1:2:1 - How Markets Work Flashcards
What is meant by a Market?
Where consumers and producers come into contact with each other to exchange goods and services
What must be agreed for an exchange to take place?
A price
What do Buyers/Consumers represent?
Represent the Demand side of the market
What do sellers/producers represent?
Represent the supply side of the market
Consumers are assumed to make [……….] decisions
Rational
What does it mean when consumers make rational decisions?
Consumers will allocate their income to maximise their utility or satisfaction from the goods and services they purchase
What is meant by the term Utility?
Refers to the amount of satisfaction obtained from consuming a good or service
What do economists assume about utility?
Utility can be measured
Do we assume that producers make rational decisions?
Yes
How do firms make rational decisions?
This means firms will use their resources to maximise profits from the goods and services produced. - Producing at a level of output where total revenue exceeds total cost by the largest amount.
The buyers or consumers in a market are said to what?
Demand goods or services
What is meant by Demand?
Refers to the quantity of a good or service purchased at a given price over a given time period.
What is meant by effective demand?
A want backed up by the ability to pay
What does the Demand curve show?
Shows the quantity of a good or service that would be bought over a range of different price levels in a given period of time.
What is the shape of a Demand curve?
Slopes downwards from left to right.
Why is the Demand curve sloped downwards from left to right?
The good becomes cheaper compared to substitute goods and also more can be purchased with a given level of income
When is there a movement along the Demand curve?
When a good ONLY changes in price
What does a fall in price cause on the Demand curve?
An extension in demand
How does a rise a rise in demand affect the Demand curve?
Causes a contraction in demand
The downward sloping Demand curve can also be explained by the concept of what?
Diminishing marginal Utility
What is meant by Diminishing Marginal Utility?
As more units of a good are consumed, the utility gained from each extra unit will fall
What is meant by Marginal Utility?
The utility or satisfaction obtained from consuming one extra unit of a good or service
As more is consumed what happens to total utility?
Will increase at a diminishing rate.
As marginal utility [……] from each extra good consumed, it means consumers will only buy more of it if price […….]
1-Falls 2-Falls
Which way does the Demand curve shift if there is an increase in demand?
Shifts to the right
Which way does the Demand curve shift if there is a decrease in demand?
Shifts inwards to the left.
Factors which can shift the demand curve for a good.
- A fall in the price of complementary goods - Rise in the price of substitute goods - Change In fashion or tastes - Increased advertising - Increase in real incomes - Decrease In income tax - Demographic Changes - Increase in credit facilities
A change in [……] of a good will lead to a movement along the Demand curve for that particular good.
Price
A decrease in demand is shown by a [………] shift in the demand curve.
Leftward
An increase in demand is demonstrated by a [……..] shift by the demand curve
Rightward
What is meant by Price Elasticity of Demand?
The responsiveness of demand for a good / service to a change in price
What is the Price Elasticity of Demand Formula?
(% change in Quantity Demanded of Good A) / (% change in price of Good A)
Price Elasticity of Demand - If the value you get is greater than 1 what does this mean?
Good is relatively price elastic
Price Elasticity of Demand - If the value you get is less than 1 what does this mean?
The good is relatively price inelastic
Price Elasticity of Demand - What does it mean if you get a value of 1?
The good has unit Elasticity
Price Elasticity of Demand - What does it mean if the value you get is 0?
The good is perfectly inelastic
Price Elasticity of Demand - What does it mean if the value you get is infinite?
The good is perfectly elastic
What is meant by relatively price elastic?
The percentage change in demand is less than the percentage change in price
What is meant by Relatively Price Inelastic?
The percentage change in demand is less than the percentage change in price
What is meant by Unit Elasticity?
Percentage change in demand is the same as the percentage change in price.
What is meant by perfectly inelastic?
A change in price has no effect on the quantity demanded
What is meant by perfectly elastic?
A rise in the price causes demand to fall to 0, Curve is horizontal
How do you calculate percentage change?
(New Value - Old Value) / Old Value x 100
What is meant by total revenue?
The price per unit of a good Multiplier by the quantity sold.
What is total revenue equal to?
Total amount consumers spend on that good
A Firms Total Revenue will Increase as long as…
Price is moving towards the mid-position of the Demand curve (unit Elasticity)
Why is important for firms to know the Price Elasticity of Demand of their output when making price decisions?
