Micro Year 1 Flashcards
(106 cards)
1
Q
What is a firm?
A
an organisation that brings together factors of production to create output
2
Q
What is an economic model? Why are they used?
A
A model is a simplified representation of reality, designed to provide insight into economic decisions and events. They allow economists to make assumptions that help them better understand the complexity of the real world.
3
Q
What is Ceteris paribus?
A
Latin for ‘all else being equal’ - changing one variable at a time while holding the others constant
4
Q
Why can’t economists conduct scientific experiments?
A
As economics is a social science, it deals with real world problems. It would be impossible for all variables to be controlled at a large enough scale to give meningful results and to control how people act
5
Q
What is a positive statement
Give an example
A
A statement that is fact based, objective and can easily be tested.
For instance, the tax rate is 40%
6
Q
What are normative statements and value judgements? Give an example
A
Normative statements are statements which use value judgements (personal beliefs about the worth of something) usually to state what ought to be. They are subjective, less easily tested and based off the speakers opinion. For example “the tax rate should be lowered - it’s too high”
7
Q
What is the economic problem?
A
That, at an individual and societal level, we have unlimited wants and finite resources, and this creates scarcity. Thus, decisions have to be made on how best to allocate resources.
8
Q
What is the difference between a renewable and a non renewable resource?
A
A renewable resource is a resource that will replenish it’s stocks naturally to replace that lost through consumption within a human time frame
A non renewable resource is a resource that can’t replenish its stocks at the same rate at which it is consumed, so will eventually run out - they are finite
9
Q
What is an opportunity cost?
A
In decision making, the next best alternative forgone.
10
Q
What is the relevance of opportunity cost to consumers?
A
Consumers have to make choices on how to use their limited income to give them the greatest level of utility
11
Q
What is the relevance of opportunity cost to producers?
A
Producers have to decide how best to allocate their scarce factors of production to make the most profit
12
Q
What is the relevance of opportunity cost to producers?
A
Producers have to decide how best to allocate their scarce factors of production to make the most profit
13
Q
What is the relevance of opportunity cost to the government?
A
How best to spend their limited tax revenue to maximise societal welfare
14
Q
What are factors of production
A
Resources used in the production process to create output
Capital
Enterpise
Land
Labour
15
Q
What is a ppf?
A
a graphical representation showing the maximum combinations of output for two goods or services that can be produced in a given time with available resources
16
Q
How do you show economic growth or decline on a PPF?
A
A shift in or out
17
Q
How do you show an inefficient, efficient and unobtainable (in the short run) use of resources on a PPF?
A
Any point within the PPF curve is ineffecient, as factors of production are not being used to their full extent to create maximum output.
Any point along the PPF is effecient, as FoPs are being used to their full extent.
Any point beyond the PPF curve is unobtinable production as the society/buisness does not have the resources necessary to produce at that level
18
Q
Why are most PPFs curved?
A
to illustrate the law of diminishing returns, which states that each additional factor of production has less marginal benefit than the previous one.
19
Q
What do movements and shifts represent on a ppf?
A
A movement along the curve represents a change in the combination of the goods or services produced
A shift in or out represents a change in the productive capacity of an economy
20
Q
What is specialisation?
A
When an economic agent focusses their resources on producing a particular good or service.
21
Q
What is the division of labour?
A
A process whereby the production procedure it broken down into a sequence of stages and workers are assigned to a particular stage.
22
Q
What are the benefits of the division of labours
A
Productivity will increase as workers become specialised in a skill, increasing unit output per worker and therefore reducing average cost.
Quality increases as workers become specialised in a skill, therefore increasing ups
More efficient use of time, as workers don’t waste time moving from task to task
23
Q
What are the drawbacks of division of Labour?
A
Work becomes repetitive, making work boring, possibly decreasing worker motivation and therefore increasing absenteeism
Workforce becomes inflexible, so hard to find cover
24
Q
What are the four functions of money?
A
Medium of exchange
Measure of value
Store of value
Method of deferred payment
25
What is the main problem of a barter economy
It requires a double coincidence of want - to complete an economic transaction, you have to find someone who wants what you have, and you have to want what they have - if thi was to be faced by a whole economy, transactions would be extremely inefficiient
26
What is a free market economy?
An economy where the allocation of resources is decided entirely through the 'invisible hand' of market forces, with no government intervention.
