1.1 + 1.2 ( nature of economics and how markets work) Flashcards
Define Scarcity
resources being finite and limited relative to demand for their use
Define Opportunity Cost
the cost of missing out on the next best alternative
Define Marginal Analysis
Examination of the additional benefits of an activity compared to the additional costs
Define Capital Goods
goods (typically technology) that are used to make consumer goods and services
Define Consumer Goods
products that satisy our needs and wants directly
Define the PPF and draw/imagine the curve
Possibility Production Frontier- maximum combination of goods and services that can be produced with a certain level of resources
What are the 4 Factors for productive capacity
Land (all natural resources)
Labour
Capital ( All tech used in production )
Entrepreneurship
What is the Pareto Efficiency
any point on the PPF Curve, it is impossible to increase one value w/o less production of another
What does point E on the PPF Curve represent
An inefficient economy, where not all factor inputs are being used so the economy hasnt reached its full potential productive capacity (PPF)
At this point we can increase both variables without an opportunity cause
What is the difference between point C and point D
Point C has a higher % of capital investment than point D
so point C has relatively higher economics
How do you get Point F
By running a trade defecit (importing goods) to live beyond your means
How do you get to point A2
Economic Growth caused by an increase in the 4 factors of production (typically improvement in tehcnology)
What happens as you shift to one side of the PPF Curve
The result is that opportunity cost rises ( due to the law of diminishing returns). Hence the curve shape
What does a linear (straight) PPF show
the opportunity cost is constant
4 factors causing inward PPF shift (depreciation)
1) Natural Disaster
2) ‘Brain Drain’
3) civil war/conflict
4) poor infastructure
How does a PPF convey a recession
Output falling below the PPF
What does A and B in the PPF with recession
A = full employed
B = unemployed resources
What increases as you move closer to one extreme on the PPF
-Marginal Opportunity Cost will rise due to the law of diminishing returns
How does opp. cost affect different economic agents (personal,business and government)
Personal : Choosing to buy clothes instead of a trip to the cinema
Buisness : Buying an expensive piece of equipment, rather then employing an extra person
Government : may decide to spend more on defence, than education
What is the economic problem?
the issue of
our infinite needs/wants vs the scarcity of resources
Thus resulting in economics: the study of how to allocate these scarce resources. In turn creating the concepts of choice and opportunity cost
What are Samuelsons 3 questions ( the first clear response to the economic problem)
- What to produce? (best combination of K + C)
- How to produce (best combination of factor inputs)
- For whom to produce (the problem of distribution)
Define a Free Good
a zero marginal cost of supply - they do not use use factors of production when extra units are supplied (air)
Define a non-renewable resource
finite in supply as no other mechanisms exist at present to replenish them
Define a renewable resource
natural rate of resource replenishment>rate of extraction
What is a positive statement and positive economics
FACTS.
Objective statements that can be proven true or false
Positive economics deals with objective explanation and the testing of theories
What is a normative statement
OPINIONS.
Subjective statement that carry value judgements about what ‘ought to be’
define specialisation
producing a narrow range of goods or services
Define Division of Labour
Where an individual worker specialises in a limted range of skills
Who famously wrote about the concept of the division of labour
Adam Smith wrote about it in ‘ The Wealth of Nations’
What does specialisation refer to in countries
Individual countries that produce certain goods that they are the best at producing.
Moreover, the theory of comparitive adv, states that countries should specialising in producing goods they are the best at
At what economic levels does specalisation occur at:
All economic levels
specilisation of an extended family
within buisness and organisations
in a country e.g. Bangladesh
What are the main advanatges of specialisation in labour
- lower unit cost
- gain specialist skill and deterity as less time wasted
- becomes cost effective to give workers specialist tools
What are the main disadvantages of specialisation of labour
- Alienation causes lower quality and abseteesism
- High worker turnover
- risk of structural unemployment and occupational immobility
What are the main advantages of specialisation within economies
- Fits with theory of comparitive advanatge
- Increases output and quality
- larger range of g/s avaliable
What are the main disadvanatages of specialisation within economies
- overspecialisation makes it vulnerable to market prices and conditions
- may lead to overextraction
- changing tastes
- nation interdependence
- typically have low income elasticity
Define Production
measure of the value of the output of goods + s
Define productivity
a measure of the efficiency of the factors of production
(inc. in production DOES NOT equal an increase in productivity)
Define an economic good
Resources which are scarce
Define working capital
stocks of raw materials, and goods waiting to be sold
Define fixed capital
stocks of PPE (property,plant and equipment)
fixed as it wont be transformed into a final product
Define entrepreneurship
the seeking out of profitable opportunities and taking a risk
What is the law of diminishing returns
the decrease in marginal output of a production process as the amount of a single factor of production is incrementally increased
What is Adam Smith’s central thesis (invisible hand)
Our indiviual self interest results in societal benefit
What did adam smith believe about the division of labour
It allows us to be more efficient and create a web of mutual interdependencies.
