How markets work Flashcards
(90 cards)
1
Q
What is rational decision making ?
A
A range of assumptions are made about the rationality of economic agents involved in the transactions.
2
Q
Define utility
A
The amount of satisfaction obtained from consuming a good or service.
3
Q
What is the consequence of consumers not having enough income to buy all goods/services they want
A
They have to make a choice about what goods and services to buy and in what quanitites
4
Q
Define rational decision making for firms
A
Where producers allocate their resources to maximise profits from the goods/services produced.
5
Q
Define rational decision making for consumers
A
Where consumers allocate their expenditure on goods and services to maximise utility
6
Q
Define demand
A
The quantity of a good/service purchased at a given price over a given time period
7
Q
Why does the demand curve for a good, slope downwards from left to right
A
- As price falls, the good becomes cheaper compared to substitute goods.
- More goods can be purchased with a given level of income
8
Q
When is there a movement along a demand curve
A
Only when there is a price change.
9
Q
Extension in demand cause
A
A fall in price
10
Q
Contraction in demand cause
A
A rise in price
11
Q
Factors that cause a shift in the demand curve
A
- Real incomes
- Trends
- Size of the population
- Prices of substitutes or complements.
- Interest rates
- Advertising
12
Q
Define marginal utility
A
The satisfaction obtained from consuming one extra unit of a good or service
13
Q
Example of the law of diminishing utility
A
- E.g at a buffet, the first meal may give a high level of utility if you are hungry.
- However a second meal will not provide as much utility as the first as you would be less hungry.
- The more meals consumed, the less utility gained
14
Q
Define diminishing marginal utility
A
As successive units of a good are consumed, the utility gained from each extra unit will fall
15
Q
Define total utility
A
the total satisfaction gained from the total amount of a product consumed.
16
Q
How can the concept of diminishing marginal utility explain the downward-sloping demand curve
A
- As marginal utility falls from each extra good consumed:
- Consumers will only buy more of the good if price falls
- This explains the downward-sloping demand curve
17
Q
Define price elasticity of demand(PED)
A
The responsiveness of demand for a good or service to a change in price
18
Q
Calculate % change
A
new value - old value / old value times 100
19
Q
PED formula
A
% change in Q.D / % change in Price
20
Q
What does it mean if a good is relatively price elastic
A
*PED is greater than 1
*% change in demand is greater than % change in price
21
Q
What does it mean if a good is relatively price inelastic
A
*PED is less than 1
*% change in demand is less than % change in price
22
Q
What does it mean if a good has unit elasticity
A
*PED is equal to 1
*% change in demand is equal to % change in price
23
Q
What does it mean if a good is perfectly inelastic
A
*PED is equal to 0
*A change in price has no effect on the quantity demanded
24
Q
What does it mean if a good is perfectly elastic
A
- PED is equal to infinity
- A rise in price causes demand to fall to zero
25
Determinants of PED
- Availability of substitutes- higher value of PED (elastic)
- Addictiveness of the product-turns products into necessities, low value of PED ( inelastic).
- price of product as a proportion of income- lower proportion=low value = inelastic.
- Time period- short term=inelastic, long term= elastic.
-Brand Image= inelastic= willing to pay a premium price.
26
Define total revenue
The total payments a firm receives from selling a given quantity of goods or services.
27
Relationship between price elasticity of demand and total revenue
- Elasticity falls as you move along the curve from top left to bottom right.
-
28
Elastic demand on total revenue
If demand is elastic:
*A cut in price increases total consumer spending
*This will increase revenue to the firm
*A rise in price reduces total consumer spending
*This will decrease revenue to the firm
29
Inelastic demand on total revenue
If demand is inelastic:
*A increase in price increases total consumer spending
*This will increase revenue to the firm
*A fall in price reduces total consumer spending
*This will decrease revenue to the firm
30
Define income elasticity of demand
The responsiveness of demand for a good or service to a change in real income
31
Formula for YED
% change in Q.D / % change in income
32
What does it mean if YED is positive?
- product is a normal good
*A rise in income causes a rise in quantity demanded
33
Define normal good
A good with a positive income elasticity of demand:
*As income rises, demand for the good RISES
34
What does it mean if YED is negative
- product is an inferior good
- as income rises, demand for the good falls.
35
What is the value of normal necessity good, and explain.
- 0 to 1
- Demand increases when income increases
36
What is the value of normal luxury good, and explain.
- YED > 1
- demand increases when income increases.
-income elastic = relatively responsive to a change in income.
37
What is the value of an inferior good, and explain.
- YED < 0
- Demand decreases when income increases.
38
Factors that influence YED
- Recession= wages fall = demand for inferior good rises = luxury good falls.
- Economic growth = luxury good increases = inferior good falls.
39
Define cross elasticity of demand
reveals how responsive the change in quantity demanded
40
XED formula
% change in Q.D of good A / % change in price of good B
41
what does the negative sign of the XED value mean?
