Unit 2 - The price mechanism and the microeconomy Flashcards
1
Q
Define
Market
A
where buyers and seller meet with the intention of either buying or selling
2
Q
Define
Product market
A
manufactured good
3
Q
Define
Labour market
A
market for workers
4
Q
Foreign Exchange Market
A
Market for currencies
5
Q
Commodity market
A
Agricultural goods
6
Q
Stock Market
A
market for financial securities
shares/bills/bonds
7
Q
Who are buyers?
A
consumers whose main aim is to maximise utility
also reffered to as households
8
Q
Define
Utility
A
Satisfaction derived from consuming a good or service
measures in utils
9
Q
What is the aim of the seller?
A
to maximise profits
profits are the yard stick for success
10
Q
Define
Demand
A
The amount of goods and services that buyers are willing to buy, at a given price, per period of time, ceteris paribus
11
Q
What ways can the definition of demand be broken into?
A
- Quantity
- Products
- Buyers
- Willing to buy
- Able to buy
- Various/given prices
- Ceteris paribus
12
Q
Define
Notional demand
A
want is not backed by purchasing power
buyer can’t afford
13
Q
Effective Demand
A
Wanting is backed by purchasing power
14
Q
Why is ceteris paribus part of the definition of demand?
A
The market is very turbulent for the price mechanism theory to work
15
Q
Define
Demand Schedule
A
a table showing the levels of demand for a product at different prices per period of time, ceteris paribus
16
Q
Define
Demand Curve
A
A curve showing the levels of demand at different prices, per period of time ceteris paribus
17
Q
Explain the relationship show by the demand curve
A
The demand curve is downward sloping, showing an inverse relationship between price and
quantity demanded
18
Q
What are the factors affecting demand
for a product or service
A
- Price of a good Itself
- Price of Complements
- Price of substitutes
- Consumers’ disposable income
- Advertising and promotion
- Availability of credit facilities
- Fashion taste and preferences
- Population
- Seasonal demand
- Changes in legislation
19
Q
What causes movement of the demand curve?
Change of quantity demanded
A
This is caused by the price of the good itself and no other factor
20
Q
What causes Expansion of the demand curve?
extenstion
A
Increase in demand caused by decrease in price of a good
21
Q
What causes contraction of the demand curve?
A
A decrease in demand caused by an increase in the price of a good
22
Q
What causes a shift in the demand curve?
Change in demand
A
All other factors affecting demand except the price of the good itself
23
Q
Individual demand curve
A
The demand curve of an individual buyer.
This can be a consumer firm or government
24
Q
Horizontal summing for the individual demand curves
A
The sum of the x axis of individual demand curves are added up to put on the market demand curve for the entire market.
25
Individual Demand
The amount an individual or single firm will buy at each price
26
Supply
The amount of goods or services that producers are willing **and able** to bring onto the market and sell at different prices per period of time Ceteris paribus
27
Describe the relationship between supply and price
Price and Quantity demaned have a direct relationship
28
What factors affect movement of the supply curve?
Only the price of the good itself
29
What factors affect shifts in the supply curve?
| change in supply
all factors except the price of the good itself
30
What causes expansion of the supply curve?
Increase in the price of the good
31
What causes contraction of the supply curve?
Decrease in the price of the good itself
32
# Define
Equilibrium
State of rest with no tendency to change
33
# State
Law of supply
*ceteris paribus* more goods will be supplied onto the market at a higher price than at a lower price
34
# State
Law of demand
More goods will be demanded at a lower price
35
What is excess supply?
Any price above the equilibrium price
36
What is excess demand?
Any price below the equilibrium price
37
What is equilibrium price?
The price at which supply is equal to demand because the market is always in equilibrium
38
When is the market in disequilibrium?
Excess supply (Any point above equilibrium price)
Excess Demand ( any price below equilibrium)
39
What roles does price play in the market?
Rationing
Incentive
Signalling and the transmission of preferences
40
What is the invisible hand?
The price mechanism working automatically
41
How does the price system lead to **Rationing**
If demand is high and supply is low then prices will be high.