What are the main advantages of a free market
- high level of competition, so strong incentive to innovate
- price mechanism removes shortages and surpluses
- Variety of goods
- Quicker response to demand changes
What are the main disadvantages of a free market
- Lots of waste and enviromental damage
- public/ merit goods missing/underprovided
- Demerit goods overprovided
- Unequal income distribution
What was Marx’s theory of surplus value
The capitalist pays the worker less than the value of their labour to create a profit.
Define a command economy ( commuist )
a central gov, authority dictates the level of production that is premissible and the prices of goods and services
Define a free market
where resources are allocated by the price mechanism and there is no gov. intervention
What are the main advantages of a command economy
- Gov can employ resources to full employment
- Equal/better income distrubution
- Gov can use resources to maximise welfare
- Social optimums of merit,demerit and public goods
What are the main disadvantages of a command eonomy
- avoid hard work as cannot be unemployed
- Many products produced are useless
- low competition
- Often controlled through political repression
- lack of variety of goods
- illegal black market growth
Define a mixed economy
Some resources are owned by public and some by private
What are the main advantages of a mixed economy
- Gov. can intervene to prevent the worst excesses of private buisness
- Utilise taxes to create a safety net
- still maintain competitive markets to incetivise innovation
What are the main disadvantages of a mixed economy
- Difficult to decide how and when to intervene
- argued welfare payments create work shy
- argued not enough wealth distrubution
Define demand
the quantity of a good or service that consumers are willing and able to buy at a given price in a given time period.
What is effetive demand
level of demand that represents a real intention to purchase by people with the means to pay
What is the basic law of demand
Demand has an inverse relationship with price
( as price goes up, demand goes down )
What does price going up or down do to the demand curve
Price going up leads to a contraction of quantity demanded
Price going down leads to an expansion of quantity demanded
What causes movement along the demand curve
ONLY a change in market price
What does it mean if the demand curve shifts inwards ( to the left ) or outward ( to the right )
It is due to non-price factors
What are 7 non-price factors in the demand curve(PIRATES)
P- Population
I- Income
R- Related goods ( subtitutes/complements )
A- Advertising
T- Tastes and fashions
E- Expectations
S- Seasons
Define a normal good
As income increases, so does demand for these goods
e.g. a car
What is the substituion effect
a fall in price of Good X makes it relatively cheaper compared to substitutes so there will be increased demand
What is the income effect
As price falls, the purchasing power of consumers increases
so people can buy more
What is derived demand and an example
The demand for a factor of production used to produce another good
e.g. higher demand for mobile phones = higher demand for batteries
Explain Composite Demand and give an example
A Product has multiple uses; thus as demand for one use goes up, the supply for the other goes down.
e.g. milk is used in cheese, yoghurt, cream and butter
What is rationing effect concerned with Composite Demand
- As a result of having many uses; if one of these uses goes up in demand , it will limit the avaliability of another
e. g. If there is a higher demand for butter, there will be a more limited avaliablity of milk to make cheese
What is joint demand and an example
- When demand for 2 goods is in interdependent
e. g. a decrease in price for printers will cause an increase in printers but alsoa higher demand for ink
Define Utility
Measure of the satisfaction we get from purchasing and consuming a good
What is the law of diminishing marginal utility
As there is more consumption, people’s utility decreases.
The first consumption has the highest utility as it grants the majority of the immediate need
How does the law of diminishing marginal utility explain the inverse relationship between price and quantity demanded
As people’s consumption increases, their utility decrease so they are willing to pay less.
Define Supply
quantity of good/serv. that a producer is willing and able to supply onto the market at a given price in a given time period.
