1:2:1 How Markets Work (2) Flashcards
How is price determined in a competitive market?
By the interaction of supply and demand
What is meant by equilibrium?
The price where the Quantity Demanded (QD) equals the Quantity Supplied (S) for a good or service in the market
In equilibrium there is […….] tendency for price or quantity to change
No
What is meant by Excess Supply?
Where the quantity supplied exceeds the quantity demanded for a good at the current market price
In a free market can price remain above the equilibrium position for long?
No
How do producers get rid of a surplus of supply?
- Producers Reduce Prices
- Encourages consumers to buy more
When producers reduce their prices to get rid of a surplus what happens to demand?
There is an extension in demand
What is meant by excess demand?
Where the quantity demanded exceeds the quantity supplied for a good at the current market price
When there is excess demand in a market what do consumers and producers do?
- Consumers tend to bid up prices in order to obtain the good
- This encourages producer to supply more
What happens to supply and demand when there is excess demand?
- Supply Extends
- Demand Contracts
- Until equilibrium is reached
What did Adam Smith refer the price mechanism to?
The ‘invisible hand’
What automatically eliminates Surpluses and Shortages in a market?
The price mechanism (‘invisible hand’ Adam Smith)
What is the Price Mechanism?
The use of market forces to allocate resources in order to solve the economic problem, of unlimited wants and limited resources.
What is price?
The exchange value of a good / service
What are the different functions of the Price Mechanism?
- Rationing Device
- Incentive Device
- Signalling Device
Price mechanism - Rationing Device.
- Resources are scarce, which means that goods and services produced from them are limited in supply
- Price mechanism allocated these goods and services to those who are prepared to pay for them.
- In effect, Price will rise or fall until equilibrium is reached between the quantity demanded and quantity supplied
Price mechanism - Incentive Device.
- Rising prices tend to act as an incentive to firms to produce more of a good or service since higher profits can be earned
- Rising Prices also means firms are able to cover extra costs involved with increasing output
Price mechanism - Signalling Device.
- Indicates Change In the conditions of demand or supply.
Any of the factors which may shift demand or supply curves will lead to a change in [……..] of a good or service
Price
What is a Consumer Surplus?
Is the extra amount of money Consumers are prepared to pay for a good or service above what they actually pay.
- Is the satisfaction gained in the excess of the amount paid for it
What is a Producer Surplus?
- The extra amount of money paid to producers above what they are willing to accept to supply a good / service.
- Extra earnings obtained by a producer above the minimum required for the to supply the product
What effect will an increase in demand have on Consumer and Producer surpluses?
Raise both consumer and producer surpluses (assuming Ceteris Paribus)
What affect will a decrease in the supply of good have on consumer and producer surpluses?
Reduce consumer and producer surpluses
What is a tax?
A compulsory charge made by the government, on goods, services, incomes or capital.
What is the purpose of taxes?
To raise funds to pay for government spending programmes.
What are the two types of tax?
Direct and indirect tax.
What is direct tax?
Is levied directly on an individual or organisation.
- Generally paid on incomes.
- Eg. Income Tax, Cooperation tax
What is an Indirect Tax?
A tax imposed on goods or services supplied by businesses. Includes both specific and as Valorem taxes
What does an Indirect Tax represent?
A tax on expenditure
What are the two different types of indirect tax?
- Specific
- Ad Valorem
What is a Specific Tax?
Is charged as a fixed amount per unit of a good.
- Eg. An exercise tax
What is an Ad Valorem Tax?
Is charged as a percentage of the price of a good.
- eg. VAT
The imposition of indirect tax raises the [……..] of goods and services
Price
When an indirect tax is applied what happens to supply?
- Supply Curve shifts upwards and to the left (decrease in supply)
What does a Specific Tax do to the supply curve?
Causes a parallel shift left of the supply curve.
How does an Ad Valorem Tax Affect Supply?
Cause a pivotal rotation of the supply curve to the left.
What is the Incidence tax?
The distribution of the tax paid between consumers and producers
Incidence of tax falls partly on consumers and producers what causes this?
The elasticities of Demand and Supply for the good or service
What Elasticities cause cause most of the incidence of a tax to be put on consumers?
•Combination of price inelastic demand and Price elastic supply
- Addictive Goods such as tobacco tend to make goods price inelastic in demand
• Firms Can then pass the burden on tax onto consumers via higher prices
What causes producer get get most of the incident tax?
- Combination of price elastic demand and price inelastic supply
- Less to a significant reduction in output and employment
- Therefore Government May be reluctant to do this.
What is a Subsidy?
Is a grant, usually provided by the government, to encourage suppliers to increase production of a good or service, leading to a fall in its price.
Who is a subsidy paid to?
Producers
How do producers respond to a Subsidy? And what happens to the market price?
- Firms Increase Output
- Market price falls and indirectly passes on some gain to the consumers
When given a Subsidy what type of product causes the market price to fall by a relatively large amount?
If demand for the good is relatively price inelastic
When given a Subsidy what causes the market price to fall by a relatively small amount?
If the demand for the good is price elastic
What happens to the gain that consumers get from a Subsidy if the good being subsidised is Demand is price inelastic?
