Everything (- econometrics) Flashcards
Microeconomics, macroeconomics, public economics, international economics & economic growth (325 cards)
1
Q
What is demand?
A
The quantity of a good or a service that a consumer is willing and able to purchase at any given price level
2
Q
What is supply?
A
Supply is the quantity of a good or service that a producers is will and able to sell at any given price level
3
Q
What is the equilibrium price?
A
The intersection of supply and demand - the price at which quantity demanded is equal to the quantity supplied
4
Q
What does the assumption that consumers/producers are price takers mean?
A
No single consumer/producer can influence the market price, hence they can only chose the quantity and take the price as given
5
Q
What is consumer surplus?
A
Difference between the price consumers are willing to pay and the price they actually pay
6
Q
What is producer surplus
A
Difference between the price sellers are willing to sell for and the price they actually receive
7
Q
What is own price elasticity and how can it be estimated?
A
Own price elasticity measures the demand response of a good to a change in its price
change in quantity demanded / change in price
8
Q
What does an own price elasticity of demand smaller than 1 suggest?
A
Inelastic demand e.g., necessities
9
Q
What does an own price elasticity of demand greater than 1 suggest?
A
Elastic demand e.g., luxury goods
10
Q
What is the cross price elasticity of demand and how is it estimated?
A
Cross price elasticity measures the responsiveness of the quantity demanded of one good (x) to the change in price of another good (y)
change in quantity demanded of good x / change in price of good y
11
Q
If the cross price elasticity of a good is positive what type of goods are they?
A
substitutes
12
Q
If the cross price elasticity of a good is negative what type of goods are they?
A
complements
13
Q
What is income elasticity of demand and how is it estimated?
A
Income elasticity of demand measures the responsiveness of quantity demanded to a change in income
change in quantity demanded / change in income
14
Q
What does it suggest if the income elasticity of a good is greater than zero?
A
it is a normal good
15
Q
What does it suggest if the income elasticity of a good is greater than one?
A
it is a luxury good
16
Q
What does it suggest if the income elasticity of a good is less than zero?
A
it is an inferior good
17
Q
What causes a shift in the demand curve?
A
Factors that change the quantity demanded at a given price e.g., change in tastes, population, income, prices of substitutes of complement goods and expectations of future prices
18
Q
What causes a movement along the demand curve?
A
A change in the price of the good or service
19
Q
What is the budget constraint?
A
All possible consumption bundles the consumer can afford with their income (usually focused on two goods)
20
Q
What causes a pivot in the budget constraint?
A
Price of one good becomes relatively cheaper
21
Q
What causes a shift in the budget constraint?
A
Change in income
22
Q
What is a consumption bundle?
A
A combination of different quantities of the various goods a consumer wants to consume
23
Q
What is utility?
A
The satisfaction that a consumer derives from consuming a particular consumption bundle
24
Q
What assumptions does consumer demand theory make about utility?
A
Completeness - bundles can be ranked in terms of their utility
Transitivity - the utility ranking of bundles is internally consistent
Preference for more over less
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What is 'diminishing marginal rate of substitution'
In order to hold utility constant, diminishing quantities of a good or service need to be sacrificed so as to obtain successive equal increases in the quantity of another good
26
What is the budget constraint line?
A line showing all possible consumption bundles which are affordable and exploit all the resources available to the consumer
27
What does the non-satiation assumption about taste imply?
Consumers will chose a point on the budget constraint and certain points will be preferred to others
28
What is an indifference curve?
A line that shows combinations of two goods that give a consumer the same level of satisfaction
29
What concept measures the slope of the indifference curve?
Marginal rate of substitution
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What is the income effect?
the change in consumption that happens when a person's income changes
31
What is the substitution effect?
the change in demand for a product when its price increases relative to other products
32
What is absolute advantage?
When one firm can produce a given quantity of a good with fewer inputs compared to another firm
33
What is comparative advantage?
When one firm can produce a good at a lower opportunity cost compared to another firm
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How is overall output maximised according to comparative advantage?
