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Economics > 1.2 - How markets work > Flashcards

1.2 - How markets work Flashcards

1
Q

How do consumers act rationally?

A

By aiming to maximise utility.

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2
Q

How do producers act rationally?

A

By aiming to maximise profits.

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3
Q

What is demand?

A

How much is demanded at a given price over a certain time period.

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4
Q

What is the shape of the demand curve?

A

Downward sloping.

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5
Q

What does the shape of the demand curve indicate?

A

Demonstrates how a fall in price will cause an increase in the quantity demanded.

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6
Q

What effects cause the shape of the demand curve?

A

Substitution effect - when there is a rise in price, the consumer tends to buy more of a relatively lower priced good and less of a higher priced one.

Income effect - when price rises, purchasing power decreases, this leads to a decrease in demand.

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7
Q

What causes movement along a demand curve?

A

A change in price.

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8
Q

What factors cause a shift in the demand curve? (Think PASIFIC)

A

Population
Advertising
Substitutes
Incomes
Fashion and Trends
Interest Rates
Complements

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9
Q

What is total utility?

A

Amount of satisfaction a person gets from the total amount of product consumed.

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10
Q

What is marginal utility?

A

The change in total utility from consuming an extra unit of a product.

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11
Q

What is the law of diminishing marginal utility?

A

With each consumption of a product, utility increases but at a decreasing rate.

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12
Q

What is price elasticity of demand (PED)?

A

A measure of the responsiveness of quantity demanded of a product to a change in its price.

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13
Q

What is the PED equation?

A

percentage change in quantity demanded / percentage change in price

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14
Q

Why is PED always a negative value?

A

As price increases, demand decreases.

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15
Q

What does a PED of 0 mean?

A

Perfectly inelastic demand.

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16
Q

What does a PED of between 0 and -1 mean?

A

Inelastic demand.

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17
Q

What does a PED of -1 mean?

A

Unitary elastic demand.

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18
Q

What does a PED of between -1 and negative infinity mean?

A

Elastic demand.

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19
Q

What does a PED of negative infinity mean?

A

Perfectly elastic demand.

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20
Q

What does HEVI stand for?

A

Horizontal-Elastic Vertical-Inelastic.

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21
Q

Name 3 factors influencing PED.

A

Availability of substitutes - the more substitutes there are the more of an incentive there is to switch consumption.

Proportion of income - the greater the percentage of income, the more elastic

Nature of product - if the product is addictive is it is more likely to be inelastic.

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22
Q

When demand is perfectly inelastic, a change in price causes total revenue to…

A

Change in the same direction by the same proportion.

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23
Q

When demand is inelastic, a change in price causes total revenue to…

A

Change in the same direction.

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24
Q

When demand is unitary elastic, a change in price causes total revenue to…

A

Remain unchanged.

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25
Q

When demand is elastic, a change in price causes total revenue to…

A

Change in the opposite direction.

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26
Q

When demand is perfectly elastic, a rise in price causes total revenue to…

A

Fall to 0.

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27
Q

What is the significance of PED for firms?

A

If firms know if a product is price elastic or inelastic, they can change price accordingly.

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28
Q

What is the significance of PED for government?

A

If government wishes to maximise its tax revenue it will place indirect taxes in inelastic products.

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29
Q

What is cross elasticity of demand (XED)?

A

A measure of responsiveness of quantity demanded for one product to a change in price of another.

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30
Q

What is the XED equation?

A

Percentage change in quantity demanded for one product / percentage change in price of another.

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31
Q

What does a positive XED suggest?

A

Products are substitutes - as the price of one product rises the demand for another product will also rise.

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32
Q

What does a negative XED suggest?

A

Products are complements - as the price of one product rises the demand for the other one falls.

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33
Q

What is the significance of XED for firms?

A

If a firm is selling products that are complements or substitutes, they will be able to price there products accordingly to make maximum profit.

34
Q

What is income elasticity of demand (YED)?

A

A measure of responsiveness of quantity demanded of a product to a change in real income.

35
Q

What is the YED equation?

A

Percentage change in quantity demanded / percentage change in real income

36
Q

What does a positive YED indicate?

A

Normal good - as real incomes rise, demand for the good also rises.

37
Q

What does a negative YED indicate?

A

Inferior good - as real incomes rise, demand for the good falls.

38
Q

What is the significance of YED for firms?

A

If firms know the demand for a product is income elastic then they know that demand and total revenue will increase significantly during periods of economic growth.

39
Q

What is the significance of YED for government?

A

If the government wish to maximise tax revenue during an economic boom it place indirect taxes on those products whose demand is income elastic.

40
Q

What is supply?

A

How much is supplied at a given price level over a certain period of time.

41
Q

What is the shape of the supply curve?

A

Upwards sloping.

42
Q

What does the shape of the supply curve indicate?

