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BTF > 11. The Economic Environment Of Business And Finance > Flashcards

11. The Economic Environment Of Business And Finance Flashcards

1
Q

What is a market?

A

Where potential buyers and sellers come together for the purpose of exchange

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2
Q

What is the market mechanism?

A

The interaction of supply and demand foe a particular item

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3
Q

What is demand?

A

The demand for a particular good is the quantity that consumers are willing and able to buy at a given price

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4
Q

What happens to demand when price falls?

A

The quantity demanded will rise as lower prices make the goods more affordable to people on lower incomes and lower relative price makes the goods more attractive

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5
Q

What are the determinants of demand?

A
  • price of the good itself
  • price of other goods
  • substitutes (different brands of same product)
  • complements (shirts and ties)
  • national income - normal and inferior goods
  • fashion
  • population size
  • credit terms
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6
Q

What causes movement along the demand curve?

A

Changes in price

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7
Q

What causes the demand curve to move right?

A

An increase in demand due to:
- an increase in household income
- an increase in the price of substitutes
- a decrease in the price of complements
- the food becoming more fashionable
- an expectation that the price of the good will be higher in the next period

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8
Q

What causes the demand curve to move to the left?

A

Less demand

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9
Q

What is price elasticity of demand and how is it calculated?

A

Looks at the degree to which demand is affected by changes in the selling price
Price elasticity of demand = % of change in demand divided by % change in price

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10
Q

What are the common values for price elasticity of demand?

A

Inelastic = PED < 1
Elastic = PED > 1
Perfectly inelastic = PED = 0
Perfectly elastic = PED = ♾️
Unitary elasticity = PED = 1

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11
Q

What are factors affecting the PED?

A

Availability and closeness of substitutes i.e. if readily available or close substitutes exist then demand will tend to be much more elastic
Time - generally, in the short run demand tends to be much less elastic, while in the long run it tends to be much more elastic
Competitors pricing - if competitors copy a price cut then demand is unlikely to rise (inelastic). The same competitors may not copy a price rise resulting in a large fall in demand (elastic). This can give rise to ‘price stickiness’
Nature of the product - in the case of luxuries demand tends to be more elastic, with necessities less elastic. Habit-forming products are price inelastic
Proportion of income accounted for by a good. If a good accounts for a large proportion of income, demand will tend to be elastic; if it accounts for only a small proportion, much less elastic

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12
Q

What is the significance of price elasticity?

A

Allows managers to predict the effect of price changes on demand and revenue
Inelastic products (PED <1) - increasing the price will increase the total revenue even though fewer units are sold
Elastic products (PED >1) - increasing the price will cut the total revenue and fewer units will be sold. For elastic demand the price must be cut to increase revenue

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13
Q

What kind of demand curves and price elasticity of demand do giffen and Veblen goods have?

A

Upward sloping demand curves and positive PED

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14
Q

What are giffen goods?

A

Giffen looked at the income effect of price changes:
The price of bread increases so people still buy bread (staple) then people can no longer afford other more expensive goods so end up buying even more bread

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15
Q

What are Veblen goods?

A

Bough for ostentation so a higher price makes them more exclusive and desirable

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16
Q

What is income elasticity of demand and how is it calculated?

A

Looks at the degree to which demand is affected by changes in household income
YED = % change in demand divided by % change in household income

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17
Q

What do different values of income elasticity of demand mean?

A

YED > 0 for normal goods
YED < 0 for inferior goods
YED > 1 for luxury goods (a type of normal good)

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18
Q

What is cross elasticity of demand and how is it calculated?

A

Looks at the degree to which demand is affected by changes in the price of other products
XED = % change in demand for product A divided by % change of price of product B

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19
Q

What do the different values of cross elasticity of demand mean?

A

XED > 0 for substitutes
XED < 0 for complementary goods
XED = 0 for unrelated goods

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20
Q

What is supply?

A

Supply of a particular good is the quantity that suppliers (and would be suppliers) are willing and able to supply at a given price

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21
Q

What does the supply curve show?

A

Supply at each price, assuming that all other variables are constant

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22
Q

What happens to supply when price increases and why?

A

Quantity supplied usually extends
Existing suppliers produce more
New suppliers switch to making the product

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23
Q

What is price elasticity of supply and how is it calculated?

A

Looks at the degree to which supply is affected by changes in price
PES = % change in supply divided by % change in price
It is usually positive as the supply curve is upward sloping

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24
Q

What is perfectly inelastic supply and what does it look like?

A

Supply remains constant at all prices
Graph is perfectly vertical

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25
Q

What is perfectly elastic supply and what does the graph look like?

A

Supply is infinite at a particular price. Below this price supply drops instantly to zero
Graph is perfectly horizontal

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26
Q

What are determinants of supply?

A
  • price of the good itself
  • price of other goods - suppliers may switch to producing other more profitable goods e.g. farmers growing coffee rather than food
  • processing of joint products - a price rise for one will make production of both more attractive
  • costs
  • changes in technology
  • other e.g. weather, harvests
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27
Q

What causes movements along the supply curve?