Specialising to achieve comparative advantage and then trading
35
What is an isoquant?
A line showing all possible combinations of inputs that can produce a given efficient level of output
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What is the isocost line?
A line showing different input combinations with the same total cost
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What do we assume about how firms make production choices?
Firms wish to minimise the cost of producing their given level of output
Firms will produce an output where marginal cost equals marginal revenue
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What is the marginal rate of technical substitution in production?
the rate at which one input can be replaced with another while keeping the same level of output
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What is constant returns to scale?
When an equal proportionate increase in all inputs gives the same proportionate increase in output
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What is decreasing returns to scale?
When an equal proportionate increase in all inputs gives a smaller proportionate increase in output
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What is increasing returns to scale?
When an equal proportionate increase in all inputs gives a larger proportionate increase in output
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What is short run marginal cost?
The increase in short run total cost if output increases by one unit
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What is long run marginal cost?
The increase in long run total cost if the output increases permanently by one unit
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Where does the marginal cost curve intersect the average cost curve?
at the minimum point
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Assumptions of perfect competition (6)
Firms produce homogenous products
Firms are price takers
No barriers to entry or exit
Average cost curves eventually end up sloping upwards
Perfect information between buyers and sellers
Firms maximise profits
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What level of output do firms choose in perfect competition?
Where marginal cost equals marginal revenue, under perfect competition the marginal revenue is always equal to the price
47
Under perfect competition, how should firms respond when marginal cost is less than marginal revenue?
increase output to increase profits
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Under perfect competition, how should firms respond when marginal cost is greater than marginal revenue
reduce output to increase profits
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Characteristics of a monopoly (4)
One firm supplies the whole market
Significant barriers to entry
Firm is price maker
No close substitutes
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How do price and output differ between perfect competition and monopoly market structures?
Price is higher and output is lower under a monopoly
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Characteristics of monopolistic competition (3)
Many firms
Free entry and exit
Differentiated product but high degree of substitutability
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Characteristics of an oligopoly (4)
Market power held by a few firms
High barriers to entry
Product differentiation
Interdependence of firms
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What is a 'Game' in the context of game theory?
A situation in which decisions by rational agents are necessarily interdependent
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What is a 'Strategy' in the context of game theory?
A detailed game plan describing how the agent will act or move in every conceivable situation
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What is a 'Dominant Strategy' in the context of game theory?
Where an agent's best strategy is independent of those chosen by others
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What is the Prisoners' Dilemma?
A paradox that shows how two rational people making decisions in their own self-interest can lead to a worse outcome for both - highlighting the incentive for collusion
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What is a cartel?
An agreement between a group of producers to control supply or manipulate prices
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Why are cartels unstable?
It is the dominant strategy for all firms involved to cheat the agreement by reducing their price and then increasing their market share
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What is a Bertrand competition
Where firms, in an oligopolistic market, compete by setting prices for identical products
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Key features of Bertrand competition (4)
Firms compete on price
Homogeneous products
Simultaneous decision making
No capacity constraints - firms can meet demand
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What is the Bertrand paradox?
In a duopoly, the Bertrand model predicts that both firms will continue to undercut each other until price equals marginal cost resulting in zero economic profit
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What is Cournot competition?
Where firms, in an oligopolistic market, compete by setting quantities not prices
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Key features of Cournot competition (5)
Products are homogenous
Simultaneous decision making
Price determined by market demand
Results in positive profits and price above marginal cost
Less competitive than Bertrand
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What is Stackelberg competition?
A sequential quantity-setting model, in an oligopolistic market with a leader-follower dynamic
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Key features of Stackelberg competition (4)
leader moves first and sets quantity
Follower observes and responds optimally
Leader has first mover advantage and earns higher profit
Assumes homogenous product and quantity competition
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Example of perfect competition
Agricultural markets
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Example of monopolistic competition
Soft drinks industry
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Example of an oligopoly
Airlines
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Example of a natural monopoly
Public utilities
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Example of a monopoly
Amazon
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What is the Chain Store Paradox?
