1.2 How Markets Work Flashcards
Rational consumer behaviour
Aim to maximise utility (satisfaction)
Rational firm behaviour
Aim to maximise profit to keep shareholders happy
Rational government behaviour
Aim to maximise social welfare as they are voted in by the public
Demand
The ability and willingness to buy a particular good at a given price and at a given moment in time
Conditions of demand
Population - high population, increased demand.
Income - increase in income, increased demand (more people can afford product).
Related goods - related to XED.
Advertising - good advertising, increased demand. Good advertising from rival, less demand.
Taste/fashion - more fashionable good, increased demand
Expectations - expecting shortage or increased price of good, increased demand.
Seasons e.g hot summers, increased demand for sunscreen
Gov legislation - legal requirement, increased demand
Law of diminishing marginal utility
The satisfaction derived from the consumption of an additional unit of a good will decrease as more of a good is consumed
PED
The responsiveness of the quantity demanded for a product given a change in price
%change in QD/%change in price
PED numerical values
PED=1 - unitary elastic (change in QD = change in P)
PED>1 - relatively elastic (QD>P)
PED<1 - relatively inelastic (QD<P)
PED = infinite - perfectly elastic
PED = 0 - perfectly inelastic
PED factors
Availability of substitutes - more substitutes, PED elastic.
Time - longer time to produce good, people can find an alternate supplier of product, PED elastic.
Necessity - Necessary, PED inelastic
% of total expenditure - small%, price increase will not affect QD, PED inelastic.
Addictive - PED inelastic
PED and revenue
Elastic demand curve - decrease in price leads to increase in revenue and vice versa
Inelastic demand curve - decrease in price leads to an decrease in revenue and vice versa
Unitary elastic curve - change in price does not affect total revenue
YED
The responsiveness of quantity demanded for a good given a change in income.
%change in QD/%change in income
YED numerical values
YED<0 - inferior good (rise in income leads to fall in demand for this good)
YED>0 - normal good (rise in income leads to rise in demand for this good)
YED>1 - luxury good
Significance of YED
Important for businesses to know how their sales will be affected by a change in income.
Impact on type of goods that a firm produces.
XED
The responsiveness of quantity demanded for one product given the change in price of another good
%change in QD of goodA/%change in price of goodB
XED numerical values
XED>0 - substitutes (positive relationship)
XED<0 - complementary (negative relationship)
XED=0 - unrelated goods (no effect)
The size of the integer represents the strength of the relationship (the larger, the stronger the relationship)
Significance of XED
Firms need to know how price changes by other firms will impact them so they can take appropriate action
Competitive demand
Substitute goods that are in the same market (positive XED)
Joint demand
Goods that are compliments and are demanded together (negative XED)
Derived demand
Where a FOP is demanded not for what it is but for what it can provide e.g transport is demanded for a destination
Supply
The ability and willingness to provide a good or service at a particular price at a given moment in time.
Joint supply
Where the production of one good automatically causes the production of another good e.g production beef produces leather.
Competitive supply
The production of one good prevents the supply of another.
Supply factors
COP - increase in costs, increase in price of goods (to avoid making loss), less supplied at each price, decrease in supply
Price of other goods- for joint supply, if price of other good increases, supply of the good will increase.
Weather - supply may be dependent on weather for supply e.g good weather=more supply
Technology - new technology = more productive efficiency = firms can produce more goods at same price
Goals of supplier - motivation for social welfare = more supplied even without profit incentive
Gov legislation - laws passed for goods to be mandatory = increased supply, however increased regulation= increased costs= less supply
Taxes and subsidies - tax decreases supply and subsidy increases supply
Producer cartels - some firms/countries may come together in order to decrease supply and therefore increase the price of good to increase profit
Price elasticity of supply
The responsiveness of quantity supplied given a change in price for the good.
