Theme 1 - Introduction To Markets And Market Failure Flashcards
(129 cards)
1
Q
What does Certeris Paribus mean?
A
Latin for ‘All other things being equal’ or “all other things remaining the same’. DONE
2
Q
Why is Economics a social science?
A
It provided a unique and special way of examining many areas of human behaviour, as individuals or as organisations.
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3
Q
What is a positive statement?
A
They’re objective statements that can be tested. They’re based on facts that can be proved or disproved using evidence.
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4
Q
What is a normative statement?
A
They’re subjective statements. They’re based on value judgements and cannot be proved or disproved.
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5
Q
What is the basic economic problem?
A
Wants are infinite but resources are scarce/limited.
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6
Q
What is an economic system?
A
A complex network of individuals, organisations and institutions which allocate resources.
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7
Q
Who are the ‘actors’ within an economic system and what do they do?
A
Individuals - Consumers/ workers. May own a factor of production which they supply for production purposes.
Groups- Firms, trade unions, political parties, families and charities.
Government- Range from a local parish council, to a local police authority to a national parliament or supranational body. They exercise power. It establishes or influences the relationships between individuals and groups (e.g. laws).
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8
Q
What is the definition of scarcity?
A
The shortage of resources in relation to the quantity of human wants (unlimited wants but limited resources).
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9
Q
What does opportunity cost mean?
A
The value of the next best alternative forgone.
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10
Q
What are the four factors of production?
A
Land - Natural resources and raw materials. Land included non-renewable and renewable resources. Nearly all things in this factor are scarce (air is an exception). Owners receive rent from land/money from sales of land.
Labour - The work done by people (contribute to production process). The population who are available to work = labour force (of age and capable to work). Different people have different levels of education/experience/training (makes them more valuable).
Capital - Equipment used in production goods and services like factories, schools and machinery. Capital has to be made before land. Much of an economies capital is paid by the government. Owners of capital receive interest on their land.
Enterprise - Willingness to take risk to make a profit. Entrepreneurs who combine the other 3 factors to take risks. If it fails they can lose money but if it succeeds they make a profit.
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11
Q
What are economic goods?
A
They are created from resources that are limited in supply and so are scarce. Consequently, they command a price.
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12
Q
What are free goods?
A
Free goods are unlimited in supply such as sunlight or sand on a beach. Consumption by one person Ford not limit consumption by others. Therefore, opportunity cost of consuming a free food is zero.
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13
Q
What is does a production possibilities frontier show?
A
Illustrates the maximum potential output of an economy when all resources are fully employed/used.
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14
Q
What are capital goods?
A
Those required to produce other goods (e.g. machinery, factory buildings)
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15
Q
What are consumer goods?
A
They give satisfaction/utility to consumers (e.g. smartphones and cars).
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16
Q
What does it mean if a point is on the PPF?
A
Indicates the maximum productive potential of an economy and that resources are being used efficiently.
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17
Q
What does it mean if a point is inside the PPF?
A
Resources are not being allocated efficiently and not all resources are being used (e.g. workers may be unemployed or machinery may be unused).
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18
Q
What is marginal analysis?
A
Involves consideration of the impact of small changes on the current situation. The rational decision-maker will only decide on an option if the marginal benefit exceeds the marginal cost.
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19
Q
What is economic growth?
A
Refers to an increase in the productive capacity of an economy indicating an increase in real output.
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20
Q
What is economic decline?
A
Refers to a decrease in the productive capacity of the economy indicating a decrease in real output.
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21
Q
Would economic decline be associated with an inward or outward shift in the PPF?
A
Inward.
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22
Q
Would economic growth be associated with an inward or outward shift of the PPF?
A
Outward.
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23
Q
What caused movements along a PPF and shifts in PPF?
A
• Reallocating scarce resources from one product to another (opportunity cost)
• If we increase our output of capital goods then fewer resources are available to produce consumer goods.
• Changes in the combination of the tow goods being produced (e.g. capital and consumer goods ~ more to capital, fewer to consumer).
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24
Q
What factors would cause an outward shift in the PPF?
A
• Advances in technology
•Discovery of new natural resources (e.g. oil)
• Improvements in education and training ( increased productivity of workforce)
• Immigration
• Investment
• An increase in the detriment age
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25
What factors would cause an inward shift of the PPF?
