1.1-1.4 Edited Exam Flashcards
What is meant by a model in economics?
A model is a simplified version of reality used to predict or describe what will happen in an economy if one of the variables changes.
What does ‘ceteris paribus’ mean?
All other things being equal, and it means that when we change one variable then we hold all others constant in order to isolate the consequences of the variable we changed.
Give an example of when you would use the ceteris paribus assumption?
e.g. when we change the price of a product we assume that no other variables, such as income change at the same time, so we can look at the effect just of the price change.
Why do economists use models, assumptions and ceteris paribus?
In order to analyse clearly the effect of a change in one of the variables, we need to simplify reality otherwise predicting and describing cause and effect becomes too complicated e.g. when drawing a PPF we assume that an economy only produces 2 goods, and that when we look at a movement along the PPF we assume that nothing else changes.
How does Economics differ from a science such as Physics?
It is not possible to conduct laboratory experiments in most areas of economics, particularly with macroeconomics where we are looking at the whole economy in aggregate, which is why economics relies on the collection of statistics to analyse the effects of a change in a variable.
What is the main objective of consumers when making economic decisions?
To maximise utility.
What is the main objective of producers when making economic decisions?
To maximise profit.
What is meant by effective demand?
Demand backed up by an ability to pay.
What are the main determinants of demand (the demand function)?
Price (p), Income (y), Tastes and preferences (t) and the prices of ‘other’ goods (p1……..pn).
What does a point on a demand curve show?
The amount/quantity of a good that will be bought at that price.
What would cause a movement along a demand curve?
A change in the price of the product itself is the only thing that causes a movement along a demand curve.
What would cause a shift in a demand curve?
A change in the conditions of demand would cause a shift in a demand curve. This would mean that more or less of a good would be bought at each and every price level.
E.g. real incomes, size age and distribution of the population, tastes fashion and preferences, prices of substitutes and complements, advertising and promotions, interest rates.
Give an example of something that would shift the demand curve for potatoes to the right?
A shift to the right indicates an increase in demand. Demand for potatoes would increase if it was revealed that potatoes could be classed as one of the five a day, or if the price of a substitute increased e.g. the price of rice increased, or if the price of a complementary good fell such as cod (fish and chips).
Give an example of something that would shift the demand curve for potatoes to the left?
A shift to the left indicates a decrease in demand. Demand for potatoes would decrease if potatoes were found to be unhealthy or the price of a substitute decreased.
Define Price Elasticity of Demand (PED)
PED measures the responsiveness of demand to a change in price. Alternatively you can use the formula for calculating PED instead of the definition. (% change in Qd)/(% change in P).
Define Income Elasticity of Demand (YED)
YED measures the responsiveness of demand to a change in income. Alternatively you can use the formula for calculating YED instead of the definition. (% change in Qd)/(% change in Y).
Define Cross-Elasticity of Demand (XED)
XED measures the responsiveness of demand to a change in the price of another good. Alternatively you can use the formula for calculating XED instead of the definition. (% change in Qd of good A)/(% change in the P of good B).
Define normal good and link this to Income Elasticity
A normal good is one where demand increases if income increases. In other words it has a positive YED.
Define inferior good and link this to Income Elasticity
An inferior good is one where demand decreases if income increases. In other words it has a negative YED.
Define substitute and link this to Cross Elasticity
A substitute is a good which is an alternative to another good. A substitute has a positive XED.
Define compliment and link this to Cross Elasticity
A complement is a good which is used with, or purchased at the same time as another good. A compliment has a negative XED.
How to do you calculate % change?
(new – old)/old x 100.
What range of values is there for price elasticity of demand and what does each value mean?
0 = perfectly inelastic 0 to -1 = inelastic -1 = unitary elastic -1 to – infinity = elastic - infinity = perfectly elastic
What is the formula for calculating price elasticity of demand?
% change Qd/% change P.
- What is the formula for calculating income elasticity of demand?
% change Qd/% change Y.
What is the formula for calculating cross-price elasticity of demand?
% change Qd (good A)/% change P (good B).
Name 4 factors that affect the Price Elasticity of Demand for a good and explain how these factors affect elasticity
Availability of substitutes
i. If there are many close substitutes then PED will be more elastic as
consumers can easily switch to an alternative product if the price of one good
goes up
ii. If there are few or no close substitutes then PED will be less elastic as
consumers cannot easily switch
Necessity or luxury
i. If the good is a necessity, then PED tends to be less elastic, especially if there are few or no substitutes
ii. If the good is a luxury, then PED tends to be more elastic, especially if there are many substitutes
Proportion of income spent on the product
i. If the proportion of income spent is high, then PED will be more elastic, as a
rise in price will have more of an impact on that person’s overall budget/real
income
ii. If the proportion of income spent is low, then PED will be less elastic, as a
rise in price will not have a significant effect on that person’s overall
budget/real income
Time
i. The longer the time period in question the more elastic the PED will be. This is because it takes time for consumers to change their buying habits and identify substitute or alternative goods. If none are available, then over time some new products will be released which ARE substitutes, reducing PED over time.
If demand is inelastic and price increases, what affect will this have on the firm’s total revenue?
Total revenue = P x Q, PED = % change Qd/% change P
Inelastic is when PED is between 0 and -1
If price increases by 10%, then quantity demanded will fall by less than 10%.
This means that total revenue will increase
If demand is inelastic and price falls, what affect will this have on the firm’s total revenue?
If price falls by 10%, then quantity demanded will rise by less than 10%
This means that total revenue will decrease
If demand is elastic and price increases, what affect will this have on the firm’s total revenue?
Elastic is when PED is between -1 and – infinity
If price increases by 10%, then quantity demanded will fall by more than 10%
This means that total revenue will fall
If demand is elastic and price falls, what affect will this have on the firm’s total revenue?
If price falls by 10%, then quantity demanded will rise by more than 10%
This means that total revenue will rise