27
What is a mixed economy?
Where market forces are complemented by some government intervention.
28
What is a command economy?
A command economy is where resources are allocated entirely through the government.
29
What are the benefits of a free market?
* Allocative efficiency - market in the long run will always operate at P* Q* (D=S), here resources are allocated exactly to meet consumer demand and societal surplus is maximised. Here, any shortages/surpluses in the system will not exist in the long run due to the price mechanism
* increased consumer sovreignty
* Encourages competition - in a highly competitve market, firms will have to compete with each other, meaning prices should stay low and consumers have greater sovreignty
* Dynamic efficency - firms have an incentive to invest in R&D, so technological advancements may happen at a greater rate. This may bring long run average costs down, increasing economic welfare.
30
What are the negatives of a free market?
* Markets can fail - in acheiving the benefits of a free market, a lot of assumptions have beeen made. it is very rare for a market to be perfectly allocatively efficient. If a firm has monopoly power, it will produce at MC=MR, as firms are profit maximising, so artificially raise prices to acheive supernormal profit.
* No control over merit and demerit goods - leadinging to greater externalities in society, creating deadweight welfare loss
* Higer inequity and inequality - the market price may exclude consumers in a lower socio-economic group from accessing a good or service, if this is a necesity it can lead to low wekfare.
31
What are the pros of a command economy?
* greater control over externalities - as the government is motivated by societal wellbeing, they are likely to produce at the society optimum level of production, internalising externalities and ensuring adequte levels of merit goods
* In a command economy, the government controls wages, employment, and prices. Therefore, extremes in wealth and income will not exist.
32
What are the drawbacks of a command economy?
* lack of innovation - as the government is the sole supplier for industry, there is no incentive to become more productively efficient or invest in R&D as there is no competition. This means prices may be higher and society will not advance in the same way
* Bureaucratic ineffeciencies - a central planning government will allways have imperfect information, they will not be able to allign supply and demand to match perfectly with the demands of consumers. thus, the market will never be allocatively efficient.
* consumers will have less choice and freedom, as there is only one supplier in the market.
*
33
What are the assumptions of rational decision making?
* consumers try to maximise utility, firms try to maximise profits
* economic agents have complete and perfect knowledge
* prefrences are consistent and transitive (If a person prefers option A to B, and option B to C, they will also prefer option A to C)
* consumers choose independently
* consumers can compare different options easily
34
What are the limits of rational decision making
consideration of the influence of other people's
behaviour
the importance of habitual behaviour
consumer weakness at computation
35
What is the definition of demand?
The quantity of a good or service that consumers are willling and able to buy at any given price in a given period of time
36
What is the law of demand?
There is an inverse relationship between quantity demanded and price
37
What are the three reasons the demand curve is downward sloping?
1. The substition effect - changes in the price of a good or service motivate consumers to move to/away from substitute goods - decreasing the price will make consumers move away from now relatively more expensive substitute goods
2. The income effect - changes in price affect the purchasing power of consumers income - increasing the price means our income cannot go as far so we demand less
3. Law of diminishing marginal utility - less aditional utility (satisfaction) is gained from each additional unit consumed. A consumers willingness to pay decreases as quantity increases, so price must be lowered as people are willing to pay less for it.
In all cases, an increase in price makes consumers less willing and able to buy a product
38
What is the snob effect?
However, some goods may be valued higher simply because they are more expensive, as they use it as a status symbol. This was noted by Veblen
However, while this is the casse for particuclar consumers, there is no evidence to suggest whole markets are upwards sloping.
39
What is it called when price changes, leading to a change in quantity demanded?
A contraction or extension of demand - movements ALONG the demand curve
40
What non price factors affect demand? what does this lead to?
Population
Advertising
Substitue price
Income
Fashion
Interest rates
Compliments price
41
What is a normal good?
What is an inferior good?
A normal good is a good or service where the quantity demanded of it increases as consumer incomes rise
Conversly, an inferior good is a good or service which experiences a fall in quantity demanded in response to a rise in consumer income.
42
What is an elasticity?
The measure of the sensitivity of one variable to changes in an another variable
43
What is price elasticity of demand? How do you calculate it?
a measure of the sensitivity of quantity demanded to a change in the price of the good or service. Because the demand curve is downwards sloping, PED will always be negative (as changes in price and quantity will always happen in the opposite direction).
