Topic 1 - Introduction To Markets Flashcards
(215 cards)
1
Q
What do economists develop to understand behaviour?
A
Models
2
Q
What are economic models based on ?
A
a set of assumptions
3
Q
What does ceteris paribus mean ?
A
This means ‘everything else remains equal’.
So when economists study the relationship between two factors, they’ll assume that one factor changes while the rest stay constant.
This is the most important assumption for economists to create functioning models.
4
Q
Why do economists make models ?
A
Inability to make scientific experiments
Controlled laboratory tests aren’t possible. In real life, economists can’t keep variables constant.
Therefore, economists build models based on a set of assumptions
5
Q
How can you ‘think like an economist’ ?
A
Economic methodology is similar to that of other social sciences:
Models and theories are used to explain real world evidence.
These models use real life data and can be used to make forecasts about the future.
Statistical analytics can be used to test hypothesise against evidence.
Nearly all models rely on assumptions and simplifications.
6
Q
What are the similarities between economics and other social sciences ?
A
The models use real life data
The theories are used to prove empirical evidence
The models rely on assumptions
7
Q
What is the difference between posited and normative statements ?
A
Positive statements describe the world as it is (can be proved)
normative statements describe how the world should be (opinions that contain value judgments)
8
Q
What’s an example of a positive statement ?
A
the proposal of the new high speed rail HS2. If the exact benefits exceed the exact costs, you could say the project is worth doing. This is positive analysis. However, you may not always know costs & benefits perfectly.
9
Q
What’s a normative statement ?
A
imagine an economist argued for higher unemployment benefits during a recession, because a rich country should take care of its citizens. This is normative analysis
10
Q
What are value judgments?
A
Value judgments are often found in normative statements. They are judgements about society that cannot be quantified and tested.
E.g the homelessness problem in Oxford needs to be addressed and funds should be redistributed to do this. This judgement is within a normative statement.
Value judgements affect economic decision-making, so normative statements are important.
11
Q
What’s the economic problem ?
A
The basic economic problem is that there are not enough resources to satisfy humans’ consumption demands and desires
(It’s a problem of scarcity, there’s unlimited wants but not enough (finite) resources)
OR
There are not enough resources on earth to satisfy humans’ unlimited wants and needs.
The basic economic problem involves working out how to allocate limited resources as effectively as possible to satisfy people’s unlimited wants and needs.
12
Q
What are needs ?
A
Needs - things people can’t live without (e.g. water).
13
Q
What are wants ?
A
Wants - things people can live without but desire (e.g. smartphones).
14
Q
How do we allocate our scare resources ?
A
There are scarce resources in society. Because of this, choices have to be made on how to use these resources. This brings us to the foundation of economic decisions
15
Q
What is the foundation of economic decisions ?
A
What goods/services we produce?
How we produce those goods/services?
Who we produce those goods/services for?
16
Q
What is opportunity cost ?
A
defined as the ‘next best alternative foregone’
17
Q
What are the issues with opportunity cost ?
A
Not all factors have alternatives.
Some alternatives are unknown.
Agents may lack information on alternatives.
It can be difficult to switch some factors to another use.
18
Q
What’s meant by opportunity cost as a price ?
A
You can sometimes refer to the opportunity cost as a price.
If you buy a new bike for £300, then £300 measures the amount of consumption you have given up.
19
Q
How can opportunity cost be used ?
A
Opportunity cost is a useful concept when thinking about allocating resources.
E.g. consumers use it to decide how to spend their earnings
20
Q
What’s an example of a trade off ?
A
Tradeoffs
People face a tradeoff when they make choices.
If you choose to buy a video game, you cannot spend that income on movies.
The opportunity cost is the ‘next best alternative foregone’ - what you would use the money from the video game to buy instead.
21
Q
What’s opportunity cost as time and money ?
A
In some cases, opportunity cost exceeds the monetary cost.
For example, attending university.
As well as the financial cost of tuition, you are giving up time that could be spent earning money at a paying job.
So the total opportunity cost is greater than the financial cost of university because of the lost potential earnings.
22
Q
What are the three main economic agents ?
A
Producers - people/firms that produce goods or supply services.
Consumers - people/firms who purchase the goods/services.
Governments - establishes rules for economies.
23
Q
What’s it up to the the three economic agents to decide ?
A
on how to allocate resources
Producers - people/firms that produce goods or supply services.
Consumers - people/firms who purchase the goods/services.
Governments - establishes rules for economies.
24
Q
How do economic agents make their decision making (how do the decisions link to one another) ?
A
Economic agents make decisions based on their various incentives.
E.g. for firms this might be profit maximisation.
Producers must decide what products to make and the selling price of products.
Consumers decide what products to purchase and how much they want to spend on products.
Governments decide how much they should get involved in the production and consumption process.
25
What is economic activity ?
Production of goods (tangible products) and services (intangible products).
Consumption of goods/services.
Because resources are scarce, we must ask three questions about economic activity.
What, how, and who to produce for?
26
What’s are the two types of resources ?
Renewable and non renewable
27
What are the features of non renewable resources?
There is a finite supply of these resources.
