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H1 Economics > 02.1 Price Mechanism and its Applications > Flashcards

02.1 Price Mechanism and its Applications Flashcards

1
Q

Market System

Characteristics

A
  • Perfect Competition
    • Many Sellers & Buyers
  • Rational Behaviour of both Consumers & Producers
    • Activity within the Market is driven by self-interest
      • Consumers want to maximise Utility
      • Producers want to maximise Profits
  • Freedom of Choice & Enterprise
    • Consumers decide what to buy with their income aka Consumer Sovereignty
    • Producers decide what to sell and production methods
  • Private Ownership of Property
    • Individuals have the right to own, control & dispose of FOPs
    • Owners of FOPs have the right to the income earned from the use of the FOPs.
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2
Q

Market Adjustment Process

A
  1. Price, $, ↑/ ↓ to above equilibrium, eqb, $?
  2. Surplus/ shortage?
  3. Downward/ upward pressure?
  4. Producers ↓/ ↑ $?
  5. Consumers ↑/ ↓ willing and able to purchase more
  6. QD, ↑/ ↓?
  7. Producers ↓/ ↑ incentivised to produce?
  8. QS ↓/ ↑
  9. Process repeats until eqb $ and qty is reached
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3
Q

Demand, DD

Definition

For ‘Effective’ Demand, both willingness and ability to pay is needed

A

The amount that consumers are willing and able to purchase at every given price over a given period of time.

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4
Q

Demand, DD

Curve

Based on the LDMU

A

The quantity demanded of a good/ service is inversely related to its price, ceteris paribus.

↓ in DD = shift ←
↑ in DD = shift →

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5
Q

The Law of Diminishing Utility, LDMU

Definition

A

Beyond a certain point of consumption, each extra unit consumers gives less additional utility than previous units.

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6
Q

Demand, DD

Non-price Determinants

A
  1. Change in tastes & preferences
    a. Seasonal changes
    b. Climatic changes
  2. Expectations of future prices
  3. (Real) Income i.e disposable income
  4. $ of related goods
    a. Substitutes: Competitive DD
    b. Complements:
  5. Derived DD
  6. Government Policies
    a. Direct Tax
    b. Direct Subsidy
  7. Population
  8. Interest Rates
  9. Exchange Rates
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7
Q

Supply, SS

Definition

A

The quantity of a good or service that producers are willing and able to offer for sale at each given price over a given period of time.

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8
Q

Supply, SS

Curve

Based on LDMR

A

The quantity supplied is directly related to the price of a product, ceteris paribus.

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9
Q

The Law of Diminishing Marginal Returns, LDMR

Definition

A

Beyond a certain point of production, adding an additional factor of production results in a smaller increase in output, i.e an increase in marginal cost.

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10
Q

Supply, SS

Non-Price Determinants

A
  1. ↑ cost of production, COP
  2. ↑ innovation/ state of technology
  3. Natural factors
  4. ↑ no. of firms
  5. Government policies
    a. Indirect Tax
    b. Indirect Supply
  6. $ of Related Goods
    a. Joint SS
    b. Competitive SS
  7. Expectations of future prices
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11
Q

Demand-Supply Model

Analysis

A
  1. DD/ SS affected?
  2. Direction of shift of DD/ SS curve?
  3. MAP
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12
Q

Price Elasticity of Demand, PED

Definition

A

A measure of the degree of responsiveness of the quantity demanded of a good to a change in its price, ceteris paribus.

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13
Q

Price Elasticity of Demand, PED

Formula

A

PED = Percentage change in quantity demanded/ Percentage change in price = % Δ in QD/ % Δ in $

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14
Q

Price Elasticity of Demand, PED

Interpretation

A
  1. Sign: -ve, |PED| is used instead of
  2. Magnitude
    a.|PED| < 1: Price Inelastic, PIE, DD
    b |PED| > 1: Price Elasticity, PE, DD
    c.|PED|= 0: Perfectly PIE DD
    d.|PED|= ∞: Perfectly PE DD
    e. |PED| = 1: Unitary PE DD
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15
Q

Price Elasticity of Demand, PED

Determinants

A
  1. Habituality of Consumption
  2. Proportion of Income spent on Good
  3. Time horizon
  4. Number and closeness of Substitutes

Acronym: HITS

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16
Q

Price Elasticity of Demand, PED

Applications

A
  1. In Demand-Supply Model to explain change in $ and qty
    a. Increase in SS
    i. PED < 1: Large drop in $, less than proportionate, LTP, increase in Qty
    ii. PED > 1: Small drop in $, more than proportionate, MTP, increase in Qty
    b. Decrease in SS
    i. PED < 1: Large increase in $, less than proportional, LTP, drop in Qty
    ii. PED > 1: Small increase in $, more than proportional, LTP, drop in Qty
  2. Changes in TR
  3. Behaviour of Firms
17
Q

Total Revenue, TR

Formula

A

TR = $ x Qty

$ = Price
Qty = Quantity

18
Q

Price Elasticity of Supply, PES

Definition

A

A measure of the degree of responsiveness of the quantity supplied of a good to a change in price, ceteris paribus.