A game theory paradox where a large firm, with multiple stores, faces new competitors in different markets (e.g., towns) - they can chose to engage in aggressive price competition or accommodate the new entrant
72
Explain the chain store paradox
In each market, at the introduction of a competitor, the large incumbent can either fight (price war) or accommodate the new entrant
In theory, fighting is costly and could reduce long term profits as reducing prices in one store might have to be reciprocated across the other stores so therefore the firm should accommodate
But in reality, if firms fight early entrants they can deter future entry
The paradox highlights the conflict between short-term profit maximisation and long-term strategic considerations
73
Why is the supply curve upward sloping?
The law of supply says that as the price of a good or service increases, the quantity supplied will increase
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Why is the demand curve downward sloping?
The law of demand says that as the price of a good or service decreases, the quantity demanded will increase
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How does tax affect the supply curve?
Shifts it upwards
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How does tax affect the demand curve?
Shifts it downwards
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What is marginal utility?
The benefit derived from consuming an additional unit of a good or service
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When are markets in equilibrium?
When the supply and demand curves are equal
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What are economies of scale
cost advantages realised through an increased level of production
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What is a natural monopoly
a monopoly that occurs due to high barriers of entry
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What is asymmetric information?
When one party has more information on the transaction than the other
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How do firms demand labour?
labour is a derived demand which means that it depends on the demand for the firm's good or service
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How do competitive firms determine their demand for labour
Firms will employ labour until the marginal revenue product of labour equals the wage rate
84
What is the marginal revenue product of labour (MRPL)?
the extra revenue obtained from one unit of labour - it is the product of marginal revenue and marginal product of labour
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What is the shape of the MRPL curve?
downward sloping - determined by diminishing marginal returns to labour
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What is the labour force?
all individuals in work or seeking employment
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What is labour supply?
the number of hours people are willing and able to supply at a given wage rate
88
What does the backward bending labour supply curve mean?
after a certain point, higher wages can lead to a reduction in hours worked
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What is the shape of the labour supply curve?
Upward sloping - as the wage increases people are incentivised to work more
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How does a change in wages of one industry affect another?
labour is incentivised to move into the industry with higher wages which shifts the labour supply curve left in the other industry
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What is a monopsony labour market?
When there is a single employer dominating the hiring of labour in a particular market - allowing them to better control the wage
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What are the differences (in wages, employment & market power) between monopsony and competitive factor markets?
One firm dominates labour demand in monopsony whereas there are many firms demanded labour in a competitive market and therefore no single firm can influence wages
Key differences:
- Wages: monopsonists pay less than marginal revenue product, whilst competitive market pays where wage equals MRP
- Employment: monopsonists hire less labour than competitive markets
- Market power: Monopsonists have power in labour market, competitive firms do not
93
What is marginal revenue product (MRP)?
The extra revenue a firm earns from employing one more unit of a factor (e.g., labour)
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What are policy responses to monopsony power? (4)
Minimum wage laws
Encouraging unions
Anti-trust action
Public provision
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Example of a monopsony labour market
NHS
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What does the Lorenz curve measure?
Inequality
97
What is the elasticity of labour supply in the short run?
Often inelastic as it is difficult for people to switch markets in the short-run
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What does human capital theory suggest?
If the rate of return on human capital (investment into education) is greater than the rate of return on alternatives people will take up educational opportunities
99
What causes wage differentials in the labour market? (4)
skills
discrimination
job characteristics
trade unions
100
What does risk averse mean?
a reluctance to take risk
101
Why is there demand for insurance?
Most people are risk averse
102
Why is there supply for insurance?
Profits can be made through risk pooling and risk sharing
103
What is moral hazard?
When one participant does not know what the other participant is doing (behaviour)
104
What is adverse selection?