A

Changes in price

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28
Q

What factors influence the elasticity of supply?

A

Market period - inelastic as changes in supply limited to availability of inventory
Short run - can change production plans but still limited by capacity due to fixed plant and machinery for example
Long run - can expand capacity, new firms can enter industry - more elastic

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29
Q

What happens if the price is too high?

A

Supply will exceed demand causing a surplus
This will be reflected in the short term by retailers having unwanted goods, returns made to manufacturers, reduced orders and so,em products being thrown away
The supplier will respond by lowering price to attract more demand

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30
Q

What happens when price is too low?

A

Demand will exceed supply causing a shortage
This will be reflected in the short term by retailers having empty shelves, queues, increased orders and high second hand values
The supplier will respond by increasing prices to reduce shortage

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31
Q

What is equilibrium price?

A

Price at which supply and demand is equal

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32
Q

Why are maximum prices used and what are the results?

A

To ensure that essential foods are affordable
To limit inflation as part of a prices and incomes policy
Result is excess demand - queues, rationing, black markets

33
Q

Why are minimum prices used and what are the results from them?

A

To protect suppliers e.g. EU cap, minimum wage requirements
Result is excess supply - butter mountains, farmers paid not to grow crops, unemployment?

34
Q

What is the national output of goods and services measured as?

A

Gross domestic product (GDP)

35
Q

How does the government influence the national economy?

A

Producing goods and services e.g. education and health etc
Purchasing goods and services e.g. uniforms and supplies etc
Investing in capital projects e.g. new roads and schools etc
Transferring payments from one section of economy to another e.g. taxes to fund unemployment payments

36
Q

How do consumers influence the economy?

A

Spending their disposable income on goods and services rather than saving it
The amount spent depends on:
- changes in disposable income and marginal propensity to consume (spend rather than save)
- changes in distribution of wealth
- government policy (via taxation and spending)
- development of major new products
- interest rates
- price expectations

37
Q

How do savers influence the economy?

A

Investing what they choose not to spend
The amount saved depends on:
- income
- interest rates
- need for long term savings

38
Q

How do businesses influence the economy?

A

The amount they invest in capital goods which drives growth of the economy

39
Q

What are the four main phases of the business cycle and the order in which they occur?

A

Recession
Depression
Recovery
Boom

40
Q

What is recession?

A

Consumer demand falls
Businesses sell fewer goods
Business failures occur
Production and employment fall
Deflation may occur as supply exceeds demand
Business and consumer confidence diminish
Recession begins relatively quickly due to the speed with which declining demand is felt by businesses subverting s loss in sales revenue -> reducing inventory and cutting back on investment -> adds momentum to the recession

41
Q

What is depression/stagflation?

A

Eventually if demand is not stimulated a period of full depression may set in and the economy will reach depression

42
Q

What is recovery?

A

can be slow to begin because of lack of consumer confidence. Governments try to limit the decline by boosting demand in the economy as a whole. Once begun, recovery is likely to quicken as confidence returns

43
Q

What is boom/expansion?

A

As recovery process, output levels climb reaching point in the boo, phase
During the boom:
- demand may outstrip supply causing inflation
- Businesses tend to be profitable
- expectations of the future are very optimistic

44
Q

What is inflation?

A

An increase in price levels generally, and a decline in the purchasing power of money

45
Q

What is deflation?

A

Falling prices generally, which is normally associated with low rates of growth and recession

46
Q

Why is inflation a problem?

A

Most governments aim for stable prices. A high rate of inflation is undesirable because:
Fewer people can afford goods
Wage inflation = productivity falling whilst new rates are agreed
Exports falling as imports appear cheaper (exchange rates usually alter to accommodate this)
Consumers may stock pile fearing price increases = shortages = prices being pushed up further

47
Q

What are the 2 types of inflation?

A

Cost push inflation
Demand pull inflation

48
Q

What is cost push inflation?

A

Prices rises resulting from an increase in the costs of production of goods and services e.g. of imported raw materials or from wage increases

49
Q

What is demand pull inflation?

A

Prices rises resulting from a persistent excess of demand over supply. Supply cannot grow any further once ‘full employment’ is reached

50
Q

What are the 2 main causes of demand pull inflation?

A

Fiscal - an increase in government spending or a reduction in taxes will raise demand in the economy
Credit - if levels of credit extended to customers increase, expenditure is likely to rise. In this case, inflation is likely to be accompanied by customers increasing the debt burdens

51
Q

What is the monetary policy?

A

Government policy on interest rates, exchange rates and the money supply

52
Q

What are the effects of a rise in interest rates, as well as on companies and households and what is the outcome?

A

The price of borrowing in the economy will rise
Impact on companies - reduced borrowing and investment non-current assets
Impact on households - increase in saving and reduced spending, become less willing to borrow for household purchase
Outcome: reduced the aggregate demand in the economy

53
Q

What are the results and outcome for higher exchange rate for sterling?

