Theme 1 Flashcards
(118 cards)
1
Q
Economics
A
Study of
Individuals, households, businesses and governments
With scarce resources
Make choices to satisfy needs
1
Q
Positive Statement
A
Describing the world as it is, they can be tested and verified
2
Q
Normative Statement
A
Statements that make a value judgement - “should be”
3
Q
Models
A
Assumptions are made to make analysis manageable
Models provide a framework for understanding economic processes
HOWEVER
They are simplifications of reality, assumptions can be unrealistic
4
Q
Ceteris Paribus
A
‘All else being equal’
Assumption that allows economists to isolate the effect of one variable
5
Q
Economic agents + choices
A
Producers, consumers, government
Economic agents have to make choices and look at opportunity cost
6
Q
Basic Economic Problem
A
The central purpose of economic is the production of goods and services to satisfy our changing wants and needs.
Resources are scarce; as a result, choices have to be made about how to use resources.
7
Q
Opportunity cost
A
The value of the next best decision forgone
8
Q
Production Possibility Frontier
A
Shows the maximum combination of goods that can be produced in a given time with a given set of resources.
Macro PPF is likely to be consumer and capital goods
9
Q
Marginal Analysis
A
An approach to decision making based on considering the additional benefit and cost of a change in one unit
10
Q
Outward shift in PPF
A
Increase in an economy’s potential to produce goods and services.
For a shift to occur, there needs to be an increase in the factor inputs or an improvement in efficiency of supply.
11
Q
Q2CELL + examples
A
Quantity
Quality - LR change in productivity
Capital - Technological advancements
Enterprise - Investment in education
Land - New resources
Labour - Immigration / Emigration
12
Q
Productive Efficiency
A
Produces goods at the lowest cost
13
Q
Dynamic Efficiency
A
Refers to expanding the PPF at all times - seen by outward shift, done through technological advancements, investments and innovation
14
Q
Division of Labour
A
Production process is broken into separate specialised tasks
By focussing on a specific task, workers can become highly adept and thus more efficient
15
Q
Division of Labour Advantages
A
Leads to economies of scale
Higher productivity + efficiency → increased output
Lower unit costs
Reduce cost of training, focussing on a narrow range of skills
16
Q
Division of Labour Disadvantages
A
Risk of worker alienation
Boredom, monotony
Risk of disruptions to production process
Restrict consumer choice
Risk of structural unemployment
17
Q
Potential gains from division of labour
A
Higher productivity → increased outputs → higher profits
Surplus outputs can be traded for mutual benefit → increased range of products for consumers
Lower prices → higher real incomes → give consumers more purchasing power → economic
18
Q
Role of Money in Specialisation
A
In the past, goods were bartered. This wouldn’t work now as economies and businesses specialise many workers to carry out one task along the production so would have nothing to barter with. Therefore, money is an essential medium of exchange.
19
Q
Main functions of money
A
Medium of Exchange
Store of Value
Unit of Account
Standard of Deferred Payment
20
Q
Three economic questions
A
What goods should be produced?
How should a country’s resources be used to produce these goods and services?
For who should these products be allocated to?
21
Q
Free Market
A
Allows market forces to guide the allocation of resources through the price mechanism.
Very limited role for the government
Adam Smith argued in such a system, resources would be allocated by an ‘invisible hand’
22
Q
Command Economy
A
The government directs the allocation of resources.
