1.2 - How Markets Work Flashcards
What are the assumptions of rational economic decision making
Consumers aim to maximise utility (satisfaction)
Firms aim to maximise profit
Governments aim to maximise social welfare
What is demand
The willingness to buy a good at a moment in time
What causes movement along the demand curve
A change in the price of the good
What causes a shift in demand
Caused by a change in any of the factors which affect demand
What’s a contraction in demand
When demand moves back. Quantity demanded falls because of price increase
What’s extension in demand
When demand moves forwards. Demand rises due to a decrease in price
What are the conditions/factors of demand
Population, Income, Related goods, Advertising, Taste/fashion, Expectations, Seasons, Government legislation
What is total utility
The satisfaction a customer gets from consuming a good
What is the Law of Diminishing Marginal Utility
The satisfaction coming from a good will decrease the more a good is consumed
What is elasticity of demand
A measure of how much is demanded due to a change in other variables
Elastic = responsive
Inelastic = unresponsive
What is Price Elasticity of Demand (PED)
The responsiveness of demand to a change in the price of goods
Price elasticity of demand (PED) equation
% change in quantity demanded
———————————————
% change in price
What are the numerical values for PED
> 1 is relatively elastic
< 1 is relatively inelastic
= ♾ is perfectly elastic
= 0 is perfectly inelastic
Factors affecting PED
Availability of substitutes
Time
Necessity
How much of % of income it takes
Addictiveness
What happens to tax if demand has a steep (inelastic) curve
Consumers pay more tax
Producers pay less tax
What happens to tax if demand has a flat (elastic) curve
Producers pay more tax
Consumers pay less tax
What is income elasticity of demand (YED)
The responsiveness of demand to a change in income
Numerical values for YED
< 0 is inferior good (rise in income leads to fall in demand)
> 0 is normal good (rise in income leads to rise in demand)
> 1 is a luxury good (type of normal good)
Equation for income elasticity of demand (YED)
% change in quantity demanded
———————————————
% change in income
What is cross elasticity of demand
The responsiveness of demand for one product to the change in price of another product
Numerical values for XED
> 0 is substitutes (increase price of good B increases demand for good A)
< 0 is complimentary goods (increase price of good B decreases demand for good A)
= 0 is complimentary goods (change price of good B has no impact on good A)
What is supply
The willingness to provide a good/service at a specific price at a moment in time
What causes movement along the supply curve
A change in price of the good
What causes a shift in the supply curve
A change in any of the factors which affect supply
What are the conditions/factors of supply
Cost of production, Price of other goods, Weather, Technology, Government legislations, Taxes and subsidies
What is Price Elasticity of Supply (PES)
The responsiveness of supply to a change in price of the good
Price Elasticity of Supply equation
% change in quantity supplied
——————————————
% change in price
PES numerical values
> 1 is relatively elastic PES
< 1 is relatively inelastic PES
= ♾ is perfectly elastic
= 0 is perfectly inelastic
Factors that affect PES
Time, Stocks, Working below full capacity, Availability of factors of production, Availability of substitutes
What is price equilibrium
Where supply is equal to demand
What is excess demand
Where the price is set below demand
What is excess supply
Where the price is set higher than the equilibrium
What is the rationing function
When there is limited resources and too much demand, price can be increased in order to keep up with supply.
What’s the signalling function
If prices are rising because of high demand from consumers, this is a signal to suppliers to expand production to meet the higher demand
What’s the incentive function
It encourages producers to supply more when prices rise, because of the possibility of greater profit
What’s consumer surplus
The difference between the price the consumer is willing to pay and the price they actually pay.
What’s the producer surplus
The difference between the price the supplier is willing to produce their product at and the price they actually produce at
What does decrease in demand do to producer and consumer surplus
Decrease in demand leads to a fall in producer and consumer surplus
What does an increase in demand do to producer and consumer surplus
Increase in demand leads to an increase in producer and consumer surplus
How does decrease in supply affect producer and consumer surplus
Decrease in supply leads to fall in producer and consumer surplus
How does increase in supply affect producer and consumer surplus
Increase in supply leads to an increase in producer and consumer surplus
What is indirect tax
Where the person charged the tax is not responsible for paying it to the government
What’s ad valorem tax (indirect tax)
A tax where it’s a percentage of the good. (E.g. VAT)
What’s specific tax (indirect tax)
A tax where an amount is added to the price of the product. (E.g 10p per litre on petrol)
What’s the incidence of tax
Who pays more tax, the consumer or producer
What happens if demand is elastic or supply is inelastic, for tax
The producer pays more of the tax
What happens if demand is inelastic or supply is elastic, for tax
The consumer pays more of the tax
What are subsidies
Money given by the government to firms
Why do people not always behave rationally
Influences of other people
Influences of habitual behaviour
Consumer weakness at computation (consumers can’t compare prices)
Why may people not behave rationally
Influences of other people
Influences of habitual behaviour
Consumer weakness of comparing prices