This means that as they are increasingly used up, their cost will get higher.
28
What are examples of non renewable resources ?
Gas
Coal
Oil
29
What is the feature of renewable resources?
the resource comes in unlimited supplies
Deemed as better for environment
30
Why can a renewable resource have an issue with its supply ?
It this depends on the 'rate of extraction'.
If the rate we consume the resource is quicker than the natural rate of production, the resource will become depleted and will have a finite supply.
31
What are examples of renewable resources?
Oxygen (O2)
Wind energy
Solar energy
32
What is division of labour ?
Division of labour involves dividing the workforce and allocating specific individuals to specific tasks
33
What’s the benefit of division of labour ?
It allows labour to specialise in a tasks - workers will become more efficient over time cutting out on waste and therefore costs
34
What’s a real life example of division of labour ?
E.g restaurant operations like Nando's divide up their labour force.
There will be a business manager to oversee the process, as well as designated cooks to make the food and sometimes waiters to serve it.
If each person does one job a lot, they are usually better at that one job than if they did four different jobs with a quarter of their time
35
Who in the late 1700s proved through an example that division of labour could boost productivity in his book The Wealth of Nations ?
Adam Smith
He used the example of a pin factory he visited. He said 10 workers produced 48,000 pins through specialisation. But if each individual carried out every step of production themselves, they'd only make 10-20 each. So the firm avoids employing 2,400-4,800 people through division of labour.
36
How does specialisation through division of labour allow firms to take advantage of economies of scale ?
So as production increases, average unit cost decreases.
E.g if a BMW factory made 1,000 cars each year, each car would be quite expensive.
If they make 50,000 each year, then it can set up an assembly line and cost per unit will decrease.
37
What are the advantages of specialisation ?
Specialisation can lead to economies of scale.
This lowers the long run average cost for the firm.
Specialisation reduces the cost of training workers because they only have to be trained for their particular job.
Specialisation can increase labour productivity. Workers do tasks they're good at and so should produce better quality and/or a higher quantity of products.
38
What are the disadvantages of specialisation ?
Specialised firms are often not flexible.
Workers may struggle to adapt and do a new role quickly if the environment changes. This is because they are only trained in their specialised skill.
Workers may become bored. This could reduce productivity if they start to do their work more slowly.
Countries may be less self-sufficient and struggle when trade suffers
39
What problem did money solve ?
problems created by the barter system
40
What are the 4 main functions of money ?
Deferred payment - Money is a standard of deferred payment
Unit of account - Money is a comparable unit of account
Store of value - Money is a store of value
Medium of exchange - Money is a medium of exchange between the buyer and the seller
41
What’s the issues of a PPF ?
Only a finite amount of goods & services can be produced with a fixed amount of resources
42
What does PPF show ?
The PPF shows economy at its maximum productive potential
43
How many good are in a PPF ?
Society can choose any two goods on or inside the PPF.
44
How is opportunity cost shown on a PPF ?
The opportunity cost is the slope of the PPF
45
Why is the PPF curved ?
The PPF is curved because of the law of diminishing returns
46
As you increase units of one resource and keep other factors constant in a PPF, what happens to the marginal benefit from the extra units ?
the marginal benefit from the extra units will eventually start to decline
47
How is economic growth shown on a PPF ?
The PPF shifts outward if there is economic growth.
This is because the productive capacity of the economy has increased.
E.g. this could be caused from improvements in technology.
But this improvement isn't necessarily equal across all products.
E.g. an improvement in the technology to produce cars isn't necessarily going to affect the ability to produce butter.
48
Why does a trade off occur on the PPF ?
The trade-offs occur when producing on the PPF.
To produce more of one good, you must produce less of another.
For example, if an economy is producing at point A and wants to increase the number of Good X they produce, they must give up producing some of good Y.
The PPF shows the economy working at its maximum potential.
If there are any points underneath the PPF, this means not all economic resources are being deployed.
49
If point A is outside the PPF what’s does this mean ?
If point B is on the PPF what does this mean ?
If point C is inside the PPF what does this mean ?
Point A is a point outside the PPF. It is not currently possible to produce at this point.
Point B is a point on the PPF. At this point, all available factors of production are being fully used. All points along the PPF like point B are productively efficient.
Point C is inside the PPF. At this point, there are factors of production being underemployed.
50
What does PPF stand for ?
Production Possibility Curve
51
Are all points on the PPF productively efficient or allocative efficient.
Every point on the Production Possibility Frontier (PPF) is productively efficient.
Not every point is allocatively efficient.
52
What is efficiency?
Efficiency refers to a lack of waste
53
What is static efficiency ?
Static efficiency refers to the efficiency at a point in time.
54
How does productive efficiency occur ?
With all available inputs and technology, it is impossible to produce more of one good without decreasing the quantity of another good being produced.
So, every point on the PPF is productively efficient.
55
How does allocative efficiency occur ?
This occurs when a specific combination of goods is efficient for society.
As this is a specific combination of goods, it refers to a point on the PPF, not the entire curve.
So, not every point on the PPF is allocatively efficient
56
When the total level of resources change what happens to the PPF ?
When the total level of resources changes, the PPF shifts.
