1.2 How Markets Work Flashcards
What are the underlining assumptions of rational economics decisions making:
- consumers aim to maximise utility
- firms aim to maximise profit
- governments aim to maximise social welfare
Consumers aim to maximise utility:
Utility is the satisfaction gained from consuming a product. The rational consumer is called “homo economicus”, who makes decisions by calculating the utility gained from each decision
Firms aim to maximise profit:
Economic theory assumes that firms are run for their owner and shareholders and so aim to maximise profit in order to keep the shareholders happy.
Governments aim to maximise social welfare:
Governments are voted in by the public and work for the public, so should aim to maximise their satisfaction by taking decisions which increases social welfare
What is demand
The willingness to buy a particular good at a given price and at a given moment in time
What are conditions of demand
Factors which cause the demand curve to shift. A way to remember the conditions is the mnemonic PIRATES
Population as a Condition of demand
If population rises, we would expect demand for all products to increase and so the demand curve will shift to the right
Income as a condition of demand
If income increases for most goods demand increases as a person can afford to buy more of the product.
Related goods as conditions of demand
If goods are complements or substitutes of each other then a change in price of another good can cause a shift in the demand curve.
Advertising as a condition of demand
If a firm carries out a successful advertising campaign, demand is likely to increase and vice versa.
Taste/fashion as a condition of demand
If something becomes more fashionable we expect demand to increase and if it becomes less fashionable, then demand will fall
Expectations as conditions of demand
Expectations of what might happen in the future can have a big impact on the level of demand for some goods. If people expect a shortage of something, or that price will rise in the future, then demand for that product will increase.
Seasons as a condition for demand
Some products will find their demand affected by the weather.
Government legislation as a condition effect on the demand of goods
Demand for a car seat increased after the government made it a legal requirement that young children have to sit in them
Diminishing marginal utility demand curve is downward sloping
- demand curve slopes downwards showing the inverse relationship between price and quantity. If more of a good is consumed, there is less satisfaction derived from the good. This means consumers are less willing to pay high prices at high quantities
-we assume people are going to behave rationally excepting them to spend it according to what gives them the greatest level of satisfaction or welfare
What is total utility compared to marginal utility
total utility represents the satisfaction gained by s customer as a result of their overall consumption of a good whilst marginal utility represents the change is satisfaction resulting in consumption of the next unit of good
What does The Law of Diminishing Marginal Utility state
The satisfaction derived from the consumption of an additional unit of a good will decrease as more of a good is consumed assuming all goods remain constant
What is elasticity of demand
An attempt to measure the responsiveness of quantity of demand to changes in other variables
Difference between price elastic and inelastic
Elastic = relatively responsive
Inelastic = relatively unresponsive
What is price elasticity of demand (PED)
The responsiveness of demand to a change in the price of the good
%change in quantity demanded / %change in price
Why are most PED values negative
Since a raise in price leads to a fall in output therefore we look at the integer alone disregarding negative signs
Unitary elastic PED
Where PED = 1: quantity demanded changes by exactly the same percentage as price. This will be shown as a reciprocal curve
Relatively elastic PED
PED > 1: quantity demanded changes by a larger percentage that price so demand is relatively responsive to price. Curve will be more sloping
Relatively inelastic PED
PED < 1: quantity demanded changes by a smaller percentage than price so demand is relatively unresponsive to price. The curve will be steep
Perfectly elastic PED
PED = infinity : a change in price means that quantity falls to 9 and demand is very responsive to price. This would be a horizontal line.
Perfectly inelastic PED
PED = 0 : a change in price has no effect on output so demand is completely unresponsive (vertical line)
Factors influencing PED:
-Availability of substitutes
-Time (in short term many goods are inelastic as people may not even notice a price difference)
-necessity
-how large of a % of total expenditure
-addictive
Significance of PED on tax
The price elasticity of demand along with the price elasticity of supply determine the effects of the imposition of indirect taxes and subsidies.