Government likely to own most of the country’s scarce resources
They will tell businesses what and how much to produce and who to sell it to
23
Q
Advantages of a Free Market
A
Efficient allocation of scarce resources
Competitive prices for consumers and then protect market share
Competition drives innovation and invention
Profit motive stimulates investment which encourages economies or scale
Competition helps to reduce monopoly power and increases choices
24
Disadvantages of a Free Market
Potential of market failure - may require government intervention
Lead to a rise in the scale of income and wealth inequality - Gini coefficient
No intervention may lead to monopolies being formed
Under or non-provision of public goods
Under-provision of merit goods
May fail to address negative externalities
Deregulated financial markets often prone to bouts of instability
25
Advantages of a Command Economy
Enables government to overcome market failure, inequality and create a society that maximises social welfare rather than profit
Can prevent abuse of monopoly power
Can prevent high unemployment
May be more equitable
26
Disadvantages of a Command Economy
Government agencies usually have poor information about what to produce - centralisation means decisions are made by people with little understanding, leading to underproduction of goods and services and a waste of scarce resources
Unable able to respond to consumer preferences
Lack of incentives for workers and businesses
Bureaucratic
27
Private Goods
They are excludable, the use of the good is exclusive to the user
They are rivalrous, if the good is used by one person it reduces the amount left over for another - limited supply
28
Public Goods
Non-excludable and non-rivalrous
e.g. lamp post, road, police, lighthouse, flood defence
The free market will not provide public goods. There is no incentive to produce it as businesses cannot charge for it and it is impossible to prevent anyone else from consuming
29
Quasi or Non-Pure Public Goods
Have elements of both public and private goods
Some ways can be found to exclude consumers from benefitting from some public goods - tolls can be charged for road use or sections of a park can be cordoned off with paid entry
30
Free-rider Problem
People can still enjoy the benefits of consumption at no financial cost
31
Information Failure
Occurs when people have inaccurate, incomplete, uncertain or misunderstood data and so potentially make the wrong choices
32
Symmetric Information
All participants in a market have the same information about market conditions
33
Asymmetric Information
Some participants in a market have better information than others
34
Causes of Information Failure
Ignorance of real costs/benefits
Technical/complex information - insurance
Addiction - cigarette
Misleading information - online sellers
Hidden charges - airline ticket
Asymmetric information - second-hand car
Myopia - short term thinking - tanning bed
35
Effects of Information Failure
e.g. Dentistry
Producer has more info as they have dental education
Could mean consumers are vulnerable to pay unnecessary fees which could lead to market failure as resources aren't being allocated to the right people
36
Demand
The quantity of a good or service that consumers are willing and able to buy at a given price in a given time period
37
Consumer Sovereignty
Suggests the consumers control resources by deciding what to buy
38
Complementary Goods
Two or more goods typically consumed or used together
39
Substitute Goods
Two goods that could be used for the same purpose by consumers
40
Normal Goods
A good that experiences an increase in demand due to an increase in income
41
Inferior Goods
A good whose demand drops when people's incomes rise
42
Determinants of Demand
Price of related goods - substitutes and complements
Consumer preferences
Population changes
Expectations
Changes in consumer income
43
Supply
The quantity of a product that a producer is willing and able to supply onto the market at a given price in a given time period
44
Determinants of Supply
Changes in production costs
Government taxes and subsidies
Climate
Technological changes
Legislation
Changes to the number of firms in an industry
45
Equilibrium/disequilibrium
'State of rest' - the market is at rest when supply = demand
Disequilibrium is where there is excess demand or supply
46
Price Mechanism following a increase in demand
Rise in demand creates disequilibrium (initially shift is at P1)
The increase in demand causes a rise in price:
Signalling - that there has been excess demand and need for more resources
Incentive - higher prices incentivise firms to extend supply curve
Rationing - higher prices causes a contraction of demand so only those who are willing and able to pay higher price will access the good
Allocation - reach allocative efficiency
THINK CIRCUMSTANCES FOR INCREASE IN SUPPLY
47
Consumer Surplus
The value consumers gain from consuming a good or service over the price paid. It is the difference between the maximum that consumers are willing and able to pay for a product and the total amount the actually do pay
48
Producer Surplus
The difference between the price the producer is willing to charge and the price they actually receive
49
Economy Welfare
The total benefit society receives from an economic transition - calculated by the combined area of producer and consumer surplus added together.