57
What happens to the PPF when there’s increasing resources?
- PPF shifts outwards as output increases (economic growth).
58
What happens to the PPF when there decreasing resources ?
PPF shifts inwards as output decreases (negative economic growth).
59
What’s one reason that the PPF shifts outwards even when there is fixed resources?
Improvements in technology
When resources are fixed but output increases (e.g. through improving labour or technology), the PPF shifts outwards.
So an outward shift reflects economic growth.
60
Explain opportunity costs using a PPF with consumer goods vs capital goods ?
Capital vs consumer goods
Goods can be split into two groups:
Capital goods.
Consumer goods.
There is an opportunity cost in producing these goods. For example, if we increase the output of capital goods, we cannot produce as many consumer goods.
But if a country invests in increasing capital goods, the economy's productive capacity can increase and the PPF curve can shift outwards.
61
What are the two types of market systems (economies) ?
A free market and a command economy
62
How does the free market economy work ?
This type of market allocates scarce resources based on the price mechanism.
63
What are the benefits of a free market economy ?
It is efficient - only the highest value products are in demand. So firms are incentivised to produce as efficiently as they can.
It rewards entrepreneurship.
Consumers have greater choice of products because of the increased levels of innovation.
64
What are the negatives of a free market economy?
Inequitable - what is fair in the free market may not necessarily be fair in reality.
Missing markets - goods we need in society may not be produced if they cannot generate a profit.
Monopolies may arise.
65
How does the command economy work ?
Government is in charge of resource allocation. North Korea has a command economy.
66
What are the benefits of a command economy ?
This can correct the inequalities that exist in the free market.
There could also be a possible reduction in unemployment.
They can break up monopolies.
67
Negatives of the command economy ?
Less efficient - the government is not a profit maximising entity. So the incentive for entrepreneurship and efficiency pushing activities is reduced.
Asymmetric information - the government may not actually know what is best because of asymmetric information.
Choice restriction.
68
What’s the mixed economy ?
Where the government meets the free market
The government forms the public sector.
Firms form the private sector.
Together, they are responsible for the allocation of scarce resources.
69
What did Adam smith believe when it came to free market economies and command economies ?
Smith was an advocate of the free market and the power of the 'invisible hand'.
He thought consumers and producers were both driven by self-interest.
He believed that the interaction of profit maximising firms and consumers would lead to a mutually beneficial allocation of resources.
He believed that there should be no monopolies and low barriers to entry.
70
What did Karl Marx believe when it came to free market economies and command economies ?
Marx argued that the free market creates inequality and a situation where the working class are exploited.
He said this would lead to a revolution where means of production would be seized.
Marx's theories gave rise to communism, even though they said little about how command economies could actually work. Communism started to lose popularity when communist states began collapsing towards the end of the 20th century.
71
What did Friedrich Hayek believe when it came to free market and command economies ?
Hayek was skeptical of command economies. He argued that asymmetry of information stopped them from making good decisions about resource allocation.
He believed that firms and consumers know best, and they should use the price mechanism to interact effectively.
He thought the price mechanism was a means of communication between producers and consumers.
72
What are the rational agents ?
(people, governments or companies/producers)
who use utility theory to guide their decision-making
73
How do agents make decisions?
A rational agent wants to maximise their utility.
To do this, they will try to maximise their total utility.
A rational consumer will want to consume something up until the point where marginal utility and price are equal
74
How is the rational agent (producers) meant to gain their utility ?
Through maximising profits
75
What are the reasons that the rational agent (producers) want to profit maximise ?
Survival.
To reinvest profits.
To offer managers and staff members better rewards.
Maximising revenue.
Maximising market share (and gaining monopoly power).
Ethical objectives (e.g. supporting the local economy).
76
What does the rational agent (government) do to get their utility ?
Governments should act in ways that best serve the population and, trying to maximise overall welfare.
Achieving economic growth.
Reducing inflation.
Reducing or eliminating unemployment.
Achieving a balance between payments in and payments out (equilibrium).
77
How do the rational agent (consumers) maximise utility?
Consumers are said to act rationally and maximise utility within the limits of their income.
Different consumers will have different interpretations of utility. One consumer might prioritise financial security (e.g. in saving for a property). Another consumer might want flashy clothes.
Consumers may also want to maximise their work-life balance (i.e. maximising their income while enjoying as much free time as they can). Consumers act as workers when they do this.
78
What illustrates the relationship between quantity demanded and price ?
A demand curve
79
What’s the relationship between price and quantity demanded ?
Price is what the buyer pays for a specific good or service.
Quantity demanded is the total number of units purchased at that price.
The demand curve is downward sloping and shows the relationship between price and quantity.
This means that the higher the price is, the lower demand is.
The law of demand shows the inverse relationship between price and quantity, assuming all other variables are constant.
80
What is “willingness to pay” ?
desire to pay based on tastes and preferences
81
What is “ability to pay” ?
Ability to pay - factors in a person's income, and whether they can afford the good or service or not
82
What are substitute goods ?
an increase in the price of one good will increase the quantity demanded of the other.
