1.2 How markets work Flashcards
what is the law of diminishing marginal utility?
the more you consume of something the less utility you receive from it
what is the relationship between marginal and total utility
total utility is inversely proportional to marginal utility
define marginal utility
the additional utility gained from consuming one additional unit of good or service
define demand
ceteris paribus - the quantity of a good or service that consumers are willing and able to buy at a given price in a given time period
what is notional demand
demand focused on wants but are not purchased
what is effective demand
demand backed up by a purchase
what is the relationship between price and quantity demanded
inverse
what is the substitution effect
if prices rise of a specific good then we are likely to find a cheaper substitute
what is the income effect
as prices fall our income allows us to buy more of a good
what does a shallow demand curve mean
the good is really sensitive to price changes
what does a steep demand curve mean
the good is not that sensitive to price changes
what does a horizontal demand curve mean
if the price changes then there is no demand for a product
what does a vertical demand curve mean
no matter the price change the demand for the product stays the same
what causes a contraction or extension along the demand curve
price changes
what causes a shift in the demand curve
quantity demanded changes
what is the acronym for non price determinants of demand
PIRATE
what does PIRATE stand for
P - population size and demography
I - income
R - related goods (price and availability of complements and substitutes
A - advertising and awareness
T - tastes and preferences (weather/season/fashion)
E - expectations of future price changes/changes in income/changes in factors that affect consumer and business confidence
define supply
the quantity of a good or service that producers are willing and able to produce at a given price in a given time period
what is notional supply
supply focused on wants but are not purchased
what is effective supply
supply backed up by a purchase
why does a supply curve slope upwards from left to right
if prices are rising business have a greater incentive to supply because they are receiving a higher return on their investment
what does a shallow supply curve mean
change in price significantly impact on supply
what does a steep supply curve mean
change in price has little to no impact on supply - this usually happens when supply has restrictions
what does a horizontal supply curve mean
there is only one price no matter the supply
what does a vertical supply curve mean
a set amount of quantity supplied no matter the price change - capacity constraints
what is the acronym that affects the supply curve
CREST
what does CREST stand for
C - costs of production
R - related goods and services
E - expectations of future prices
S - subsidies from government/taxes on goods and services
T - technology
what is market equilibrium
equilibrium is a state of equality or balance between market demand and supply
what does utility maximisation mean
total utility is maximised when marginal utility is 0
what is PED
price elasticity demand is a measure of the responsiveness of quantity demanded to change in price
PED: sign
the sign denotes the relationship between the two variables. PED has a - sign
PED: value
the value determines whether demand is price elastic or price inelastic
PED: 0
perfectly inelastic - a change in price has no effect on Qd
PED: 0 -1
relatively inelastic - a change in price causes a less than proportional change in Qd
PED: 1
unitary elastic - a change in price has a proportional change in Qd
PED: 1 - …
relatively elastic - a change in price causes a more than proportional change in Qd
PED: formula
% change in Qd / % change in P
PED: gradient of price elastic good
small gradient, shallow line
PED: gradient of price inelastic good
large gradient, steep line
what is revenue
price x quantity
what is XED
cross elasticity demand - the sensitivity of the quantity demanded for good A against the change in the price of good B
XED: formula
% change in QD Good A / % change in P Good B
XED: sign
it indicates whether the good is a complement or substitute
- = complement
+ = substitutes
XED: value
the value determines whether demand for good A is cross elastic or cross inelastic. this indicates the strength of the relationship between the two goods and how close they are complements or substitutes for each other
XED: 0
perfectly inelastic - a change in price of good B has no effect on Qd for good A
XED: 0 - 1
relatively inelastic - a change in price of good B has a less than proportional change on Qd for good A
XED: 1
unitary elastic - a change in price of good B has a proportional change on Qd for good A
XED: 1 - …
relatively elastic - a change in price of good B has a more than proportional change on Qd for good A
what is YED
income elasticity of demand (YED) measures the responsiveness of demand to a change in income
YED: formula
% change in Qd / % change in Y
YED: basic goods
^income = same demand
YED: luxury goods
^income = ^demand
YED: inferior goods
vincome = ^demand
YED: sign
the sign denotes the nature of the good, it indicates whether the good is basic, luxury or inferior.