When one participant does not know what the other participant is like (characteristics)
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What is productive efficiency
an economy or entity can no longer produce additional amounts of a good without lowering the production level of another product
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What is pareto efficiency?
when an allocation of resources cannot be changed without making somebody worse off
107
Criticism of pareto efficiency
it does not consider inequality
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What is a market failure?
where there is an inefficient allocation of goods and services in a market
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Causes of market failures (5)
public goods
externalities
imperfect competition
missing markets
imperfect information
110
What is a public good
a good that is non-rivalrous and non-exclusive
111
Why is there no incentive for the free market to provide public goods
Cannot charge people for it
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What is an externality
where production or consumption directly impacts a third party which is not considered by the party producing or consuming
113
How does asymmetric information affect markets?
It distorts markets by creating unequal access to information between buyers and sellers which can lead to inefficient outcomes (e.g., moral hazard, adverse selection or market failure)
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What is a negative externality?
Marginal social cost > Marginal private cost
(over-consumption/production)
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Examples of a negative externality (3)
Pollution
Smoking
Congestion
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What is a positive externality?
Marginal social benefit > marginal private benefit
(under-consumption/production)
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Examples of a positive externality? (3)
Education
Vaccinations
Research and development
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How can you address externalities?
Taxes (e.g., carbon tax)
Subsidies/Grants (e.g., R&D grants)
Regulations (e.g., emission limits)
119
What is Coase Theorem?
It states that if property rights are clearly defined and transaction costs are low, private negotiations will lead to efficient outcomes regardless of who holds the initial rights (and therefore no need for government intervention)
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Assumptions of Coase Theorem (4)
Clearly defined property rights
Low or no transaction costs
Perfect information
Small number of parties (so negotiation is practical)
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Example of Coase Theorm
Situation: a factory pollutes a river, harming fisherman downstream
- if the fisherman have the right to clean water, the factory must pay them to pollute
- if the factory has the right to pollute, fisherman can pay the factory to reduce pollution
Outcome: as long as the parties can bargain costlessly, the final level of pollution will be efficient
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What is the population of working age?
All people aged between 15-64
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Limitations of the Coase Theorem (4)
High transaction costs
Power imbalances
Poorly define property rights
Enforcement issues
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What is employment rent
The difference between the value of employment and its opportunity cost (unemployment) - e.g., wages - unemployed benefit
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What is the reservation wage?
The wage at which a person is indifferent from working or being unemployed
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What is a stock?
A quantity measured at a point in time
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What is a flow?
A quantity measured per unit of time
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What are the functions of money (£)
Acceptability
Unit of account
Store of value
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Types of money aggregates (4)
Currency
M0: currency + funds deposited at the central bank - 'base money'
M1: M0 + demand deposits issued by financial institutions - 'broad money'
M2: M1 + term deposits and money market shares
126
How does money relate to the business cycle?
It is procyclical - growing when the economy is growing and falling when the economy is in recession
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Other desirable characteristics of money (4)
fast and low cost transactions
privacy / auditability - transactions should generally be private but auditable by authorities
recourse / fidelity - fraudulent transactions should be reversible and money balances should reflect past transactions
accessibility - monetary services should be easily accessed by all
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What does the budget constraint look like for an impatient consumer?
Will typically borrow, even if their expected future income is less than their current income
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What are assets?
Everything owned by an entity and everything that is owed to that entity
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What is consumption smoothing?
Where people borrow if income is lower than their expected future income and will save if their current income is higher than expected future income
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What are liabilities?
Everything an entity owes to others
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What is net worth?
Difference between assets and liabilities
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Components of aggregate demand
Consumption
Investment
Government spending
Net exports
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What does it mean if a bank is illiquid?
When it does not have enough reserves to meet demand for deposit withdrawals
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What does it mean if a bank is insolvent?
When the value of its fixed liabilities exceed the value of its assets
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What is quantitative easing?
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What is the bank rate?
the interest rates at which some banks can lend to or borrow from the Bank of England
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Disadvantages of lending for banks
increase in illiquidity risk (fewer deposits)
increase in insolvency risk as loan assets are more risky than deposit assets
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Incentive to loan for banks
loans may pay higher interest than deposits held at the bank of england
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What does it mean for a bank lending money?
they replace deposits held at the central bank with loan assets
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What is the objective of quantitative easing?
