1.2 How Markets Work Flashcards
What is diminishing marginal utility
The demand curve is downward sloping, showing the inverse relationship between satisfaction derived from a product and the number of times that product is used
What is a market
Where buyers and sellers come into contact for the purposes of exchange
What does utility refer to
It is the amount of satisfaction obtained from consuming a good or service.
What is demand
Demand refers to the quantity of a good or service purchased at a given price over a given time period.
What does a demand curve show
A demand curve shows the quantity of a good or service that would be bought over a range of different price levels in a given period of time.
What is the relation ship between price and demand
When price falls the demand for a good increases
What is an increase in demand on a demand curve
refers to the whole demand curve shifting outwards to the right at every price level.
What is a decrease in demand
A decrease in demand refers to the whole demand curve shifting inwards to the left at every price level
What is price elasticity of demand and how is it calculated
Price elasticity of demand (PED) is the responsiveness of the demand for a good to a change in its price. The formula to calculate it is:
PED = percentage change in quantity demanded of good A / percentage change in price of good
What does it mean if a good is price elastic
This means the PED is greater than one as the percentage change in demand is greater than the percentage change in price
What does is mean is a good is price inelastic
The PED of the good is less than 1 and that the percentage change in demand is less than the percentage change in price
What does it mean if a good has unit elasticity
This means the PED is equal to one as the percentage change in demand is equal to the percentage change in price
What does it mean if a good is perfectly inelastic
The PED is equal to zero and a change in price has no impact on a change in quantity demanded
What does i mean if a PED is perfectly elastic
This means the PED is infinite and the good is perfectly elastic
What is total revenue and how is calculated
The price per unit of a good multiplied by the quantity sold
What is marginal revenue
Revenue gained by a firm from selling one extra unit of output
what are some factors which determine the PED of a good
- Availability of substitues
- If the good is more of a luxery than necessity
- The proportion of income spent on the good
- How addictive the good is
- Brand image
what are normal goods
Normal good A good with a positive income elasticity of demand, As real income rises, so too does demand for the good
what are inferior goods
A good with a negative income elasticity of demand, As real income rises, demand for the good falls
How is cross elasticity of demand calculated and what is it
Cross elasticity of demand The responsiveness of demand for good B to a change in price of good A
XED = percentage change in demand for good B/ percentage hcage in price of good A
what are substiute goods
Subsitute goods are in competitive demand and the XED is posotive for substitute goods along with a posotive gradient
What are complementary goods
Complementary goods are in joint demand they can be consumed. the XED is negtive along with a negative gradient
what are unrealeated goods
Unrealeted goods have and XED of zero
what is supply
The quantity of a good or service that firms are willing to sell at a given price and over a given period of time
what does a supply curve show
It shows the quantity of a good or service that firms are willing to sell to a market over a range of different price levels in a given period of time
what is the movement along a supply curve and what is it caused by
movment along a supply curve is caused by a change in price.
a rise in price causes an extension in supply
a fall in price causes a contraction in supply
what are shift along a supply curve
An increase in supply refers to the whole supply curve shifting outwards to the right at every price level. A decrease in supply refers to teh wohole supply curve shifting inwards to the left at every price level
what is price elasticity of supply and how is it calculated
The responsiveness of the supply of a good or service to a change in its price
PES = percentage change in supply of a good / percentage change in price of a good
what are some factors which determine price elatsticity of supply
- level of spare capacity
- state of the economy
- level of stocks of finished goods in a firm
- Perishability of the product
What is the equilibrium price
The price where the quantity demanded equals the quantity supplied for a good or service in a market
How is price determined
It is determined through the interaction of supply and demand in an competitive market.