19
Q

Price Elasticity of Supply, PES

Formula

A

PES = Percentage change in quantity supplied/ Percentage change in price of good = % Δ in QS/ % Δ in $

20
Q

Price Elasticity of Supply, PES

Intrepretation

A
  1. Sign: +ve, |PES|/ PES can be used
  2. Magnitude
    a. PES < 1: PIE SS
    b. PES > 1: PE SS
    c. PES = 0: Perfectly PIE SS
    d. PES = ∞: Perfectly PE SS
    e. PES = 1: Unitary PE SS
21
Q

Price Elasticity of Supply, PES

Determinants

A
  1. Mobility of FOPs
  2. Availability of Spare Capacity
  3. Length of Production Period
  4. Time Horizon
  5. Level of Stock

Acronym: MALTS

22
Q

Price Elasticity of Supply, PES

Application(s)

A
  1. In Demand-Supply Model to explain change in $ & Qty
    a. Increase in DD
    i. |PES|< 1: Large increase in $, LTP increase in QD
    ii. |PES|>1: Small increase in $, MTP increase in QD
    b. Decrease in DD
    i. |PES|< 1: Large decrease in $, LTP decrease in QD
    ii. |PES|>1: Small decrease in $, MTP decrease in QD
23
Q

Price Elasticity

Limitations

A
  1. Computation Issues
    a. Large amount of data
    b. Inaccurate data
    c. Inaccurate analysis
  2. Prediction Issues
    a. Dynamic economy
    b. Outdated data
    c. Incorrect prediction of future market changes
  3. Concerns about Cost
    Related to Profits which is Profit = TR - TC
  4. Ceteris Paribus Assumption
24
Q

Government Intervention

Taxation

A
  1. Indirect Tax
    a. Specific Tax
    b. Ad Valorem Tax
  2. Direct Tax
25
Q

Indirect Tax

Definition

A

Taxes on spending on good and services and are paid to the tax authorities by the suppliers of the goods and services.

26
Q

Specific Tax

Definition

A

A fixed sum by unit sold.

27
Q

Ad Valorem Tax

Definition

A

A certain percentage of the price of the good.

28
Q

Indirect Tax

Mechanism

A
  1. Tax levied on Producers
  2. COP ↑
  3. SS ↓
  4. SS shifts ←
29
Q

Direct Tax

Definition

A

Taxes on income and wealth and are paid to the tax authorities directly by the economic agent with the income/ wealth.

30
Q

Direct Tax

Mechanism

A
  1. Tax levied on economic agent
  2. Disposable income ↓
  3. DD ↓
  4. DD shifts ←
31
Q

Government Intervention

Subsidies

A
  1. Indirect Subsidies
  2. Direct Subsidies
32
Q

Indirect Subsidies

Definition

A

A subsidy granted by the tax authorities to the supplier of the goods and services.

33
Q

Indirect Subsidy

Mechanism

A
  1. Subsidies granted
  2. COP ↓
  3. SS ↑
  4. SS shifts →
34
Q

Direct Subsidy

Mechanism

A
  1. Tax granted
  2. Disposable income ↑
  3. DD ↑
  4. DD shifts →
35
Q

Price Controls

A
  1. Minimum Price aka Price Floor
    a. P set ↑ eqb P
    b. Surplus seen

Consequence(s):
- Surpluses
- Overallocation of resources → allocative inefficiency

  1. Maximum Price aka Price Ceiling
    a. P set ↓ eqb P
    b. Shortage seen

Consequence(s):
- Shortages
- Non-price rationing
- Underground market aka black market
- Underallocation of resources → allocative inefficiency

36
Q

Price Controls

Factor(s)

A
  1. Level where price floor is set
  2. PED & PES
  3. Changes in DD & SS
37
Q

Quantity Controls

A

Quotas
a. Qty set below eqb qty
b. Consumers willing and able to pay P1 at Qquota

H1 Economics (5 decks)

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