What is the basic law of supply
As prices increase, there is an expansion of supply
What is the profit motive and how does it link to the supply curve
Suppliers look to get the best prices for their product
thus if the price rises, there is an expansion of supply
What ONLY causes movement ALONG the supply curve
Change in market price
What effect does a rising price have on the supply curve
An expansion of supply ( chase profit motive )
What effect does a falling price have on the supply curve
a contraction of supply
What are the 3 Laws of Supply
1) The Profit Motive
2) Production Costs
3) Newcomers
Explain the effects of the 3 laws of supply
Profit motive - expansion of supply as price rises as it becomes more profitable
Production Costs - Higher output leads to higher production costs so they must raise the price
Newcomers - higher prices incetivise new businesses to enter raising total supply
What is Joint Supply and an example
Changes in one product leads to changes in a by-product of it
e.g. expansion in beef markets will lead to expansion of supply of beef hides
What does it mean if the supply curve shifts inwards ( to the left ) or outwards (to the righr)
It is due to non-price factors
What are 7 non-price factors in the supply curve and if they cause an inward or outward shift
- change in unit cost of production (either)
- fall in exchange rate as it increases cost of imports ( inward )
- Advances in production technology ( outward )
- Newcomers ( outward )
- seasonal factors ( either )
- Subsidies ( outward )
- Taxes and Regulations ( inwards )
Define equilibrium (market clearing price)
a balance between demand and supply
(where the supply and demand curves intersect)
What is happening at Point A
At Point A there is an excess supply thus there is downward pressure on the price. as people lower the price to sell more to stop the glut of products
What is happening at point B
At Point B there is excess demand there is upwards pressure on the price as producers chase profit motive and increase supply and thus price. Eventually reducing demand.
What is the effect of an inward shift of demand on a Price-Demand Graph
There is a lower equilibrium price so there is a contraction of supply
What is the effect of an inward shift of supply on a PD Curve
a higher price equilibrium so a contraction of demand
What is the effect of an outward shift of demand on a PD Graph
A higher equilibrium price so there is an expansion of suppy
What is the effect of an outward shift of supply on a PQ graph
lower price equilibrium and an expansion of demand
Explain the movement from Point A to Point C
A rise in demand causes price to peak at B as supply cannot catch up as fast
When an expansion of supply occurs, due to profit motive, the price falls to C
What about when there is an outward shift in both supply and demand
Both factors cause quantity of goods bought and sold to increase but the market price will be dependent upon which one increased more
e.g. here supply exceeds so market price falls
Define Elasticity
the percentage change of one economic variable in response to a change in another
How is Price Elasticity of Demand calculated
What is an alternative formula to the basic PED Formula
How do you work out % Δ
What is an elastic good
A good with a PED >1
Meaning, a change in price leads to a bigger change in demand
What is the demand curve like for a good with PED>1
What is an inelastic good
A good with a PED<1, Meaning a change in price leads to a smaller change in demand
what is the demand curve for an inelastic good
What happens if PED = O
The good is perfectly inelastic, the demand doesn’t relate to price anymore
What happens if PED = infinity
The good is perfectly elastic, there is only one price at which a consumer is willing to pay
What happens if the PED = 1
It is described as unitary elastic demand, a change in price is met with a propotionate change in demand throughout
What is the demand curve for a perfectly inelastic curve look like and how do shifts in supply interact with it
a horizontal line. if supply falls, market equilibirum can rise without any contraction in demand
What is the demand curve for a perfectly elastic good and how do supply shifts interact with it
a horizontal line
change in market supply will not lead to any change in market price. Implying that the supplier has no pricing power (typically in a very competitive market)
What is the demand curve for a unitary elastic good like and how does it relate to consumer spending
total consumer spending remains the same at every level
What will happen to the coefficient of a PED along a linear line
The PED will vary as you move along the curve
What is the PED at high prices ( on a linear demand curve )
It is elastic
What is the PED at low prices ( along a linear demand curve )
It is inelastic
What 3 things is PED used to predict
- effect of change in £ on total revenue
- price volatility
- effect of a change in indirect tax on £ and Q.D.