What is excess supply
Where the quantity supplied exceeds the quantity demanded for a good at the current market price
What are the three functions of price mechanisms
Rationing
Incentivising
Signalling
What is excess demand
Where the quantity demanded exceeds the quantity supplied for a good at the current market price
What is a price mechanism
The use of market forces to allocate resources in order to solve the economic problem of what, how and for whom to produce
Why does the price mechanism act as a rationing device
Resources are scarce and therefore the price mechanism provides a way for those who are willing to pay the most to get the good. This means price will fall until equilibrium between quantity supplied and demanded
Why does the price mechanism act as an incentive device
Rising prices mean that firms are more likely to produce more of a product in response to a rise in its price. Furthermore the increased profits will negate the extra costs of increasing out put
Why can the price mechanism act as a signalling device
If a good is high in demand this can cause a firm to expand their production and increase their cost however if a good is in higher supply than demand a firm can take resources away from that product.
What is a consumer surplus
A consumer surplus is the extra amount of money a consumer is willing to pay for a product past what they actually pay
What is a producer surplus
Extra amount of money paid to producers above what they are willing to accept to supply a good or service
What is the impact of an increase in demand on producer surplus and consumer surplus
This is likely to raise producer and consumer surplus
What is the impact in a decrease in supply on consumer producer surplus
This is likley to reduce both consumer and producer surplus.
What are indirect taxes
A tax imposed on goods or services supplied by businesses It includes both specific and ad valorem taxes
What is an add valoren tax
This is a tax which is charged as a percentage of the price of a good
What is the effect of a specific and AD valorem tax
A specific tax causes the supply curved to shift to the left
An ad valorem tax causes a pivotal rotation of the left to the supply curve
What is the incidence of tax
The distribution of the tax paid between consumers and producers
How does the incidence of tax differ when compared to elastic and inelastic demand
On elastic goods often have the tax on consumer and producer where as inelastic goods mainly put the tax onto the consumer
What is a subsidy
Subsidy A government grant to firms, which reduces production costs and encourages an increase in output
Why is the government willing to give out subsidies
The government knows that producers will often respond by increasing output which causes the market price to fall and passes some of the gain onto consumers.
What does rational decision making need consumer and producers to have
- Perfect market information
- computational skills and judgment
- the ability to take decisions free from the behaviour of others
- sufficient time to take decisions
What is a default option
The default option is the option that a consumer “selects” if he or she does nothing e.g organ donations
What are the factors which shift the demand curve
- Population
- Income
- Related goods
- Advertising
- Tastes and fashions
- Expectations
- Seasons
What are all the effects of a subsidy
- increases output and lowers costs for consumers
- reduces inequality in society
- they can help control inflation, by keeping production cost low
- encourage consumption of demerit goods
- if demand is price inelastic it will have a large egg et on equilibrium price
What is the assumption made about consumers and producers
Consumers aim to maximise utility and producers aim to maximise profit. However people do not always behave rationally
Why influences of other people cause the consumer to behave irrationally
Rationality assumes people act individually to maximise their own benefit is but sometimes they are influenced by social norms.
How does the influence of habitual behaviour cause the consumer to behave irrationally
Most people have habits these reduce the amount of time it takes to do something as consumers no longer have to think about their actions. This can cause consumers to stick with what they know rather than expanding to the rational change
How can the consumers weakness at computation cause the consumer to make irrational choices
Consumers cannot make comparisons so buy more expensive goods then they need.
What are the underlying assumptions of rational economic decision making
Consumers aim to maximise utility
Firms aim to maximise profit
Governments aim to maximise social welfare
Draw a demand curve
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What are the key conditions which result in a change in demand
PIRATES
Population
Income
Related goods
Advertising
Taste/fashion
Expectations
Seasons
What is the effect of population on demand
If population rises, we would expect demand for all products to increase and so the demand curve will shift to the right. This is because the more people there are in the country, the more people who will want a good.
What is the effect of income on demand
For most goods, if income increases, demand increases because a person can afford to buy more of the product. If there is a fall in income then the demand would decrease and shift to the left. However, for some goods an increase in income can lead to a fall in demand and vice versa, this is a concept called income elasticity of demand.