A

Keeps the cost of exports higher and the cost of imports cheaper
Foreign investors will be attracted to sterling investments
Reductions in spending and investment
Outcome = reduces the aggregate demand in the economy

54
Q

What is quantitative easing?

A

A relatively unconventional monetary policy that involves the central bank (bank of England) buying financial assets (such as government an corporate bonds) using ,only that it has generated electronically. It is a form of expansionary monetary policy

55
Q

What is fiscal policy?

A

The governments policy on government spending, taxation and borrowing

56
Q

Government spending

A

The government can increase spending to stimulate aggregate demand and influence the distribution of wealth

57
Q

Taxation

A

The government can increase taxation to raise funds, influence the distribution of wealth and suppress economic growth

58
Q

Government borrowing

A

The government can borrow to fund spending in excess of its income (primarily from taxation)

59
Q

Expansionary fiscal stance

A

Government spending > taxation = increased borrowing

60
Q

Contractionary fiscal stance

A

Government spending < taxation = reduced borrowing

61
Q

Neutral fiscal stance

A

Government spending = taxation

62
Q

What are supply side economics?

A

Policies designed to encourage suppliers to produce more goods at lower prices

63
Q

What are the main supply side macroeconomic policies?

A

More involvement of the private sector in the provision of services
Reduction in taxes to increase incentives to supply
Increasing flexibility in the labour market by reducing the power of trade unions
Improving education and training do the quality of labour is enhanced
Increasing competition through deregulation and privatisation of utilities
Abolition of exchange controls and allowing the free movement of capital

64
Q

What is market structure?

A

A description of the number of buyers and sellers in a market for a particular good and their relative bargaining power

65
Q

What are the 4 main types of market structure that can exist?

A

Perfect competition
Monopolistic competition
Oligopoly
Monopoly

66
Q

Perfect competition - structure and implications

A

Structure:
Large number of buyers and sellers, none of whom alone can influence the market price (and no collusion)
Free entry to/exit from the market place in the long run
Free access to perfect information on all market conditions, resulting in identical cost structures
Homogeneous/identical products
Implications:
There is a single selling price across the market
Suppliers are ‘price takers’ - they can sell as much as they like but only at the market price
Suppliers only make ‘normal’ profits in the long run (hence seen as good for consumers)

67
Q

Monopoly - structure and implications

A

Structure:
One supplier
Many buyers
Barriers prevent new entrants - size/economies of scale, patents, public sector protection, unique talent, access to unique resources
Implications:
Suppliers can fix price or quantity (other is determined by demand curve)
Firms make super-normal profits (hence often seen as bad for consumers)

68
Q

What are the different types of monopoly?

A

Pure monopoly - only one supplier
Actual monopoly - one dominant supplier
Government franchise monopoly - based on government policy e.g. NHS
Natural monopoly - not due to legal factors (e.g. economies of scale)

69
Q

Monopolistic competition - structure and implications

A

Structure:
Many buyers and sellers
Some differentiation of products (e.g. via branding and advertising)
Some customer loyalty
Few barriers to entry
Implications:
Firms have some freedom to set prices (face downward-sloping demand curve so price rises will lose customers)
Lack of barriers to entry ensure only normal profits in the long run

70
Q

Oligopolies - structure and implications

A

Structure:
Few large suppliers
Differentiation of products
High degree of mutual dependency
Implications:
Difficult to predict the actions of competitions. Possibilities include follow the leader pricing, rivals copy price cuts but not increases and price wars
May prefer non-price competition e.g. via advertising
Collusion to form cartels

71
Q

What js market failure?

A

When a free market fails to produce the optimum allocation of resources

72
Q

Market imperfections

A

Markets do not satisfy assumptions of perfect competition
Monopolists can charge higher prices
Powerful customers can drive prices too low
Imperfect information, resulting in poor decisions
Time lags

73
Q

Public goods

A

Without government intervention some goods would not be provided at all by a market economy
E.g. street lighting, police force, national defence

74
Q

What are externalities?

A

Costs or benefits which the market mechanism fails to take into account because the market only incorporates private costs and benefits
Private cost measures the cost to the supplier of producing the good
Private benefit measures the benefit obtained directly by the supplier/buyer
Social cost measures the cost to society as a whole of producing the good
Social benefit measures the benefit obtained by society as a whole

75
Q

What are negative externalities?

A

Social cost > private cost
Pollution
Climate change

76
Q

What are positive externalities?

A

Social benefit > private benefit
Training staff who subsequently leave

77
Q

Economies of scale

A

Perfect competition involves many smaller firms. In practice large firms exist which may benefit from economies of scale
These may result in lower prices for consumers than under perfect competition
However economies of scale may result in larger firms simply making more profit or larger firms pushing smaller firms out of business, reducing choice

78
Q

What are the different type of economies of scale?

A

Internal economies - arising from the size of the firm
- specialisation and the division of labour
- indivisibilities in inputs (more efficient utilisation of capacity)
- financial economies e.g. bulk discounts, inventory policy
External economies - arising from the size of the industry
- specialisation in the local labour force that reduces training costs
- agglomeration economies i.e. provision of ancillary or back up service industries

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