A

As price increases so does supply.

43
Q

What causes the shape of the supply curve?

A

It is more profitable for producers to supply at higher prices, increasing the incentive to produce.

44
Q

What causes movement along the supply curve?

A

A change in price.

45
Q

What factors cause a shift in the supply curve? (Think PINTSWC)

A

Productivity
Indirect Taxes
Number of Firms
Technology
Subsidies
Weather
Costs of Production

46
Q

What is price elasticity of supply (PES)?

A

A measure of the responsiveness of quantity supplied for a product to a change in its price.

47
Q

What is the equation for PES?

A

Percentage change in quantity supplied / percentage change in price

48
Q

What does a PES of 0 mean?

A

Perfectly inelastic supply.

49
Q

What does a PES of between 0 and 1 mean?

A

Inelastic supply.

50
Q

What does a PES of 1 mean?

A

Unitary elasticity of supply.

51
Q

What does a PES of between 1 and infinity mean?

A

Elastic supply.

52
Q

What does a PES of infinity mean?

A

Perfect elastic supply.

53
Q

Why is PES always a positive value?

A

As price increases, so does quantity supplied.

54
Q

Name 3 factors influencing PES.

A

Time - in the short run, it is difficult to change supply quickly so it tends to be more inelastic.

Spare capacity - if firms have unused machinery or underemployed workers then supply is more likely to be elastic.

Ability to switch resources from one use to another - if firms are able to switch workers and machinery between tasks quickly and efficiently supply is likely to elastic.

55
Q

Where can the equilibrium price and quantity be found?

A

The point of intersection between the demand and supply curves.

56
Q

When is there excess supply in an economy?

A

When the price is above the equilibrium price.

57
Q

When is there excess demand in an economy?

A

When the price is below the equilibrium price.

58
Q

What causes a change in equilibrium price?

A

A change in demand and/or supply.

59
Q

What are the 3 key functions of the price mechanism?

A

Rationing device - market forces ensure that the amount demanded is exactly equal to amount supplied.

Incentive - the prospect of making a profit acts as an incentive for firms to produce goods and services.

Signalling device - to producers to increase or decrease amount supplied.

60
Q

What is consumer surplus?

A

The difference between how much consumers are willing to pay and what they actually pay for a product.

61
Q

Where can consumer surplus be found on a demand-supply diagram?

A

Below the demand curve but above the equilibrium line.

62
Q

What are the 2 factors affecting consumer surplus?

A

Gradient of demand curve - the steeper it is the greater the consumer surplus.

Movement of demand curve - an increase in demand leads to an increase in consumer surplus.

63
Q

What is producer surplus?

A

The difference between the minimum price a producer will sell a product for and what they actually sell it for.

64
Q

Where can producer surplus be found on a demand-supply diagram?

A

Above the supply curve but below the equilibrium line.

65
Q

What are the 2 factors affecting producer surplus?

A

Gradient of the supply curve - the steeper it is the greater the producer surplus.

Movement of supply curve - an increase in supply leads to and increase in producer surplus.

66
Q

What is an indirect tax?

A

A tax on expenditure.

67
Q

What are the 2 types of indirect tax?

A

Ad valorem taxes.

Specific taxes.

68
Q

What is an ad valorem tax?

A

A percentage of the price of a product, e.g. VAT.

69
Q

What is a specific tax?

A

A set amount per unit of a product, e.g. tax on cigarettes.

70
Q

What direction do taxes cause the supply curve to move to?

A

To the left.

71
Q

What is the consumer incidence of tax?

A

Relates to the burden of the tax that falls onto consumers.

72
Q

What is the producer incidence of tax?

A

Relates to the burden of the tax that falls onto producers.

73
Q

Where can the consumer incidence of tax be seen on a graph?

A

Above the equilibrium line.

74
Q

Where can the producer incidence of tax be seen on a graph?

A

Below the equilibrium line.

75
Q

What does consumer incidence of tax + producer incidence of tax equal?

A

Total revenue earned by the government.

76
Q

What is a subsidy?

A

A grant from the government that is designed to reduce the costs of producer.

77
Q

What direction do subsidies cause the supply curve to move to?

A

To the right.

78
Q

Where can the consumer gain of a subsidy be viewed on a graph?

A

Below the equilibrium line.

79
Q

Where can the producer gain of a subsidy be viewed on a graph?

A

Above the equilibrium line.

80
Q

What does consumer gain + producer gain equal?

A

Total amount of spending by government.

81
Q

What are the 3 main ways consumers don’t act rationally?

A

Herd mentality - this following what the majority or ‘relevant’ do, instead of maximising utility.

Habitual behaviour - this the tendency to stick with the current situation due to comfort. This is often linked to ‘playing safe’.

Computational weakness - some consumers may be unable or unwilling to make comparisons between prices.

Economics (13 decks)

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