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Edexcel A - Microeconomics: Theme 1 & 3 > 1.2 - How markets work > Flashcards

1.2 - How markets work Flashcards

1
Q

Define a contraction in demand (law of demand)

A

A decrease in demand caused by an increase in price.

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2
Q

Define a contraction in supply

A

A decrease in supply caused by a decrease in price.

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3
Q

Define an extension in demand

A

An increase in demand caused by a decrease in price.

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4
Q

Define an extension in supply (law of supply)

A

An increase in supply caused by an increase in price.

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5
Q

Define consumer surplus

A

The difference between the price the consumer is willing/able to pay and the equilibrium price.

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6
Q

Define demand

A

The quantity of a product that a consumer is willing and able to buy at a given price (in a given period of time).

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7
Q

Define elastic PED/PES

A

When PED/PES is > 1 this is because the % change in QD/QS is > the % change in price.

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8
Q

Define equilibrium

A

The point on the graph at which the quantity demanded is equal to the quantity supplied.

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9
Q

Define indirect tax and give examples: who pays it & purpose

A

= A tax that is levied by the government on expenditure i.e. charged onto the selling price of goods/services.

EXCISE DUTY (specific) : Tobacco, alcohol & fuel
- Producer and consumer
- Decrease it’s production and consumption and raise revenue to fund govt spending. This can be hypothecated to treat side effects or fund alternatives.

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10
Q

Define inelastic PED/PES

A

When PED/PES is < 1 this is because the % change in QD/QS is < the % change in price.

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11
Q

Define inferior goods

A

Goods with a negative YED. They usually have a higher quality/priced substitute which people will switch to if their income rises.

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12
Q

Define marginal

A

Each additional unit.

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13
Q

Define marginal utility

A

The change in the satisfaction gained from consuming each additional unit.

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14
Q

Define market equilibrium

A

The market clearing point where demand is equal to supply.

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15
Q

Define net welfare gain

A

The total increase in consumer/producer surplus.

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16
Q

Define net welfare loss

A

The total decrease in consumer/producer surplus.

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17
Q

Define normal goods

A

Goods with a positive YED.

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18
Q

Define PED/PES and state the formula

A

Price elasticity of demand/supply is a measure of the responsiveness of demand/supply to a change in price.

% change in QD/QS / % change in price

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19
Q

Define perfect elasticity of demand

A

When an increase in price causes demand to fall to zero and a decrease in price causes an infinite increase in demand.

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20
Q

Define perfect elasticity of supply

A

When any increase in price leads to an infinite increase in supply and any decrease in price leads supply to fall to zero

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21
Q

Define perfect inelasticity of demand/supply

A

When PED/PES = 0 this is because demand/supply is completely unresponsive to a change in price.

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22
Q

Define producer surplus

A

The difference between the market price charged and the lowest price at which the firm is prepared to supply.

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23
Q

Define shortage

A

The amount by which the QS < QD.

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24
Q

Define specific tax

A

A fixed amount of tax that is charged per unit which changes with the quantity of goods/services purchased.

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25
Q

Define subsidy

A

A payment by the government to suppliers that reduce their costs of production and encourage suppliers to increase their output.

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26
Q

Define supply

A

The quantity of a product that a producer is willing/able to provide at a given price (in a given period of time).

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27
Q

Define surplus

A

The amount by which the QS > QD

28
Q

Define the income effect

A

Consumers will demand less if their real income decreases because of an increase in goods/services.

29
Q

Define the law of diminishing marginal utility

A

As consumption of a product is increased, the consumer’s extra satisfaction from each additional unit decreases.

30
Q

Define the substitution effect

A

Consumers will tend to buy more of a lower-priced good and less of a higher-priced good, when there’s a rise in price.

31
Q

Define total expenditure

A

The quantity bought x the price paid for each good/service.

32
Q

Define unitary elasticity of demand/supply

A

When PED/PES is = 1 this is because the % change in QD/QS is opposite and equal to the % change in price.

33
Q

Define utility

A

The satisfaction derived from each good.

34
Q

Define VAT

A

A tax that is a percentage of the selling price of goods/services which is paid by the producers first then they decide how much is passed onto the consumer (incident of tax).

35
Q

Define XED and state formula

A

The responsiveness of demand for good x to a change in price of a related good y.

% change in QD of good x / % change in price of good y

36
Q

Define YED and state formula

A

A measure of the responsiveness of the QD of a product to a change in real income.

% change in QD / % change in real income

37
Q

Define rational behaviour

A

The idea that economic agents act in accordance with their preferences to maximise their own welfare and have sovereignty in decision making.​

CONSUMERS aim to maximise their utility and FIRMS aim to maximise their profits.

38
Q

State examples of rational decision making

A
  • Compute financial gains (e.g. calculating cs/ps)
  • Compute reduction in MPC and EMC
  • Choosing most efficient production process
  • Having perfect information
39
Q

State the non-price determinants of demand

A
  • Income
  • Price of substitutes
  • Price of compliments
  • Changes in fashion/tastes
  • Size of population
40
Q

State the non price determinants of supply

A
  • Cost of production
  • Price of subs
  • Price of compliments
  • State of tech
  • Expectations
  • Indirect taxes
  • Subsidies
  • Natural disasters/war/weather
41
Q

Define unitary income elastic

A

Inferior goods with a YED = -1

42
Q

Define perfectly income inelastic

A

Inferior goods with a YED = 0.

43
Q

Define luxury/superior goods

A

Goods with a YED > 1 (income elastic)

44
Q

Define income inelastic

A

Demand is unresponsive to a change in income.