to combat this then suppliers increase the prices to to limit the buyers to only those who can afford to pay high prices
Supply can also be limited to allow goods to remain exclusive allowing them to sell the goods for high prices
42
How does the price system create **Incentive**
Low prices, discounts and deals encourage customers to buy more goods, because utility increases when consumers thing they are getting a good deal
Higher prices lead to less demand but can encourage supply to increase as suppliers aim to profit more from expensive goods
43
How does the price system lead to **Signalling and transmission of preferences**
Price reflects market conditions
An increase in price signals suppliers to produce more, and if demand falls so does the price of the good, signalling to supplier they need to lower prices, improve the product or produce less
44
# Define
Complement
| Joint Demand
A good which is purchased with other goods to satisfy a want
| pen + ink
45
# Economic Theory
Complement
A rise in quantity demanded of one good, will lead to an increase in demand for it complements, resulting in an increase in price and quantity bought of the complement
46
# Define
Subsitute
| Competitive Demand
A good that can be replaced by another
| they satisfy the same want
47
# Economic Theory
Substitute
A rise in price of one good will lead to an increase demand and rise in price of its substitute
48
# Define
Derived demand
when the demand of a good is the result of the demand for another good
49
# Economic Theory
Derived Demand
An increase in demand for a good, will lead to an increase in price and quantity of goods that are in derived demand from it
50
# Define
Joint Demand
| Composite Demand
When a good is demanded for two distinct uses
| Crude oil and its fractions
51
# Economic Theory
Joint Demand
An increase in demand of a good will lead to a fall in supply, rise in price therefore a fall in quantity demanded of another good in joint demand
52
# Define
Joint Supply
When two or more goods are produced together so that a change in supply of one good, will lead to the same change to the other good in joint suppy
53
# Economic Theory
Joint Supply
An increase in demand for one good in joint supply will lead to an increase in its price. This will lead to an increase in the quantity supplied of the good.
Hence an increase in supply of the other good, and a fall in its price
54
# Define
Elasticity
The measure of the extent to which quantity demanded or supplied responds to a change in the variable which affects it
55
# State
The variables of Elasticity
Price Elasticity of:
PED & PES - supply and demand
XED - complements and substitutes
YED - Consumer's Income
56
# Define
PED
The responsivness of demand to changes in the price of a good
57
# State
The types of PED
Elastic
Inelastic
Perfectly Elastic
Perfecly Inelastic
Unitary Elastic
58
# Equation
PED
%ΔQ / %ΔP
or
ΔQ|Q / ΔP|P
59
# Describe
Elastic Demand
When a small change in price leads to a large change in quantity demand or when the elasticity ratio >1
60
What does line abc represent?
The total tax per unit
61
What does line bc represent?
Tax for producer per unit
62
What does line ab represent ?
Tax for consumer per unit
63
What does area ac P0 P2 represents
Total tax paid to the government
64
# Define
Inelastic Demand
When demand is not very responsive to changes in price or when the elasticity ratio 0
65
# Define
Perfectly inelastic demand
Demand does not vary with change, consumers are willing to pay any price for the good eg. Necessities
Elasticity ration = 0
66
# Define
Perfectly Elastic Demand
There is one price that consumers are willing to pay eg. price controlled goods
Elasticity ratio = infinity
67
# Define
Unitary Elasticity
Change in price is met with a proportional change in demand (revenue remains constant)
Elasticity ratio = 1
68
# State
Factors affecting PED
1. Habit forming goods
2. Time period
3. Percentage of income spent on a good
4. Number and availability of substitutes
5. Neccessities and Luxuries
6. Width of definition (branding)
69
How do habit forming goods affect PED?
Habit forming goods like addictive substances have inelastic demand as they cant be forgone
Non habit forming goods have elastic demand as they can be forgone
70
How do time periods affect PED?
In the Short run demand is inelastic as there is no time to look for alternatives
In the Long run demand is elastic as there is more time to deliberate
71
How does percentage of income affect PED?
If a larger portion of income is spent on a good then demand is elastic
if a smaller percentage of income is spent on a good then demand is inelastic
72
How does the availability of substitutes affect PED?
If many substitutes are available, then demand is elastic
If substitutes are few, then demand is inelastic
73
How do necessities and luxuries affect PED?
Necessities have inelastic demand as they are needs
Luxuries have elastic demand as they are wants
74
How does width of definition affect PED?
| branding
Branded goods have inelastic demand
Unbranded goods have elastic demand
75
# State
Economic relevance of PED
1. Price determination
2. Production planning
3. Price discrimination
4. Government and Taxes
76
How is PED used to determine the price of a good?
If demand is elastic, then a lower price will yield a larger revenue
If deman is inelastic, then a higher price will yield a larger revenue
if demand is unitary mantaining price will be the best option as revenue is constant
77
How does PED help in production planning?
Used to estimate the effect of changes in price,allowing the company to plan on what goods to produce, how many people to hire and the impact on cash flow
78
How is PED used for price discrimination?
79
How is PED used by governments and taxes?
Taxes reduce supply and increase prices.
If demand is elastic or supply is inelastic then the tax burden falls on producers
if demand is inelastic or supply is elastic then the tax burden falls on the consumer
80
Problems with PED
* Hard to draw this graph
* Data collection problems
* Price is affected by numerous factors
81
# Define
YED
Income elasticity of demand
measures the reponsivness of demand to changes in income
82
When is YED elastic?
When it is highly reposive to changes in income
83
When is YED inelastic?
