1.2 Flashcards
In economics, what assumptions are made about the objectives of consumers and producers
Consumers aim to maximise utility (the total satisfaction or benefit derived from consuming a good or service)
Producers aim to maximise profits
Explain how herd mentality may prevent consumers acting rationally
Herd mentality is when people are greatly influenced by others and thus are not thinking or acting rationally
Explain how habitual behaviour may prevent consumers acting rationally
Habitual behaviour is a default bias in choices which means many people are influenced to default purchase products we always buy and so not act rationally
Explain how computational weakness may prevent consumers acting rationally
Consumers are not always able to make comparisons between prices and different goods on offer
Explain the concept ‘diminishing marginal utility’
As consumption of a product is increased, the consumer’s utility increases, but at a decreasing or diminishing rate
Explain why a demand curve is downward sloping
The marginal utility of a commodity reduces when quantity of goods is more. Consequently, when the quantity of goods is more, the prices will fall and demand will increase. Hence, consumers will demand more goods when prices are less. This is why the demand curve slopes downwards
Explain the factors that cause a demand curve to shift to the right
Population
Advertising
Substitutes
Income (Disposable)
Fashion and Taste
Interest rates
Complements
NB: P A S I F I C
What might cause an extension along a demand curve
An increase in demand due to the fall in price, all other factors remaining constant
What might cause an contraction along a demand curve
A fall in demand due to the rise in price, all other factors remaining constant
Explain why a supply curve is upward sloping (3 reasons)
¬The profit motive- If market price rises following an increase in demand, it becomes more profitable for a business to increase their supple.
¬Production+costs - when output expands, a firms production costs tend to rise, therefore a higher price needed to cover extra costs. This may be due to the effects of diminishing returns as more factor inputs are added to production.
¬New entrants coming into the market - higher prices may create an incentive for other business to enter a market leading to an increase in total supply
Explain the factors that cause a supply curve to shift
PintsWc
P A rise in productivity by the labour force
I Indirect tax
N no. of firms in market
T Technology
S Subsidies - grants to producers from Gov that leads to a reduction in the costs of production
W Weather
C Costs of production eg transport, oil, labour
What might cause an extension along the supply curve
A rise in price causes an increase in the quantity supplied
What might cause a contraction along the supply curve
A fall in price causes an decrease in the quantity supplied
Explain, using an example, the meaning of joint supply
Where an increase or decrease in supply of one good causes an increase or decrease of a by-product
Fe - A contraction in the market supply of lamb will reduce the supply of wool
Explain, using an example, the meaning of competitive supply
Term uses to describe when more than one product can be produced from the same factors of production
E.g. a farmer can plant potatoes or carrots using essentially the same factors of production.
Define price elasticity of demand
Price elasticity of demand measures the responsiveness of quantity demanded for a product to a change in price
Write the formula for price elasticity of demand
PED= Percentage change in quantity demanded/ percentage change in price
Explain the meaning of a PED of 0
Perfectly inelastic demand
A change in price has led to no effect on quantity demanded
Explain the meaning of a PED of between 0 amd -1
Price inelastic demand
A change in price has led to a smaller percentage change in quantity demanded
Explain the meaning of a PED of -1
Unitary elastic demand
A change in price has led to the same percentage change in quantity demanded
Explain the meaning of PED of between -1 and infinity
Price elastic demand
A change in price has led to a larger percentage change in quantity demanded
Explain the meaning of a PED of infinity
Perfectly elastic demand
Any rise in the price causes the quantity demanded to fall to zero. The value of PED will be infinite and the demand curve will be horizontal
List the factors that influence the PED for a good or service
Proportion of income
Loyalty
Addictive
Necessity
Time under consideration
Substitute products
(Plants)
Define income elasticity of demand
A measure of the responsiveness of quantity demanded of a product to change in real income
Write the formula for income elasticity of demand
YED= Percentage change in quantity demanded/ percentage change in real income
What YED values should we expect normal goods to have?
A positive sign as a rise in real income will cause a rise in demand for the product
What YED values should we expect inferior goods to have
A negative sign as a rise in real income will cause a fall in demand for the product
What YED values should we expect luxury and necessity goods to have?
Luxury- YED>1 become inelastic
Necessity= 0and1 as change in income doesn’t affect needs for these product
Define cross elasticity of demand
A measure of the responsiveness of quantity demanded of one product (Y) is to a change the price of another product (X)
What is the formula for cross elasticity of demand
XED= Percentage change in quantity demanded of product Y/ Percentage change in price of product X
What XED values should we expect substitute goods to have
A positive sign as a rise in the price of one product will cause a increase in demand for another product
What XED values should we expect complementary goods to have
A negative sign as a rise in the price of one product will cause a decrease in demand for another product
What XED values should we expect unrelated goods to have
Zero as price changes do not affect one another’s demand and so graph would represent a vertical
Define supply
Supply is the quantity of a good or service that a producer is able and willing to supply at a given price during a given period of time.