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• Natural disasters (e.g. earthquakes, floods)
• War
• Epidemic of disease
• Disinvestment
• Mass emigration
• A deep recession
• Depletion of natural resources
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26
What is the meaning of the division of labour?
The breakdown of production into its components. Work is split up into smaller tasks. Workers specialise in very specific tasks.
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What is specialisation?
A method of production where a business or an area focuses on a limited range of products or services in order to gain greater degrees of productive efficiency.
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What did Adam Smith have to do with the division of labour?
In his book ‘The Wealth of Nation’ Adam Smith set out the view that economic growth could be achieved by increasing the division of labour. Breaking down jobs into smaller tasks would allow works with particular skills to specialise in a particular task without the need to change jobs throughout the day. This saved time and enabled each worker to become an expert in that task so increasing his or her productivity.
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29
What are the advantages of specialisation and the division of labour?
• Greater efficiency
• each worker specialises in tasks for which he or she is best suited (only trained in one task)
• Faster production, greater productivity
• Better quality of work
• Shorter learning periods
• Leads to innovation
• Less strain
• Reduced average costs of production
• Less time is water as a worker no longer has to live from one task to another
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What are the disadvantages of specialisation and the division on labour?
• Monotony and boredom for workers (could result in a decrease of productivity)
• Loss of skills as workers are only trained in one particular task (limited skills - problem if made redundant)
• A strike by one group of workers could bring the entire production facility to a standstill (too interdependent)
• There is a lack of variety because all goods produced on a production like are identical
• Jobs at risk - workers can be replaced by machinery
• Lower labour mobility
• Workers are not motivated
• Lack of responsibility
• Only possible with large scale production
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What are the advantages of specialisation to trade?
If a country specialises in the production of certain goods and species and then it trades these in exchange for goods and services that it does not produce, then it can benefit from increased output, greater choice and lower prices.
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What are the disadvantages of specialisation to trade?
Such specialisation might mean that a country becomes over-dependent on imported goods and services. If it’s goods and services are uncompetitive then unemployment could result, and the country’s value of imports may persistently exceed the value of its exports.
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What are the limits to the division of labour?
• The size of the market (if there is only a small market then it will be difficult to specialise)
• The type of product (e.g. designer products are likely to be unique and not suitable for the division of labour)
• Transport costs (if these are high then large-scale production and the division of labour may not be possible)
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What are the functions of money?
Money’s functions help to facilitate specialisation and the division of labour. The key function are :
• As a medium of exchange enabling people Tod socialise, exchanging the money earned from doing a specialist job for the goods and services they wish to buy
• A store of value enabling people to save in order to buy goods in the future
• A measure of value enabling people to asses the value of different goods and services
• A means of deferred payment enabling people to buy goods and pay for them on credit
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35
What are the characteristics of free market economies?
• Private ownership of resources
• Market forces (i.e. supply and demand determine prices)
• Producers aim to maximise profits
• Consumers sim to maximise satisfaction
• Resources are allocated by the price mechanism
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What are the characteristics of a command economy?
• Public (state) ownership of resources
• Price determination by the state
• Producers aim to meet production targets set by the state
• Resources are allocated by the state
• There is greater equality of income and wealth than in free market economy
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What are the sectors of production?
Primary - Growing, extracting from natural resources
Secondary - Manufacturing and construction
Tertiary - Services
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What is a private sector?
It’s owned and run by individuals, profit-making.
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What is a public sector?
It’s owned and run by the government, to provide a service for the population.
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40
What’s a market?
It’s where buyers and sellers come together to exchange goods and services.
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41
What are the advantages and disadvantages of bartering?
A:
• Allowed a greater variety of goods
• Allows them to specialise
D:
• Must find someone who has what you want and you just want want they’re willing to offer
• May only want a small quantity of what they’re offering
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What are the forms of money in a modern economy?
• Notes and coins (cash)
•Electronic money
• Near monies (e.g. money in a savings account)
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43
What is the governments role in a free market?
