1.2 how markets work Flashcards
what is diminishing marginal utility?
diminishing marginal utility is based on the idea that consumers gain satisfaction or utility for goods they consume
what is total utility?
total utility represents total satisfaction gained from total amount of product consumed
what is marginal utility?
marginal utility represents the change in utility from consuming additional unit of product
what is the law of diminishing marginal utility?
as a person consumers more and more of a product, the marginal utility falls, consequently people prepared to pay less as consumption increases, resulting in a inverse relationship between price and quantity demanded.
what is price determination?
equilibrium price and quantity is determined by interaction of supply and demand.
what is equilibrium?
equilibrium is where quantity supplied is equal to quantity demanded
when would equilibrium change?
equilibrium will not change unless conditions of supply or demand will change.
what does excess supply mean?
excess supply implies quantity supplied is greater than quantity demanded at existing price
what does excess demand mean?
excess demand implies that quantity demanded is greater than quantity supplied at existing price
what does price elasticity of demand measure?
price elasticity of demand measures responsiveness of quantity demanded of a product to a change in price
when should price elasticity of demand be considered?
PED needs to be considered when considering the impact of tax or subsidy/ consumer/ producer surplus
how is PED measured?
percentage change in quantity demanded/ percentage change in price
values of PED:
> 1 = demand is price elastic
<1 = demand is price inelastic
0 = demand perfectly price inelastic
infinity = demand is perfectly price elastic
1 = demand is unit price elastic
(always negative value, price and quantity move in opposite directions)
what factors influence PED?
availability of substitutes, proportion of income spent on product, nature of product, durability of product, length of time under consideration, breadth of definition of product
how does availability of substitutes factor PED?
substitutes available means that a strong incentive to shift consumption to them when price rises
how does durability of products factor PED?
long-lasting and hardwearing, possible to postpone purchases, non durable must be replaced regularly
how does length of time under consideration factor PED?
it takes time for consumers to adjust expenditure patterns following a price change
what is the significance of PED for firms?
-if they know demand for product is price inelastic, they can increase total revenue by increasing price
-if they know demand is price elastic they can increase total revenue by reducing price
what is the significance of PED to consumers
if demand is price inelastic, firms may raise prices but would reduce real incomes of consumers
what is the significance of PED to the government?
if the government wishes to maximise tax revenue, it will place indirect taxes on those whose products are demand price inelastic, but the consumer will bear most of the burden
- governments may also tax products and services whose demand is price elastic, producers bear higher proportion of tax burden, potentially making business unprofitable
what is the relationship between PED and total revenue when demand is price elastic
price change causes total revenue to change in the same direction
what is the relationship between PED and total revenue when demand is elastic
prices change causes total revenue to change in the opposite direction
what is the relationship between PED and total revenue when demand is unit elastic
price change causes total revenue to remain unchanged
what is the relationship between PED and total revenue when perfectly inelastic
price change causes total revenue to change in same direction by the same proportion
what is the relationship between PED and total revenue when demand is perfectly inelastic
price rise causes total revenue to fall to zero
what does demand refer to?
demand refers to the amount demanded by consumers at given prices over a certain period of time, demand must include ability to pay for the product or service
why is the demand curve downward sloping?
demand curve is downward sloping as when the price falls
what causes an extension in demand?
fall in price will cause an increase in demand, which is an extension of demand
what causes a contraction in demand?
a rise in price will cause a decrease in quantity demanded
what are the shifts in demand?
an increase shifts right, a decrease shifts left
what causes a shift in demand right?
real income, size age distribution of population, tastes fashions or preference (depending), prices of substitutions or complements (depending), amount of advertising or promotions, interest rates can affect the cost of borrowing money
what causes a shift in demand left?
tastes fashions or preference (depending), price of substitutes or complements (depending)
what two significant assumptions are made in rational decision making?
-consumers act rationally by aiming to maximise their utility
-firms act rationally by aiming to maximise profits
alternate views of consumer behaviour
behavioural economics applies psychological insights to economic decision making
what is herd mentality?
persons behaviour affected and influenced by others, subconsciously learning from behaviour of others, instead of choosing choices which maximise own utility, going along with the choice of majority.
what is habitual behaviour?
past behaviour influences current behaviour, habits are difficult to change, incentives may be needed to change the habits
what is computational weakness?
computational weakness is where people are not always willing or able to make comparisons
what are other alternate views of consumer behaviour?