Because this affects revenue and profitability
If demand is elastic then a cut in prices mean that?
Total consumer spending increases causing firms revenue to increase. (Think about the Demand curve, think of it to understand it)
If demand is elastic then a rise in prices causes what?
- Causes Total consumer spending to fall and firms lose revenue. (Think about the Demand curve, think of it to understand it)
What does it mean if a firm is at unit Elasticity?
The firm is maximising total revenue.
As long as Marginal Revenue is Positive….
Demand is price elastic
When marginal revenue is zero demand is….
Demand is unit elastic
When marginal revenue is negative demand is…
Demand is elastic
What are the determinants of Price Elasticity of Demand (PED)?
- Availability of substitutes - Luxury and Necessity goods - Proportion of Income spent on the Good - Addictive and habitual - Time Period - Brand image
Determinants of Price Elasticity of Demand - Availability of Substitutes?
- The more narrowly a good is defined, the more substitutes it has (eg, cod has many substitutes, like haddock etc, but fish in general doesn’t)
Determinants of Price Elasticity of Demand - Luxury and Necessity Goods.
Luxury goods tend to have an elastic demand, whereas necessity goods, tend to have an inelastic demand
Determinants of Price Elasticity of Demand - Proportion of Income Spent on the Good.
- If a high percentage of income is spent on the Good demand tend to be price elastic. - Goods that take up a small percentage of income such as newspapers demand will tend to be price inelastic in demand
Determinants of Price Elasticity of Demand - Addictive and Habitual.
These kinds of goods tend to be Price Inelastic in Demand
Determinants of Price Elasticity of Demand - The Time Period.
- Demand is less elastic for goods in the short run than in the long run.
Determinants of Price Elasticity of Demand - Brand Image.
- Goods with a strong brand image have a price inelastic demand as consumers are often willing to pay a premium price for them.
What is meant by the term Price Elasticity of Demand (YED)?
The responsiveness of demand for a good or service to a change in income.
What is the Price Elasticity of Demand Equation?
(Percentage Change In Demand for a good) / (percentage change in real income)
What value for Price Elasticity of Demand (YED) gives a normal good?
A positive value
What does a value that is Positive when calculating Income Elasticity of Demand (YED)?
Gives a Normal Goods
What does a value that is More than 1 when calculating Income Elasticity of Demand (YED)?
Luxury good
What does a good with a YED less than 1 tell us about the good?
It is relatively income inelastic
What does a good with a YED above mean tell us about the good?
Relatively income elastic in demand
What does a YED of 1 tell us about a good?
The good has Unitary Elasticity
What is meant by the term normal good?
A good with a positive income Elasticity of Demand. As income rises, so too does demand for the good.
What is meant by an Inferior good?
A good with a negative income Elasticity of Demand. As income rises, demand for the good falls.
What does a YED value which is negative tell us about a good?
It is an Inferior Good
Why does a negative value of YED give us an inferior good?
- Means income and demand move in opposite directions. - Because people tend to demand higher-quality goods as their income rise, substituting them for lower quality products.
What is meant by Cross Elasticity of Demand?
The responsiveness of demand for Good B to a change in price of Good A
What does YED mean?
Income Elasticity of Demand
What can we abbreviate income Elasticity of Demand to?
YED
What can we abbreviate across Elasticity of Demand to?
XED
What does XED mean?
Cross Elasticity of Demand
What is the Cross Elasticity of Demand Formula?
(Percentage Change In Demand for Good B) / (Percentage Change In price of Good A)
Cross Elasticity of Demand refers to how a change in 1-[……..] of one good affects the 2-[……..] for another good.
1-Price 2-Demand
What does Cross Elasticity of Demand determine?
Wether Goods are complements or substitutes for each other.
What does a positive value of XED tell us about a good?
Is a Substitute good.
What gradient do substitutes have?
- Positive Gradient - As the two variables of Price and demand move in the same direction.
Substitute goods are in [………] demand
Comperitive
Complementary goods are […….] in demand
Joint
What value for XED do you get for complementary goods?
Negative value
What is the gradient for a Complementary good?
- Negative Gradient - As the two variables of Price and demand move in opposite directions
What XED value do unrelated goods have?
0
A cross Elasticity of Demand of […….] means there is no relationship between goods.