Define price elasticity of supply
A measure of the responsiveness of quantity supplies for a product to a change in its price
Whats the formula for price elasticity of supply
PES= %change in quantity supplied/ %change in price
Explain meaning of a PES of 0
Perfectly inelastic supple as a change in price has no effect on quantity supplied
Explain meaning of a PES of infinity
Perfectly elastic supply as any change in price will cause quantity supplied to fall to 0
Explain meaning of a PES of between 0 and 1
Price inelastic supply
A change in price has led to a smaller percentage change in quantity supplied
Explain the meaning of a PES of between 1 and infinity
Price elastic supply
A change in price has lead to a larger change in quantitiy supplied
Explain the meanin of a PES of 1
Unit elasticity of supply
Supply is said to be unit elastic as a change in price has lead to the same % change in quantity supplied
When supply is unit elastic, value of PES is equal to 1 and supply curve is a straight line through the origin
In a free market economy what is the ratioining function in the price mechanisms
The price system is a way of rationing goods because when price increases, some people will no longer be able to afford to buy the product and others may no longer have the desire to. The limited resources can be rationed and allocated to those who are able to afford them and those who value them most highly.
In a free market economy what is the signalling function in the price mechanisms
The price system acts as a signal where resources should be used. When prices rise, producers move resources into the manufacture of that product. The change in price indicates to suppliers and consumers that market conditions have changed so they should change the quantity bought and sold- when price equilibrium moves, output equilibrium moves with it
In a free market economy, what is the incentive function in the price mechanisms
Acts as an incentive for people to work hard. Buyers realise that the more money they have, they are able to buy more products. Suppliers relaise if they produce more goods, they will make more money. Also, low prices acts an an incentive for consumers to buy more of a good and high prices act as an incentive to suppliers to sell more of a good. The price mechanism encourages people to behave a certain way.
define producer surplus
The difference between the price the producers recieve and the cost of supply. In other word it represents the profit.
define consumer surplus
The difference between the amount consumers are willing to pay and what they actually pay for a product
Explain the difference between direct and indirect taxes
Direct- tax on income or profits of the person who pays it (income tax, corporation tax)
Indirect- tax on goods or services eg. (VAT, excise duties (a form of tax imposed on goods for their production, licensing and sale.))
Explain the difference between ad valorem and specific taxes
Ad valorem- a tax whose amount is based on the value of the transaction (a %) thus supply curve separates as price increases and value of tax increases
Specific taxes- a tax that is a fixed amount for each unit of a good or service sold. Main type we are concerned with are excise duties
Explain the meaning of consumer incidence and producer incidence of a tax
The consumer burden of a tax increase reflects the amount by which the market price rises (difference between new and old price). The producer burden is the decline in revenue firms face after paying the tax.
Explain the impact of consumers when an indirect tax is imposed on a good
They pay more, less consumer surplus.
Evaluation- how much ones affected depends on your income, size of tax and PED
Explain the impact of producers when an indirect tax is imposed on a good
Earn less revenue +less profit, less producer surplus
Evaluation- depends on size of tax+ PED
Explain the impact of Governments when an indirect tax is imposed on a good
+evaluation
Gain tax revenue
May meet its objective to reduce consumption
Evaluation depends on PED and size of tax
Explain the impact of third parties when an indirect tax is imposed on a good
Should be a decrease in the amount of people affected by the taxed items eg cigarettes- passive smoking
Define ‘subsidy’
A payment by the government to suppliers that reduce their costs of production and encourages them to increase output
Explain consumer and producer gain from a subsidy
Consumer gain - pay less, consumer surplus increases
Producer gain- produce product lower with lower costs so producer surplus increases
Explain the impact on consumers when a subsidy is placed on a good
Get product/service cheaper/more affordable, increase consumer surplus
Evaluation amount depends on size of subsidy + price elasticity of demand and supply
Explain the impact on producers when a subsidy is placed on a good
Costs of production lower
increased quantity demanded and increased price causes increased revenue and profit
Producer surplus increases can cause more firms to enter market
Evaluation amount depends on size of subsidy + price elasticity of demand and supply
Explain the impact on Governments when a subsidy is placed on a good
Increased gov spending thus an opportunity cost elsewhere
Change in consumer behaviour
Evaluation amount depends on size of subsidy + price elasticity of demand and supply
Explain the impact on Third parties when a subsidy is placed on a good
May benefit from the positive externalities or suffer from extra consumption of negative externalities (Externalities occur when producing or consuming a good cause an impact on third parties not directly related to the transaction.)
Evaluation amount depends on size of subsidy + price elasticity of demand and supply
5 Factors affecting PES
BRITS
Barriers to entry
Resources (CELL)
Inventory
Time
Spare Capacity
