1.2 How Markets Work Flashcards
What is Rational Decision Making for Consumers, Firms and Government
Consumers- Maximise utility
Firms- Maximise profits
Government- Maximise social welfare
Demand?
The willingness and ability to buy a g/s at a given price at a given time
Factors causing demand to shift
Population, Income, No. of substitutes, Advertising, Taste/Trends
Law of diminishing returns?
The satisfaction derived from consuming and additional unit will decrease as more is consumed
PED definition and equation
The responsiveness of demand after a change in price
%change in Qd / %change in P
What does PED=1, >1, <1, 0 show
1= unitary elastic (qty changes by exactly price change)
>1= elastic
<1= inelastic
0= perfectly inelastic (price has no effect on qty
Factors influencing PED (SPLAT)
Subsititutes
Proportionof income
luxury/necessity
Addictiveness
Time period
PED effects on tax incidence
higher elasticity means lower incidence of tax on consumer vice versa
YED definition and equation
responsiveness of demand after a change in income
%change in qty / %change in income
YED >0, <0 , 1 meanings
> 0= normal good - rise in income leads to a rise in demand
<0= inferior good - rise in income leads to a fall in demand 1= luxury good - is a normal good
XED definition and equation
Responsiveness of demand of good A in response to a change in price of good B
%change in Qty A / %change in P B
XED >0, <0, 1, 0 meanings
> 0- Substitute
<0- Complementary
0= unrelated
Supply?
willingness and ability to provide a g/s at a given price at a given time
Factors influencing supply 4
Cost of production
Price of another good
Technology
Taxes , subsidiesP
PES definition and equation
responsiveness of supply after a change in price
%change Qty supplied / %change in price
PES 1, >1, <1, 0, 1
1= unitary elastic
>1= elastic
<1= inelastic
0= perfectly inelastic
Factors effecting PES
Time
Stocks
Capacity
Substitutes available
Price Mechanism- Rationing Function
When resources become scarcer the price will rise further. Only those who can afford to pay for them will receive them
Price Mechanism- Signalling Function
Prices provide info to producers and consumers about where resources should be allocated
Price Mechanism- Incentive Function
Prices act as incentives for people to work hard and for suppliers to supply more to make more profits
Consumer and producer surplus definitions
C- the difference between what consumers are willing and able to pay and what they actually pay
P-the difference between the price suppliers are willing to produce at and what they actually produce at
What can cause surplus to shift
Decrease in demand -> less output and lower price-> lower C and P surplus
Decrease in supply->less output-> lower C and P surplus
Indirect tax
A tax on expenditure where the person paying doesn’t pay it straight to govtt
Two types of Indirect Tax with explanations
Ad Valorem Tax- The amount of the tax increases in proportion to the price of product
Specific Tax- A fixed tax per unit of output
Impact of taxes (COA)
Increased cost of production-> inwards supply shift->Price increase
Govt also gain tax revenue
Subsidy
A grant given to firms by the government to encourage consumption/production of a g/s
Subsidy effect
Lower production costs-> increased supply-> rise in output->fall in price