50
Price Elasticity of Demand
% Change in demand / % Change in price
The responsiveness of demand to a change in price
51
Elastic Demand
Responsiveness or sensitive to a change in price, a change in price will lead to a more than proportional change in quality demanded
Perfect elasticity - horizontal line
52
Inelastic Demand
Demand is not very responsive to a change in price, a change in price leads to a less than proportional change in quantity demanded
Perfect inelasticity - vertical line
53
Unitary Elasticity
The percentage change in quantity demanded is equal to percentage change in price
54
Factors influencing PED
S - Substitutes
P - Proportion of income
L - Luxury or necessity
A - Addiction
T - Time
55
Income Elasticity of Demand
% Change in quantity demanded / % Change in income
56
Normal Goods
Have positive income elasticity of demand
As consumer incomes rise, more is demanded at each price level
Shift right in demand curve
Split into necessities and luxuries
57
Inferior Goods
Have negative income elasticity of demand
Demand falls as incomes rise
Typically tend to be where superior goods available
Demand may increase in a recession
58
Cross Elasticity of Demand
% Change in demand (Product A) / % Change in price (Product B)
Measures the responsiveness of a change in demand of one good to a change in price of another product
From the perspective of the government knowing the PED will help inform them of the impact of imposing/increasing direct taxes the revenue received
59
Price Elasticity of Supply
% Change in Quantity Supplied / % Change in Price
Measures the responsiveness of quantity supplied of a good or service to a change in price of that good
60
Inelastic Supply
Change in price causes a smaller proportional change in quantity supply
Grapes - harvest is once a year so would be inelastic
61
Elastic Supply
Change in price causes a bigger proportional change in supply
Taxi services - easy for people to work as a driver
62
Factors that affect PES
Spare production capacity - can change output with rising costs and supply will be elastic
Stocks of finished products and components and perishability
Ease and cost of factor substitution/mobility
Time period and production speed
63
Tax
A charge or fee that a government imposes on a citizen or business
64
Indirect taxes
Imposed by the government and they increase production costs for producers
e.g. VAT, cigarettes + alcohol tax (excise tax), landfill, insurance premium tax
65
Ad Valorem taxes
Percentage
e.g. VAT adds 20% of the unit price
66
Specific taxes
Set tax per unit, such as the 58p per litre tax
67
Burden of Tax
Although the seller is responsible for the mechanics of paying the tax, it is effectively divided between the buyer and seller. Part of the tax can be passed onto the buyer.
68
Subsidies
The government may wish to encourage production of a particular good or service
Involves a payment by the government to suppliers that reduce their costs of production
69
Reasons for Subsidies
Encourage infant industries that are struggling to compete
Strategic industries e.g. Food + Defence
Encourage consumers to buy products for positive individual or societal effects
70
Rational Decisions
The decision you take to try and get maximum satisfaction
Economists assume that rational consumers aim to maximise their utility and rational firms will aim to make as much profit as possible
71
Diminishing Marginal Utility
Where individuals gain less additional utility from consuming a product the more of it is consumed
72
Factors Impacting Irrational Decisions
Behaviour of other people - 'follow the crowd'
Habitual behaviour, or inertia
Consumer Weakness at Computation - suggests consumers can't identify optimal benefit where the law of diminishing returns applies
Bias - rule of thumb/mental shortcuts
- anchoring, relying on one piece of info when making decisions
- availability bias
- social norms
73
Bounded Rationality
People's ability to make rational decisions is severely restricted due to:
- human mind has limited ability to process/evaluate
- the info available is invariably incomplete and often unreliable
- the time available to make decisions is limited
74
Nudge Theory
Suggests consumer behaviour can be influenced by small suggestions and positive reinforcements
Well-placed nudges can encourage desirable actions
75
Market Failure
Occurs when markets and price mechanisms lead to an inefficient or inequitable allocation of resources
In some failure where the market exists but there is over or under production/consumption of goods
In others there is complete market failure where markets fail to lead to any production of goods or services - a missing market
76
Externalities
Where consumptions or production of a good on society/third party
77
External costs of production
Private costs + external costs = social costs
e.g. particulates from industry, noise pollution, pollution from fertilisers
78
Societal Welfare
Welfare of society is maximised when the market successfully allocates its resources efficiently
79
Positive externalities of consumption
Positive externalities exist when third parties benefit from the spill over effects of consumption
e.g. vaccines, education, public libraries
80
Government Intervention
When the state gets involved in markets and takes action to try to correct market failure, improve economic efficiency, impact upon the macroeconomic performance of the country and change the distribution of income and wealth
81
Advantages of indirect taxes
Internalises the externality - provides funding for some of the external costs of consuming/producing
Raises revenues to fund healthier choices
Persuades some consumers to switch to better alternatives
Encourages manufacturers to redesign their product
82
Disadvantages of indirect taxes
Might be regressive
Other policies may be more effective in cutting consumption
People may switch to other unhealthy products or alternatives (e.g. sugary drinks tax)
It is hard to measure an exact monetary value of an externality
83
Advantages of Subsidies
Enables greater social efficiency
Subsiding the societally beneficial good will discourage people to do more harmful option and reduce the negative externalities. Long term change in consumer preferences, thereby altering the products that firms are producing
84
Disadvantages of Subsidies
Cost may have to be met through taxation, not all that are being taxed will receive the benefit of the subsidy - is this equitable? Perhaps raise revenue by taxing goods with negative externalities
Difficult to estimate the extent of the positive externality.