• Provide public goods like defends and street lighting
• To set up a legal framework and to enforce the laws
• To issue property rights
• To regulate markets ensuring fair competition and consumer protection
• To facilitate trade of to stop practices that hinder it
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44
What is the government’s role in a mixed economy?
• Provided high quality merit goods like education, healthcare, public transport and perhaps also libraries, museums and public parks
• Uses the tax and benefits system to reduce inequality
• Ensures a safety net of social housing for the less well-off
• Regulated business activity to ensure adequate protection for consumers, employees and the environment
• Redistribution of income from the rich to the poor
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45
What is a mixed economy?
It’s a mixture of the free market economy and command economy. In practice, there are no absolutely free markets and no absolutely command economies (mostly mixed). In these economies, some resources are allocated by the price mechanism while others are allocated by the state (e.g. Norway, France)
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46
What is a free market economy?
Refers to all the buyers and sellers of a product or service who determine it’s price (e.g. USA, Hong Kong)
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47
What is a command economy?
One in which resources are allocated by the state (e.g. China, North Korea, Cuba).
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48
What are the advantages of a free market economy?
• Consumer sovereignty - this implies that spending decisions by consumers determine what is produced.
• Flexibilty - the free market system can respond quickly to changes in consumer wants
• No officials are needed to allocate resources
• Competition and the profit motive help to promote an efficient allocation of resources
• Increased choice for consumers in comparison to a command economy
• Economic and political freedom for consumers and producers to own resources
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What are the disadvantages of a free market economy?
• Inequality - those who own resources are likely to become richer than those who don’t own resources
• Trade cycles - free market economies may suffer from instability in the forms of booms and slumps
• Imperfect information - consumers may be unable to make rational choices if they have inadequate information or if there is asymmetric information
• Monopolies - there is danger that a firm may become the sole supplier of a product and then exploit consumers by charging prices higher than the free market equilibrium
• Externalities - there are costs and benefits to third parties which are not taken into account when goods are produced and consumed
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50
What is the price mechanism?
The system of resource allocation based on the free market movement of prices, determined by the demand and supply curves.
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51
What are the key functions of the price mechanism?
• As a rationing device - market forces will ensure that the amount demanded is equal to the amount supplied
• As an incentive - the prospect of making a profit acts as an incentive to firms to produced goods and services
• As a signalling device to producers to increase or decrease the amount supplied
• To determine change in wants - a change in demand will be reflected in a change in price
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52
What is consumer surplus?
The difference between the price the consumer is willing to pay and the price they actually pay.
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53
What is the law of diminishing marginal utility?
States that the marginal utility of a good or service declines as its available supply increases. As each unit of the good is consumed, the consumer satisfaction decreases.
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54
What is producer surplus?
The difference between the price the producer is willing to charge and the price they actually charge.
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55
What are the advantages of a command economy?
• Greater equality - the state can ensure that everyone enjoys the minimum standard of living and that no one is extremely rich
• Macroeconomic stability - the state can ensure that booms and slumps are smoothed out.
• External benefits and external costs may be taken into account when planning production
• No exploitation - there is no exploitation of workers and consumers by privately owned monopolies
• Full employment - the state can ensure that all workers are employed
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56
What are the disadvantages of a command economy?
• Inefficiency - the absence of the profit motive and competition may reduce incentives for investment
• Lack of incentives to take risks - again the avens economy of profit motive may reduce incentives for investment
• Restriction on freedom of choice - people would be directed into jobs deemed to be needed by the state
• Shortages and surpluses - if the state miscalculates supply and demand then there may be excess demand and/ or excess supply of goods and services
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57
What is the neo-classical theory?
A theory of Economics which typically starts with the assumption that economic agents will maximise their benefits and act rationally, and which develops how resources will be allocated in markets and at what price through the forces of demand and supply (margin is a key concept).
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58
What does utility mean?
Refers to the level of satisfaction a consumer receives from the consumption of a product or service.
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What is demand?
The quantity of a good/service that consumers are able and willing to buy at a given price at a given moment of time
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What assumptions are made about consumers’ and firms’ behaviour?
• Consumers act rationally by aiming to maximise their utility
• Firms act rationally by aiming to maximise profits
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61
What does the demand curve demonstrate?