E.g Persil and Ariel washing pods
83
What are complement goods ?
an increase in the price of one good will cause a decrease in the quantity demanded of the other.
E.g flights to Spain and suncream.
84
What are the two theories that explain the relationship between price and quantity ?
Income and substitution effects
85
What’s the income effect ?
when prices fall, consumers can afford a greater quantity of goods and services (assuming income is fixed). So demand for these goods and services increases.
86
What’s the substitution effect ?
when the price of one good falls, consumers will buy more of the cheaper good or service and less of the more costly good or service. So demand for the cheaper good will increase; demand for the costlier good decreases.
87
If you increase the price of one good, what will happen to the quantity demanded of its complement good?
Decreases
88
What are factors that cause shifts in the demand curve ?
Change in demand
Change in income
89
What happens to the demand curve when there is an increase in demand for a good at each price level ?
The demand curve will shift right
E.g if a product were to suddenly become more popular, the demand curve would shift right.
90
What happens to the demand curve when there is a decrease in demand for a good at each price level ?
The demand curve will shift left when
91
The effect of a change in income depends on what ?
The type of good
92
For a normal good, increased income will lead to what ?
For a normal good, increased income will lead to an increase in quantity demanded.
E.g new cars
93
For an inferior good, increased income may lead to what ?
For an inferior good, increased income may lead to a reduction in quantity demanded.
E.g rice (if more expensive products like meat can be afforded).
94
What do changes in prices cause on a demand curve ?
Changes in prices cause a move along the curve
Movements along the curve happen in response to a price change.
95
What happens to demand when there’s a rise in price ?
A demand contraction.
96
What happens to demand when there’s a fall in price ?
a demand expansion
97
What is the law of diminishing marginal returns ?
Diminishing marginal returns is the concept that the more of something you add, the lower the impact of each additional unit, assuming all else is fixed
98
What’s the law of diminishing marginal utility?
Marginal utility is the extra benefit to an individual of consuming a good or service.
The law of diminishing marginal utility states that the more an individual consumes (ceteris paribus) the utility of the good/service decreases with every additional unit consumed.
99
How does the law of diminishing marginal returns explain why demand curves slope downwards ?
As the quantity purchased rises, the price that consumers are willing to pay falls.
Consumers may be willing to pay a lower price for a higher volume because they gain less utility (or satisfaction) from each extra unit
100
How is domino’s an example of diminishing marginal utility ?
The first slice of Domino's pizza is very satisfying, but the 100th may not be quite as enjoyable.
Your tastes can be satiated (you can have enough of something). Eventually, the marginal utility of another slice of pizza may be negative.
101
Which economic concept does this describe?
"The more of something you add, the lower the impact of each additional unit"
Diminishing marginal utility
102
What is level of consumption determined by?
Marginal utility from good
Utility from other goods
The budget the consumer has to spend
The preferences of the consumer
103
The price of flights to Ibiza drop dramatically. What would we expect to happen to the quantity of flights demanded to Greece (all other things being equal)?
They would fall
104
How is too many workers an example of diminishing marginal returns ?
In the short-run, factors such as land and capital can be fixed or hard to expand.
Therefore, increasing labour (the number of workers) could be the quickest route to expanding.
But the marginal product of each worker may decrease over time.
Think of employing an additional ten waiters in a small restaurant: the first few might be useful and improve the experience but the ninth and tenth might just get in everyone else's way!
105
What do elasticities measure ?
Elasticity measures the responsiveness of one variable to the change in another variable
106
What is the formula for PED ?
Price elasticity demand (PED) = % change in quantity demanded ÷ % change in price.
107
What is the PED of an elastic demand ?
Elastic demand is where the PED > 1
108
What is the PED of an inelastic demand ?
Inelastic demand is where the PED < 1
109
What is unitary elasticity?
Unitary elasticity is where the PED = 1.
110
Why is PED almost always negative ?
PED is almost always negative as an increase in price would result in a decrease in demand. But you may see some questions refer to it as positive for ease.
111
What’s the equation for income elasticity of demand (YED) ?
Income elasticity of demand = % change in quantity demanded ÷ % change in income.
112
What is the YED of a normal good ?
Normal goods have a positive income elasticity, YED > 0 (income rises; demand increases)
113
What is the YED of inferior goods ?
Inferior goods have negative income elasticity, YED < 0 (income rises; demand decreases).
114
What is Cross-price elasticity of demand (XED) ?
Cross-price elasticity of demand is when a change in the price of one good can change the quantity demanded of another.
115
What is the formula for XED ?
Cross-price elasticity of demand = % change in quantity demanded of good A ÷ % change in the price of good B.
116
If XED is positive what are the goods ?
XED is positive if the goods are substitutes
117
If XED is negative what are the goods ?
If XED is negative the goods are complements
118
If XED is close to 0 what goes this suggest about goods ?
If XED is close to zero this would suggest that the goods are unrelated.
119
Why might the demand for burgers go up in a recession?
Burgers may be an inferior good
120
Why is the XED of compliments negative ?
For complements, a fall in the price of one good will lead to an increase in the quantity demanded for the other good. Complements have negative cross-price elasticities of demand.
E.g. peanut butter and bread.