It iis calculated using the formula
PED = % Change in quantity demanded/
% change in price
44
explain what the following are, their nummerical value, their implication for firms and how to represent on a demand curve:
* Perfectly elastic demand
* relatively elastic demand
* unitary elastic demand
* relatively inelastic demand
* perfectly inelastic demand
* perfectly elastic demand - an increase in price reduces demand to 0. Here, PED = infinity, and is shown by a horizontal demand curve. Here, firms have no incentive to change price
* relatively elastic demand - a change in price leads to a larger % change in quantity demanded, and is represented by a gently sloping demand curve. here, PED= more than 1, and firms should not increase price as it woud lead to a fall in revenue
* unitary elastic demand - a change in price leads to a proportional change in quantity demanded, shown by a curved demand curve. PED = 1. Here, it does not matter if firms increase price
* relatively inelastic demand - An change in price leads to a relatively smaller % change in quantity demanded, here PED = 1-0, and is represented by a steep demand curve. Firms should increase price as it will lead to greater revenue.
* perfectly inelastic demand - a change in price does not effect demand at all - PED = 0, and is represented by a perfectly horizontal demand curve. Here, firms should increase price infinitely to maximise revenue.
45
Why will a straight line demand curve be unitary elastic at the half way point?
Even though the slope of a straight-line demand curve is constant, the elasticity changes because the relationship between the percentage changes in price and quantity varies depending on where you are on the curve. At high prices and low quantities, a small % change in price leads to a larger percentage change in quantity demanded. At low prices and high quantities, a small change in price leads to a smaller percentage change in quantity demanded
The midpoint of a straight-line demand curve represents the point where the percentage change in price equals the percentage change in quantity demanded. This is the point where elasticity equals 1 (unitary elastic).
46
Give examples for each of the different elasticities
Perfectly Elastic Demand (PED = ∞) - Perfectly competitive market for identical products (e.g., a particular brand of wheat in a perfectly competitive market).
Perfectly Inelastic Demand (PED = 0) - Life-saving medications like insulin for diabetics (assuming no substitutes).
Relatively Elastic Demand (PED > 1) - Substituable, non necesity goods (where small price changes lead to large changes in demand).
Relatively Inelastic Demand (PED < 1) - Necessities like salt or bread (price changes don't greatly affect demand), or addictive products
47
What factors influence price elasticity for demand?
1. Availability of Substitutes - When substitutes are readily available, consumers can easily switch from one product to another in response to price changes, making demand more elastic. This is driven by the substitution effect, which reflects consumers' ability to find alternative goods that provide similar utility. Conversely, when a product has few or no substitutes, consumers have limited options to adjust, resulting in inelastic demand.
2. Necesity vs luxury - Goods classified as necessities typically have inelastic demand because they are essential for consumers, regardless of price increases - consumers will continue to purchase these goods to maintain their well-being. On the other hand, luxuries exhibit elastic demand because they are non-essential and can be forgone or substituted if prices rise.
3. The price elasticity of demand is greater in the long run than in the short run due to the consumer adjustment effect. In the short run, consumers have limited ability to substitute or change consumption patterns, so demand tends to be inelastic. This is because many of the necessary adjustments (like finding alternative products or technologies) require time. Over a longer period, however, consumers can explore substitutes, alter consumption habits, and adjust their behavior, leading to more elastic demand
4. The income effect indicates that goods representing a larger share of a consumer's budget tend to have more elastic demand. When the price of a good that consumes a significant portion of income increases, consumers are more likely to reduce their quantity demanded or find alternatives, as the price change significantly impacts their overall budget. In contrast, for goods that constitute a small proportion of income, price increases have less effect on total expenditure, making demand
inelastic.
5. whether the good is addictive
48
How are changes in total revenue portrayed on a demand curve?
Total revenue is given by price multiplied by quantity. In Figure 2.10, if price is at Po, quantity demanded is at Qo and total revenue is given by the area of the rectangle OPAQo. If price falls to P, the quantity demanded rises to Qi, and you can see that total revenue has increased, as it is now given by the area OP, BQ. This is larger than at price Po, because in moving from Po to P, the area P, PoAC is lost, but the area QoCBQ, is gained, and the latter is the larger. As you move down the demand curve, total revenue at first increases like this, but then decreases — try sketching this for yourself to check that it is so.