When demand is unreposive to changes in income
84
# Describe
Normal goods
These are goods with positive YEDs, showing a positive relationship
As income increases so does demand
85
# Describe
Necessity goods
Type of normal good
YED is positive but 0> x>+1
quantity demanded is unlikely to change even with changes in income
86
# Describe
Superior goods
| luxury
Type of normal good
PED ratio of >+1
Income rises, more proportionate increase in demand
87
# Describe
Inferior goods
YED ratio is negative
As income increases demand decreases
88
# Graph
Elastic YED
Small change in income big change in demand
| YED>1
89
# Graph
Inelastic YED
Big change in income small change in demand
| YED 0>x>1
90
# Graph
Perfectly Elastic YED
Demand can vary at the same income
| YED = infinity
91
# Graph
Perfectly Inelastic YED
Demand is constant irrespective of changes in income
| YED = 0
92
# Graphy
Unitary YED
Change in demand is proportionate to change in income
| YED = 1
93
Relevance YED
Determine what types of goods to stock
Normal goods during economic booms and inferior goods during hardships to ensure money is always being made.
Products in the primary sector have inelastic YED in the secondary sector they have elastic YED
Used so that the government knows when to make changes for income tax
94
# Define
XED
Cross elasticity of demand
A numerical measure of the responsiveness of demand of one product to changes in price of another related product
95
What does a negative XED represent?
Goods that are complements
96
What does a positive XED represent?
Goods that are substitutes
97
How is the closeness between substitutes and complements observed?
If the two goods being compared have an Elastic XED then they are close substitutes or complements of each other as the price of Good A drastically affects demand for good B
If the XED is inelastic then they are weak complements or substitutes as the change in price of one does not highly affect demand for another.
98
Economic relevance of XED
Allows a business to estimate the effects of changes in price of their competitors on their own goods
Allows businesses to estimate effects of changes of price of complements on their own goods
Allows the company to estimate the effects on customers expenditure using special deals and promotions (make complements cheaper to draw in customers, increase price of the goods itself)
99
# Define
PES
Price elasticity of supply
A numerical measure of the responsiveness of supply to changes in price of the product itself, ceteris paribus
100
Why is PES positive?
Price and supply have a direct relationship
101
Why does a price increase for PES always favoured?
Price and Quantity supplied have a positive correlation between price and quantity supplied, price increases will always lead to more revenue
102
# State
Factors affecting PES
1. The number of producers
2. The existence of spare capacity
3. Ease of storing stocks
4. The time period
5. Factor mobility
6. Length of the production period
103
Economic relevance of PES
If demand increases for a good, the the good with inelastic demand will have larger increase in price than the one with elastic demand.
This knowledge informs supplier with goods with inelastic demand to raise prices more sharply in response to surges in demand
104
How does the number of producers impact PES?
If there are many producers then the PES will be elastic as it is easier to increase output to the market
If there are few then it will be inelastic as it is difficult to supplement during shortages
105
How does spare capacity affect PES?
If there is spare capacity then is is easy to increase output with increases in price, so it is elastic
If there is no spare capacity then PES will be inelastic
106
How does ease of storing stocks affect PES ?
If it is easier to store stocks then PES will be elastic, as stocks can be kept and sold later
If it is difficult to store stocks then PES will be inelastic eg. Agriculture and seats in stadiums
107
How does time period affect PES?
In the short run PES is inelastic as there is not time to increase productivity
In the long run PES is elastic as there is time to improve factors of production and be more efficient
108
How does factor mobility affect PES?
Easy elastic
Hard inelastic
109
How does length of production period affect PES?
If the length of production is short then PES will be elastic as it is easy to increase output eg. manufacturing
if the length of production is long then PES will be inelastic as it is difficult to increase output with changes in the market
110
# Define
Consumer Surplus
The difference between what consumers are willing to pay and what they actually pay
It is a measure of the welfare consumers receive
111
What area represents consumer surplus?
The area below the demand curve and equilibrium price
112
What is the consumer surplus when PED is perfectly elastic
ZERO as consumers are only willing to pay one price
113
What is consumer surplus when PED is perfectly inelastic?
Infinity as consumers are willing to pay any price for the good
114
Relate consumer surplus to PED?
The more elastic demand is the less the consumer surplus because buyers are only willing to pay lower prices
115
Relate price and consumer surplus
As price increases consumer surplus decreases and the greater the change in price the greater the change in consumer surplus
116
Economic relevance of Consumer surplus
Used to analyse the impact of government intervention in any market
117
# Define
Producer surplus
Measure of producer welfare
The difference between the price that consumers are willing and able to provide a good or service to the market, and the price they actually receive
118
Relate Price and producer surplus
The greater the price, the greater the producer surplus as there is more incentive to supply
119
What area represents producer surplus?
The area underneath the supply curve and equilibrium price
120
Relate demand to economic welfare?
If demand increases both consumer and producer surplus increase
121
Relate supply to economic welfare
If supply increases (shift right) both consumer and producer surplus increases