May encourage firms to be inefficient and reliant on the subsidy
Effect depends on PED
Opportunity cost for government
85
Maximum Pricing
Legally imposed maximum price in a market that suppliers cannot exceed. To be effective a maximum price has to be set below equilibrium
The government may use this to prevent harmful effects of wrong choices or if the good is essential for daily living
e.g. rent capping, energy price caps
86
Advantages of maximum pricing on housing
More affordable for more people
Reduce exploitation
Increased disposable income if maximum price is on a necessity (e.g. housing)
High rent impedes geographical mobility and therefore keeps structural unemployment higher
87
Disadvantages of maximum pricing
Excess demand means a decrease in supply. As landlords look to sell instead of rent, this means less rentable houses available which could lead to homelessness (government failure)
88
Minimum Pricing
A legally imposed price floor below which the normal market price cannot fall. To be effective, the minimum price has to be set above the market equilibrium
89
Minimum pricing for alcohol
In Scotland, since 2018 they have a minimum price a unit of alcohol
50p per unit
Introduced to reduce how much people drink and prevent problems caused by caused
Government is raising minimum price to 65p in order to control alcohol-related deaths and hospitalisations
90
Advantages of alcohol minimum pricing
Reduces the negative externalities
Reduce burden on NHS
May reduce alcohol related crimes and disturbances
If the differential between drinking at home and in pubs becomes smaller, it may mean that business benefit from increased customers and sales revenues
91
Disadvantages of minimum pricing
Responsible drinkers also have to pay a higher price
Better alternatives? Alcohol tax would fund socially beneficial projects and internalise the externality
Demand may be inelastic for 'problem drinkers'
If the minimum price is close to equilibrium, the impact will be negligible
92
Provision of public goods
These goods benefit society but are likely to be under provided by the private sector. The state either provides these goods directly (i.e. defence) or it contracts private companies to provide it
93
Advantages of provision of public goods
Society benefits - necessary for a functioning society - legal system, roads etc
Redistribution of wealth - tax received from richer parts of society are used to fund the provision of public goods for all
Increases consumption of public goods compared to free market levels.
External benefits? Education
94
Disadvantages of provision of public goods
Absence of market forces - no price mechanism so likely to be excess demand/supply
Opportunity cost
Reduces independence of the consumer - e.g. overuse of the NHS
Technological change has changed the degree to which public goods are non-excludable
95
Merit goods
Goods that have private or external benefits and the government believes they are under consumed, this means that the government tends to subsidise these goods or make them free at the points of consumption
96
Demerit goods
Goods that are bad for society - cigarettes
The government can intervene by disincentivising the consumption of these goods
97
Provision of information
Providing information to people where a lack of information may be dangerous or risky in an economic transaction
e.g. government campaign on phone usage amongst young people while driving
smoking kills on cigarette packets
98
Advantages of provision of information
Market friendly as it doesn’t disrupt the market
Market efficiency
Protects customer
Helps consumer act rationally
Can be used alongside other policies
Costs can be passed on to the producer - cigarette packaging
Increases demand for merit goods and decreases demand for demerit
99
Disadvantages of provision of information
Can be expensive to produce - opportunity cost
Government may not have all the information themselves
Consumers may act irrationally - addiction
No guarantee for effectiveness, especially if inelastic
May target wrong people
Most effective in long run
100
Government Regulation
A set of rules, normally imposed by the government, that seeks to modify or determine the behaviour of firms
101
Deregulation
The removal or reduction of government regulations in a specific industry
102
Prohibition
The act of forbidding something by law
103
OFGEM
Office for Gas and Electricity Markets
Aim to protect energy consumers by ensuring they are treated fairly and benefit from a cleaner, greener environment
Carry out investigations into company behaviour, have the power to require disclosure of information, and to impose fines and enforcement orders on companies where breaches have occurred
104
Advantages of regulators
Encourages competition
Efficiency
Prevents exploitation
Allows market to work effectively
105
Disadvantages of regulators
Regulatory capture
Asymmetric information ~ firms - regulators
Theory of second best - rarely the best option to correct a market imperfection
106
Advantages of regulation - think about what regulation targets
May be effective if demand is unresponsive to price changes
Often straightforward and easy to apply
May act as a spur for businesses to innovate to cut the level of carbon emissions.
