1.2 How markets work Flashcards
when making economic decisions what is assumed?
- consumers aim to maximize utility
- firms aim to maximize profits
what’s demand?
the quantity of a good/service that consumers are willing and able to buy at a given price in a given time period
what is a movement in the demand curve?
when the point on the line moves,as price goes down demand will go up moving the point on the line
what causes a movement in the demand curve?
a change in the price of the good/service
what is a shift in the demand curve?
when the price stays the same even though demand/supply changes causing a new line of demand to be made
what causes a shift in the demand curve?
any non-price factor EG
- Income
- employment rate
- price of other goods
- trends
what is supply?
the quantity of a good that sellers are prepared to produce at a given price in a given time period
If prices rise what happens to supply?
quantity supplied rises
what does a supply curve show?
the relationship between the market price and how much a firm is willing to sell
what’s a movement on a supply curve?
a change in the point on the supply curve,as price increases the quantity produced will rise
what causes movement on a supply curve?
a change in price
what’s a shift on a supply curve?
how the supply will change due to other factors than price,a new line is created
what causes a shift of the supply curve?
-cost of production
-new technologies
-price of other (capital) goods
-the government
-weather
these all effect how easily the product will be made and how likely it is to sell
definition of equilibrium price?
a state of equality/balance between market demand and supply - there is no excess demand or supply
how is equilibrium shown on a supply demand diagram?
it’s the point where the price and quantity meet the cross of supply and demand curves
what’s excess supply?
when supply is greater than demand and there are unsold goods in the market which puts a downwards pressure on price
what do suppliers have to do if they have excess supply ?
lower price until they find equilibrium,if they have to sell at higher price there will be a shift in supply as they will have to produce less as they are selling less
how can you see excess supply on a supply demand diagram?
when the points don’t create an equilibrium,the space between the two points of quantity eg Q2 and Q3
what’s excess demand?
when quantity demanded exceeds supply resulting in queuing and putting an upwards pressure one price
what do suppliers have to do to deal with excess demand ?
increase their prices as more quantity will be supplied as firms are able to make more money
what’s consumer surplus?
the difference between what a consumer would pay for a product and what they actually pay
where is consumer surplus on the diagram?
from the top of demand curve point to the pe point of axis to the equilibrium point
what is the producer surplus?
the difference between what producers are willing and able to supply of a good and what they actually receive (what the goods actually worth)
where is producer surplus shown on the diagram?
from the pe point to the equilibrium to the bottom of the supply curve
what is marginal utility?
the additional satisfaction a consumer gets from consuming one more unit of the product,as more is consumed the marginal utility (satisfaction) will decrease (diminishing marginal utility)
what is the function of the price mechanism?
to allocate resources through : rationing,incentives and signalling
what are the rules of elasticity?
0 - perfectly inelastic
>1 - elastic
<1 - inelastic
1 - unitary elastic
definition of price elasticity of demand?
measurement of how responsive quantity demanded of a product is after a change in its price
formula for PED?
% change in demand/% change in price
what does it mean if the price elasticity of demand is higher?
the more price elastic the demand is, a high responsiveness to changes in price
uses of ped?
- determine optimum price
- calculate the impact of change or price on revenue
- decided on non-price strategies to increase demand
- price discriminate
- aim to be price inelastic
limitation of ped?
- values based on estimates
- info may become outdated
- other factors may cause demand to shift
whats ped affected by?
SPLAT
Substitutes
Percentage of income
Luxury/neccesity
Addictive
Time period
what happens when demand is price inelastic?
a rise in price won’t have a significant impact on demand as the product is a necessity
what happens if demand is price elastic?
the quantity demanded is very sensitive to price
what does cross price elasticity of demand measure?
how responsive demand for good x is following a change in price of good y
what are substitutes?
have a positive cross price elasticity of demand, an increase int he price of one product will lead to a rise in demand for its substitutes
how can you tell if products are close substitutes?
if there’s a high value, very elastic
what are complementary goods?
negative cross price elasticity,an increase in the price of good t will lead to a contraction in demand for t and fall in demand for s
formula for XED?
