1.2 How Markets Work LS7-11 Flashcards
Whats the difference between deduction and induction?
The two approaches to a solution
Deduction is when you start with a hypothesis
Induction is when you collect evidence
What does it mean when consumers are rational?
They buy products that maximise utility
Whats utility?
The satisfaction or benefit derived from consuming a good
Whats utility for firms?
Maximising profit
How do firms maximise profit?
- Producing as efficiently as possible
- Making things that consumers both want and can afford
What three things do economic agents need to make rational decisions?
- Time
- Information
- Ability to process information
Deductive or inductive?
What approach does behavioural economics take?
Inductive (collect evidence) as its based on evidence and observations
Whats bounded rationality?
When individuals wish to maximise utility but are unable to do so due to a lack of time, information and ability to process information
What human behaviours can prevent rational decision making?
- Habitual behaviour
- Consumer inertia (fear of changing)
- The influence of others
- Consumer weakness of computation
Demand definition
The quantity of a good or service purchased at a given price of a given time period
State the law of demand
Ceteris paribus, as the price of a good increases, quantity demanded decreases
As the price of a good decreases, quantity demanded increases
How is a decrease in price shown on a demand diagram?
Decrease in price = extension/expansion in demand
Shown by a movement along a demand curve
—>
How is an increase in price shown on a demand diagram?
Increase in price = contraction in demand
Shown by a movement along a demand curve <—
Substitute goods?
Two alternative products that could be used for the same thing
i.e. Xbox and playstation
Complementary goods?
Products that are used together
i.e. tea and sugar
What factors can affect demand?
- A change in the age structure of the population
- Changes in incomes
- Advertising (successful or unsuccessful)
- Changes in consumer tastes/preferences
Revenue definition?
The income that a government or company receives
Total revenue definition?
Price x quantity
Who supplies goods and services in a market?
Firms
Supply definition?
The quantity of a good or service that firms are willing to sell at a given price over a given time period
State the law of supply
Ceteris paribus, as the price of a good increases, quantity supplied increases (as producers want to maximise profit).
As the price of a good decreases, quantity supplied decreases.
How is an increase in price shown on a supply diagram?
Increase in price = extension/expansion in supply
Shown by a movement along the supply curve
How is a decrease in price shown on a supply diagram?
Decrease in price = contraction in supply
Shown by a movement along the supply curve
What two things does a supply diagram assume?
- Firms are motivated to produce by profit
- The cost of producing a unit increases as ouput increases
Excess demand?
When demand exceeds supply at a given price in a given time period
Excess supply?
When supply exceeds demand at a given price over a given time period
Equilibrium price?
When supply meets demand
Direct tax definition?
A tax levied directly on an individual or organisation
eg. income tax/corporation tax
Indirect tax definition?
A tax levied on a good or service
e.g. VAT
Specific tax?
- Causes a parallel shift in the supply curve
- Tax is same fixed amount at all prices
Ad Valorem tax?
- Causes a non-parallel shift in supply curve
- Tax increases as amount sold rises (income tax)
Why do governments impose taxes?
- In order to raise government revenue and/or
- To discourage certain economic activities
Subsidy definition and why do governments give these to firms?
- Money given by the government to encourage production which is not paid back