Strengthens competition when regulation targets asymmetric information
Protects small businesses
Reduces supernormal profits for businesses with market power
107
Negatives of regulation
High cost of enforcement/administration of laws
Can lead to unintended consequences (government failure)
Cost for businesses to abide to regulations - may mean they're less competitive globally
Tight regulation may lead to illegal trading
Compliance with regulations can cause delays
Can be misguided
Regulation on collusion means price competition which may increase prices for consumers
108
Tradable Pollution Permits
Government gives firms a permit which allows them to produce up to a set amount of carbon each year. These can be traded.
UK has a national price on carbon, companies can buy and sell permits to match their aims
109
EU emissions trading system
Makes polluters pay for their greenhouse gas emissions
Covers emissions form energy and manufacturing as well as air, maritime and road transport
Since 2005, 37% in emissions in power and industry plants
Fine of €100 per tonne of pollution over permit
110
Advantages of tradable pollution permits
Selling permits can raise revenue and can invest in energy efficient innovation
Incentive to invest in green energy
Benefits companies who already have low emissions
Internalises the externality - polluter pays principle
Allows free market mechanism to resolve situation
111
Disadvantages of tradable pollution permits
Firms can base in other counties without the system - not global
Cost of administration/enforcement
What is the right amount of CO2
How much CO2 does a firm emit - difficult to calculate an exact amount
Cheating - VW lied about emissions of their cars
No international agreement means firms in some countries have an advantage over other firms with pollution permits
Political interference
112
Government Failure and cases
Occurs when an intervention leads to a deeper market failure or a new failure:
Short term policies may have damaging long-term consequences e.g. advertising vaping
Polices may be ineffective in meeting their aims
May create wealth/income inequality
Unintended consequences
113
Key causes of government failure
Political self interest/lobbying
Myopia
Regulatory capture
Information failure e.g. advertisement of diesel as an eco-friendly alternative to petrol
Disincentive effects
Conflicting policy objectives
Damaging effects of red tape - regulation leading to higher business costs
114
Examples of government failure
Smoking ban introduced in restaurants - increase in smoking outside - antisocial behaviour and litter
Government introduces landfill taxes - increase in fly-tipping
UK government offers a guarantee to all bank deposits to protect the financial system - moral hazard
Scottish government introduces a minimum price of 50p per unit of alcohol - formation of a black market with no regulation on ingredients
Government announces £10bn project to widen the M25 to reduce congestion - increase in vehicles on the road leads to increased pollution
115
Regulatory capture
A form of government failure where those bodies regulating industries become sympathetic to the businesses they are supposed to be regulating. It means monopolies can continue to charge high prices
116
Regulatory capture examples
May limit innovation in fast-growth markets
Price caps may stop new firms entering a market
Regulation becomes bureaucratic and costly
May lack the powers to be truly effective in protecting consumers
May be "behind the curve" with new technologies
Frequent rule changes can stifle business investment
117
Evaluation of government intervention
Value judgement - many people have vested interest
Changing prices to change incentives + behaviour - PED has effect on effectiveness
Social science - effects of intervention is hard to forecast as people's behaviour is subject to change
Combination policies - one single intervention is unlikely to be a solution
Power of markets - market forces can be powerful in finding profitable solutions to problems
Law of unintended consequences - policy doesn't always work in the intended ways