What is surge pricing
When demand > supply ⇒ ⇡£
e.g. uber
What are the main problems with PED
- inaccurate data
- Assumption of profit maximisation
- price sensitivity subject to time, region and range
Define total spending
amount buyers spend on a product
Define total revenue
the amount sellers recieve from selling the product
If the good is inelastic what will happen to total revenue as ⇑£
⇑ Revenue with ⇑ £
If a good is elastic, what will happen to total revenue as prices rises
⇓ Revenue with ⇑ £
If the good is unitary elastic, what will happen to total revenue as prices rise
nothing
What is cross elasticity of demand (XED)
Measures the responsiveness of demand of Good X after a change in price of a related Good Y
What is a substitute
a good which can replace another e.g. coke and pepsi
What is the formula for XED
What are close substitues and weak subtitues and what is the demand curve for each
close subtitues are products that can be directly replaced so have a positive and high YED
weak substitues are products that are less similar so still have a positive but low YED
What is a complement
a good which is demand as it is in use with another good (joint demand)
e.g. printers and ink
What are close and weak complements
Close complements are those where they have strong joint demand so have a negative high XED
Weak complements are those with a weak joint demand so have a negative low XED
What is the XED of unrelated goods
They have a XED of O
Define YED (income elasticity of demand
the relationship between a change in quantity demanded for good X and a change in real income
What is the formula for YED
What is a normal good
a good which is income elastic
What 2 categories of normal goods are there
Normal neccesities: low but +ve
Normal luxuries: high and +ve
What is an inferior good
a good that has -ve YED and is a counter-cylical good
How is YED useful for firms
it allows firms to estimate how demand for its products will change
Define and identify on the graph where consumer surplus is ( to do with demand )
the gap between what the consumer is willing to pay and what they actually pay
e.g. consumer is willing to pay $5 for a good, but pays $3
How does low and high PED ( price elasticity of demand ) interact with consumer surplus
a low PED = high consumer surplus
a high PED = low consumer surplus
How does consumer surplus change with shifts in supply + demand
It increases with outward shifts
It decreases with inward shifts
Define producer surplus and identify where it is on the graph
difference between what producers are willing and able to supply a good for and the price they actually receive
e.g. producer would be willing to sell a good for $4, but he is able to sell it for $10, he achieves producer surplus of $6.
how does producer surplus interact with shifts in demand + supply
outward shifts = higher producer surplus
inward shifts = lower producer surplus
Identify both consumer AND producer surplus on this graph and what does it tell you
they operate in equilibrium, ceteris paribus
What are the 3 main functions of price
- Rationing
- Singalling
- Incentives
*
What is the rationing effect
Prices rise as supply falls to decrease demand and preserve the good
What is the signalling effect
Prices adjusting to demonstrate market conditions
e.g. where market resources are needed(or not)
What is the incentive effect
The rising price of a good causes supply increase
Decrease of price causes demand increase
What is an ad valorem tax
percentage tax e.g. 20% on the unit price
specific tax
set tax per unit
What is the effect of an ad valorem tax on a supply curve
to cause a pivotal shift in the supply curve
If PED>1 and indirect tax who will absorb most of the costs.
if the co-efficient of price elasticity of demand >1, then most of the burden of an indirect tax will be absorbed by the supplier
indirect tax & PED<1 who will absorb most costs
If the co-efficient of price elasticity of demand <1, most of an indirect tax can be passed on to the final consumer
What does a government subsidy do to the supply curve ( Draw graph and show subsidy)
Causing an outward shift
How do you calculate government spending on the subsidy.
Both formula and shading on a graph
Total spending = government susbsidy per unit * quantity produced
If the market PED is elastic, what is the stronger effect of a subsidy
It has a strong effect on the quantity
If the PED is inelastic what is the larger effect of the subsidy
it has a larger effect on the new price
What is cost benefit analysis
process used to measure the benefits of a decision or taking action minus the costs associated with taking that action.
