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Econ Theme 1 > 1.2 How Markets Work > Flashcards

1.2 How Markets Work Flashcards

1
Q

What is a market?

A

A place where buyers and sellers meet to exchange goods

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2
Q

What is a demand curve?

A

A curve that shows the relationship between the price of a product and the quantity of the product demanded

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3
Q

What is effective demand?

A

An individual can afford to pay for the good and service

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4
Q

What is market demand?

A

Sum of each individual demand curve for a particular good or service

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5
Q

What influences the shape of the demand curve?

A

As price falls, people are more willing to buy a good

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6
Q

What causes a movement along the demand curve

A

A change in price of the good

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7
Q

What causes a shift in the demand curve?

A

A change in any of the factors which affect demand, EXCEPT price

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8
Q

What are the conditions of demand?

A
  • income
  • taste - advertising, branding
  • fashion
  • price of substitutes (e.g. adidas and Nike)
  • price of complementaries ( e.g. cheese and crackers)
  • population increase/decrease, ageing population
  • availability of credit (e.g. loans)
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9
Q

When does extension occur?

A

When the quantity demanded rises due to decrease in price

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10
Q

When does contraction occur?

A

When the quantity demanded falls due to an increase in price

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11
Q

What happens to the demand curve if demand decrease?

A

Shifts to the left

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12
Q

What happens to the demand curve when demand increases?

A

Shifts to the right

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13
Q

How does population affect demand?

A
  • size of population rises - more people want the good - increase in demand for all products — rightward shift
  • ageing population - people at different ages demand different things — goods that affect ageing population will be more in demand -> rightward shift
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14
Q

How does income affect demand?

A
  • higher income levels - more disposable income so people can afford more goods - demand increases
  • rightward shift
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15
Q

What is a normal good?

A
  • where the quantity demand increases in response to an increase in consumer income
  • e.g. holidays, branded items
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16
Q

What is an inferior good?

A
  • where the quantity demanded decreases in response to an increase in consumer incomes
  • canned food vs fresh, bus vs taxi
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17
Q

How do related goods affect demand? (Substitutes)

A
  • an increase in price of X —> leads to contraction of demand for X, but increase in demand for Y
  • a decrease in price of X —> people switch away for substitutes and demand more of X
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18
Q

How do related goods affect demand? (Complements)

A
  • if price or X decreases —> extension of demand for X and an increase in demand for Y - rightward shift
  • if the price of X increases —> contraction of demand for X and a decrease in demand for Y - leftward shift
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19
Q

How does advertising affect demand?

A
  • if a firm advertises well demand will increase - rightward shift
  • if a rival advertises this can lead to a decrease in demand - leftward shift
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20
Q

How does expectation affect demand?

A
  • if people expect a shortage of X —> greater demand - rightward shift
  • if people expect a fall in price of X —> lower demand - leftward shift
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21
Q

What is real income?

A
  • income adjusted for inflation
  • cuts in income tax could lead to an increase in disposable income
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22
Q

Impact of real income on demand

A
  • increase in disposable income —> increase demand for normal goods
  • fall in demand for inferior goods
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23
Q

What does price elasticity of demand measure?

A

PED measures the responsiveness of demand to a change in the price of a good

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24
Q

What is the formula for PED?

A

% change in quantity demanded/ % change in price

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25
Q

Why are most values of PED negative?

A

A rise in price leads to a fall in quantity demanded

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26
Q

What is unitary elastic PED?

A
  • When PED = 1
  • quantity demanded changes by exactly the same percentage as price
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27
Q

What is relatively elastic PED?

A
  • PED > 1
  • quantity demanded changes by a larger percentage than price so demand is relatively responsive to price
  • shallow gradient
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28
Q

What is relatively inelastic PED?

A
  • PED < 1
  • quantity demanded changes by a smaller percentage than price so demand is relatively unresponsive to price
  • steep gradient
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29
Q

What is perfectly elastic PED?

A
  • PED = infinity
  • a change in price means that quantity demanded falls to 0 and demand is very responsive to price
  • horizontal line
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30
Q

What is perfectly inelastic PED?

A
  • PED = 0
  • a change in price has no effect on output so demand is completely unresponsive to price
  • vertical line
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31
Q

Factors that affect PED

A
  • availability of substitutes
  • % of income spent on product
  • necessity or luxury
  • habit forming
  • number of uses
  • time
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32
Q

How does availability of substitutes affect PED?

A
  • if there are lots of substitutes, people will switch to other products when prices rises —> elastic PED
  • if no substitutes, people have to still buy that good as there are no alternatives —> inelastic PED
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33
Q

How does time influence PED?

A
  • the longer the time, the easier it will be for a person to find an alternative supplier of the product —> more elastic PED
  • short run goods tend to be more inelastic
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34
Q

How do necessities influence PED?

A
  • inelastic PED if you need something you’re still going to buy it if prices rise
  • e.g. petrol
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35
Q

How does % of income spent influence PED?