49
What is income elasticity of demand? How is it calculated?
Income elasticity of demand is a measure of the sensitivity of quantity demanded of a good or service to a change in consumer income. It can be positive or negative.
To calculate it, you use the formula
YED = % change in QD/% change in income
50
What are inferior, normal/necesities and luxury goods in terms of YED?
An inferior good has a negative YED, where an increase in income decreases quantity demanded. For instance, coach travel
A normal good or a necesity has a YED of between 0-1, where incomes rise so does quantity demanded.
a luxury good a YED of greater than 1, where an increase in income leads to a proportionately higher % change in QD
51
How do you know if a good or service has a inelastic or elastic YED?
Any value, positive or negative, of more than one shows the good is highly income elastic. Any value less than one shows the good is income inelastic, and changes in income dont have a great affect on in it.
52
What is Cross elasticity of demand? How is it calculated?
A measure of the sensitivity of the QD of a good or service in response to a change in the price of a different good or service. It is calculated using the formula
XED= % change in QD of good X/
% change in price of good Y
53
What are the numerical values (in terms of XED) for substitute, compliment and unrelated products?
1. substitutes - the two products are replacements for each other, so an increase in the price of one will lead to an increase in QD for the other. This means YED will be positive. Eg, Pepsi and coca-cola
2. Compliments - The two goods are used together, so an increase in the price of one will reduce the demand for the other. This means XED is negative. Eg milk and cereal
3. An unrelated product - the two products have no influence on each other, so XED = 0. Eg foreign holidays and paper
54
How can you tell if two goods are close or weak substitutes/compliments?
If YED is a value of less than one, negative or positive, than the goods/service are weak substitutes or compliments. A % change in the price of one leads to a smaller % change in price of the other.
If YED is a value of greater than 1, the goods/service are strong substitutes/compliments, as a change in price of one strongly affects the demand for the other.
55
What is the significance of elasticity of demand when iposing an indriect tax on a product?
When demand is elastic, consumers' responsiveness to price increases leads to a significant reduction in quantity demanded. As a result, producers, facing a decrease in sales, are unable to pass the entire tax burden onto consumers without experiencing substantial revenue losses. In order to avoid this, producers may absorb a greater portion of the tax to prevent a sharp decline in sales, thereby shifting a larger share of the tax burden onto themselves. In contrast, when demand is inelastic, consumers' quantity demanded is less responsive to price changes, meaning they will continue to purchase nearly the same amount even as prices rise. As a result, producers are able to pass most, if not all, of the tax burden onto consumers, since the reduction in sales will be minimal.
56
What is the significance of elassticites of demand when imposing a subsidy on a product?
Subsidies are more effective when applied to goods with elastic demand, as the subsidized reduction in price leads to a larger increase in quantity demanded, thereby enhancing consumer welfare and stimulating economic activity to a greater extent.
57
What is the definition of supply?
The quantity of a good or service that producers are willling and able to produce at any given price point in a given period of time.
58
What is the law of supply? Why is it the case?
There is an direct relationship between market price and quantity supplied. This is because of the law of diminishing marginal returns. As a firm adds more of a variable input (like labour) to a fixed input (like capital or land), the marginal output of each additional variable input will eventually decrease. This increases marginal cost of production, so firms need to be compensated with higher prices to be incentivised to increase price.
59
What causes a movement along the supply curve?
A movement is caused by a change in maret price. an increase in market price causes an extension of supply, while a decrease in price causes a contraction of demand.
60
What causes a shift in supply?
Productivity
Indirect taxes
Number of firms
Technology
Subsidies
Weather
Cost of production (!!!!!)
61
What is price elasticity of supply? How is it calculated?
Price elasticity of supply is a measure of the sensitivity of quantity supplied of a good or service to a change in the price oof that good or service. It is always positive.
It is calculated using the formula
PES = %change in Quantity Supplied/
% change in price
62
What will happen to a firms elasticity of supply in the long run?
In the long run, firms willl be able to change production to a greater extent and thus supply will become more price elastic. In the short run, the firm may be operating close to full capacity, meaning it can not increase production straight away even if there is a significant increase in price. However, in the long run, firms will be able to build new factories for example, so supply can be increased.
