1.2.4 onwards Flashcards
Definition of supply
Supply is the quantity of a good or service that a producer is willing and able to supply onto the market at a given price in a given time.
Basic law of supply
The basic law of supply is that as the price of a product rises, businesses expand supply to the market.
What does the supply curve show?
Shows a relationship between market price and how much a firm is willing and able to sell.
When does a supply curve experience expansion and contraction?
A rise in the market price brings about an expansion of supply. If market prices fall, we expect to see a contraction of supply.
What causes a movement along the supply curve?
A movement along the supply curve is caused solely by a change in price, all factors remaining constant.
3 reasons why supply curves are drawn as sloping upwards from left to right
- The profit motive: If the market price rises, it becomes more profitable for businesses to increase output. 2. Production and costs: When output expands, a firm’s production costs tend to rise. 3. New entrants coming into the market: Higher prices may create an incentive for other businesses to enter a market.
What is market supply?
Market supply is the total supply brought to the market by producers at each price.
What causes a shift of the market supply?
An outward shift of the market supply will take place if there is a change in a non-price factor affecting producers.
Causes of shifts in the market supply curve
- Changes in the unit costs of production. 2. A fall in exchange rates increases prices of imported components. 3. Advances in production technology. 4. Favourable weather conditions. 5. Taxes, subsidies, and government regulations.
Relationship between cost and supply
An increase in costs leads to a decrease in supply. A decrease in costs leads to an increase in supply.
What is joint supply?
Where an increase or decrease in supply of one good leads to an increase or decrease in supply of another by-product.
What is price elasticity of supply?
Measures how supply responds to a change in price.
Formula for price elasticity of supply
% change in quantity supplied / % change in price.
How do we use the PES value to predict the elasticity of supply?
When PES > 1, supply is elastic. When PES < 1, supply is inelastic. When PES = 0, supply is perfectly inelastic. When PES = infinity, supply is perfectly elastic.
Factors affecting price elasticity of supply
- Spare production capacity. 2. Stocks of finished products and components. 3. Ease and cost of factor substitution. 4. Time period and production speed.
Difference between the short run and long run
In the short run, at least one factor of production is fixed. In the long run, no factors of production are fixed.
How does the short run affect price elasticity of supply?
Supply cannot respond to the increase in demand because all the factors cannot be changed.
What is market equilibrium?
Market equilibrium is that point at which demand is equal to supply.
What is excess supply?
If the current market price shifts, there would be an excess supply which would put downward pressure on price.
How do we get back to equilibrium from excess demand or supply?
Market forces are always pushing prices towards market equilibrium.
What does an outward shift of market demand lead to?
Leads to a rise in equilibrium price and an expansion of market supply.
What does an inward shift of market demand lead to?
Leads to a fall in equilibrium market price and a contraction of market supply.
What does an inward shift in market supply cause?
An inward shift in market supply leads to a rise in equilibrium price and a contraction in market demand.
What happens immediately after demand increases?
An increase in demand leads to the price increasing at a high price before an expansion of supply takes effect.
What happens if the size of the outward shift of market supply exceeds the increase in market demand?
Both quantity bought and sold increases but the market price falls.
Reasons for change in supply of beef
- Increase in costs of animal foodstuff. 2. Higher rents paid by beef farmers. 3. Rise in wages of farm labourers.
Reasons for change in demand of beef
- Rise in price of beef substitutes. 2. Rise in real incomes if YED > 0. 3. Change in taste and preferences.
An increase and decrease in demand causes what effect on equilibrium price and quantity?
When demand increases, both equilibrium price and quantity increase. When demand decreases, equilibrium price and quantity decrease.
An increase and decrease in supply causes what effect on equilibrium price and quantity?
When supply increases, quantity increases and price decreases. When supply decreases, quantity decreases and price increases.
Three elements of the price mechanism
- Rationing. 2. Signalling. 3. Incentive.
What is the rationing function?
When there is a shortage of a product, price will rise and deter some consumers from buying the product.
What happens to price when there is excess demand and why
Excess demand for a good or service will lead to a rise in the price due to its scarcity.
What is the signalling function?
Changes in price provide information to both consumers and producers about the changes in market conditions.
What signal does an increase in price give?
Gives an indication to producers that they should increase supply and to consumers that they should reduce demand.
What signal does a decrease in price give?