A
  • if a good/service represents a very small percentage of a person’s total income expenditure, an increase in price will have relatively small impact on whether they buy that product - inelastic
  • but if it is a large percentage of their income they will be less inclined to keep buying after a price increase - elastic
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36
Q

How does habit forming influence PED?

A
  • if a product is addictive then it’s inelastic
  • no matter how high prices rise people will still buy to fulfil their addiction
  • e.g. cigarettes, alcohol
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37
Q

How does number of uses influence PED?

A
  • if there are lots of uses then PED will be more inelastic
  • e.g. electricity
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38
Q

What happens to revenue with an elastic demand curve?

A
  • decrease in price —> increase in revenue
  • increase in price —> decrease in revenue
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39
Q

What happens to revenue with an inelastic demand curve?

A
  • decrease in price —> decrease in revenue
  • increase in price —> increase in revenue
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40
Q

What happens to revenue with a unitary demand curve?

A

A change in price doesn’t affect total revenue because a change in price is met with a proportionate change in demand

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41
Q

What is income elasticity of demand?

A

Measure the responsiveness of demand to a change in income

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42
Q

Formula for YED

A

% change in quantity demanded / % change in income

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43
Q

What happens when YED is negative + income rises

A
  • it is an inferior good
  • a rise in income will lead to a fall in demand for a good
44
Q

What happens when the YED is positive

A
  • it is a normal good
  • a rise in income will lead to a rise in demand for the good
  • e.g. fresh fruit
45
Q

What is YED > 1

A
  • income elastic
  • luxuries
46
Q

What is YED < 1

A
  • income inelastic
  • necessities
47
Q

What happens to income when the economy is in recession?

A

Average incomes are falling

48
Q

What happens to incomes when the economy is booming?

A

Average incomes are rising

49
Q

What is cross elasticity of demand?

A

Measure the responsiveness for good A following a change in the price of another product, good B

50
Q

Formula for XED

A

% change in quantity demanded of good X / % change in price of good Y

51
Q

What happens when XED is positive?

A
  • goods are substitutes
  • an increase in price of B will increase demand of A
52
Q

What happens when XED is negative?

A
  • the goods are complementary
  • an increase in price of B will decrease demand for A
  • e.g. DVDs and DVD players
53
Q

What happens when XED = 0?

A
  • goods are unrelated
  • a change in price of good B has no impact on good A
54
Q

What does the size of the integer represent in XED?

A
  • represents the strength of the relationship
  • the larger the number, the stronger the relationship between the two goods
55
Q

What is the significance of XED?

A
  • 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
56
Q

What is supply?

A

Supply is the ability and the willingness to provide a good or service at a particular price at a given moment in time

57
Q

What causes a movement along the supply curve?

A

A change in the price of the good

58
Q

What causes a shift in the supply curve?

A

A change in the factors which affect supply (conditions of supply)

59
Q

When does contraction of supply occur?

A

When quantity supplied falls, due to a decrease in price

60
Q

When does extension of supply occur?

A

When quantity supplied rises due to an increase in price

61
Q

What happens to the supply curve when there is a decrease in supply

A
  • leftward shift
62
Q

What happens to the supply curve when there is an increase in supply?

A

Rightward shift

63
Q

Conditions of supply?

A
  • cost of production
  • advances in technology
  • weather
  • taxes + subsidies
  • transport costs
64
Q

How does cost of production affect supply?

A
  • if a business has an increase in their costs but selling price remains same, they make less money on what they sell
  • increasing the price —> avoids making a loss so less is supplied at each price - leftward shift
  • decrease in price —> rightward shift
65
Q

How does weather affect supply?

A
  • agricultural goods are reliant of weather
  • weather is good = more supply - rightward shift
  • weather is bad = less supply - leftward shift
66
Q

How does technology affect supply

A
  • new technology causes a fall in production costs due to higher productive efficiency
  • provides incentives for firms to lower prices or produce more goods at the same price —> rightward shift
  • during war, firms use less efficient technology —> leftward shift
67
Q

How do taxes and subsidies affect supply?

A
  • tax decreases supply
  • subsidy increases supply as it reduces both production cost + price of the commodity - therefore more affordable to produce
68
Q

How does joint supply affect supply?

A
  • increase or decrease in the supply of one good leads to the increase or decrease in supply of a by - product
  • e.g. cows can be used for milk, beef and hide
  • if the supply of cows increases, so will the supply of dairy + beef product
69
Q

What is price elasticity of supply?

A

Measures the responsiveness of supply to a change in price

70
Q

Formula for PES

A

% change in quantity supplied / % change in price

71
Q

Why is the supply curve upwards facing?

A
  • profit motive
  • at higher prices, producers have an incentive to supply more as they will get more profit
72
Q

When is PES relatively elastic?

A
  • PES > 1
  • starts at Y axis
  • quantity supplied changes by a larger percentage than price so supply is relatively responsive to price
73
Q

When is PES relatively inelastic?