E.g ice cream and sun cream.
XED < 0
121
Why is the XED of substitute goods positive ?
For substitutes, a fall in the price of one will lead to a fall in the quantity demanded of the other. Substitutes have positive cross elasticities of demand.
E.g. coffee and tea.
XED > 0
122
What is the XED of independent goods ?
Independent goods have a cross-price elasticity of demand of zero.
E.g donkeys and ice cream.
XED = 0
123
What is the PED of a perfectly elastic good ?
Perfectly elastic demand - PED = +/- infinity.
Any price increase will cause demand to drop to zero.
124
What is the PED of an inelastic good ?
Perfectly inelastic demand - PED = zero.
Any price change won't affect demand.
125
What does a perfectly in elastic diagram ?
A perfectly inelastic demand curve would look vertical on a diagram as the quantity demanded would be the same regardless of the price.
An easy way to remember this is that the more inelastic demand is, the more the demand curve looks like an 'i' for 'inelastic'.
126
What affects the elasticity of demand?
Impact of indirect taxes
Impact of subsidies
Type of good
Percentage of income and time
Availability of substitute goods/services
127
How do indirect taxes affect the elasticity of demand ?
The impact of an indirect tax depends on the PED of the good or service.
Picture a tax as effectively shifting supply to the left. This leads to a fall in demand.
However, if the good has inelastic demand, the reduction in consumption will be small. The consumer burden is significantly higher than the producer burden.
The reverse is true for an indirect tax on a good or service with elastic demand.
Therefore PED is central to the impact of an indirect tax.
128
How do subsidies affect the elasticity of demand ?
The impact of a subsidy depends on the PED of the good or service.
Effectively, a subsidy shifts the supply curve to the right. This means demand should increase.
If the good or service has an inelastic demand, the price will drop more than the quantity increases.
If the good or service has an elastic demand, the price will drop less than the quantity increases.
Therefore PED is central to the impact of a subsidy.
129
How does the type of good affect the elasticity of demand ?
The nature of the good can influence how elastic the demand is.
Addictive goods tend to be more price inelastic because a change in price is unlikely to affect quantity significantly (if users feel they have a need for the product).
E.g. cigarettes.
But items that are not absolutely essential are more elastic.
E.g. kitchen roll.
130
How does the percentage of income and time affect the elasticity of demand ?
The higher the proportion of income spent, the more elastic the good or service is. People are more sensitive to the price of a TV vs a Mars bar.
Goods tend to be more price elastic in the long run because time can be devoted to searching for appropriate alternatives.
131
How does the availability of substitutes affect the elasticity of demand ?
The more substitutes there are available, the more price elastic a good is.
This is because it is easy to find an alternative product as a replacement if the price of one good rises.
E.g. washing detergents are fairly price elastic. If the price of one goes up, you can easily swap it for an alternative.
132
For the majority of households, how could you describe the elasticity of demand for a car?
Elastic
133
If demand is inelastic, how should a firm change their price to maximise revenue?
Raise their price
134
Imagine Ed Sheeran is selling tickets to his concert at Wembley
How do different PEDs effect his revenue and how he prices ?
He must set a price to maximise revenue from ticket sales.
He starts off with a fixed price in his head. He will sell a number of tickets at this price.
If demand is elastic, then Ed should cut the price because this will raise total revenue.
If demand is inelastic, then Ed should raise the price because this will raise total revenue. Ed Sheeran is likely to sell the same number of tickets but at a higher price. Perhaps he has Shawn Mendes turning up too.
135
How does unitary elasticity work ?
If there is unitary elasticity, any percentage change in price will be offset by an equivalent percentage change in quantity demanded.
So for moderate price changes, revenue will not change.
136
How do you solve total revenue ?
Total revenue = price per unit × quantity
137
How does the PED change along the demand curve ?
At zero demand or high price - PED is minus infinity.
At midpoint - PED is minus one.
At zero price or high quantity - PED is zero.
PED of +/- one = maximised total revenue.
The closer a product's price is to the midpoint, the higher the revenue.
138
If a product has an elastic PED what happens to revenue when you decrease the price ?
Decreasing price = increases total revenue
139
If a product has an elastic PED what happens to revenue when you increase the price ?
Increasing price = decreases total revenue.
140
If a product has an inelastic PED what happens to revenue when you decrease the price ?
Decreasing price = decreases total revenue
141
If a product has an inelastic PED what happens to revenue when you increase the price ?
Increasing price = increases total revenue.
142
What does the supply curve show ?
The supply curve shows the relationship between price (on the vertical axis) and quantity (shown on the horizontal axis).
143
What cause shifts in the supply curve ?
Changes in the price of inputs (these will affect the cost of production).
A discovery of a new technology (allowing the firm to produce at a lower cost).
Changes in Government policy.
E.g taxes, regulations and subsidies.
144
What effect does tax have on the supply curve ?
The U.S. government imposes a tax on alcoholic drinks that collects eight billion dollars per year from producers.
Taxes are treated as a cost by businesses.
Higher costs decrease supply.
So taxes decrease supply.
145
Hat cause an outward shift in supply ?
