1: Introduction to Markets Flashcards
Certius Paribus
All things being equal
Positive Statements
Can be tested by evidence
Normative Statements
Express an opinion on what ought to be
Value Judgements
A view of the rightness or wrongness of something based on a personal view
Economic Problem
Infinite human wants and needs but finite resources to satisfy
Opportunity Costs
The loss of other alternatives when another is chosen
Economic Agents
Producers
Governments
Consumers
Production Possibilities Frontier (PPF)
Explains constraints experienced by society. Only a finite amount of goods and services produced with a fixed amount of resources. (P1 for diagram)
Where is it imossible to produce at on a PPF?
Outside it
When are all factors of production being used on a PPF?
On the line
When are factors of production being underemployed on a PPF?
Inside it
What will happen to the PPF curve if there is economic growth?
It will shift outward
Where is productive efficiency achieved on the PPF curve?
Any point on the PPF curve
Where is allocative efficiency achieved on the PPF curve?
A specific point on the PPF curve that maximises social welfare
What are the two types of goods?
Consumer goods and capital goods. If the output of a consumer good increases the output of a capital good decreases. However, can depend on if a country invests in producing more capital goods -> shift PPF curve outwards
Division of Labour
When modern businesses divide their labour force, allocating specific tasks to individuals
Specialisation
Workers become more efficient at their task, improving the productivity of the entire production process. Proved by Adam Smith in Wealth of Nations (4800 pins with 10 specialised workers or 10-20 pins with unspecialised workers making the whole pin each)
Advantages of specialisation
Economies of scale
Reduces costs of training workers
Increase labour productivity
Disadvantages of specialisation
Less flexibility
Workers may become bored and less productive
Countries may become less self-sufficient
What are the functions of money
Unit of amount
Store of value
Deferred payment
Medium of exchange
Free market
Where people can buy and sell freely with no government intervention. Allocates scarce resources based on the price mechansim
Advantages of free market
Efficient
Rewards entrepreneurship
Consumers have greater choice due to more innovation
Disadvantages of free market
What is fair in the free market may not be fair in reality
Goods needed in society may not be produced if they don’t generate a profit
Monoplies may arise
Command economy
Resources allocated by the government
Advantages of a command economy
Can correct inequalities that exist in the free market
Reduction in unemployment
Break up monoplies
Disadvanatges of a command economy
Less efficient
Asymmetric infomation
Choice restriction
Mixed economy
Resources partly allocated by the government and partly allocated by firms
Who was Adam Smith?
Free market and ‘Invisible Hand’ believer
No monoplies and low barriers to entry and exit
Interaction of profit maximising firms and consumers would lead to mutually beneficial allocation of resources
Who was Karl Marx?
Believed free market has inequalities and workers are exploited
This lead to revolution and means of production would be seized
Gave rise to communism without explaining how it would work
Who was Friedrich Hayek?
Skeptical about command economies and believed asymmetric infomation stopped them from making good decisions about resource allocation. Firms and consumers knew best
Rational agents
Economic agents who use utility to guide their decision making
Rational producers
Want to maximise profits to survive, reinvest profits and offer staff and managers better rewards
In a world of asymmetric information firms may want to maximise revenue, maximise market share and achieve ethical objectives
Rational governments
Act to best serve the country i.e. achieving economic growth, reducing inflation, reducing or elimination unemployment and achieving equilbrium in payments in and payments out
Rational consumers
Maximise utility within their income
Different consumers and different interpretations of utility (some may save, some my spend)
Maximise work-life balance
Demand
Quantity of a good or service a consumer is willing and able to buy at a given price and quantity
What happens if the price of a substitute good rises?
Demand for the other good will rise
What happens if the price of a complementary good rises?
Demand for the other good will fall
Income effect
When prices fall consumers can afford more. Demand increases
Price elasticity of demand
% change in quantity demanded / % change in price
PED values:
Elastic -
Inelastic -
Unitary -
Perfectly elastic -
Perfectly inelastic -
> 1
<1
1
infinity
0
Income elasticity of demand (YED)
% change in quantity demanded / % change in income
YED values:
Normal goods (income rises, demand increases) -
Inferior goods (income rises, demand decreases) -
> 0
<0
Cross price elasticity of demand (XED)
% change in demand for good A / % in price of good B
Cross Price Elasticity (XED) values:
Positive -
Negative -
Close to zero -
Substitute
Complementary
Unrelated
Factors affecting elasticity of demand
Availibility of substitutes
Indirect tax/subsidies
Type of good
Percentage of income and time
Total revenue =
Price per unit x quantity
Revenue values:
Max total revenue -
Zero demand or high price -
Zero price or high quantity -
Midpoint -
PED of +/- 1
Minus infinity
0
minus 1
Law of supply
Rise in price causes a rise in supply and vice versa
Price elasticity of supply (PES)
% change in quantity supplied / % change in price
PES values:
Elastic -
Inelastic -
Unitary -
> 1
1>PES>0
0
What does high elasticity of supply give firms?
Allows them to react quickly to changes in price and demand
What products have more inelasticity of supply?
Ones perishable to weather conditions i.e. crops, agriculture
What gives firms more elasticity of supply?
Ones that keep extra stock. In periods of high unemployment we see more elastic supply as labour pod is larger
Short run
Capacity is fixed
One or more factors of production is fixed
Hard to increase supply in this period
Supply = inelastic
Long run
No factors of production are fixed
Firms able to increase capacity
Supply = more elastic than short run as firms have more time to react
What has different time scales for long and short run?
Industries i.e. long run is shorter for software comapnies than aeroplane manufacturers
Equilibrium
Where supply and demand meet
Disequilibrium
When supply and demand don’t meet and cause excess supply or demand. Market forces stabilise this overtime
What affect how much the equilibrium price and quantity change by?
Price and elasticity of demand and supply i.e. a rightward shift along an elastic supply curve will influence quantity more than price
Price mechanism
Shows how demand and supply interact
Functions of the price mechanism
Incentive - rise in price, encourages firms to produce more
Signalling - price changes, consumer/producer adapts accordingly
Rationing - resources are scarce, price of a good rations it and decides who is willing and able to pay for it
Advantages of price mechanism
Allocate efficiently
No time lost as no one is paid to monitor it
Efficient as prices are as low as possible
Consumers have control on what producers make
Disadvantages of price mechansim
Some goods not produced through price mechansim
Missing markets
Disparity in wages between low and skilled workers causes inequalities
No moral overlay or beliefs before a government intervenes
Consumer surplus
Sum of all the extra benefit consumers get in buying/consuming a good/service
Producer surplus
Sum of the extra money earned above the cost of production
Total Surplus =
CS + PS. Benefit to society as result of buying and selling a particular good or service. If the market isn’t at market clearing equilibrium there is deadweight loss. This is due to the extra benefit to society not being generated as result of over or under production/consumption
Specific taxes
Taxes paid per unit. Increase cost of production by the tax amount on each unit and leads to a decrease in supply
Ad valorem taxes
Based on the value of the good being sold. They increase price by a fix percentage
Indirect tax
Tax on consumption
Direct tax
Tax on income/wealth
When is the tax burden more on the consumer?
When the good is inelastic
When is the tax burden on the producer?
When the good is elastic
Subsidy
Money given by the government to enourage production for firms. Causes producer and consumer surplus to rise