A
  • PES < 1
  • starts at X axis, steep
  • quantity supplied changes by a smaller percentage than price so supply is relatively unresponsive to price
74
Q

When is PES unitary?

A
  • PES = 1
  • starts from origin
  • quantity supplied changes by exactly the same percentage as price
75
Q

Factors affecting price elasticity of supply?

A
  • time
  • long run
  • level of sparse capacity
  • stocks/ inventories
  • ease + cost of factor substitutability
  • speed of production
76
Q

How does time affect PES?

A
  • more elastic in long run as this gives producers more time to increase resources
77
Q

How does the long run affect PES?

A
  • all factors of production are variable (land, labour, capital, enterprise)
78
Q

How does level of sparse capacity affect PES?

A
  • more space to increase supply = more elastic
79
Q

How does stock affect PES?

A
  • higher stock = more to supply - more elastic
80
Q

How does ease + cost of substitutability affect PES?

A
  • can machines + labour switch easy to making the products
  • e.g. ventilators in coronavirus epidemic
81
Q

How does speed of production affect PES?

A
  • longer it takes to produce the good = the more inelastic
  • e.g. malt whiskey - brewing, housing - planning permission
82
Q

What is perfectly inelastic PES?

A
  • PES = 0
  • a change in price has no effect on output so demand is completely unresponsive to price
  • shown by vertical line
83
Q

What is perfectly elastic PES?

A
  • PES = infinity
  • horizontal line
  • a change in price means that quantity supplied falls to 0 and supply is very responsive to price
84
Q

What is the equilibrium point?

A
  • where there are no more forces bringing about change
85
Q

What is price equilibrium?

A

When supply is equal to demand (where the curve crosses)

86
Q

Why is it also known as the market clearing price?

A

All the products supplied to the market are cleared (bought) as no buyers are unable to buy the good

87
Q

When is price set below the equilibrium?

A

When there is excess demand

88
Q

What impact does excess demand have?

A

There’s a shortage in the market

89
Q

What do firms do when there is excess demand?

A
  • theyre increase prices and still sell their goods
  • extension in supply
  • higher price -> contraction in demand -> now at equilibrium
90
Q

What happens when price is set higher than equilibrium?

A

There is excess supply

91
Q

What impact does excess supply have on the market?

A

Firms have unsold goods

92
Q

What do firms do when there is excess supply?

A
  • put sales on to sell these excess goods
  • contraction in supply
  • lower price —> extension in demand
  • now at equilibrium
93
Q

Functions of price mechanisms to shortages

A
  • shortages signal producers to increase price
  • incentive to supply more to increase profit
  • rationing of demand -> contraction of demand
  • equilibrium restored
  • price mechanism self corrects
94
Q

Function of price mechanism for excess supply?

A
  • signal to lower price -> leads to extension of demand
  • contraction of supply - less incentive to produce as profits are lower
  • equilibrium is restored
  • price mechanism self corrects
95
Q

What is consumer surplus?

A
  • area below demand curve + above price level
  • shows the difference between what customers are willing to pay + market price
96
Q

What is producer surplus?

A
  • area above supply curve + below price level
  • shows the difference between the price the supplier is willing to produce their product at + market price
97
Q

Are consumers rational?

A

Traditional economic theory has assumed consumers are perfectly rational and make choices to maximise happiness

98
Q

What are the two types of thinking?

A
  • automatic and intuitive
  • reflective and rational
99
Q

Describe the automatic system

A

It’s your gut reaction

100
Q

Describe the reflective system

A

It’s your conscious thought

101
Q

What helps us make choices?

A
  • relying on rules of thumb
  • this is because we cannot spend hours analysing all our decisions
  • information is often too complex to make assessments of everything
102
Q

What suggests that consumers are irrational?

A

Behavioural biases

103
Q

Reasons why consumers may not behave rationally?

A
  • consideration of influence of other people’s behaviour
  • habitual behaviour
  • consumer weakness + computation
  • choice overload
  • information failure or asymmetric information
104
Q

How does the influence of other effect decisions?

A
  • herding behaviour - if we see someone else doing something we are more likely to do so too
  • we are influenced by what other people do when making decisions
105
Q

How does habitual behaviour affect decisions?

A
  • status quo - individuals tend to stick with their current situation
  • this may be because they want to play it safe and not risk a change as it may make them worse off (loss aversion)
  • this can lead to consumers losing out on possible utility gain + not maximising their utility
106
Q

How does choice overload affect decisions?

A
  • if there’s too many options to choose from, it’s difficult for the consumer to work out the benefits of each one + is too much information to process
  • so they may not reach a rational decision to maximise utility
107
Q

Information failure/ asymmetric informations affect on decisions

A
  • there may not be enough info on a rational decision
  • or other buyer know more than the seller so their decision isn’t always rational and may reflect onto self interest

Econ Theme 1 (11 decks)

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