When a firm's profits increase, it is incentivised to produce more output. This is because the more it produces, the more profit it will earn.
So, when costs of production fall, a firm will be incentivised to supply a higher quantity at a given price.
This is shown by a rightward shift in the supply curve.
Subsidies can lower a firms average cost per unit, encouraging them to expand production also.
146
What factors affect the supply of goods and services in an economy ?
Price of the good
Technology
Costs of production
Productivity
Taxes
147
How does the price of a good affect the supply of goods and services in an economy ?
A rise in price will almost always lead to an increase in the quantity supplied of that good or service. This is also called an extension in supply.
This is because the increase in price incentivises the firm to increase output.
Economists call this positive relationship 'the law of supply'.
148
How does technology affect the supply of goods and services in an economy ?
A reduction in the costs of production will lead to an increase in supply because producer profits have risen
149
How does productivity affect the supply of goods and services in an economy ?
Increases in productivity means the output per input of a factor of supply increases, so supply shifts right.
150
How do taxes affect the supply of goods and services in an economy ?
An indirect tax on supply raises the overall cost of production, shifting supply left.
151
How does technology affect the supply of goods and services in an economy ?
Technological improvements can increase the efficiency of the productive process.
This will reduce the costs of production, shifting supply to the right.
152
What does the price elasticity of supply measure ?
The price elasticity of supply measures how the quantity of supply reacts to a change in price
153
What is the equation for price elasticity of supply (PES) ?
PES = % change in quantity supplied ÷ % change in price.
So an elasticity of supply greater than one means that the percentage change in quantity supplied will be greater than a one % price change.
154
Why do firms want a high elasticity of supply ?
Firms aim for high elasticity of supply so that they can react rapidly to changes in price and demand.
155
What can firms do to increase elasticity of supply (PES) ?
Improve their technology.
Introduce flexible working patterns.
Have excess production capacity.
156
A firm has an elastic supply, PES > 1 what does this mean ?
So a higher PES value means more elastic supply
157
A firm has an inelastic supply, 1 > PES > 0 what does this mean ?
So a smaller PES value means more inelastic supply
158
A firm has a unit elasticity of supply, PES = 1 what does this mean ?
Percentage change in quantity supplied = percentage change in price.
159
What factors influence the price elasticity of supply (PES) ?
Recessionary period
Perishable goods
Agility
160
How does a recessionary period influence the price elasticity of supply (PES) of a good ?
During periods of high unemployment, we tend to see a more elastic supply.
This is because if a firm tried to expand their production, they would have a larger pool of labour to hire.
Their ability to attract this labour is also high.
161
How does a how perishable a good is influence its price elasticity of supply (PES) ?
Products that are likely to perish because of weather conditions will have a more inelastic supply.
E.g crops and agriculture.
162
How does a the agility of a good influence its price elasticity of supply (PES) ?
Firms that are agile keep high levels of stock.
This makes supply price elastic as they can quickly respond to increases in demand by releasing more stock.
More generally, firms with agile factor mobility will be more price elastic in supply.
163
What is price elasticity of supply like in the short run ?
Capacity is fixed.
One or more factors of production are fixed (usually capital).
Often hard to increase production in this period.
Supply = inelastic
164
What is price elasticity of supply like in the long run ?
No factors of production are fixed - all are variable.
Firms are able to increase capacity.
Supply = more elastic than in the short run. Firms have more time to react to price and demand shifts.
165
Why do time periods differ in different industries?
Capital equipment and production times differ across industries. This means that different industries have different time scales for the short run and the long run.
E.g the long run is probably shorter for a software company like Facebook than a aeroplane manufacturer like Airbus.
166
What is an equilibrium price ?
This is the only price where the amount consumers want to buy is equal to the amount producers want to sell.
If the market is at equilibrium, there is no reason to move away.
Supply and demand (market forces) dictate the equilibrium quantity and price in a free market.
167
What is an disequilibrium price ?
Disequilibrium is when the market is not at a stable price and quantity.
If the market is not at equilibrium, economic pressure arises to move the market towards a stable price and quantity.
E.g if petrol prices were to rise above their equilibrium level, the market would respond and the quantity demanded would fall
168
What does excess supply do to equilibrium?
Excess supply and demand occur at disequilibrium.
The higher price makes it more profitable for petrol producers, so output expands.
The difference between the quantity demanded and quantity supplied is now the excess supply.
When quantity demanded exceeds quantity supplied, there is excess demand.
169
What does a shift to the right in the demand curve (but not the supply curve) do ?
An increase in demand (D->D1) will cause an increase in price. Supply will extend and form a new equilibrium (Q1,P1).
170
What does a shift to the left in the demand curve (but not the supply curve) do ?
A decrease in demand (D->D2)will cause the price to fall. Supply will contract and form a new equilibrium (Q2, P2).
171
What does a shift to the right in the supply curve (but not the demand curve) do ?
An increase in supply (S->S1)will cause a decrease in price. Demand will extend and form a new equilibrium (Q1,P1).
172
What does a shift to the left in the supply curve (but not the demand curve) do ?
A decrease in supply (S->S2) will cause an increase in price. Demand will contract and form a new equilibrium (Q2,P2).
