1.2) how markets work Flashcards
what are the aims of consumers?
their aim is to maximise utility
what are the aims of firms?
their aim is to maximise profit
what are the 5 influences on demand?
1) the price of a good - this will cause movement along curve
2) the price of an other good-shift in demand
3) the income-shift in demand
4) tastes and preferences
5) time period over which demand is considered
what is the law of diminishing marginal utility?
a situation where individuals gain less additional utility from consuming a product, the more of it is consumed
what is the law of demand?
there is an inverse relationship between the price of a good and service or quantity demanded, cetiris paribus
state two reasons why the demand curve slopes downward?
1) the real income effect- at a higher price, consumers will have less income left over
2) the substitution effect- the more expensive a good the more likely a consumer will decide to purchase something else
define PED
a measure of how sensitive demand is to a change in price.
what are the 4 influences on PED?
1) availability of substitutes
2) if good is perceived as neccessity
3) proportion of income spent on good
4) time period for which ped is considered
how can you increase revenue at different PED
inelastic- increase price to increase revenue
elastic- decrease price to increase revenue
define YED
a measure of how sensitive demand is to a change in income
what are the types of good shown by YED?
1) inferior- x<0 - as income falls, demand rises faster- bus travel
2) normal -x>0- two categories, neccesity is good above 0 but less than 1, luxury is good above 1
formula for YED
%change in demand/%change in income
formula for PED
%change in demand/%change in price
define XED
a measure of the sensitivity of demand of one good to the change in price of another good
formula for XED
%change in demand of good X/ %change in price of good Y
what are the three relationships between goods in XED?
substitutes - x>0 - higher value of XED means closer
substitute
complementary- x<0 - coffee and sugar
unrelated - x=0
why is it hard to agree on YED?
it is usually a value judgement about if something is considered a luxury, therefore interpreted differently
what are the uses of PED?
-see how consumers respond to change in price- see
how to maximize revenue
-when imposing indirect taxes, gov can use ped to
forecast tax revenue
-when gov imposes subsidy, ped can access impact of
it
what are the uses of YED?
Firms will make use of income elasticity of demand by producing more luxury goods during periods of economic growth.
In a recession with falling incomes, supermarkets might be advised to promote more ‘value’ inferior goods.
what are the uses of XED?
anticipate changes in demand for one company from changes in price of another’s good.
can be used by the competition and market authoritys to see if firms have susbtitute goods
what does a perfectly elastic PED look like on a price against quantity graph?
horizontal line
what does a perfectly inelastic PED look like on a price against quantity graph?
vertical line
define supply?
the quantity of a good or service a firm is willing and able to supply at any given price, over a given period of time
define a firm?
a firm is an organisation that bring together the factors of production to produce output
what factors influence supply?
1-production costs-shift supply left
2-technology- if it improves , supply shifts right
3-taxes and subsidys- taxes shift left, subsidy shift right
4-prices of related goods- if price increases, firms may choose to increase production
5-expectations of future prices- if prices expected to rise then firms may choose to stockpile goods for future
6-number of firms in the market
define price elasticity of supply?
a measure of the sensitivity of supply of a good in response to a change of price of the good
what is the formula for PES?
percentage change in quantity supplied/ percentage change in price
what causes a firm to be elastic?
when they have stockpiles of goods available
when they are working below full capacity
what causes a firm to be inelastic?
when they have significant costs involved with increasing production ie paying overtime or hiring new machinery
in the short run are firms likely to be elastic or inelastic PES
they are likely to be inelastic as they can only vary one factor of production, typically labour, therefore they are less able to respond
in the long run are firms likely to be inelastic or elastic PES?
they are likely to be elastic as they can vary both capitol and labour so easier to respond to change in price
what does perfectly elastic supply mean and what does it look like on graph?
it means there PES=infinity, no change in price no matter the amount of quantity supplied, horizontal line
what does perfectly inelastic supply mean and what does it look like on graph?
it means PES=0, no change in quantity supplied no matter change in price, vertical line
define market equilibrium?
it occurs when in a market, the quantity demanded by consumers is directly balanced by quantity supplied by firms
what will happen the price is too high in a market?
it will act as a signal for firms to lower price so they can clear the excess supply
what happens when the price is too low?
the firms will realise that some consumers are willing to pay more so they will raise prices to clear the excess demand
define consumer surplus?
the value that consumers gain from consuming a good or service over and above the price paid ( consumers are willing to pay up to point where price=marginal utility, so if price is lower than MU then there will be consumer surplus)
what can the demand curve be seen as?
the marginal benefit curve
what is producer surplus?
the difference between price received by firms for a good or service and the price they were willing to supply at
what will affect the the size of consumer surplus?
shifts of the supply and demand curves
how can you work out the net welfare of society?
sum of consumer and producer surplus
what can the supply curve be seen as?
the marginal cost curve
define the price mechanism?
a process by which resource allocation is influenced through rationing, incentives and signalling
define a price signal?
where a price of a good carries information to producer or consumers that guides the market towards equilibrium and assists in resource allocation
how will the market react to an increase in demand?
the demand curve will shift right creating a higher new equilibrium price, this will encourage firms to join market until the incentive is gone , so supply shifts right until the equilibrium is at original price at larger quantity
define marginal cost?
the cost of producing an additional unit of output
how do prices act as a rationing device?
if a firm cannot supply as much ie bad harvest, then supply will shift left increasing price, the increased price will then reduce demand until at original equilibrium price but at lower quantity
what does free movement of firms mean for changes in price?
when a price is high firms will join market due to trying to maximise profits. when price is low firms will leave the market
define productive efficency?
when a economy is using all avaliable factors of production
define allocative efficency?
it is achieved when a society is producing a appropiate bundle of goods relative to consumer preferences, MC=Price
in short run how do firms adjust to changes in demand?