%change in QS/%change in price
PES numerical values
PES=1 (unitary elastic) : QS changes by same % as price
PES>1 (relatively elastic) : QS changes by more than price
PES<1 (relatively inelastic) : QS changes by less than price
PES=infinity (perfectly elastic) : QS falls to 0
PES=0 (perfectly inelastic) ; no effect
Short term
Period of time when at least one FOP is fixed
Long term
When all FOPs are variable
PES factors
Time - short term = inelastic, long term = elastic
Stocks - if firm has stock of goods, then when price goes up they can use some or all of their stock piles = elastic
Working below full capacity = in response to a change in price they can produce at full capacity = elastic(e.g producing 100 goods rather than 50)
Availability of FOP - less availability = inelastic
Ease of entry into market - large costs of start up equipment may make it difficult to increase supply = inelastic
Available substitutes - lots of producer substitutes = elastic. Producers can easily switch between the two meaning suppliers can alter the pattern of production if price rises/falls
Productivity
Output per unit of input
Labour productivity
Output per unit of labour input
Equilibrium point
There are no forces bringing about change
Price equilibrium
Where supply is equal to demand (also known as market clearing price because all products are bought and no buyers are unable to buy the good
Price mechanism
How resources are allocated in the free market. Three types: rationing, signalling and incentive
Rationing
Prices serve to ration scarce resources typically when market demand outstrips supply
Signalling
Prices adjust to demonstrate where resources are required and where they are not
Rationing
Consumer surplus
The difference between the price is willing to pay and the price they actually pay
Producer surplus
The difference between the price the supplier is willing to produce their product at and the price they actually produce at
Income effect
The impact on quantity demanded where a change in price changes the income of a consumer (reason for downward slope of demand curve)
Substitution effect
The impact of quantity demanded where a change in price switches the consumer from or to another substitute product
Shortage
A disequilibrium where there is excess demand (price below equilibrium)
Surplus
A disequilibrium where there is excess supply (price is above equilibrium)
Tax
A charge levied on a good or service - supply shifts left, reduces consumer and producer surplus
Indirect tax
A tax on expenditure e.g VAT
Direct tax
A tax on income (cooperation tax for firms)
Ad valorem tax
A charge levied as a percentage of the value of the good e.g VAT
Specific tax
Tax per unit consumed e.g excise duties on alcohol
Stamp duty
A tax paid on property when it is sold
Progressive tax
A tax that takes a greater percentage of income from the rich e.g income tax
Regressive tax
A tax that takes a greater percentage of income from the poor e.g tax on alcohol and cigarettes
Subsidy
A grant given by the government to firms to lower their costs of production - increases consumer and producer surplus
Revenue
Price x quantity. This is the inflow of money firms receive for selling their product
Profits
Revenue - costs . If a firm experiences an increase in costs they can choose to reduce their profit margin or reduce other costs to maintain profit margins
Average revenue
Total revenue/total output
Fixed costs
Costs that do not change with output e.g capital and fixed contract labour
Variable costs
Costs that change with output e.g raw materials and part-time labour
Economies of scale
The cost advantage experienced by a firm when it increases its level of output
Spare capacity
A point within the PPF where there are unemployed factors of production
Influence of others
Rational behaviour - people act individually to maximise own benefits
Irrational - Some consumers are influenced by social norms and become unwilling to change them even if doing so will benefit them because it goes against norms of society and they want to fit in
Herding behaviour
Occurs when an individual copies the actions of a large group
Habitual behaviour
Many consumers have habits as it reduces the amount of time it take to do or think about something.
Habits create a barrier to decision making since they limit or prevent consumers from considering an alternative that may maximise their welfare e.g a cheaper option. Examples are addiction, and buying something at eye level
Weakness at computation
Many consumers are unable or unwilling to make comparisons between price and so they will buy more expensive goods than needed. Consumers lack self control and fail to look long term so may make irrational decisions
Inertia
The unwillingness to gather and assess all the information needed to make the best economic choice and then act on it