Benefits to the consumer is increased
What happens to the gain that consumers get from a Subsidy if the good being subsidised is Demand is price elastic?
Less gain for consumers
What do economists assume about the way consumers behave?
- Consumers behave in a rational manner and so allocate their income to buy goods and services to maximise their utility (Note some income may be saved for the future of the utility gained is greater than current spending on extra items)
What causes Consumers to be irrational?
- Influence of other people’s behaviour
- Importance of habitual behaviour
- Consumers weakness at computation
What are Economic models based on?
Consumers are expected to aim to maximise their utility
Why might a consumer seem irrational?
Consumers may seek a satisfactory level of utility rather than maximising it.
Why consumers are irrational - The influence of other people’s behaviour.
- Consumers are influenced by the behaviour of others
- ‘herd like’ mentality is often displayed in various markets.
- Consumers that come late often receive little benefit
Why consumers are irrational - The importance of habitual behaviour.
- Consumers prefer what they know and have, rather than risking something new where there is more uncertainty.
- Takes up time with paperwork, some consumers prefer doing nothing
- Consumers are often unrealistic about their future behaviour
Why Consumers are irrational - Consumer weakness at Computation.
- Many consumers have difficulty calculating the Best Buy
- Imperfect information is a consumer weakness, consumers do not always buy a good at the cheapest price or a good of the best quality since market do not always operate efficiently.
In a 1-[……….] Market, the equilibrium price and quantity of a good or service is determined by the interaction of supply and 2-[……….]
1 - Competitive
2 - Demand
The [………………] is the use of market forces to allocate resources in order to solve the economic problem.
Price mechanism
What are the 3 function of the price mechanism?
- Rationing
- Incentive
- Signalling
Consumer surplus is….
Is the utility or satisfaction gained from a good or service in excess of the price paid for it.
Producer surplus is…
Is the extra earnings obtained by a producer above the minimum required for them to supply the good or service
An excess demand for a good will price to […….] until equilibrium is reached.
Rise
An excess supply of a good will cause price to […..] until equilibrium is reached.
Fall
An indirect tax will on a good will cause an 1-[…………] shift in the supply curve, leading to a 2-[……..] in output and a 3-[………] in price.
1- Inward
2- Fall
3- Rise
A unit subsidy on a good will cause an 1-[…….] shift in the supply curve, leading to a 2-[……….] in output and a 3-[………] in price.
1- Outward
2- Rise
3- Fall
Alternative views of consumer behaviour are based on […………………..] of how consumers actually behave.
Real-World investigations
What can Private Benefits also be referred to as?
The revenue that a firm obtains from selling a good or service
What are Social Benefits?
The sum of external benefits and private benefits from a market transaction.
By adding [……..] to [………] we get Social Benefits.
By adding private benefits to external benefits we get social benefits
External benefits are the difference between what?
Private benefits and social benefits
The marginal private benefit and the marginal social benefit curves often…
Diverge
Because marginal private benefit and marginal social benefit curves diverge what does this mean?
That external benefits increasing disproportionately with output consumed.
In what instance will the marginal private benefit and the marginal social benefit be drawn parallel to each other??
In the case that external benefit per unit consumed will remain constant
When looking at Market Failure, What is the Supply Curve also equal to?
The marginal private cost curve (MPC)
What does the addition of the Marginal Private Cost (MPC) Curve do?
Forms the market supply curve
When looking at Market Failure, the Demand curve for consumers is?
The marginal private benefit curve (MPB)
When looking at the Marginal Private Benefit, what do economists assume?
That it is possible to measure the benefit obtained from consuming a good by the price people pay for it.
As an individual consumes more of a good, the marginal utility (marginal benefit) [………..]
Falls
Why does the Demand curve slope down?
Because of diminishing marginal utility
What is Market Equilibrium?
Where Marginal Private Benefit equals Marginal Private Cost
What is the Social Optimum?
Where marginal social benefit equal marginal social cost
What is achieved when social optimum equilibrium is reached?
Welfare maximisation
What does the free market ignore?
Negative and Positive externalities
In Market Failure, when adding the external costs on the production of a good or service, what happens to the supply curve?
Supply curve PIVOTS left and becomes the marginal social cost curve
In Market Failure, what happens to the demand curve when external benefits are added on to the consumption of the good?
Demand curve PIVOTS to the right, making the marginal social benefit curve.
How do External Costs cause Market Failure?
External costs are ignored by consumers and and producers when they make their economic decisions
What are some of the impacts of external costs on consumers and producers?
- Overproduction (deee Market Level of output exceeds the social optimum level of output)
- Underpricing (since the free market price is below the social optimum price)
- Welfare Loss (since marginal social costs exceed marginal social benefits)
What are some of the impacts of external benefits of consumer and producers?
- Underproduction ( Free Market Level of output is less than the social optimum level)
- Underpricing ( Free Market Price is below the social optimum price)
- Potential Welfare vain (since marginal social benefits exceed marginal social costs)
What are Public goods?
Those goods that have non-rivalry and non-excludability in their consumption.