Increase money supply in the economy - reducing
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What are the intermediate targets of monetary policy? (9)
market interest rates
asset prices
expectations / confidence
exchange rate
import prices
net exports
aggregate demand
domestic inflationary pressure
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What does a decrease in the bank rate mean for banks?
increase loan assets
increase deposit liabilities
132
How does a decrease in the interest rate affect current and future consumption for a saver? (all income in current period)
Substitution effect - future consumption is relatively more costly to current consumption, encouraging saver to reduce future consumption and increase current consumption
Income effect - relatively less well off, cannot afford as much in each period, encouraging saving to reduce consumption in each period
Both effects encourage reduce consumption in future period but impact on current consumption is ambiguous
133
How does a decrease in the interest rate affect current and future consumption for a borrower? (all income comes in future period)
Substitution effect - current consumption is cheaper than future consumption hence increases current consumption relative to future consumption
Income effect - can afford more than before incentivising an increase in both current and future consumption
Both effects encourage higher consumption in the current period but the impact on future consumption is ambiguous
133
What is the main instrument of monetary policy?
The bank rate
134
What is the inflation rate?
The rate of growth of prices of goods and services in the economy
134
What is the main target of monetary policy?
Inflation rate
135
What are intermediate targets of monetary policy?
The channels through which changes in the
policy interest rate affect inflation
135
What can affect the pass through of monetary policy?
market conditions
monopoly or monopsony power
regulation
136
What is the technical definition of a recession?
two consecutive quarters of falling GDP
136
Approaches to measuring GDP (3)
Production approach - value of goods and services produced in the economy
Income approach - sum of all incomes
Expenditure approach - sum of aggregate demand
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What is Okun's law
The empirical negative relationship between GDP growth and unemployment rate
136
What is an alternative definition of a recession?
The level of output is below its normal level - the economy could still be growing but its producing less than its potential
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What happens to unemployment when real output falls?
unemployment rises
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What does Okun's coefficient tell us?
how the costs of recessions are distributed across society - a shallow slope suggests there is little unemployment response to recessions and hence the recession is shared more evenly across society (not concentrated to those who lose their jobs)
138
Limitations of GDP
It does not consider sustainability (e.g., environmental externalities)
Not a measure of wellbeing
Difficult to value services
Difficult to measure over time
139
What are the opportunity costs for firms of investment? (3)
Paying off outstanding debt
Purchase of financial securities
Paying dividends
139
What is real GDP?
nominal GDP adjusted to account for changes in the price of goods and services
140
Why is investment more volatile than income and consumption? (4)
There is no natural incentive to smooth investment and it can easily be postponed
Emergence of new technology
Coordination problems
Credit cycles
140
Why is consumption smooth?
Households use savings or borrow to smooth consumption against temporary falls in income
140
What are automatic stabalisers?
Government interventions which dampen fluctuations over the business cycle e.g., income tax, unemployment benefits and social insurance
140
Measures of inflation
CPI
CPIH
RPI
GDP deflator
140
What does the GDP deflator measure?
changes in prices of domestically produced goods
140
What is the GDP multiplier?
The proportionate change in GDP from a change in expenditure
141
How do transfers impact the fiscal multiplier?
some money will be saved and therefore not circulate into the economy - dampening the multiplier
141
Which components of government spending are smooth over the business cycle?
Health
Education
141
How does trade affect the fiscal multiplier?
Openness to trade reduces the effect of fiscal policy as more money will be spent on imports
141
Determinants of the fiscal multiplier (7)
The composition of spending
Economic Slack
Flexible prices and wages
Monetary policy response
Direct spending vs transfers
Trade
Taxes
141
How does tax affect the fiscal multiplier?
When tax rates are high, increases in gross income will only partially increase disposable income
141
What is the fiscal multiplier?
The proportionate change in GDP in response to fiscal policy
142
How does the composition of spending affect the fiscal multiplier?
Multipliers are higher when the new spending is a complement to rather than a substitute for households and firms spending
142
When is the government budget in defecit?
When government spending is greater than tax revenues
142
When is the government budget in surplus?
When government spending is less than tax revenues
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