How a fall in price will cause an increase in the quantity demanded (or an extension in demand) and a rise in price will cause a decrease in quantity demanded (or contraction in demand).
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What is the demonstration of the demand curve based on?
• The substitution effect : When there’s a rise in price, the consumer (whose income has remained the same) will tend to buy more of a relatively lower priced hood and less of a higher priced one
• The income effect : When there is a rise in price, consumers will suffer a fall in their real incomes. With normal goods, the fall in real incomes will reduce the quantity demanded so the income effect reduced the substitution effect
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Who are the economic agents?
Individuals, firms and the government.
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What does rational mean in the neoclassical theory?
Economic agents are able to rank the order of different outcomes from an action in terms of their net benefits from them.
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What causes a movement along the demand curve?
Price changes. Given the demand curve has a negative slope, then a rise in price would cause a fall in quantity demanded and a fall in price would cause a rise in quantity demanded.
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What causes a shift in demand curve?
• Real incomes - An increase in real incomes implies that incomes (after discounting the effects of inflation) have increase. This would result in an increase in means for most goods and services, causing a rightward shift in the demand curve.
• Size or age distribution of the population - An increase in the size of the population will cause an increase in the demand for most goods and services. And ageing population would cause demand for some goods and services to rise and the demand for others to fall
• Tastes, fashions or preferences- e.g. W decrease in the popularity of cabbage will cause a leftward shift in its demand curve
•The amount of advertising or promotion - A successful advertising campaign would cause an increase in demand
• Interest rated - They affect the cost of borrowing money (e.g. increase in interest rates increased the cost of borrowing money for mortgages. The demand for houses decreases)
• Prices of substituted or complements - If there is a change in the price of a related hood, it will effect the demand curve for the product.
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If there’s a decrease in demand, what way does the curve shift?
To the left.
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If there’s an increase in demand, what way does the curve shift?
To the right.
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What does decisions being made at the margin mean?
To look at the one decision in isolation.
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What does it mean to think at the margin?
You’re thinking about what the next or additional action means to you. You compare the costs and benefits (which decision will give you the greatest utility).
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What is total utility?
The amount of satisfaction a person derived from the total amount of a product consumed.
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What is marginal utility?
The change in tootle utility from consuming an extra unit of a product.
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What is the law of diminishing marginal utility?
As an extra unit of that good is consumed, the marginal utility (benefit derived from consuming the good) falls.
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What is price elasticity of demand (PED)?
It’s a measure of the responsiveness of quantity demanded for a product to a change in its price.
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What does it mean if the PED is relatively elastic?
The price increase causes a large drop in the quantity demanded.
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What does it mean if the PED is relatively inelastic?
The price increase causes a small drop in the quantity demanded.
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What does it mean if the PED is between 0 and 1?
It’s inelastic, meaning the price change has not had a very significant effect on the quantity demanded.
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What does it mean if the the PED is greater than 1?
The PED is elastic, meaning that a price change has had a relatively significant effect on the quantity demanded.
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What does it mean if the PED is 0?
Perfectly inelastic
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What does it mean if the PED is 1?
Unitary elasticity
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What does it mean if the PED is infinity?
Perfectly elastic
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What is the difference between a vertical and horizontal demand curve?
Vertical - inelastic
Horizontal- elastic
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83
What does a curved PED curve mean?
It’s a curve with unitary elasticity and it’s a rectangular hyperbola with the formula PQ=k.
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What does supply mean?
Quantity of goods that sellers ate prepared to sell at a given price.
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What factors influence PED?
• Availability of substitutes - If substitutes are available there will be a strong incentive to shift consumption to them when the price of the product rises. The existence of substitutes will there gore tend to make demand for the product elastic.
• Nature of the product - if the product is affected then demand will tend to be inelastic
• Durability of the product - if the product is long-lasting then it will be fairly elastic since it is possible to postpone purchases. However, demand for non durable goods tend to be inelastic as these need to be replaced regularly
• Proportion of income spent of product - if only a small percentage of income is spent on a product (like salt) then demand will be inelastic, whereas if a high percentage is spent on a product (like holidays) then the demand tends to be elastic
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86
What is total revenue?
The value of goods sold by a firm and is calculated by multiplying price times quantity sold.