movement along the supply curve
in long run, how do firms react to changes in demand?
firms will leave or join a market depending on the relative profitability of the markets
are prices in agricultural markets stable or volatile and why?
they are volatile due to the fact demand for food is inelastic however supply is affect by weather and climate so prices vary year to year
how can you show agriculture volatility on graph?
on price and quantity graph show an inelastic demand with supply curve shifted (right for good harvest and left for bad harvest) this will then decrease or increase price
how might the volatility be reduced in agricultural markets?
they can smooth out volatility by creating stores of surplus produce from previous years to stabalise the bad years
are the prices in the commodity market stable or volatile and why?
the prices are volatile due to demand reasons. demand for goods vary during different parts of economic cycle so when economys are in a boom stage then the demand will be shifted right and price increases. the futures market also adds a speculative element as you can purchase future goods in present
what is the nature of prices in the market for oil?
the price of oil is usually high due to the fact that the OPEC cartel restricts supply. there is also increase in price from increase in demand from the rising Chinese economy
why is demand for oil inelastic in short run?
as there is not a good alternative for oil in short run when your car runs on oil and so does your house heating
what is a cartel?
an agreement between firms in a market on price and output in order to maximise joint profits
what is the nature of prices for the housing market?
the demand for housing is largely affected by the interest rate, the interest rate have been low recently so demand will shift right, the supply of houses are increasing slowly as it takes time to build and regulations. therefore price increases usually
what is the type of demand in the foreign exchange market
it is derived demand as people don’t want the currency for the sake of having currency but to buy goods and services
define the exchange rate?
the price at which two currency’s exchange
what happens to domestic supply when exchange rate is high?
when exchange rate is high from pounds to euros, uk citizens will supply more pounds
what does the acronym SPICED mean?
Strong Pound Imports Cheap Exports Dear
why do people purchase stocks in the stock market?
they purchase them in order to receive dividends (cut of profit) or capital gains ( increase in value of company)
why do firms sell stocks?
in order to raise funds for investment
what affects the demand for stocks?
the demand for stocks are affected by expectations of future success of firm, and expectation of price increase of stock, also the interest rate as if you gain more from holding stocks compared to holding it in banks then you will purchase stocks
what affects the supply of stocks?
expectations of future demand for the companys product as that will determine the level of investment necessary
why are the prices of stocks volatile?
the prices of stocks are volatile due to the fact they are based on expectations so they are value judgements, therefore expectations can be self fulfilling ( if stock is expected to fall in price , people may sell stocks which through that , causes stock to fall in price)`
what does the demand for money depend on?
the demand for money depends on the number of transactions people wish to undertake
what can the price of money be viewed as?
the opportunity cost of not spending money is the interest earned from saving so the price of money can be interpreted as interest rate
when interest rate is high, what is the demand for money?
the demand for money is low as people aren’t making as many transactions rather they are just saving
what determines the supply of money?
the bank of england so it is not affected by the interest rate ( vertical line on interest quantity graph)
what is an indirect tax
a tax levied on expenditure on goods and services
what is the difference between direct and indirect tax
direct tax is on income, indirect is on expenditure
what is a specific tax?
a tax with a fixed rate for example £5 tax on each good
what is the incidence of a tax
how the burden of the tax is split between consumer and producer
what affects the incidence of a tax?
the price elasticity of demand and supply
what would be the incidence of a tax for perfectly inelastic demand
complete burden on consumer
what would be the incidence of a tax for perfectly elastic demand
complete burden on producer
how does an indirect tax affect the supply curve
it shifts it upwards by the amount of the tax
what does an indirect tax do the output of a good?
it reduces the output that suppliers are willing to produce
how does an indirect tax affect price?
increases cost of production so increases price
what are examples of indirect taxes?
fuel duties, landfill taxes , alcohol duties, sugar taxes, tobacco duties
what is an ad valorem tax
a tax on the percentage of the price of good , 10% tax will equal £1 on £10 good, £2 on £20 good.
what is the difference between the supply + tax curve to supply curve for ad valaorem tax
the supply + tax curve is steeper
what an advantage for society for a indirect tax
it internalises the externality, produces at social optimum output, welfare maximised
what is advantage of a indirect tax for government?
raises revenue, can be used to solve externality other way ie education - eval : depends on effectiveness of revenue
what is a disadvantage about information failure?
difficult to target tax due to not knowing size of externality
what is a disadvantage about conflicting objectives?
conflicting objectives between government revenue and solving externality
what is disadvantage about the effect of tax
if demand is inelastic then the tax will not be effective at reducing output
what is the effect of indirect tax on different groups of people?
indirect taxes are regressive, disproportionately affect the poor as they spend higher amount of their income on them
what is a subsidy
a grant given by the government to producers to encourage the production of a good or service
how does a subsidy affect the supply curve
shifts supply curve downwards by the amount of the subsidy
what is the advantage about a subsidy?
it achieves the socially optimum, social welfare is maximised
what is the disadvantage about government spending?
as governments have to spend a lot for a subsidy, there is a high opportunity cost
what is a disadvantage of subsidy about information failure
hard to target subsidy due to fact its hard to work out true size of externality
what is the disadvantage of a subsidy for the producers?
they may become inefficient, especially if subsidy is in place for long time
what is a disadvantage for the government of subsidy?
difficult to remove once subsidy has been put in place
what are examples of markets where subsidies are used
wind farms, railways, apprenticeship schemes, solar panels, biofuels
how does the elasticity affect the imposition of a subsidy?
the more inelastic demand, the greater the percentage share of the benefits for the consumer
the demand is inelastic, who has the larger share of the benefit?
consumer
the demand is elastic, who has the larger share of the benefit?
producer
