1.2 Flashcards
What are the assumptions of rational economic decision making?
- consumers aim to maximise utility
- firms aim to maximise profits.
What is a consumer’s utility?
the total satisfaction received from consuming a good or service.
What is demand?
the q of a good or service that consumers are able and willing to buy at a given price during a given time.
What causes movements along the demand curve?
- lower the price, more affordable the demand and so demand increases.
Expansion of demand (increase in quantity)
Contraction (decrease in demand)
ONLY price causes movement along
What factors shift the d curve?
P- population
I- income
R- related goods
A- advertising
T- tastes and fashions
E- expectations
S- seasons
What are the 3 types of demand?
Derived demand= demand for one good is linked with demand for another good.
composite demand= when a good demanded has more than one use. Example= milk.
- an increase in demand for cheese, means less butter is supplied.
Joint demand= when goods are bought together
Why is the demand curve downwards sloping?
the law of diminishing marginal utility.
As a extra unit of good is consumed (marginal utility), the benefit derived from consuming the good, falls. Therefore, consumers are willing to pay less for the good.
What is PED?
responsiveness of a change in demand to a change in price.
How do you calculate PED?
% CHANGE IN QD/ % CHANGE IN PRICE
What is a price elastic goods value?
- very responsive to a change in price.
- PED >1
What is a price inelastics goods value?
demand is relatively unresponsive to a change in price.
PED<1
What is a unitary elastic good?
a change in demand is equal to a change in price.
PED=1
a 1% decrease in price, leads to a 1% increase in QD.
Value for perfectly inelastic good?
0
Value for a perfectly elastic good?
infinity.
What are the factors that influence PED?
- necessity - inelastic
- substitutes- elastic if more substitutes available
- addictiveness- inelastic
- proportion of income spent on good- only inreases from £1 to £1.50= inelastic.
- peak or off peak demand- peak times= more inelastic
- durability of the good= a good which lasts a long time, will have elastic demand, consumers wait to buy another.
How does the burden of the indirect tax depend on the elasticity of the good?
- taxes shift supply, not demand.
- if a firm sells a good with inelastic demand, likely to put most of tax burden on the consumer, because a p increase won’t cause a huge change in demand.
- most effective for raising gov revenue.
- if firm sells good with elastic demand, most of tax burden will go to the producer.
- good for reducing the demand of a particular good.
How does the elasticity of the good affect subsidies?
- increases supply.
- opposite effect of a tax.
- the benefit of a subsidy can go to both the producer (increased revenue) or to the producer ( lower prices).
What is the relationship between ped and total revenue?
TR= P X Q
If a good is inelastic demand, firm can raise its price and increase total revenue.
What is income elasticity of demand YED?
responsiveness of a change in demand due to a change in income
formula for YED?
YED= % CHANGE IN QD/ % CHANGE IN INCOME
What is an inferior good?
a fall in demand as income increases.
For example, as income increases consumers switch to branded goods
YED<0
What is a normal good?
Demand increases, as income increases
YED>0
What is a luxury good?
an increase in income, causes an even bigger increase in demand.
For example, a holiday is a luxury good.
YED>1
What happens to luxury goods when there is economic growth?
They increase as incomes are rising.
Fewer inferior goods.
What is cross elasticity of demand? XED
the change in demand of one good X, to a change in price of another good Y.
What is the formula for XED?
% CHANGE IN QD OF X / % CHANGE OF PRICE OF Y
XED of a complementary good?
- negative XED
- if one good becomes more expensive, the QD for both goods will fall.
XED of a subsitute good?
substitutes can replace another good so XED is positive.
- demand curve is upward sloping
XED of unrelated goods?
=0
Why are firms interested in XED?
allows them to see how many competitors they have.
What is supply?
the quantity of a good or service that a producer is able and willing to supply at a given price at a given time.
Why is the supply curve upward sloping?
- if price increases, it is more profitable for firms to supply the good, so supply increases.
What factors cause a shift in supply?
PINTSWC
productivity- outward shift
indirect taxes- inward shift
number of firms- more, outward shift
technology= outward shift
subsidies= outward shift
weather= favourable conditions increase supply
costs of production= if they fall, firms can afford to supply more.
What is joint supply?
increasing the supply of one good causes an increase or decrease in supply of another good.
Formula of price elasticity of supply?
% change in qs/ % change in p
Value for elastic supply?
PES>1
Value for inelastic supply?
PES < 1
perfectly inelastic supply?
PES=0
Perflectly elastic supply?
PES= infiinity
What factors influence PES?
- Time scale- in SR, supply is more inelastic because producers cannot quickly increase supply. In the LR= more elastic.
- spare capacity- if there are spare resources supply can be increased quickly.
- levels of stocks- if goods cannot be stored for long, such as apples, supply is more inelastic.
- how substitutable factors are= if capital and labour are mobile, supply is more elastic because resources can be allocated where extra supply is needed.
- barriers to entry to the market= high barriers means inelastic, difficult for new firms to enter.
1.2.6
What are the 3 functions of the price mechanism to allocate resources?
- rationing
- incentive
- signalling
How is rationing used?
When there is scare resources, price increases due to excess demand.
- the increase in price discourages demand and rations the resources.
How is incentive used?
this encourages a change in behaviour of a consumer or producer.
for example, a high price would encourage firms to supply more.
How is signalling used?
the price acts as a signal to consumers and new firms entering the market.
A high price signals to firms to enter the market because it is profitable.
What is consumer surplus?
difference between the price the consumer is willing to pay and the price they actually pay.
(top triangle)
How can consumer surplus be increased?
increase in demand
What is producer surplus?
difference between the price the producer is willing to charge, and the price they actually charge.
The bottom triangle
What is total economic welfare?
total benefit society receives from an economic transaction.
both producer and consumer surplus added.
What are two types of indirect taxes?
ad valorem= percentages, such as VAT
specific taxes= a set tax per unit.