Indicates to producers that they should decrease supply and to consumers that they should increase demand.
What is the incentive function?
Higher prices provide an incentive to existing producers to supply more.
Price mechanism in a local market
The price mechanism functions normally.
Price mechanism in a national market
The price mechanism will still work the same but implications can be much greater.
Price mechanism in an international market
The price mechanism will still play the same role but is influenced by all countries.
What is consumer surplus?
Consumer surplus is the difference between the total amount that consumers are willing and able to pay for a good and the amount they pay.
How is consumer surplus indicated?
By the area under the demand curve and above the market price.
How does higher supply costs affect consumer surplus?
Higher supply costs lead to a rise in market price and therefore a decrease in consumer surplus.
How does an increase in market demand affect consumer surplus?
An increase in market demand causes consumer surplus to increase.
Relationship between consumer surplus and price elasticity of demand
When demand is inelastic, there is a greater consumer surplus.
What is producer surplus?
Producer surplus is the difference between the price producers are willing to supply for a good and the price they actually receive.
How is producer surplus indicated on a graph?
Shown by the area above the supply curve and below the current market price.
How do higher prices affect producer surplus?
Higher prices provide an incentive to supply more due to the profit motive.
How do lower supply costs affect producer surplus?
Lower supply costs cause the market price to fall and the equilibrium quantity to rise, increasing producer surplus.
How does an increase in demand affect producer surplus?
An increase in demand means a higher equilibrium price and quantity leading to a rise in producer surplus.
What is social welfare
Total money available to society from an economic transaction or situation
How to work out social welfare
Consumer surplus plus producer surplus
Why would the government have to intervene in the market
To make sure that the markets (demand and supply forces) are working fairly and equitably
What is taxation
Medium through which governments finance their spending and control the economy
Charge imposed on products, individuals or businesses
Difference between indirect and direct tax
An indirect tax is a tax on a good or service that increases the supply cost faced by the consumer
A direct tax is a tax on an individual
What is the incidence or burden on tax
The incidence (or burden) on tax is the amount that the consumer (or producer) will pay for the tax
Definition of subsidy
A subsidy is a financial incentive (reward) to produce or consume a given product
How can we find the amount of tax on a graph
Always shown by the vertical distance between the 2 supply curves
Transmission of an imposition of indirect tax
Imposition of indirect tax leads to an increase in cost of supply for a firm, this will lead to a shift in the supply curve up and to the left. Quantity supplied will decrease by Q-Q1. P will increase from P to P1
How to find out government revenue from tax
Government revenue = tax x quantity after tax
Definition of specific tax
A set tax per unit
Definition of an ad valorem tax
Percentage tax (VAT)
Relationship between PED and tax burden
If the price elasticity of demand >1, then of the burden is on the supplier
If the price elasticity of demand is <1 most of an indirect tax can be passed ob the final consumer
Relationship between PES and tax burden
If supply is price elastic the incidence of the tax will be greater for the producer
If the supply is price elastic the incidence of tax will be greater for the consumer
Evaluation arguments when assessing indirect taxes
Effectiveness of a tax
- depends on the coefficient of elasticity of demand
- Unintended consequences from a tax?
- Indirect tax could negatively effect competitiveness and trade
- Higher taxes have encouraged tobacco smuggling - cause a significant loss of tax revenue
Transmition for imposition of a subsidy
Will lead to a decrease in the cost of supply for a firm, will lead to an increase in supply, price decreases
What is irrational behaviour
When people make systematic and persistant deviations from rational choices
Bounded rationality
A concept that acknowledges that people’s decision making is limited by cognitive biases incomplete information and other constraints. They may be influenced by emotions, social pressures, limited cognitive resources
Herd behaviour
Herd behaviour is when consumers make decisions based on what others are doing instead of using their own judgement
Habitual behaviour
- People often develop habits around purchasing and consuming certain products and services, which can influence demand
- Habits can be seen as a type of “automatic” or “unconscious” decisions making, where people act out of habit.
- Habits can be powerful forces in the economy because they can be difficult to break and can influence behaviour in a predictable and consistent way
Consumers weakness at computation
- Consumers often don’t have the time, knowledge or inclination to make optimal economic decisions
- Eg. due to limited cognitive resources, information overload and bounded rationality eg. people will look at price as a proxy for quality
- Means consumers are more easily influenced by marketing tactics like social proof