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What are the key relationships between PED and total revenue?
• When demand is inelastic, a price change causes total revenue to change in the same direction
• When demand is elastic, a price change causes total revenue to change in the opposite direction
• When demand is unit elastic, a price change causes total revenue to remain unchanged
• When demand is perfectly inelastic, a price change causes total revenue to change in the same direction by the same proportion
• When demand is perfectly elastic, a price rise causes total revenue to fall to zero
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What is the significance of PED for firms?
If firms know that demand for their product is inelastic then they know they can increase total revenue by increasing price. However, if they know it’s elastic, they can increase total revenue by reducing the price.
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What is the significance of PED for the government?
If the government wishes to maximise tax revenue then it will place indirect taxes on those products whose demand is price inelastic (e.g. alcohol, petrol and tobacco). However, in this case the consumer will bear most of the tax burden.
The government may therefore also tax products and services whose demand is price elastic, in which case the producers will bear a higher proportion of the tax burden.
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What does cross elasticity of demand (XED)mean?
It’s a measure of the responsiveness of quantity demanded for one product (Y) to add change in the price of another product (X).
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What is the equation for XED and what do the results mean?
• Percentage change in quantity demanded of good A over percentage change in price of good B
• Positive XED = products are substitutes (as price of good B rises, quantity for good A rises)
•Negative XED = products are complements (as price of good B rises, quantity of good A falls )
(If XED is close to zero it implies that the products are not closely related)
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Why is knowing the XED helpful to a business?
It helps them set prices for their products. Firms know that complementary goods can command high prices (printed is relatively cheap but the ink is relatively expensive. If a firm is selling a product with a close substitute, if they increase the price of that product the demand for the product will decrease.
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What does income elasticity of demand (YED) mean?
It’s a measure of the responsiveness of quantity demanded to a change in real income.
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What is the equation for YED and what do the results mean?
• Percentage change in quantity demanded over percentage change in real income
• Positive YED = Product is a normal good (as income rises, quantity demanded rises) (income inelastic is between 0 and 1 and income elastic is greater than 1)
• Negative YED = Product is an inferior good (as income rises, the quantity demanded falls)
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Why is PED always negative?
Price and quantity move in opposite direction (since the demand curve is downward sloping)
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What would the relationship between demand and income look like on a graph for a normal and inferior good?
Normal - upwards sloping
Inferior - downward sloping
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What is the significance of YED for firms?
If firms know that demand for their product is income inelastic then they know that demand and total revenue will increase significantly during periods of rapid economic growth but fall significantly during recessions. Knowledge of income elasticity of demand may be important for firms when making investments decisions.
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What is the significance of YED for the government?
If the government wishes to maximise tax revenue during and economics boom it will place indirect taxes on those products whose demand is income elastic. Knowledge of income elasticity might also help the government in estimating tax revenues from indirect taxes on particular goods and services.
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How does a price change affect the quantity supplied?
• A rise in price will cause an increase in the quantity supplied or an extension in supply
• a fall in price will cause a decrease in quantity supplied or a contraction in supply
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What causes a movement along a supply curve?
Price changes. Has a positive slope so a rise in price will cause a rise in quantity supplied.
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What causes a shift in the supply curve?
• Costs of production - Wages, raw materials, electricity (increase in costs of production causes the whole supply curve to shift to the left)
• Productivity of the workforce - If there’s a rise in productivity then the whole supply curve will shift to the right
• Indirect taxes - An I direct tax raises the cost of supply and so cause the supply curve to shift to the left. A rise in VAT will cause the supply curve to become steeper, whereas a rise in specific tax (tax per unit) will cause a parallel leftward shift in the supply curve
• Technology - There’s an increase in productivity so the supply curve shifts to the right
• Discovery of raw materials - Shifts to the right
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What’s a necessity?
It’s a basic good and they’re income inelastic.
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What’s a luxury?
It’s a superior good and it’s income elastic.
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What’s the difference between necessities and luxuries?
Necessities have a lower PED because we need them. However, this isn’t always true as strong branding and advertising will reduce the PED of a product
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What’s a market?
Where buyers and seller meet to exchange goods at services.
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What is the point where demand and supply meet called?
Equilibrium. Quantity supplied is equal to the quantity demanded.
