastic
1 < PES < infinity means that supply is price elastic
infinity means that supply is perfectly elastic.
82
What does it mean when supply is price elastic?
Supply is elastic if the percentage change in quantity supplied is greater than the percentage change in price.
83
What does it mean when supply is inelastic?
Supply is inelastic if the percentage change in quantity supplied is smaller than the percentage change in price.
84
What does it mean when supply is elastic?
Supply is elastic if the percentage change in quantity supplied is greater than the percentage change in price.
85
What does it mean when supply is perfectly elastic?
Supply is perfectly elastic if any changes in price cause an infinitely large change in the quantity supplied.
86
What does it mean when supply is perfectly inelastic?
Supply is perfectly inelastic if changes in price cause no change in the quantity supplied.
87
What does it mean when supply is unitarily elastic?
Supply is unitarily elastic if the percentage change in quantity supplied is the same as the percentage change in price.
88
What are the factors affecting price elasticity of supply?
PSSST acronym: 1. Production Lag 2. Spare Capacity 3. Stocks of Finished Goods 4. Substitutability of Factors of Production 5. Time Period.
89
How does elasticity of supply affect inflation rates?
When supply is elastic, producers can respond quickly to a rise in demand without an increase in costs and prices. Inflation tends to increase when (aggregate) supply becomes inelastic.
90
What is market equilibrium?
Market equilibrium is a situation in which the quantity of a good or service supplied by producers equals the quantity demanded by consumers.
91
Graphical Market Equilibrium
Market equilibrium is where the supply curve intersects with the demand curve.
92
What is another name for the market equilibrium price?
It is also called the market clearing price.
93
What happens when the price in a market is too low?
When the price is too low, there is disequilibrium in the market, and there's a shortage of goods.
94
What happens when the price is too high?
When the price is too high, there's a disequilibrium in the market, and this causes a surplus as the producer is willing to supply, however, the buyers are not willing to pay.
95
What is the price mechanism?
The price mechanism is a fundamental concept in economics that uses the forces of supply and demand to allocate resources and determine the prices in a market economy.
96
What are other names for the price mechanism?
Price system or market price system.
97
What are the main functions of the price mechanism?
Allocating function, Incentives function, Rationing function, Signalling function.
98
Define the allocating function.
This changes market prices to allocate scarce resources among competing uses.
99
Define the rationing function.
This raises prices in order to ration output when market demand outstrips supply.
100
Define the incentives function.
This is when the price of a product rises, quantity supplied increases as businesses respond.
101
Define the signalling function.
This is when price changes send contrasting messages to consumers and producers about whether to enter or leave a market.
102
How do the rationing and incentive functions work together?
The rationing and incentive functions work together to bring supply and demand back to equilibrium.
103
What are the advantages of the price mechanism?
Efficient Resource Allocation, Incentives for Innovation and cost reduction, Consumer Choice.
104
What are the disadvantages of the price mechanism?
Income Inequality, Lack of Equity, Market Failures.
105
What is consumer surplus?
Consumer surplus refers to the difference between the total maximum amount a consumer is willing to pay and the total amount she actually pays for a given quantity of a good.
106
What's the formula for consumer surplus?
Consumer Surplus (CS) = Total Utility (TU) - Total Expenditure (TE).
107
Graphically, where is consumer surplus?
Consumer surplus is the area underneath the demand curve and above the market price.
108
How does a leftward shift of the supply curve change consumer surplus?
Higher supply costs (decrease in supply) leads to a rise in market price and therefore a fall in consumer surplus.
109
How does a rightward shift in supply change consumer surplus?
An increase in supply will reduce the market price, which will lead to a rise in consumer surplus.
110
How does a leftward shift in demand cause a change in consumer surplus?
A decrease in market demand causes consumer surplus to decrease as well.
111
How does a rightward shift in demand lead to a change in consumer surplus?
An increase in market demand causes consumer surplus to rise as well.
112
What is producer surplus?
Producer surplus refers to the difference between the total amount a producer actually receives and the minimum amount he must receive to produce a given quantity of a good.
113
What's the formula for producer surplus?
Producer surplus (PS) = Total Revenue (TR) - Total Variable Cost (TVC).
114
Graphically, where's producer surplus?
Producer surplus is the area above the supply curve and below the market price.
