1.2. How markets work Flashcards
What assumptions are made about the objectives of consumers and producers
That consumers and businesses will act rationally
Consumers aim to maximise utility
Producers aim to maximise profit
Explain how herd mentality may prevent consumers from acting rationally
If a consumer sees another consumer acting irrationally they are likely to also react irrationally as to not miss out
Explain how habitual behaviour may prevent consumers from acting rationally
A consumer prefers to do what they have always done as it takes less effort to decide to do something else
Explain how computational weakness may prevent a consumer from acting rationally
Consumers are not always capable of comparing prices and offers of products
Prices and offers are often presented in difficult ways
Explain diminishing marginal utility
Satisfaction diminishes with the consumption of an additional good or service.
Explain why a demand curve is downward sloping
As prices rise fewer consumers are inclined to or can afford to buy a good or a service
Explain the factors that cause a demand curve to shift
to the right
Population - more people, more demand
Advertising - influence people into buying
Substitutes - price increase, demand decrease
Income - more disposable income, more consumption
Fashion and Taste - herd mentality and trends
Interest Rate - low interest rates, higher demand
Compliments - decreased price, more demand
Explain why the supply curve is upward sloping
The profit motive - higher prices create higher profit
Increased supply leads to higher costs which need to be covered by higher prices
Higher prices attract new firms into the market
Explain the factors that cause a supply curve to shift
to the right
Productivity - higher productivity, more supply
Indirect taxes - lower taxes, increased supply
Number of Firms - more producers, more supply
Technologies - better technologies, higher supply
Subsidies - more money to invest, increased supply
Explain, using an example, the meaning of joint supply
When two products are in joint supply, an increase in the suoplu of one will lead toan increase in the supply of the other.
For example: sheep and wool - wool is a by-product
Explain the meaning of a consumer surplus
The difference between how much a consumer is willing to pay and how much they actually pay
Explain the meaning of a producer surplus
The difference between the price at which a firm is willing to sell for and how much they actually sell for
Define “price elasticity of demand”
the responsiveness of quantity demanded to a change in price
What is the formula for price elasticity of demand
PED = % change in QD / % change in price
Explain the significance of a PED of 0
Perfectly inelastic
Explain the significance PED between 0 and -1
Inelastic
Explain the significance of a PED of -1
Unitary elasticity
Explain the significance of a PED between -1 and infinity
Elastic
Explain the significance of a PED of infinity
Perfectly Elastic
List the factors that influence PED
Proportion of Income
Luxury
Addictiveness
Necessity
Time between purchase
Substitutes
Define “price elasticity of supply”
The responsiveness of quantity supplied to a change in price
What is the formula for price elasticity of supply
PES = % change in QS / % change in price
Explain the significance of a PES of 0
Perfectly Inelastic
Explain the significance of a PES between 0 and 1
Inelastic
Explain the significance of a PES of 1
Unitary elasticity
Explain the significance of a PES between 1 and infinity
Elastic
Explain the significance of a PES of infinity
Perfectly elastic
List the factors that influence PES
Barriers to entry Resources Inventory Times Spare capacity
Define “income elasticity of demand”
The responsiveness of demand to a change in income
What is the formula for income elasticity of demand
YED = % change in QD / % change in Y
What YED would you expect from a normal good
Positive values - when income rises, demand rises
What YED would you expect from an inferior good
Negative values - when income rises, demand falls
What YED would you expect from an luxury good
Value > 1 - more elastic
What YED would you expect from a necessity good
Value between 0 and 1 - more inelastic
Define “cross elasticity of demand”
The responsiveness of demand for one product to a change in price of another product
What is the formula for cross elasticity of demand
XED = % change in QD for A / % change in P for B
What XED values would you expect from a substitute good
Positive - price of A increase, demand of B increase
What XED would you expect from a complementary goods
negative - price of A increases, demand of B decreases
What XED would you expect from an unrelated good
0 - price of A increases, demand of B is unaffected
Explain rationing
Prices ration scarce resources
When there is a shortage, prices increase, only those with the willingness to pay will purchase the product
Explain incentive
Higher prices created by shortages are an incentive for producers to increase supply
Producers are motivated by profit
If there is a surplus, prices will be lower, this acts as an incentive to reduce supply
Explain signalling
Prices adjust to demonstrate where resources are required and where they aren’t
Prices rises and fall to reflect scarcities and surpluses
e.g. if prices rise due to high demand, suppliers are signalled to expand to production to meet the demand
Explain, with examples, what a direct tax is
A tax levied on income, wealth, profits of the person who pays it
e.g. income tax
Explain, with examples, what an indirect tax is
A tax levied on goods or services
e.g. VAT
Explain, with examples, what an ad valorem tax is
Tax based on the value of a transaction or of property
e.g. VAT
Explain, with examples, what a specific tax is
A tax that is a fixed amount for each unit of a good sold
Excise duty
Explain the meaning of consumer incidence
How much of the tax the consumer pays
Explain the meaning of producer incidence
How much of the tax the producer pays
Define “subsidy”
A grant from the government to firms, designed to lower the price of a good and encourage production, lowers the cost of production for firms
Explain the meaning of “consumer gain” from a subsidy
The amount of money that the product has been lowered by andthe consumer no longer has to spend
Explain the meaning of “producer gain” from a subsidy
The reduction in the cost to produce the product