1.2 How Markets Work Flashcards
What is demand?
The ability and willingness to buy a particular good at a given time
Why does the demand curve slope downwards?
- Income effect: the impact of a change in price on a consumers income
- Substitute effect: how easily a good can be replaced with another
- Diminishing marginal utility
What is diminishing marginal utility?
Reduced rate of satisfaction gained from consuming additional units of a good
What is normal good?
Goods and services which see a rise in demand when incomes rise
What is an inferior good?
Goods and services which see a fall in demand when incomes rise
What are 6 conditions of demand?
- Income levels
- Substitute goods
- Complementary goods
- Advertising
- Population
- Government policy
What is supply?
The ability and willingness of firms to produce a good or service at a particular price at a given time
Why does the supply curve slope upwards?
As the price level increases, more firms are incentivized by profit to join the market and to extend their supply
What are 7 conditions of supply?
- Production costs
- Indirect taxes
- Number of firms
- Technology
- Subsidies
- Weather
- Cartels
What is joint supply?
When two or more products are derived from a single source. Increased production of one will lead to increased production of the other (e.g increased supply of beef=increased supply of leather)
What is competitive supply?
When the production of multiple goods require the same resources. Increasing the production of one, decreases the other e.g a farmer can plant potatoes or carrots (not both simultaneously)
What are the 3 functions of the price mechanism?
- Incentive: rising prices give a profit incentive for producers to extend supply
- Rationing: resources become scarce leading to price rises, discouraging consumers from entering the market and allocating goods to those willing to pay
- Signalling: notifies producers of the market conditions
What is the price mechanism?
The way price changes in response to changes in demand or supply, so that new equilibrium position is reached
What is consumer surplus?
The extra satisfaction gained by a consumer for paying a price that is lower than which they were prepared to pay
What is producer surplus?
The difference between what producers are willing and able to supply a good for and the price they actually receive
Where is consumer surplus found on a diagram?
Below the demand curve, above the price line
What is allocative efficiency?
When the cost of producing a good matches how much a consumer is willing to pay for it (the optimal distribution of goods and services)
What is price elasticity of demand?
A measure of the responsiveness of demand to a change in price
What is the difference between relatively inelastic and relatively elastic demand?
Relatively inelastic: large % change in price will result in a smaller % change in demand
Relatively elastic: small % change in price will result in a larger % change in demand
What is the difference between perfectly inelastic and perfectly elastic demand?
Perfectly inelastic: % change in price has no effect on the quantity demanded
Perfectly elastic: % change in price leads to an infinite change in demand
What is the equation for price elasticity of demand?
% change in quantity demanded / % change in price
Name 4 factors that affect PED
- Number/closeness of substitutes
- Degree of necessity
- Proportion of income
- Time
What is the difference between consumer and producer burden?
Consumer burden is the amount which consumer surplus has reduced by the imposition of a tax
Producer burden is the amount which the imposition of a tax will reduce producer surplus
What is tax incidence?
A measure of how the burden of tax is distributed between firms and consumers (taxpayer)