115
How does a rightward shift in demand change producer surplus?
If demand increases, the market price increases, which causes an increase in the producer surplus.
116
How does a leftward shift in demand cause a change in producer surplus?
A decrease in demand causes a reduction in price, which leads to a decrease in production surplus.
117
How does a rightward shift in supply cause a change in producer surplus?
A rightward shift in supply typically leads to a decrease in producer surplus.
118
How does a leftward shift in supply lead to a change in producer surplus?
A leftward shift in supply typically leads to an increase in producer surplus.
119
How does a leftward shift in supply lead to a change in producer surplus?
120
What is economic welfare?
Economic welfare is the total surplus available to society from an economic transaction or situation.
121
What is another name for economic welfare?
Total Society Surplus or Community Surplus
122
How do firms reduce consumer surplus?
If firms have market power (monopoly), they can raise prices to maximize profits, reducing consumer surplus. They may also engage in price discrimination.
123
How does elasticity of demand affect consumer surplus?
124
What is an excise duty?
These are indirect taxes levied on three types of goods in the UK: alcoholic drinks, tobacco products, and road fuels.
125
What are the two types of taxes on goods?
- Ad valorem tax
- Specific/unit tax
126
What is an ad valorem tax?
An ad valorem tax is a tax calculated as a percentage of the value of the good or service being taxed.
127
What is a specific tax?
A specific tax is a fixed amount of tax charged per unit of a good or service, rather than based on its value.
128
Draw the graph of a specific tax.
129
Draw the consumer and producer's tax burden on a De/Su graph.
130
If PED is more elastic than PES, how does this affect the distribution?
If the elasticity of demand is greater than the elasticity of supply, then most of the tax burden will be absorbed by the supplier. 
131
If the PES is greater than the PED, how will this affect the distribution of tax?
If the elasticity of demand is smaller than the elasticity of supply, most of the tax burden will be absorbed by the final consumer. 
132
When will a producer pass on all the tax burden to consumers?
When demand is perfectly price inelastic. 
133
When again can the producer shift all the burden of tax?
When the supply is perfectly price elastic. 
134
Give examples of ad valorem tax.
VAT-20%
Insurance Premium tax
135
Draw ad valorem tax on a supply and demand graph.
136
Define regressive tax.
A regressive tax is a tax system where the tax rate decreases as income increases, meaning lower-income individuals pay a higher proportion of their income compared to higher-income individuals.
137
What are the justifications and drawbacks for indirect taxes?
138
Give examples of government subsidies.
Job retention scheme
Food/fuel subsidies
Childcare
Apprenticeship
Solar/Wind farms
139
Draw the impact of subsidy on a demand-supply graph.
140
How would PED affect the distribution of subsidy?
If PED<1 (inelastic), there will be a small expansion of demand when the price drops. If PED>1 (elastic), there will be a huge expansion of demand, costing the government much more. 
141
What are some justifications for subsidies?
• Helping poorer families with food and childcare costs particularly during a crisis
• Improved nutrition can lift labour productivity and reduce the burden on health services
• Encourage output and investment in sectors such as life sciences and renewable energy
• Protect jobs in loss-making industries hit by recession and by external economic shocks
• Improve housing and transport affordability to improve geographical mobility of labour
• Reduce the cost of training & employing workers
• Encourage the arts and other cultural services which have social benefits
142
What are some drawbacks of subsidies?
• Producers can become 'subsidy dependent'
• Subsidies can distort resource allocation
• Subsidies can lead to excess production/surpluses
• Environmental risks from excessive production
• Government failure arising from political lobbying
• Subsidies can be very expensive - taxpayers bear the cost
143
What is progressive tax?
A progressive tax is a tax system where the tax rate increases as the income of an individual or entity rises, reducing inequality by taxing those who can afford to pay more.
144
What is a proportionate tax?
A proportionate tax, also known as a flat tax, is a tax system in which the tax rate remains the same regardless of income level. For example, if the tax rate is 15%, both a person earning £30,000 and a person earning £100,000 would pay 15% of their income in taxes.
145
Example of progressive tax.
- Income tax-UK
- Inheritance tax
146
Example of regressive tax.
VAT
Excise tax
147
Example of proportionate tax.
Corporate tax
Property tax
Capital Gains Tax