63
What are the numerical values of the different elasticities of supply?
Perfectly Elastic (PES = ∞)
Relatively Elastic (PES > 1)
Perfectly Inelastic (PES = 0)
Relatively Inelastic (PES < 1)
64
Describe perfectly elastic and inelastic supply
Perfectly inelastic supply occures when there is a fixed quantity of what is being produced (ie a special type of fish) - therefore supply cannot be increased no matter how much is being demanded.
perfectly elastic supply occures where a firm will supply infinite amounts of a good or service at the given price
65
What factors influence price elasticity of supply?
1. Time - In the short term, when at least one factors of production are fixed, supply cannot be increased suddenly.
2. working at full capacity - if a firm is working below full capacity, they have room to quickly increase production in a short period of time without significant investment
3. stockpile - if a firm has a large stockpile goods, they can easily release some of their store to be sold.
4. availability of factors of production - if factors of production are hard to attain, for example labour needs to be highly trained, then supply will be harder too increase
5. barriers to entry/exit - if start up costs in a market are high, new firms will struggle to enter the market in response to an increase in price, so PES will be inelastic
66
Go to a diagram Book to draw out Market equilibrium price!!
67
What is market equilibrium?
where the price is set at a level quantity demanded is perfectly balanced by the quantity supplied.
68
What are the 4 functions of the price mechanism?
Signalling - An increase in prices act as a signal that there has been excess demand in the market, and signals the need to increase resources in the market
Incentive - higher prices incentivise firms to increase supply, as high prices will increase revenue and thus profit, the motivation for most firms
Rationing - higher prices discourage consumers from buying the product, so only consumers who are willing to pay a higher price for it do
Allocation - due to the extension in supply and contraction in demand, allocative efficiency is reached.
69
How is the initial disequilibrium in a market shown following a shift in demand or supply?
Price stays the same at first, moving along to meet the new curve and showing a difference in QD and QS
70
What is consumer surplus?
The difference in what a consumer would be willing and able to pay for a product and the price they actually pay - the area below the demand curve but above the equilibrium price.
71
How is consumer surplus shown on a diagram?
The triangle above price and below the demand curve, an individuals consumer surplus is the verticle difference between price and a particular point on the demand curve
72
What is producer surplus?
The difference between the price recieved by firms for a good or service and the price at which they would have been prepared to supply at
73
How is producer surplus represented on a diagram?
The triangle below equilibrium price and above the supply curve
74
What impact would a shift outwards in demand have on consumer and producer surplus?
If demand shifts, equilibrium price would increase, as well as quantity demanded and supplied. This increases both consumer and producer surplus, as consumers now value the good more highly and will be willing to pay a higher price.
75
What will be the impact of a shift inwards in supply on producer and consumer surplus
A shift inwards in supply will increase price but also reduce quantity. Consumer surplus will fall, as will producer surplus. This is beause the price of the good even though consumers do not value the good any higher
76
'the net welfare that society gains from the production and consumption of a good' - what is this?
The sum of the producer and consumer surplus - societal surplus
77
What is an indirect tax? Why is it implemented?
A tax levied on the producers of a good or service, which is partly paid for by consumers indirectly. (as opposed to directly on income)
It is used to raise government revenue, or to decrease the consumption of demerit goods (internalise the externality)
78
What is the impact on the imposition of an indirect tax on a market?
A shift inwards of supply, from S to S + Tax
79
What are the two different forms of indrect tax? How are they shown?
1. Specific tax - when the value of a tax is constant per unit tax, and is shown by a parralel shift in supply
2. Ad valorem tax - a tax which is set at a % of the price the good is sold at, causing a kinked shift in demand.
80
What is the effect of the implementation of a tax on the market equilibrium?
Supply shifts upwards/ to the left, causing a reduction in quantity and an increase in price.
81
Is the increase in price following the imposition of a tax going to be the same value as the value of the tax?
NO!!! This is because not all of the tax is passed onto the consumer, instead, it is the verticle distance between the two supply curves
82
How do you work out the incidence of tax? What factor affects this
The difference between the original and the new price represents the burden of the tax payed by consumers, the rest is payed by consumers.
The elactisty of demand determines the incidence of tax - a highly elastic product would force producers to take the majority of the burden, as they would be unable to rise prices without losing significant demand. While a highly price inelastic product, like cigarettes, producers can and will pass most of the price increase on to consumers.