45
Q

Define income elastic

A

Demand is highly and positively responsive to a change in income.

46
Q

Define necessities

A

Goods with a YED between 0 and 1 (income inelastic).

47
Q

State the elasticity of inferior goods

A

ELASTIC: YED > -1
INELASTIC: YED between 0 and -1

48
Q

Define substitutes

A

Goods with a positive XED.

49
Q

Define strong substitutes

A

Goods with an XED > 1

50
Q

Define weak substitutes

A

Goods with an XED < 1

51
Q

Define compliments

A

Goods in joint demand which have a negative XED.

52
Q

Define close compliments

A

Goods with a XED > -1

53
Q

Define distant compliments

A

Goods with a XED < -1

54
Q

Define unrelated goods

A

Goods which have no relationship so their XED is 0. An increase or decrease in the price of good y doesn’t affect the demand for good x.

55
Q

Explain the PED determinants (shift in supply curve)

A
  1. AVAILABILITY & CLOSENESS OF SUBS: The wider the availability of subs, the more elastic PED will be. The closer the subs the more elastic PED will be.
  2. BRAND LOYALTY: Powerful branding makes PED more inelastic and vice versa.
  3. PROPORTION OF INCOME SPENT: The greater, the more elastic PED.
  4. ADDICTIVE QUALITIES: The more addictive the good, the more inelastic PED.
  5. TIME: As the price of a product changes, it often takes time for consumers to change their buying habits. TMT, PED is more inelastic in the short term and more elastic over time.
  6. CONTRACTUAL AGREEMENTS: Firms may be locked into contracts to demand certain products at a particular price for a set term, making demand more price inelastic.
56
Q

Explain the relationships between PED and revenue

A

ELASTIC: An increase in price causes a decrease in revenue and a decrease in price causes an increase in revenue.

INELASTIC: An increase in price causes an increase in revenue and a decrease in price causes a decrease in revenue.

UNITARY: Any change in price has no effect on revenue.

PERFECTLY ELASTIC: An increase in price causes revenue to fall to 0 and a decrease in prices causes revenue to increase.

PERFRECTLY INELASTIC: An increase in price causes revenue to increase and a decrease in price causes revenue to decrease.

57
Q

Explain the PES determinants (shift in demand curve)

A
  1. FLEXIBILITY AND MOBILITY OF RESOURCES: If the production process can be adjusted quickly and easily and products can be moved in and out of storage easily, PES likely to be more elastic.
  2. SPARE PRODUCTION CAPACITY AVAILABLE: If there’s spare then firms can expand output easily. PES likely to be more elastic.
  3. LEVEL OF UNEMPLOYMENT: If low unemployment, little spare capacity, so it will take time to recruit workers and firms. PES likely to be more inelastic in short-term.
  4. STOCK AVAILABLE: If there’s low level of stock PES is inelastic. If stock can be released form storage onto market PES is elastic.
  5. AVAILABILITY OF SUBS: If FOP can easily be switched PES is elastic. If FOP are highly specialised, it will be harder to sub them so PES is likely to be more inelastic.
  6. ARTIFICAL LIMITS: Legal or regulatory constraints can make PES more inelastic.
58
Q

Explain how the time frame being considered determines PES

A

SHORT RUN: At least one fop is fixed so PES is likely to be inelastic.

LONG RUN: All fop are variable so PES is likely to be elastic.

MOMENTARY: All fop are fixed so PES is likely to be perfectly inelastic.

59
Q

Define price mechanism

A

The interaction of d+s in a free market to determine prices, so scarce resources can be allocating efficiently between competing uses.

60
Q

Explain the rationing function of the price mechanism

A

Determines how resources are allocated between competing uses. When resources become scarce, prices will rise. Only those who can afford to and value them will receive them. If there’s a surplus, prices will fall and more consumers can afford them.

61
Q

Explain the signalling function of the price mechanism

A

Changes in prices reflect market conditions and therefore provide info to producers and consumers whether to enter/exit a market or sell/buy more of less goods. TMT when the price eq moves the output eq moves with it.

62
Q

Explain the incentive function of the price mechanism

A

CONSUMERS - Motived by low prices which encourages purchases. TIB the amount of utility gained per £ spent increases relative to other goods. Higher prices discourage purchases as they receiver fewer goods per £ spent.

PRODUCERS - Higher prices encourage them to sell more to maximise revenue. Lower prices discourage production because less revenue is earnt per unit sold.

63
Q

State 3 reasons why consumers may behave irrationally

A
  1. INFLUENCE OF OTHERS BEHAVIOURS
  2. HABITUAL BEHAVIOUR:
  3. WEAKNESS AT COMPUTATION:
64
Q

Explain how the influence of other people’s behaviour is a reason as to why consumers may behave irrationally

A

‘Herd mentality’ is when consumers make decisions based on the actions of others rather than considering their own welfare, as they’re influenced by social norms. Consumers become unwilling to change their rationale even if doing so will benefit them. In this instance, the consumer is therefore not sovereign.

65
Q

Explain how habitual behaviour is a reason as to why consumers behave irrationally

A

Habits create a barrier to decision making since they limit or prevent consumers from considering alternatives which may be more beneficial to them. Habitual behaviour includes addictions.

66
Q

Explain how weakness at computation is a reason as to why consumers behave irrationally

A

Many consumers aren’t willing or able to make comparisons between prices because they lack sufficient information and computational skills to accurately asses full costs and benefits of a good/service. This is known as bounded rationality (opting to satisfice rather than maximise)

This may result in:
- Buying more expensive goods than needed
- Underestimating long-term effects

Edexcel A - Microeconomics: Theme 1 & 3 (10 decks)

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