What is the effect of related goods on demand
If goods are complements or substitutes of each other then a change in the price of another good can cause a shift in the demand curve.
What is the effect of advertising on demand
If a firm carries out a successful advertising campaign, demand is likely to increase. If a competitor firm carries out a successful advertising campaign, demand for the first firm will fall. A successful advertising campaign by Tesco will increase demand for Tesco but reduce demand for Asda.
What is the effect of taste/fashion on demand
If something becomes more fashionable, we expect demand to increase and if it becomes less fashionable, then demand will fall.
What is the effect of expectations on demand
Expectations of what might happen in the future can have a big impact on the level of demand for some goods. If people expect a shortage of something, or that price will rise in the future, then demand for that product will increase. If people expect that price will fall in the future, demand will decrease.
What is the effect of season on demand
Some products will find their demand affected by the weather. For example, hot summers cause an increase in demand for sun cream whilst wet summers cause a decrease in demand for umbrellas.
Why are the PED and PES important
The price elasticity of demand, along with the price elasticity of supply, determine the effects of the imposition of indirect taxes and subsidies.
What does an increased elasticity mean in terms of tax which is paid onto the consumer
The more elastic the demand curve, the lower the incidence of tax on the consumer. This means that when PED is elastic, a tax will only lead to a small increase in price and the supplier will have to cover the majority of the cost of the tax.
What does Increased inelasticity mean in terms of tax which is paid by the consumer
When demand is inelastic, the tax will be mainly passed onto the consumer. Since consumers are relatively unresponsive to the price of this good, quantity demanded will not fall by a large amount. This means that the tax will be ineffective at reducing output. However, it also means that there is higher tax revenue for the government. The more inelastic the demand curve, the higher the tax revenue for the government.
Draw a diagram which displays the consumer burden and producer burden
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Why is cross elasticity of demand important
Firms need to be aware of their competition and those producing complementary goods. They need to know how price changes by other firms will impact them so they can take appropriate action.
What are some of many factors which effect supply
Costs of production
Price of other goods
Weather
Technology
Draw a diagram which presents a producer/ consumer surplus
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Draw a diagram which presents producer and consumer gain from a surplus
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What are the three main reasons why people do not follow underlying assumptions on consumer behaviour
Influences of other people
Influence of habitual behaviour
Consumer weakness at computation
How do the influecnes of other people result in people not following the underlying assumption about consumer behaviour
Rationality assumes people act individually to maximise their own benefits but sometimes individuals are influenced by social norms, known as a bias. For example, someone may buy something to ‘fit-in’ or because everyone else has it, and so they are expected to too. Consumers become unwilling to change the bias, even if doing so will benefit them, if it goes against the norms of society. ‘Herding behaviour’ occurs when an individual copies the actions of a large group. One example is the stock market, and this causes huge market bubbles.
How the influence of habitual behaviour result in people not following the underlying assumption about consumer behaviour
Most people have habits and these habits reduce the amount of time it takes to do something, because consumers no longer have to consciously think about their actions. Habits create a barrier to decision making since they limit or prevent consumers considering an alternative. Habitual behaviour includes addictions and so this influences people’s decisions, for example consumers will buy more drugs/alcohol even though they know they should give up. Another habit many consumers have is buying their products at eye level so supermarkets tend to keep higher priced products near the top and lower priced products lower.
How does consumer weakness at computation result in people not following the underlying assumption about consumer behaviour
Many consumers aren’t willing or able to make comparisons between prices and so they will buy more expensive goods than needed, for example many customers buy multipack goods because they assume they are cheaper but this is not always the case. Also, consumers are sometimes poor at self-control and so do things they know they shouldn’t. Similarly, consumers will make decisions without looking at the long term effects, and so make irrational decisions. One example of this is consumers saving up for their pensions: many put off doing this because they fail to look long term.