83
What is the impact on consumer and producer surplus following the imposition of a tax?
Consumer and prodcuer surplus both falls
84
What is a subsidy? why is it used
a grant given by the government to producers to encourage the production of a good or service. This is done to increase affordability and increase the provision of merit goods
85
What is the impact of a subsidy on a supply and demand curve?
A shift downwards/to the right of the supply curve
86
How do you calculate the value of the subsidy?
The verticle difference between the two supply curves
87
How do you calculate how the the benefits of the subsidy are shared between consumers and producers?
THe decrease in price is the benefit consumers recieve, the rest is the increased revenue producers recieve.
88
how do you calculate the cost on the government in imposing a subsidy?
verticle difference of the two supply curves multiplied by the new quantity
89
What is market failure?
a situation in which the free market does not lead to a socially optimum allocation of resources
90
What are the three forms of market failure?
1. externalities
2. The under provision of public goods
3. information gaps
91
What is an externality?
The indirect costs or benefits to a 3rd party that is not involved in the market transaction, so are not reflected in market price.
92
what is:
* private cost
* external cost
* social cost
* Private cost is the cost incurred by an individual economic agent due to their production, or other economic activities
* external cost - a cost associated with an individuals production or economic activty that is bourne by third parties and not reflected in the market prices
* social costs - this is the full cost to society, and is calculated by the sum of the private annd external cost
93
What is:
* privte benefit
* external benefit
* social benefit
* private benefit - The benefit from an individuals ecnomic activity that is enjoyed by that individual
* external benefit - the benefits that 3rd parties experience due to the ecnomic activities of that individual
* social benefit - the total benefits that society experiences from an individuals economic activity, the sum of private and external benefity
94
What are the three rules to follow to always get an externality diagram right?
1. A production externality will have two cost (supply) curves, and a consumption externality will have two benefit (demand) curves
2. Negative externalites always produce too much, while positve externalities always produce too little. This means for a negative externality, the Socially ooptimum quantity will be on the left while for a positive externality they will always be on the right
3. The deadweight loss to society is always the triangle pointing towards the socially optimum equilibrium.
95
What are the characteristics of a private good?
1. Excludability - other people can be prevented from consuming it
2. Rivalrous - Once it is consumed by one person, it cannot be consumed by another.
96
What are the characteristics of a public good? what is an example?
* Non-excludability - where it is not possible to provide a product to one person without having others consume it aswell
* Non-Rivalrous - where one persons consumption of a good does not prevent others from consuming it aswell
* For example, streetlights
97
What is the main problem of a public good market?
The free rider problem - due to a public goods non-excludability, once the good has been provided for, there is no incentive for anyone to pay for it, so the market will fail, as there is no incentive for a firm to supply that good in the first place
98
How can one resolve the free rider problem?
Government intervention can be used to taxate and therefore fund the provision of public goods.
99
what is symmetric information?
a situation in which all participants in a market (both buyers and sellers) have the same infiormation of market conditions
100
What is asymmetric information?
A situation where some participants in a market have greater information of market conditions than others.
101
What is a moral hazard?
Moral hazard occurs when one party in a transaction takes on risk because they do not bear the full consequences of that risk.
102
What is adverse selection?
adverse selection is a market situation where asymmetric information results in a party taking advantage of undisclosed information to benefit more from a contract or trade.
103
How does imperfect market information may lead to a misallocation of resources
Imperfect market information leads to a misallocation of resources by distorting decision-making, causing inefficiencies. using a diagram welfare would be maximised where demand with perfect information equals supply at output 0A and a price of 0E. However, buyers in practice sufer information failure. They overestimate the benefts of the product and are therefore prepared to pay a higher price for a given level of output than it they enjoyed perfect information. Hence, the actual demand curve for the good is to the right of the one where buyers have imperfect information. The result is that 0B is bought at a
price of 0F. There is a misallocation of resources because AB too much is bought compared to a situation where buyers had perfect information.
104
What is a quasi public good?
a good which does not perfectly possess the characteristics of
non-rivalry and non-excludability and yet which also is not
perfectly rival or excludable.
105
How can government revenue from a tax be used to internalise an externality further?
Hypothecate the revenue from the tax - reinvest it into solving the problem.
106