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What factors cause the supply curve to shift (acronym)?
```
Productivity
Indirect taxes
Number if firms in the market
Technology
Subsidies
Weather
Costs
PINTS WC
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What does price elasticity of supply (PES) mean?
It’s a measure of the responsiveness of quantity supplied for a product to a change in its price.
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What’s the equation for PES and what do the results mean?
• Percentage change in quantity supplied over percentage change in its price
• PES will always have a positive value because price and quantity move in the same direction (since the supply curve is upward sloping)
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What’s are the determinants of PES (acronym)?
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Barriers to entry
Raw materials
Inventory
Time
Spare capacity
BRITS
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What’s a producer substitute?
An alternative producers can easily switch to. The wiser this is, the more highly elastic the PES (e.g. can workers be substituted for machinery?)
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What factors influence price elasticity of supply?
• Time - It’s hard to change supply quickly in response to price change in the short run, making supply inelastic. However, in the long run supply is likely to be more elastic and all resources are variable.
• Stocks - if stocks of finished goods are available, the supply will be relatively elastic as manufacturers will be able to respond quickly to a price change
• Spare capacity - if a firm has under-utilised machinery and under-employed workers then supply is likely to be elastic
• Availability and cost of switching resources - of resources, such as labour, have a specific skills or machinery is highly specific, or it is expensive to reallocate resources from one use to another, then supply will be relatively inelastic
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What does the long run mean in Economics?
Period of time when all factors of production are variable.
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What is the short run in Economics?
Period of time when at least one factor is fixed.
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What are the equilibrium price and output determined by?
Interaction of supply and demand.
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What can a change in the equilibrium price be caused by?
• A change in the conditions of demand (demand curve shifts)
• A change in the conditions supply (supply curve shifts)
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What is the price mechanism?
The price mechanism describes the means by which millions of decisions taken by consumers and businesses interact to determine the allocation of scarce resources between competing uses.
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What factors affect consumer surplus?
• The gradient of the demand curve (the steeper it is the the greater the consumer surplus would be)
• Changes in the conditions of demand (increase in demand will increase the amount of consumer surplus)
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What factors affect producer surplus?
• The gradient of the supply curve
• Changes in the contains of supply (increase in supply will increase the amount of consumer surplus)
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What are indirect taxes?
Taxes on expenditure. For example, Value Added Tax (VAT), excise taxes and taxes on gambling. Such taxes cause an increase in the cost of supply so the supply curves shifts to the left.
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What are the two types of indirect taxes?
Ad valorem taxes - percentage of the price of a product (causes supply curve to shift to the left and become steeper than the original curve)
Specific taxes - set amount per unit of the product (supply curve shifts to the left, parallel to the original supply curve)
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What does the incidence of tax measure?
The burden on the tax payer (usually partly on the consumer and partly on the producer)
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When does the incidence of tax fall wholly on the consumer?
When supply is perfectly elastic or demand is perfectly inelastic.
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When does the incidence of tax fall wholly on the producer?
When the supply in perfectly inelastic or demand is perfectly elastic.
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What is a subsidy?
It’s a grant from the government which has the effect of reducing costs of production (cause supply curve to shift to the right).
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What is behavioural economics?
Method of economic analysis that applies psychological insights to human behaviour to explain economic decision making.
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When are subsidises most effective in lowering prices?
When PED is inelastic and PES is very elastic.
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Why might consumers not behave rationally?
• Consideration of the influence of other people’s behaviour - a person subconscious mot learns from the behaviour of others as a guide (social learning).
• The importance of habitual behaviour - the frequency of our past behaviour influenced our current behaviour. Such behaviour required little or no thought (done automatically) habits are difficult to change if they are related frequently and if they’re associated with rewards which arise quickly after the action. Incentives may be required to change such habits.
• Inertia - Consumers may not change their behaviour due to information overload, the complexity of the information or too much choice available
• Consumer weakness and computation - people tend to pay more attention to recent events than distant events when they make decisions. Consumers find it difficult calculating things.
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What are the implications of behavioural economics?
The neoclassical principles of rationality will not accurately describe human behaviour. Consequently, they might have perverse and unintended results when used to formulate a policy.
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