0
The sellers or producers in a market are said to supply [……………….]
Goods and services
What is meant by supply?
The quantity of a good or services that firms are willing to sell at a given price at any time.
Which way does the supply curve slope?
Slopes upwards from left to right.
Why is the supply curve upward sloping?
- As firms raise output in the short run they face rising production costs and so pass these costs onto consumers. - As prices rise it encourages firms to supply more of a good to increase profits.
When is there a movement along the supply curve for a good?
Only when there is a change in its price
A rise in price causes an [………..] in supply.
Extension
A fall in price causes a [………..] in supply
Contraction
Factors that affect the supply.
- Improvements in technology - A Reduction in labour costs - Reduction in Capital costs - Reduction in Transport costs - Increase in the number of firms
What is meant by Price Elasticity of Supply?
Is the responsiveness of the supply of a good or service to a change in its price
What is the abbreviation for Price Elasticity of Supply?
PES
What does PES also mean?
Price Elasticity of Supply
What does it mean if the PES value is greater than 1?
The good is relatively price elastic
What does a PES value of less than 1 mean?
Good is relatively price inelastic
What does it mean if the PES value you get is equal to 1?
Good is unit elastic
What does it mean if the PES value oh get is equal to 0?
The good is perfectly elastic
What does it mean if the PES value is infinite?
The good is perfectly elastic
What are the determinants of Price Elasticity of Demand?
- Level of Spare Capacity - State of the Economy - Level of stocks of finished goods - Perishability of the Product - Ease of entry to an industry - Time Period under consideration
Factors influencing Price Elasticity of Demand - Level of Spare Capacity
- High Level of Spare capacity means a firm can raise production quickly, so Supply tends to be elastic - Firms operating at full capacity are unable to raise output quickly and its supply tends to be inelastic
Factors influencing Price Elasticity of Demand - State of the Economy
- In a recession there are many unemployed resources and so there is a high level of Spare Capacity - Firms fins it easy to raise Supply if needed
Factors influencing Price Elasticity of Demand - Level of finished stock in a firm.
- High Level of finished stock means that the firm can increase supply quickly, supply is elastic
Factors influencing Price Elasticity of Demand - Perishability of the Product
- Some Goods cannot be stockpiled (stored) and so tend to be inelastic - Manufactured Goods tend to be non-perishable and can be Stock piled in order to meet anticipated increases in demand
Factors influencing Price Elasticity of Demand - Ease of Entry into an Industry
- If there high entry barriers to an industry then it will be difficult for new firms to enter - Sometimes existing producers deliberately create entry barriers so supply may be restricted and inelastic
Factors influencing Price Elasticity of Demand - Tome Period under Consideration
- In the short run firms can only change a single production input, which makes it difficult for firms to raise production, supply is therefore inelastic - In the long run firms can change all production inputs making it easier to raise production, supply tends to be elastic
Economists assume that consumers and producer make [………] decisions
Rational
What does it mean when we say consumers and producers make rational decisions?
Consumers spend their income to maximise utility and producers allocate their resources to maximise profits
A movement along the Demand curve is caused by a change in the [……….] of a good
Price
A [………] in the demand curve is caused by changes in real income, Tastes, and the price of substitutes and complementary goods
Shift
The downward sloping demand curve can be explained by what?
Diminishing marginal Utility
What is meant by Diminishing Marginal Utility?
As additional units of a good are consumed marginal utility falls, so consumers will only buy more of a product if it falls
A change in price of a good towards unitary Elasticity of Demand will lead to an increase in […………..]
Total revenue
The determinants of Price Elasticity of Demand include…
- Availability of substitutes - Proportion of income spent on good - Time Period - Addictive
Normal goods have a [……..] income Elasticity of Demand
Positive
Inferior goods have a [……….] income Elasticity of Demand
Negative
Substitute goods have a [………] cross Elasticity of Demand
Positive
Complements have [………] cross Elasticity of Demand
Negative
A movement along the supply curve is caused by…
A change in price of the good
What are the determinants of Price elasticity of Supply?
- Level of Spare Capacity - State of Economy - Level of stock - Perishability of Goods - Ease of entry into a market - Time Period
What does a vertical supply curve indicate?
That the goo is perfectly inelastic
Changes in the Demand Curve due to changes in Price Diagram,
Diagram showing a increasing shift in demand even when the good is at the same price, due to a change in the conditions of demand.