-inertia (more effort into preventing a loss than winning a gain)
-complexity of information available
-too much choice available
what is the income elasticity of demand? YED
income elasticity of demand is the measure of responsiveness of quantity demanded of a product to a change in real income
how do you measure income elasticity of demand?
percentage change in quantity demanded/ percentage change in real income
what does a positive sign of YED mean?
product is a normal good, rise in real income will cause an increase in demand
what does a negative sign of YED mean?
product is an inferior good, rise in real income leads to fall in demand of product
normal good numbers? YED
> 1 = demand is income elastic (normal luxury)
<1= demand is income inelastic (normal necessity)
inferior good numbers? YED
> 1 = demand is income elastic
<1 = demand is income inelastic
0 = demand is perfectly income inelastic
what is the significance of income elasticity of demand for firms?
if aware that demand for product is income elastic, then they know demand and total revenue will significantly during rapid economic growth, but significantly decrease during recessions
helping investment decisions
what is the significance of income elasticity of demand for government?
maximising tax revenues during economic boom (placing indirect taxes on products which are income elastic)
estimating tax revenues from indirect taxes on particular goods and services
what is the cross elasticity of demand? XED
cross elasticity of demand is the measure of responsiveness of quantity demanded of one product to a change in the price of another product
how do you measure cross elasticity of demand?
percentage change in quantity demanded of product Y/ percentage change in price of product X
what does a positive sign of XED mean?
products are substitutes, rise of price in one product, increase in demand of another
what does a negative sign of XED mean?
products are complements, rise of price leads to decrease in demand of another
numbers of XED?
> 1 = demand between goods is price elastic, strongly related
<1 = demand between goods is price inelastic, weakly related
0 = demand between goods is perfectly price inelastic, no relationship
what is the significance of cross elasticity of demand to firms?
knowledge is useful to firms while setting prices for products
also know whether complementary goods can command high prices
what’s the relationship of income and demand between normal and inferior goods?
normal goods means that there is a positive relationship between income and demand, inferior goods the relationship is negative
what does supply mean?
quantity of a good or service that producers are willing to sell at a given price
what is individual supply?
each producer will have an increased incentive to produce more of a good or service when the price rises
what is market supply?
the total supply of all producers, referring to all of supply
what is the shape of a supply curve?
supply curve is upward sloping, from left to right, indicating that more will be supplied as price increases,
what is an extension in supply?
rise in price causes an increase in the quantity supplied
what is a contraction in supply?
fall in price causes a decrease in quantity supplied
what will shift the supply curve?
-costs of production (left)
- productivity of the workforce (right)
-indirect taxes (left)
-subsidies (right)
-technology (right)
-discoveries of new reserves of raw materials (right)
conditions of supply PINTSWC
Productivity
Indirect taxes
Number of Firms
Technology
Subsidies
Weather
Costs of Production
what is joint supply?
two products are in joint supply when a rise in the output of one product leads to a rise in supply of another.
what is competitive supply?
competitive supply is when a rise in supply of one product leads to a decline of supply in another product
what does price elasticity of supply mean?
price elasticity of supply is the responsiveness of quantity supplied for a product to a change in its price
how do you measure price elasticity of supply?
percentage change in quantity supplied/ percentage change in price
what kind of value does PES always have?
a positive value, price and quantity always move in the same direction
PES values?
0 = perfectly price inelastic (no effect)
infinity = change in price leads to infinite change in supply
0-1 = supply is inelastic
1- infinity = supply is elastic
1 = unit elasticity, proportionate change
what are factors which influence price elasticity of supply?
time, stocks, spare capacity, availability and cost of switching resources from one use to another
what is rationining?
demand meets supply equilibrium, market forces will ensure that the amount demanded is exactly equal to the amount which is supplied
what is incentive?
incentive is the prospect of making a profit, such as the incentive to firms to produce goods > services
what is signalling?
signalling is produced to increase or decrease the amount that is supplied
what is the meaning of consumer surplus?
difference between the price that consumers are willing to pay for a good or service and the price which they actually pay
what is the meaning of producer surplus?
difference between the price producers are willing and able to supply for a good or service and the price which they actually receive
what does a higher demand mean for producers and consumers?
lower prices
what does a decreased supply mean for producers and consumers?
lower quantity
what is a direct tax?
a tax which is levied on the income or profits of the persib who pays it (e.g income tax co-orperation)
what is a indirect tax?
a tax which is levied on goods or services
what is Ad volorem?
tax whose amount is based on the value of the transaction, the main example on the UK is VAT at 20%
what is a specific tax?
a tax that is a fixed amount for each unit of a good or service sold
what is the meaning of consumer incidence and producer incidence?
the analysis of the effect a particular tax has on the two parties of a transaction, the producer that makes the good and the consumer that buys it
where does excess supply occur?
occurs if the price is above the equilibrium price of Pe
where does excess demand occur?
occurs if the price is below the equilibrium price of Pe
what factors affect consumer surplus?
the gradient of the demand curve, changes in the conditions of demand
what factors affect producer surplus?
the gradient of the supply curve, changes in condition of supply
what is a subsidy?
a subsidy is the grant from the government
what effects do subsidies have?
can reduce the cost of production, causing the supply curve to shift to the right.