- two products are complements
- a high value suggests they are strong complements.
42
If XED < 0
- Complementary goods
- negative value indicates two goods are complements
43
If XED > 0
- Substitutes
- positive value indicates two goods are substitutes
44
If XED = 0
- Unrelated goods
- the closer to zero the weaker the relationship is.
45
Define supply
amount of a good/services that a producer is wiling and able to supply at a given price in a given time period.
46
Why does the supply curve slope upwards from left to right ?
- positive relationship between price and quantity supplied.
- profit maximising producers would want to supply more as prices increase in order to maximise their profits.
47
When is there a movement along a supply curve
prices changes
48
What causes an extension in supply
A rise in price causes an increase in the quantity supplied
49
What causes a contraction in supply
A fall in price causes a decrease in quantity supplied.
50
What does an increase in supply refer to
price rises = producers have an incentive to increase production
51
What does a decrease in supply refer to
price falls = less profitable to supply a product = reduce output
52
What factors cause a shift in the supply curve of a good
- Costs of production = raw materials, wages
- Indirect taxes = supply curve shift to the left.
- Subsidies = grants = supply curve shift to the right
- New technology = increase in productivity = supply curve shifts to the right.
-Productivity of the workforce = rise = shift to the right
53
Define price elasticity of supply (PES)
reveals how responsive the change in quantity supplied is to a change in price.
54
PES formula
% change in Q.S / % change in Price
55
What does a positive PES indicate
price and quantity move in the same direction
56
When is PES perfectly inelastic
- =0
- The QS is completely unresponsive to a % change in P.
57
When is PES relatively price inelastic
- 0<1
- % change in QS is LESS THAN proportional to the % change in P.
- e.g agricultural products
58
When is PES relatively price elastic
- 0 > 1
- The % change in QS is MORE THAN proportional to the % change in Price.
59
When is PES perfectly elastic
- infinity
- % change in QS will fall to zero with any % change in price.
60
Determinants of price elasticity of supply
- Mobility of the factors of production :
- Availability of raw materials:
- Ability to store goods:
- Spare capacity
- Time period:
61
Define equilibrium price
When the quantity supplied is equal to the quantity demanded at the market clearing price point.
62
Define excess supply
quantity supplied is greater than the quantity demanded at the existing price.
63
Define excess demand
quantity demanded is greater than the quantity supplied at the existing price.
64
Price and the equilibrium position in a free market
determined by the interaction of demand and supply in a market.
65
What do producers do if there is an excess supply
- lower prices to generate more revenue
- cleared the excess supply
66
What do producers do if there is an excess demand
- raise prices to generate more revenue.
67
Define the price mechanism
interaction of demand and supply in a free market
68
What is the objective of the price mechanism
determines prices which are the means by which scarce resources are allocated between competing wants/needs.
69
What are the 3 functions of the price mechanism
- Rationing
- Signalling
- Incentive
70
How does the rationing device work
- Market forces ensure ; amount demanded is exactly equal to the amount supplied.
- When resources become scarcer = price will rise further.
- If surplus = prices fall = more affordable.
71
How does the signalling device work
prices provides information to producers & consumers where resources are required (price increase) and where they are not ( price fall ).
72
How does the incentive device work
the prospect of making a profit acts as an incentive to firms to produce goods and services.
73
Define consumer surplus
difference between the amount the consumer is willing and able to pay for a product and the price they actually paid
74
Define producer surplus
difference between the amount that the producer is willing and able to sell for a product for and the price they actually do.
75
Define tax
mandatory contributions levied on individuals or corporations by a government
76
What are the two types of tax
- Direct taxes
- Indirect taxes
77
Define direct tax
a tax that a person or organization pays directly to the entity that imposed it
78
Define indirect tax
- paid on the consumption of goods and services
- usually levied on demerits good to reduce Q.D.
79
What are the two types of indirect tax
- Ad valorem
- Specific tax
80
Define specific tax
set amount per unit of the product
81
Define ad valorem tax
percentage of the price of the product
82
How does an indirect tax affect a good or service
- increase in the cost of supply
- supply curve shift to the left
83
What does a specific tax cause on the diagram
supply curve shift to the left
84
What does an ad valorem tax cause on the diagram
supply curve shift to the left and become steeper
85
Define incidence of tax
relates to how the burden of a tax is distributed between different groups e.g producers and consumers.
86
Impact of subsidies to consumers
decrease in price
86
Define subsidy
a grant from the government that has the effect of reducing costs and increase quantity of production.
87
What do economists assume about consumers and rationality
people act rationally and aim to maximise utility.
88
Define behavioural economics
psychological insights into human behaviour to explain economics decision-making.
88
Three reasons why consumers may not behave rationally
- consideration of the influence of other peoples behaviour
- habitual behaviour
- Inertia