173
How would you define the equilibrium price?
This is the only price where the amount consumers want to buy is equal to the amount producers want to sell.
174
What is the price mechanism ?
The price mechanism shows how demand and supply interact.
A change in the price of a good will change the quantity demanded.
The price mechanism is free from bias because it is not governed by one human, but lots of different agents interacting.
175
What are the functions of the price mechanism?
Incentive function
Signalling function
Rationing function
176
What is the incentive function as a function of the price mechanism?
Incentive function: rising prices encourage firms to expand their level of output because of higher profits
177
What is the signalling function as a function of the price mechanism?
Signalling function: if the price of a good changes, this signals to the consumer or producer that they should change their level of consumption or production.
178
What is the rationing function as a function of the price mechanism?
Rationing function: resources are scarce. The price of a good rations that good. This limits supply to those who are willing and able to pay for it.
179
How does the price mechanism work in local markets ?
Local markets: In a local marketplace for fruit, if one market stall sells apples for £20 and sells out of 1,000 apples. Then this is a signal for that firm to increase production and sell more apples. It also signals to competitors that they should start selling apples.
180
How does the price mechanism work in national markets ?
National markets: If Amazon lists a book at £10, but nobody buys it, then there is a signal that nobody demands that book at £10. Either people don't want the good or they are buying it elsewhere at a lower price. There is an incentive to reduce the quantity produced or to reduce the sale price.
181
How does the price mechanism work in global markets ?
Global markets: If the USA can produce steel for £100/ton and sells it for £1,000/ton, this is a signal to nations like China and India that they can make profits by producing steel. They have an incentive to produce steel and enter the market.
182
What are the advantages of the price mechanism ?
It is allocatively efficient.
There is no time cost because no-one needs to be paid to monitor it.
The process is efficient because prices are as low as possible.
Consumers have control over what producers make.
183
What are the disadvantages of the price mechanism ?
Some goods objectively shouldn't be produced through the price mechanism.
E.g being able to buy an organ through the price mechanism isn't necessarily fair.
There will be missing markets for some goods.
E.g street lighting
There will be a huge disparity in wages for low skill and high skill workers, increasing inequality.
The price mechanism usually has no moral overlay or beliefs before a government intervenes.
184
What are the unintended consequence of the price mechanism ?
Market failure can arise through unintended consequences.
E.g people who donate bone marrow might do it for reasons outside of the price mechanism.
By offering payment, it may discourage them from donating, which could lower the total amount of bone marrow donators.
Michael Sandel has done work on social vs market norms. Sometimes social norms rule our lives.
185
How do you find the consumer surplus ?
The demand line represents the value that consumers place on a particular good or service.
At the market price each consumer who values the good or service at or above that price will buy and consume it. A number of consumers value the good or service above the market price and gain utility from the good compared to keeping the money they paid for it.
The sum of all the extra benefit consumers in a market get from buying and consuming a good or service is the consumer surplus.
186
How do you find the producer surplus ?
The supply line represents the cost of producing a good or service.
At the market price, firms who can produce the good or service at or below the market price will supply it to the market.
The sum of the extra money earned above the cost of production is the producer surplus.
187
How do you get the total surplus ?
Total surplus is the producer surplus plus the consumer surplus. Total surplus is the total benefit to society of economic agents buying and selling a particular good or service.
If the market isn't at the market clearing equilibrium there is a deadweight loss. This is because there is an extra possible benefit to society which isn't being generated due to over or under production and consumption.
188
What are indirect taxes on ?
Indirect taxes are taxes on consumption
189
If the demand for a good is inelastic and it is taxed what often occurs ?
The more inelastic demand is, the more of an indirect tax is passed on to consumers
190
What does an indirect tax on a good do to the market equilibrium?
Imposing a tax on a good, shifts the market equilibrium to the left. At this point, there is a lower quantity of output and a higher price.
191
What is the burden of tax ?
When a tax is imposed, the producer may pass on some of this cost to the consumer in the form of a higher price (grey area on the diagram) and absorb the rest (red area).
The proportion of the tax passed onto the consumer depends on the elasticity of demand.
The more inelastic the demand, the more of a tax is passed on and less 'absorbed'.
E.g. demand for cigarettes is inelastic, producers would pass more of the tax onto consumers, knowing that demand won't decrease much.
192
What are the impacts of an indirect tax on the government?
Indirect taxes generate revenues for governments. These revenues can then be spent on capital investment (e.g hospitals for the NHS) or transfer (or welfare) payments.
If demand is perfectly inelastic, the quantity consumed won't change and tax revenues will increase.
However, the burden of a tax would fall completely on consumers. If this was a market made up of mainly poor consumers, then this may not be a good intervention for the government. However, this would need a value judgment.
193
What is the impact of indirect taxes on consumers?
If demand was perfectly inelastic, then the demand curve would be vertical.
The quantity demanded would not change but the price paid would rise.
The burden of the tax would fall completely on the consumer.
If demand was perfectly elastic (horizontal demand curve), then the burden would fall completely on the producer.
194
What is the impact of indirect taxes on producers ?