+ = basic and superior
- = inferior
YED: value
the value determines whether the good is income elastic or income inelastic
YED: 0
perfectly inelastic - a change in income has no effect on Qd
YED: 0 - 1
relatively inelastic - a change income causes a less than proportional change in Qd
YED: 1
unitary elastic - a change income causes a proportional change in Qd
YED: 1 - …
relatively elastic - a change income causes a more than proportional change in Qd
YED: graph of normal good
positive gradient
YED: graph of inferior good
negative gradient
what is PES
price elasticity of supply - producers respond to changes in price by increasing or decreasing the quantity of a product they supply
PES: formula
%change in quantity supplied/%change in price
PES: sign
always positive
PES: value
determines the level of elasticity of the product
PES: 0
perfectly inelastic - a change in price has no effect on quantity supplied
PES: 0-1
relatively inelastic - a change in price causes a less than proportional change in quantity supplied
PES: 1
unitary elastic - a change in price causes a proportional change in quantity supplied
PES: 1…
relatively elastic - a change in price causes a more than proportional change in quantity aupplied
PES: inelastic graph
high gradient
PES: elastic graph
low gradient
PES: perfectly inelastic graph
vertical line
PES: perfectly elastic graph
horizontal line
what are the 11 things that effect PES of a good?
- time period under consumption
- perishability
- access to storage/stocks
- availability of imports
- spare production capacity
- flexibility of capital
- flexibility of labour
- market contestability
- impact of increase in sale costs
- bottlenecks in supply chain
- length of production process
how does time period under consumption effect PES
becomes more elastic if a greater time period given to match the demand
how does perishability affect PES
can build up storage if not perishable (stockpile)
how does access to storage/stocks affect PES
able to use more of stock to produce products
how does availability of imports affect PES
can rely on other countries to supply goods
how does spare production capacity affect PES
ability to produce more if needed
how does flexibility of capital affect PES
transferable to produce different things
how does flexibility of labour affect PES
transferable time and skills to produce different things
how does market contestability affect PES
the easier it is for a business to enter a market the more elastic supply
what does market contestability mean
how easy it is for a firm to enter a market
how does the impact of increase in scale of costs affect PES
increase costs - decrease elasticity
how do bottlenecks in the supply chain affect PES
anything that stops the free flow of goods and services = inelastic
how does the length of production process affect PES
shorter time = easier to produce quicker
define indirect tax
can be passed on to a third party and not taken from the source
define subsidy
a grant given which lowers the price of a good usually designed to encourage production or consumption of a good
define specific tax
tax levied on volume
define ad valorem tax
tax levied as a percentage of the value of a good
shifts on specific tax graphs
parallel
for taxes what is the top box on the graph
consumer
for taxes what is the bottom box on the graph
producer
what are the purposes of subsidies
- reduce the price of merit goods and services (increase production and consumption)
- reduce the price of positive externalities (increase production and consumption)
- reduce the costs of production and allow domestic firms to compete internationally (protect domestic jobs)
for taxes what happens to the supply curve
shifts inwards
for subsidies what happens to supply
shifts outwards
what it the top box on a subsidy graph
producer
what is the bottom box on a subsidy graph
consumer
define consumer surplus
the difference between the total amount that consumers are willing and able to pay, and the total that they actually pay (market price)
subsidywhat does an ad valorem tax graph look like
what does an ad valorem tax graph look like
what does a specific subsidy graph look like
what does a specific tax graph look like
what is consumer surplus affected by
a shift in supply
what happens to consumer surplus if supply shifts inwards
loss
what happens to consumer surplus if supply shifts outwards
gain
what does a graph of consumer surplus look like if supply shifts inwards
what does a graph of consumer surplus look like if supply shifts outwards
define producer surplus
a measure of producer welfare. it is measured as the difference between what producers are willing to supply a good for, as shown by the supply curve, and the price they actually receive
what does producer surplus depend on
a shift in demand
what happens to producer surplus if demand shifts outwards
gain
what happens to producer surplus if demand shifts inwards
loss
what does a graph of producer surplus look like if demand shifts outwards
what does a graph of producer surplus look like if demand shifts inwards
what does a graph of consumer and producer surplus look like after a specific tax has been applied
what does a graph of consumer surplus look like after a specific subsidy has been applied
name some types of irrational behaviour
- herding
- habits
- weakness at computation
what is herd behaviour
individuals are influenced by societal norms, known as a bias
what is habitual behaviour
people have habits and these reduce the amount of time it takes to do something, as they no longer have to think consciously about their decisions
what is weakness at computation
consumers aren’t willing or an unable to make comparisons between prices so they will buy more expensive goods than needed
what are the three parts of the pricing mechanism
- rationing
- signalling
- incentive
what is the rationing function
a way of rationing goods because when the price increases, some people will no longer be able to or desire to buy the product. limited resources can be rationed and sold to people able to afford them and those who value them the highest
what is the signalling function
acts a signal where resources should be used. when prices rise, producers move resources into manufacturing the product. the change in prices indicates to suppliers and consumers that the market conditions have changes and the quantity demanded and sold should be adjusted accordingly
what is the incentive function
acts as an incentive for people to work hard. buyers realise that the more money they have the more they are able to demand. suppliers realise that if they produce more of the goods, they will make more money.
low prices = consumers buy more goods
high prices = suppliers want to produce more goods