Diagram showing a increasing shift in demand.
Factors that affect the Demand Curve.
- Income
- Quality
- Advertising
- Substitutes
- Complements
- Weather
- Expectations
Factors that influence demand - Income.
- An increase in disposable income enabling consumers to be able to afford more goods. - Could happen because of higher wages and lower taxes.
Factors that influence Demand - Quality.
Improvement in the quality of a good encourages consumer to buy the good
Factors that influence Demand - Advertising
increase brand loyalty to the goods and increases demand.
Factors that Influence Demand - Substitutes
An increase in the price of substitutes (Good A), this will increase the demand of Good B.
Factors that influence demand - Complements
A fall in the price of complements will increase demand for both goods.
Factors that Influence - Weather
In cold weather there will be increased demand for fuel and warm weather clothes.
Additionally with seasonal foods.
Factors that Influence Demand - Expectations
If people are expecting future price increases. People will buy sooner so increasing demand.
Diagram showing a Fall in Demand.
Evaluative points for Factors that Influence Demand.
- For some luxury goods income is the determinant of demand
- Advertising is important for goods that have a brand image, not general goods.
What is Economies of Scale.
Occurs when increasing output leads to lower long-run average costs.
Diagram of Economies of Scale.
Why is Economies of Scale important?
Economies of scale are important because they mean that as firms increase in size, they can become more efficient.
Examples of Economies of Scale.
- Specialisation and the Division of Labour (In large scale operations workers can do more specific tasks. With little training they can become very proficient in their task, this enables greater efficiency.)
- Technical (By using the factory to full capacity, average costs will be lower.)
- Bulk Buying (If you buy a large quantity, then the average costs will be lower. This is because of lower transport costs and less packaging.)
Diagram showing Price Elastic Demand.
Diagram showing Price Inelastic Demand.
If demand is inelastic then increasing the price can lead to an [………..] in revenue
increase
If demand is elastic, firms would be unlikely to increase revenue as this could lead to a [……] in revenue.
Fall
How could a firm selling an elastic product make that product more inelastic?
advertising to increase brand loyalty and make demand more inelastic
Diagram showing the burden on Producers and Consumer for both elastic and inelastic products.
Substitute goods will have a [……..] cross-elasticity of demand.
Positive
Complements will have a [………..] cross elasticity of demand
Negative
Unrelated goods will have a cross-elasticity of demand of [………].
Zero
Graph showing the difference between close substitutes and weak substitutes.
Graph showing the difference between strong compliments and weak compliments.
How do firms use substitutes to decide what price to charge?
When setting prices firms will have to look at what alternatives the consumer has, if there are no close substitutes they will be able to increase the price.
How do we know a good is an Inferior Goods?
when an increase in income leads to a fall in demand
Diagram showing Market Equilibrium.
Diagram showing excess demand.
Diagram showing excess supply.
Diagram showing a increase in demand and a change in equilibrium.
Diagram showing a PPF curve and an efficient economy and a not efficient economy.
PPF diagram showing economy growth.
PPF diagram potentailly showing a long term increase in the PPF.
PPF curve showing an economy entering a recession.
Different PPF curve.
PPF diagram showing an oppertunity cost.
Diagram showing a Positive Externality.
Diagram showing a Positive Externality on production.
Diagram showing the effect of subsidies on a good with positive externalities.
Diagram showing a Negative Externality.
Diagram showing a Negative Externality in Consumption.
Diagram showing the implementation of a buffer stock scheme.
Diagram showing a Buffer stock with a Shortage.
What is a Buffer Stock scheme?
s a government plan to stabilise prices in volatile markets. This requires intervention buying and selling.
What is the Aim of Buffer Stock schemes?
Stabilise prices
Ensure supply of food
Prevent farmers/producers going out of business because of a drop in prices.
- What are the advantages of Buffer Stocks?
- Stable prices help maintain incomes.
- Price stability encourages more investment
- Prevents shortages
Disadvantages of Buffer Stocks.
- Cost of buying excess supply could become quite high for the government and may require higher taxes.
- Minimum prices and buffer stocks could encourage oversupply as farmers know any surplus will be bought.
- Government subsidy to farmers may encourage inefficiency amongst farmers.
- Some goods are perishable goods