Problems with cost benefit analysis
- hard to assign monetary values e.g. water/air quality, social inclusion
- Uncertainty with major products e.g. population growth, operating costs
What is the economic incidence of a subsidy
Indicates who is made better off by the subsidy
What is the legal incidence of the subsidy
indicates who, by law, the subsidy is intended to help
Why does the price of a good fall by the full effect of the subsidy
The producer keeps the extra revenue
What is the overall cost of the subsidy to the government in this graph
CABP1
What is the gain to the consumer, the total gain and the extra they pay after the subsidy
the gain is P-P1 per unit and the whole gain to the consumer if PFB1
the extra bit they pay is LFQQ1
Mark on the sections where there is benefit to the producer and benefit to consumer as a result of the subsidy
Where is the producer revenue on this graph of indirect taxation
where is the welfare loss on this indirect tax
What is an index number
A figure refelecting price or quantity compared with a base value (always 100)
What is the formula for an index number
Index number in Year Y = (Data Value in Year Y / Base Year Value)*100
What is assumed about the ‘economic man’
rational,intelligent and emotionless
What is ‘bounded rationality’
Consumers do not have sufficient information
What is ‘bounded rationality’
Consumers do not have sufficient information
What is ‘Heuristics’
mental shortcuts for optimal, not perfected, decisions
What are default choices (habitual nature)
repeat behaviour as they require little cognitive behavious
What are choice architecture
describes how the decisions we make are affected by the layout / sequencing / range of choices that are available
What are is an example influenced by social norms
Social norms about ‘giving’
What is Herd Behaviour
Making decisions based in part on who is around us and the choices they make e.g. financial markets, items off a menu in restaurant
What is Anchoring
Value set by mental reference points e.g. 2.00 wings meal
What is Priming
Our behaviour by cues that work subconsioucsly and prime us to behave in certain waves
e.g. playing of certain types of music in a shopping mall
What is framing
framing a question or offering in a different way
What is asymmetric framing
including an obviously inferior 3rd choice or a hyper-expensive 3rd option rather than a simple expensive/cheap option that can guide consumers to more expensively priced items
Availability Bias
distortion that arises from the use of information which is most readily available
e.g. over estimate likelihood of an air crash based on recent headlines
What is the Commitment effect
The more public our position, the less willing we are to change it
What does the concave shape of the PPF show
illustrates the law of increasing opportunity cost
Which of these can you not tell from a PPF diagram :
- Productive efficiency
- Allocative efficiency
- Pareto efficiency
Cannot tell allocative efficiency since we cant see consumer demand from the PPF
define the price mechanism
a system where the forces of demand and supply determine the prices of commodities
What are the functions of money
- Medium of Exchange
- Store of Value
- Measure of Value
- Standard of Deferred Payment
What do barter systems rely on and how does a medium of exchange fix this
Barter systems rely on there being a double coincidence of wants between the two people involved in an exchange.
Money acts as a medium of exchange. This allows goods and services to be traded without the need for a barter system
What is the function of money; standard of deferred payment
the function of being a widely accepted way to value a debt, thereby allowing goods and services to be acquired now and paid for in the future.
What type of economy did Friedrich Hayek propgate and how
Free Market Economy
- Intervention caused economic instability
- Government should just maintain law and order
- Small group of individuals (government) could never have enough information to properly allocate resources to people’s needs
What are some examples of the role of the State in a mixed economy
- Progressive taxation to reduce inequality
- Government regulation
- Taxes on demerit goods
- gov’t provision of public goods
What are the underlying assumptions of rational econommic decision making
are the underlying assumptions of rational econoare the underlying assumptions of rational econo
What are the underlying assumptions of rational economic decision making (for consumer, firms and govt.)
- Consumers aim to maximise utility
- Firms aim to maximise profit
- Governments aim to maximise social welfare
How does the concept of diminishign marginal utility influence the shape of the demand curve
- If more of a good is consumed there is less satisfaction derived from the good
- Thus consumers are less willing to pay high prices at high quantities
What is PES and the formula
Price Elasticity of Supply - the responsiveness of supply to a change in the price of a good
What is unitary elastic PES
PES = 1
What is relatively elastic PES
PES.1; q.s. changes by a larger percentage change than price so supply is relatively responsive
What is relatively inelastic PES
PES<1; q.s. changes by a smaller percentage than price so supply is relatively unresponsive to price
What is perfectly elastic supply
PES = infinity ; a change in price means quantity supplied falls to 0
What is perfectly inelastic PES
Where PES = 0; a change in price has no effect on output
What are factors affecting PES
- Time; short-run inelastic, long run more elastic
- Stocks: businesses can you extra stock to respond to higher prices
- Spare capacity: businesses can respond to higher prices by increasing output
- Avaliability of factors of production
-
Ease of entry into the market
- Avaliability of substitutes
define the short run in economics
that states that, within a certain period in the future, at least one input is fixed while others are variable
define the long run in economics
a period of time where all factors of production and costs are variable