%change in demand of x/% change in price of y
are plus and minus considered when looking at price elasticity of demand?
no, they are not considered during the final calculation
what does inelastic mean?
when the price goes up, consumers’ buying habits stay about the same, and when the price goes down, consumers’ buying habits also remain unchanged.
what does elastic means?
where a change in price leads to a significant shift in demand
what does the sign tell you about goods?
if its positive they are SUBSTITUTES
if its negative they are COMPLEMENTS
what does the size tell you about how income elasticity of demand for that good is to changes in income?
how elastic demand for that good is to changes in income, the higher the number the more income elastic it is
what does price elasticity of supply measure?
how responsive quantity supplied is to changes in price
formula for working out PES?
%change in quantity supplied/%change in price
what will the answer for PES always be?
positive, represents how if supply rises price will too
whats PES affected by?
PSSST
Product Lag
Stocks, hard to hold stock = inelastic
Spare capacity, if a business is operating close to full capacity then it will be more difficult to increase supply
Substitutability of FoP
Time, the longer it takes to make a product the more inelastic it will be
availability of producer substitutes, if a product has many substitutes then the business can easily alter production if prices rise/fall – many substitutes = high elasticity
whats income elasticity of demand?
YED = % change in demand/% change of income
what are normal goods?
goods which have a positive income elasticity of demand ➡️ as incomes rise more of the good is demanded
- elasticity between 0 and 1
what are luxury goods?
have an income elasticity of demand above one, demand rises more proportionally in comparison to income
what are inferior goods?
negative income elasticity ➡️ demand falls as incomes rise (people buy superior goods instead, eg branded food instead of supermarket own brands)
what does the short-run aggregate supply refer to?
period of time where one factor of production is fixed, PES will be relatively inelastic
what does the long-run aggregate supply refer to?
period of time in which all factors of production are variable, PES will be relatively elastic
why is there an inverse relationship of demand?
- the income effect, when the price of a good falls the consumer can enjoy it for less which effectively ‘rises’ real incomes
- the substitution effect, when the price of a good falls it becomes relatively ‘cheaper’ than alternatives
- the Law of Diminishing Marginal Utility, as more of a good is consumer the additional utility from each extra unit will fall ➡️because consumers are assumed to be rational, they will not pay more for a good than the additional utility it provides
what happens to the market when there is excess demand?
queuing ➡️ upwards pressure on price
what happens to the market when there is excess supply?
downwards pressure on price
what does the price mechanism describe?
how decisions made by suppliers and consumers work together to determine the allocation scarce resources between competing resources through
- signalling (if prices are too high this is signalled by not enough supply)
- incentives function (through choices consumers send messages to producers about their changing wants and needs)
- rationing function ( when demand is high for scarce resources price increases by a lot)
why is the price mechanism important?
- incentives matter as for competitive markets to work they need to take into account all appropriate price signals in the market
- market failure occurs when signalling and incentive functions fail
how do governments intervene in the price mechanism?
- incentives of consumers and producers can be changed by government intervention ➡️if prices change due to tax or subsidies this will impact consumer spending
BUT - economic agents may not always respond to incentives in the way it would be expected, ‘the law of unintended consequences’
what is a consumer surplus?
the difference between what consumers are willing to pay and what they actually pay (a measure of welfare of what consumers get from consumption)
Consumer surplus and price elasticity of demand?
- when demand is perfectly elastic elastic, consumer surplus is zero because the price that people pay matches what they are willing to pay
-when demand is perfectly inelastic, consumer surplus is infinite, quantity demanded does not respond to a price change, whatever the price, the quantity demanded remains the same.
what is producer surplus?
- the difference between the price producers are willing and able to supply a product for and the price they get in the market
what are indirect taxes?
is a tax imposed by the government that increases the supply costs faced by producers
- impact depends on elasticity of demand
why are the types of indirect tax?
- a specific tax per unit
- ad valorem tax is a percentage tax added
what is the effect of ad valorem tax?
causes a pivotal shift in the supply curve ➡️ pushes prices up
- because the tax is a percentage of the unit cost of supplying the product
what are subsidies?
any form of government support offered to producers (and sometimes consumers)
what the justifications for government subsidies?
- help lower-income families
- protect jobs during a recession
- reduce the cost of training
- more distribution of wealth
what are the assumptions behind rational behaviour + economic agents ?
- agents choose independently of each other
- an agent has a fixed and stable tastes and preferences
- an agent gathers information on all other options
- always make an optimal choice with given preferences
➡️ the key assumption is that people make choices to maximise the satisfaction (or utility) they get from
spending a limited budget
economic agents in reality?
- have limited capacity to calculate all costs and benefits
- are influenced by their own social networks
- lack self control and seek immediate satisfaction
