1.2 How Markets Work Flashcards
1
Q
What is meant by rational decision making ?
A
when making economic decisions it is assumed that:
- consumers aim to maximise utility (satisfaction/benefit) using a limited budget
- firms aim to maximise profits
2
Q
What is demand ?
A
- the quantity of a good/service that consumers are willing and able to buy at a given price in a given time period
3
Q
What are the three different types of demand ?
A
- Effective demand: when a desire for a product is backed up by willingness and ability to buy
- Latent demand: (potential demand) where there is a desire to buy a product but consumers lack purchasing power ➡️ highly affective by advertising
- Derived demand: demand for product X is linked to demand for product Y eg. the demand for steel is strongly linked to the demand for new vehicles
4
Q
What causes a movement on the demand curve ?
A
- price
- refers to a change along the curve, the movement denotes a change in demand and price (as price decreases demand increases)
5
Q
What causes shifts of the demand curve ?
A
🔔 non-price factors
- real incomes (the more £ the more we buy)
- changes in price of substitutes (competitive demand) or complements (joint demand)
- inflation reate
- employment rate
- trends (products become more/less desirable)
- advertisement (influences people to buy)
- changes in interest rates (increased charge = decrease demand)
- seasonal factors
- changes in population (increase population = increase demand)
6
Q
What are laws of demand ?
A
- as prices fall, demand increases
- as prices rise, demand decrease
7
Q
What is the concept of diminishing marginal utility ?
A
- can help to explain the inverse relationship between price and quantity demanded
- as more of a good is consumed, the additional utility (satisfaction) 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 unit provides therefore price and qnty demanded are inversely related
8
Q
What are substitute goods ?
A
- substitute goods are two goods that could be used for the same purpose ➡️ if the price of one good increases, then demand for the substitute is likely to rise
9
Q
What are complementary goods ?
A
- complementary goods are good which are bought + used together ➡️ if demand for one rises then demand for the other will rise to eg.tennis balls and tennis rackets
10
Q
What is supply ?
A
- the quantity of a good/service that firms are willing and able to produce at a given price in a given time period
11
Q
What are the laws of supply ?
A
- as price rises, quantity supplied rises
- as price falls, quantity supplied falls
🔔 assumptions: firms are motivated by profits (increased price= increased profits) + cost of producing a unit increases as output increases (marginal costs)
12
Q
What causes a movement along the supply curve ?
A
- price
- as price increases quantity supplied increases (vice versa)
13
Q
What causes shifts of the supply curve ?
A
- cost of production: decreased costs = increase in supply ➡️ can produce more at the same price eg. price of raw materials, exchange rates, wages
- new technologies: can decrease cost of production ➡️ more efficient + lower prices for consumers
- price of other goods: if other goods are cheaper to make then may make them instead
- govt: laws/taxes/subsidies/regulations ➡️ making it easier/harder/cheaper to make
- the climate: favourable weather = increase in supply
- no. of producers in the market: more producers = greater supply
14
Q
What is meant by market equilibrium ?
A
- a state of equality/balance between market demand and supply ➡️ there is no excess supply/demand
- know as ‘fair market price’ OR ‘market clearing price’
15
Q
Why is equilibrium constantly changing ?
A
- equilibrium never stays the same as demand and supply are constantly changing therefore moving equilibrium upwards/downwards
16
Q
What is excess supply (disequilibrium) ?
A
- when supply is greater than demand and there are unsold goods in the market (waste)
- the surplus puts a downward pressure on the market price ➡️ producers are forced to lower their price bcs of waste, until it reaches equilibrium
17
Q
What is excess demand (disequilibrium) ?
A
- when quantity demand exceeds supply ➡️ happens when the current market price is set below equilibrium, results in an upward pressure on price until it reaches equilibrium
- higher prices (in theory) stimulates an expansion in supply as producers respond to higher prices
18
Q
What is the price mechanism ?
A
- describes how decisions taken by consumers and businesses interact to determine the allocation of scarce resources between competing uses
- invisible hand operates through self-interest and allocates resources in society’s best interest
19
Q
What are the three functions of price mechanism to allocate resources ?
A
- rationing: resources are scarce, thus will runout if everyone could have them (stops people from having everything)
- incentive to firms: higher prices encourages and allows firms to produce more (greater output = increased profits)
- signalling: changes in price shows changes in s&d which acts as a signal to producers and consumers of surpluses and scarcities of resources ➡️ prices adjust to show where resources are required eg. excess supply: the price mechanism will help to eliminate a surplus of goods by allowing the market price to fall
20
Q
What is consumer surplus ?
A
- the difference between what a consumer would pay for a product and what they actually pay (rises and falls as market price for a good/service changes)
- a measure of the welfare people gain from consuming goods/services ➡️ on a S&D diagram area under demand curve and above the market price
21
Q
What is producer surplus ?
A
- the difference between what producers are willing and able to supply for and the price they actually receive
- shown by area above supply curve and below the price
22
Q
Why may individuals not act in a rational way ?
A
- limited ability to calculate
- importance of social networks
- emotions overtakes logic
- altruism vs pure self interest
- desire for instant rewards/satisfaction + lack of self control
- habits/default choices
23
Q
Examples of social norms/customs that influence our behaviour ?
A
- seat belt laws
- queuing behaviour in shops
- smoking bans in public places
- buying a round of drinks at the pub
24
Q
What is habitual behaviour ?
A
- people carry on behaving as they have always done
- repeat choices/purchases become automatic as they don’t require effort
- to CHANGE behaviour requires compelling incentives
eg. broadband/energy provider, breakfast cereal
25
Q
What is herd behaviour ?
A
- we often make decisions based on who is around us and the choices they make eg. choosing food at a restaurant
26
Q
What are indirect taxes and how does PED effect this ?
A
- tax imposed by govt that increases the supply costs for producers reducing the quantity demanded (movement on the demand curve)
- elastic PED: most of tax will be absorbed by supplier
- inelastic PED: most of tax can be passed on the consumer
27
Q
What are subsidies and how can it be seen on a supply diagram ?
A
- any form of govt support (eg. financial) offered to producers and occasionally consumers ➡️ causes outward shift of supply leading to lower equilibrium price and increase in quantity (LOWERS PRODUCTION COSTS)
- total shaded area = total govt spending on sub
- consumer on bottom and producer on top
