1.2 (PMT flashcards 1.2.1-1.2.3)
What are the 3 underlying assumptions of rational economic decision making?
- Consumers aim to maximize utility
- Firms aim to maximize profits
- Governments aim to maximize social welfare
What is demand?
the willingness and ability to buy a particular good at a given price and at a given moment in time
What is a movement along the demand curve caused by?
A change in price
What is the relationship between price and quantity demanded?
inverse, so as price increases quantity demanded decreases, and vice versa
What is a contraction in demand?
A decrease in quantity demanded as price increases
What is an extension in demand?
An increase in quantity demanded as price decreases
What are the conditions for demand? (PIRATES)
- Population
- Income
- Related goods (compliments or substitutes)
- Advertising
- Tastes/Fashion
- Expectations
- Seasons
What is a usually forgotten condition of demand related to the government?
Government legislation, if something is banned, there is a decrease in demand for it, but if something is a legal requirement there is an increase in demand for it
What is total utility?
it represents the satisfaction gained by a customer as a result of their overall consumption of a good
What is marginal utility?
it represents the change in satisfaction resulting from the consumption of the next unit of a good
What does the law of diminishing marginal utility state?
it states that the satisfaction derived from the consumption of an additional unit of a good will decrease as more of a good is consumed
Explain why the demand curve slopes downwards?
- As if more of a good is consumed, there is less satisfaction derived from the good
- This means consumers are less willing to pay high prices at high quantities since they are gaining less satisfaction
What does PED measure?
the responsiveness of quantity demanded given a change in price
What is the equation for PED?
% change in quantity demanded / % change in price
Why do we disregard the negative sign in values of PED?
As most values of PED are negative, so we look at the integer value alone
What is elastic demand?
When the change in price causes a proportionately greater change in quantity demanded
What is inelastic demand?
When the change in price causes a proportionately smaller change in quantity demanded
What is a unitary elastic PED?
where PED = 1
What is a elastic PED?
Where PED > 1
What is an inelastic PED?
Where PED < 1
What is a perfectly elastic PED?
Where PED = infinity
What is a perfectly inelastic PED?
Where PED = 0
What are the factors affecting PED?
- Availability of substitutes
- Time
- Necessity
- How large of a % of total expenditure
- Addictive
What do PED and PES determine?
the effects of the imposition of indirect taxes and subsidies
What does a more elastic demand curve mean for the incidence of tax on consumers?
it means a lower incidence of tax on consumers
When PED is elastic why does that mean a lower incidence of tax on consumers?
As when PED is elastic, a tax will only lead to a small increase in price, and the supplier will have to cover majority of the costs of the tax
What does inelastic demand mean for the incidence of tax on consumers?
it means a higher incidence of tax on consumers
When PED is inelastic why does that mean a higher incidence of tax on consumers?
since consumers are relatively unresponsive to the price of the good, quantity demanded will not fall by a large amount
What will a tax when there is inelastic demand be ineffective at?
reducing output
What will a tax when there is inelastic demand generate?
a higher tax revenue for the government
For a elastic demand curve, what does an increase and decrease in price lead to in terms of revenue?
- an increase in price causes a decrease in revenue
- a decrease in price causes an increase in revenue
For an inelastic demand curve, what does an increase and decrease in price lead to in terms of revenue?
- an increase in price causes an increase in revenue
- a decrease in price causes a decrease in revenue
What is income elasticity of demand? (YED)
the responsiveness of demand to a change in income
What is the equation for YED (income elasticity of demand)?
% change in quantity demanded / % change in income
What is the equation for total revenue?
Price x quantity sold
What is the equation for percentage change?
difference / original x 100
What is a normal good?
When YED > 0,
- a rise in income will lead to a rise in demand for the good (positive relationship)
What is an inferior good?
When YED < 0
- a rise in income will lead to a fall in demand of the good
What is a luxury good?
A type of normal good, when YED > 1
What is the significance of YED?
- It is important for businesses to know how their sales will be affected by the changes in the income of the population
- it may impact the type of goods that a firm produces
What is XED?
Cross elasticity of demand
What is Cross elasticity of demand (XED)?
the responsiveness of demand for one product (A), to the change in price of another product (B)
What is the equation for XED?
% change in quantity demanded of A / % change in price of B
What are substitute goods?
where the increase in price of good B will cause the increase in demand for good A
What are complementary goods?
where an increase in the price of good B will decrease the demand for good A
What are unrelated goods?
where a change in price of good B has no impact on good A
What is the significance of XED?
- firms need to be aware of their competition and those producing complementary goods
