2 The allocation of resources Flashcards
Microeconomics
The study of individual consumers, individual firms and households in making decisions about resource allocation. It applies to different markets of goods and services.
Consumer
Any individual who has the ability and willingness to purchase goods and services for personal use.
Producer
An individual, firm or country that produces, allocates resources and supplies goods or services for sale.
Subsidies
A per-unit amount of money given by governments to firms to reduce their cost of production and increase the supply of goods and services.
Micro Decision maker
Household, firm, individuals
Macro Decision maker
Government
Macroeconomics
The study of the economy as a whole considers economic decisions and economic policies taken by the government to achieve overall economic growth.
Economy
Where goods and services are produced by firms and consumed by people.
Market system
A system that works to allocate scarce resources efficiently through the forces of demand and supply.
Price mechanism
The interaction of demand and supply that determines the prices of goods and services.
Market equilibrium
A situation in the market where at a given market price, demand for a product is equal to the supply of the product.
Surplus
When the quantity supplied of a good is larger than the quantity demanded in the market. The difference between the two is the surplus.
Shortage
When the quantity supplied of a good is smaller than the quantity demanded in the market. The difference between the two is the shortage.
Market disequilibrium
A situation in the market where the market demand for a product is not equal to the market supply of the product.
The three economic decisions
What to produce?
How to produce it?
For whom to produce?
Economic system
A system in which governments allocate resources towards the production and distribution of goods and services within a society or its geographical area.
Free market economy
A system in which all decisions on resource allocation are taken by private firms and individuals. There is little or no government involvement.
Public sector
A country’s economic sector is run and controlled by the government. It does not include any private businesses and households.
Mixed economy
A combination of a free market economy and a planned economy. Decisions about resource allocation are taken by private and public sectors.
Planned economy
All decisions about resource allocation, prices as well as how goods and services are produced and allocated are taken by public sector organisations.
Price mechanism
The interaction of demand and supply that determines the prices of goods and services.
Market
A place where a buyer buys and a seller sells
Price
The amount of money a product is worth
Supply
Is the ability and willingness of firms to provide goods and services at given price levels.
Demand
Is the ability of a product that consumers are willing to buy, able to buy at a price over a period of time.
The law of demand
When goods are cheap, people buy more, when a good is expensive people buy less
Substitute good
A good that can be used instead of another for the same purpose. If the price of one good increases, the demand for this good will decrease, and the demand for its substitute will increase.
Complementary good
Goods that have a joint demand. If the price for one good increases, the demand for it will decrease, and the demand for its complement will also decrease.
The law of supply
As price increases quantity supplied increases
Production
The process of turning a range of input resources into an output of goods or services that are required in the market.
Equilibrium price
A market price for a product where quantity demanded is equal to quantity supplied. There is no shortage or surplus in the market.
Elasticity
The responsiveness of a factor to the change in the price of a good or service or any other change in one of its determinants.
Price elastic
If a product is price elastic then an increase in its price will lead to a decrease in demand.
Price inelastic
When a change in the price of a product causes a very small or minor change in the quantity demanded or quantity supplied for that product, the demand or supply for the product is said to be price inelastic.
Elasticity Coefficient
How to calculate Elasticity
% Change in Quantity ÷ % Change in Price
Unitary elastic demand
When a change in price leads to a proportionately equal change in the quantity demanded.
Perfectly inelastic demand
When a change in price leads to no change in the quantity demanded.
Perfectly elastic demand
When a tiny change in price would lead to an infinite change in the quantity demanded.
Determinants of PED
Substitute
Proportion of income
Luxury or necessity
Addictive
Time
Necessities
Goods that are essential, and are demanded proportionately less as the income of a person increases.
Total revenue
Price x income
Price elasticity of demand
The responsiveness of quantity demanded to changes in the price of a product.
Price elasticity of supply
The responsiveness of quantity supplied to changes in the price of a product.
Unitary elastic supply/demand
When a change in price leads to a proportionately equal change in the quantity supplied/demanded.
Perfectly inelastic supply/demanded
When a change in price leads to no change in the quantity supplied/demanded.
Perfectly elastic supply
When a tiny change in price would lead to an infinite change in the quantity supplied.
Normal good
The more money you earn the more of it you buy
e.g. fresh vegatables
Inferior good
the more money you earn the less you buy
e.g. frozen vegetabless
The determinants of PES
Production lag
Stocks
Spare capacity
Substitutability of F.P
Time
Free riders
People who benefit without paying
Stakeholders
Group of people that are interested in or have a stake in the activities of a company or an economy.
Private costs
Costs borne by those who are directly involved in the production and consumption of goods and services.
External costs
Costs imposed on those who are not directly involved in the production and consumption of goods and services.
External costs are the negative spill-over costs to the third party
Social costs
The total costs to society due to economic activity. The social cost is the sum of private costs and external costs.
Causes of market failure
Underconsumption of merit goods
Over consumption of demerit goods
Tragedy of the commons
The idea that common goods that everyone has access to are often misused and exploited.
Negative externalities
Too much is bad
e.g. factory creating TVs
The government will tax these
Positive externalities
The more the better
e.g. school
The government will subside these
Regulatory policies
rules Established by government decree
Market-based policies
Policies designed to manipulate market, prices and incentives to correct market failure.
Merit good
A good with positive externalities that is under consumed and underproduced in a free market.
Demerit good
A good with negative externalities that is overconsumed and overproduced in a free market.
Market failure
Ineffective distribution of goods and services in a free market.
Causes of market failure
- The existence of costs and benefits that do not go through the price mechanism.
- A lack of financial incentive to produce certain important products.
- Under or over-consumption of products if left to market forces.
- Lack of information for consumers or suppliers
- Firms exploiting their market power
- Problems moving resources(e.g. labour) from one use to another.
Price controls
Controls are imposed by the government in the form of a minimum and maximum prices that can be charged to consumers.
Indirect tax
Taxes are imposed by the government on spending to buy goods and services.
Factors that affect demand
Price
Consumer tastes/preferences
Consumer Income
Prices of substitute/ complementary goods
Interest rates (price of borrowing money)
Consumer population (population increase = demand increase)
Factors that affect supply
Cost of factors of production
Prices of other goods/services
Global factors
Technology advances
Business optimism/expectations
Excess Supply causes
If the price is set too high, excess supply will be created within the economy and there will be allocative inefficiency
Excess Demand causes
When price is set below the equilibrium price. Creates demand that exceeds production due to the low price.
Consequences of Price Changes
An inward shift of the supply curve will increase prices and vice versa
An inward shift of the demand curve will decrease prices and vice versa
What has to be done to raise revenue?
When demand is price inelastic:
When demand is price elastic:
An increase in price would raise revenue
A decrease in price would raise revenue
Consequences of price changes: demand curve shifts to the right
increase in the demand and increase in prices
Consequences of price changes: demand curve shifts to the left
a decrease in the demand and a decrease in prices
Consequences of price changes: supply shifts to the right
increase in supply and decrease in prices.
Consequences of price changes: supply shifts to the left
a decrease in supply and an increase in prices