If demand is inelastic, then consumers bear the whole burden of an indirect tax.
If demand is elastic, then producers bear the whole burden of an indirect tax.
195
How can subsidies correct market failure ?
By encouraging the consumption and production of a good with positive externalities. Governments can pay subsidies to encourage the production and consumption of goods
196
What are some examples of subsides ?
The employment of apprentices (labour as a factor of production) can be subsidised by a government.
A food subsidy was implemented in India to help encourage the production of affordable food in India.
197
What are the impacts of subsidies?
A subsidy will shift the supply curve rightwards. The quantity produced will increase and the price paid by consumers will fall.
Consumers will pay a subsidised price, but a supplier will be paid above the original price
The subsidy payment is the size of the rectangle. The size of the rectangle is equal to the size of the subsidy per unit X total output in the market.
198
How does a subsidy effect consumers ?
Consumer surplus rises as the price that consumers pay has fallen and output has rises
199
How does a subsidy effect producers?
Producer surplus rises because the price consumers pay + subsidy is higher than the price at the previous market equilibrium.
200
How does a subside effect the government?
Producer surplus and consumer surplus rise. However, the government must pay the size of the per unit subsidy X total output. Governments must pay for subsidies using tax revenues or government borrowing.
201
What would subsidising positive consumption externalities do ?
A consumption subsidy will try to cut the price paid by consumers to a lower price to increase consumption
A subsidy will aim to shift the supply curve rightwards to the MSC curve.
202
What did Weitzman say about marginal cost curves ?
If the cost curves are elastic:
A quota set at an output level that is too high will cause no harm. Quantity will still be reduced.
A quota set too low at Q1 will still be below Qe.
However, if the government has rough information, it may be able to set this optimally.
Because the cost curves are
elastic, a relatively small change in the tax rate, can have a big change in the output produced. A tax that is set too high, leading to a price of P2, can have a huge welfare loss of triangle ABC.
If the cost curve is inelastic, the government can miscalculate the price (size of the tax) by a high proportion, and the amount consumed will not change that much. Therefore, if the marginal cost is inelastic, if the tax is too large, the impact on output will not be that great.
203
What does behavioural economics challenge?
Challenges principles of traditional economics that are unrealistic
204
What do traditional economists assume ?
That economic agents act rationally and want to maximise utility.
205
What do behavioural economists recognise about traditional economists views ?
Behavioural economists recognise that these (That economic agents act rationally and want to maximise utility) two premises are unrealistic. They consider how emotional, psychological and social factors can affect decision-making.
206
What do behavioural economists say the reasons consumers can't act perfectly rational ?
Lack of available information.
Limits on time (for decision-making).
Computation weakness - when people can't properly process all the data they need to to make an informed decision.
207
For consumers to act rationally what must they have ?
Symmetric (perfect) information. So asymmetric information limits our ability to make rational decisions
208
What is the lemon example of rational agents ?
Marvin is in a car dealership. He has a choice between two cars with similar features: one is £4,000 and another is £4,600.
In a world of perfect information, Marvin would choose the cheaper car.
In a world of asymmetric information, Marvin's decision becomes more complicated.
Sellers know the flaws of the car and have an incentive to hide these flaws.
His limited decision-making ability is an example of bounded rationality.
209
What is bounded self control ?
Traditional economists assume that people have perfect self-control.
Behavioural economists recognise that individuals have limited self-control (bounded self-control).
210
What are the biases that exist when we make decisions ?
Rules of thumb and habits
Availability bias
Social norms
Anchoring
211
How is ‘rule of thumb and habits’ a biase that exist when we make decisions ?
Rule of thumb is a guide of rules that ease the process of decision-making.
E.g always going for the least expensive option.
Habitual behaviour is where someone repeats their decision-making actions many times.
212
How is ‘availability biase’ a biase that exist when we make decisions ?
This occurs when we attach an emotional connection to an event in our head.
This can make the likelihood of a similar event occurring more or less likely in our head.
E.g England beating Panama 6-1 in the FIFA World Cup makes it seem more likely they will win the tournament.
213
How are ‘social norms’ a biase that exist when we make decisions ?
Social norms are the generally accepted modes of behaviour. So we often make our decisions to conform with these.
These change over time.
E.g 40 years ago drink driving was seen as acceptable; today it isn't.
The social norm has changed.
214
How is ‘anchoring’ a biase that exist when we make decisions ?
Anchoring occurs when we use a reference point from a previous decision to form the basis of another decision.
This reference point is normally irrelevant to the current decision, and so is a form of bias.
215
A firm makes fresh sandwiches to sell to supermarkets each day. What would influence the firm's price elasticity of supply?
Perishable goods
Products that are fresh, such as sandwiches made daily, will have a finite shelf life by the end of which they must be consumed. Hence, because these goods are perishable they will be more price inelastic because sandwiches cannot be stored if demand fell.
Recession
During periods of high unemployment, we tend to see a more elastic supply. This is because if a firm tried to expand their production, they would have a larger pool of labour to hire from. So, depending on the state of the wider economy, the number of sandwiches which can be made easily will be influenced by the firm's ability to recruit new sandwich makers.
