3.1 - Introduction to Microeconomics Flashcards
Relative Scarcity
- That our limited resources are scarce, relative to our unlimited needs and wants
- Competing uses for resources
Opportunity Cost
The cost of the next best option foregone whenever a decision is made
Allocative Efficiency
When resources are allocated in a way that maximises living standards
Productive/Technical Efficiency
When the economy is producing the maximum level of outputs from a given level of inputs
Inter-temporal Efficiency
How resources are allocated over time, so that the living standards of current generations are not jeopardising future generations’ living standards
Dynamic Efficiency
How quickly an economy can reallocate resources to achieve allocative efficiency
Conditions for a Perfectly Competitive Market
o Consumer sovereignty exists
o Large number of buyers and sellers who are all price takers
o Goods and services are homogenous
o Ease of entry and exit
Assumptions of a Perfectly Competitive Market
o Buyers and sellers operate with full information
o Resources are mobile (dynamic efficiency)
o Behaviour is rational
Demand
The ability and willingness of consumers to purchase goods and services
Law of Demand
o As the price decreases, the quantity demanded increases
o As the price increases, the quantity demanded decreases
Income Effect
o A decreased consumption of a good or service that has increased in price is due to a decrease in consumers’ purchasing power
o An increased consumption of a good or service that has decreased in price is due to an increase in consumers’ purchasing power
o Leads to substitution effect
Substitution Effect
o A decreased consumption of a good or service that has increased in price is due to a higher trade-off – consumers must give up more of another good or service to buy the same amount of this good or service
7 Non Price Demand Factors
o Changes to disposable income
o Price of substitute
o Price of complement
o Taste and preferences
o Interest rates
o Population demographics
o Consumer confidence
Law of Supply
o As the price increase, the quantity supplied increases
o As the price decreases, the quantity supplied decreases
Supply
The ability and willingness of producers to produce goods and services
Price Elasticity of Demand
Refers to the responsiveness of total quality demanded of a product to a change in the price of that product
PED=(percentage change in quantity demanded)/(percentage change in price)
Factors Affecting Price Elasticity of Demand
- Degree of necessity – necessary goods and services tend to be elastic
- Availability of substitutes – more substitutes leads to elasticity, less substitutes leads to inelasticity
- Proportion of income – lower income leads to elasticity, higher income leads to inelasticity
- Time – short term, consumers are less likely to notice changes to price so demand remains inelastic; long term, consumers are more likely to notice changes to price so demand becomes elastic (bill shock)
Price Elasticity of Supply
Refers to the responsiveness of total quality supplied of a product to a change in the price of that product
PES=(percentage change in quantity supplied)/(percentage change in price)
Factors Affecting Price Elasticity of Supply
Spare capacity:
o Lots of spare capacity – elastic supply
o No space capacity – inelastic supply
Production period:
o Short production period – elastic supply
o Long production period – inelastic supply
Durability of goods (shelf life):
o Long lasting goods – elastic supply
o Short lasting goods – inelastic supply
Market Mechanism
Describes how the forces of demand and supply influence relative prices of goods and services, which then coordinates the allocation of resources
Relative Prices
- The price of a good or service compared to the price of another good or service
- Changes to relative prices are caused by a shift of the curve (non price factor)
Relative Prices and Allocation of Resources
- Relative prices determined through forces of supply and demand interacting = market mechanism
- Increase in relative prices –> sends price signals to producers that a temporary shortage exists
- Producers investigate whether shortage is caused by demand or supply factors
- If it is caused by demand factors, producers are likely to reallocate resources due to the higher profit making opportunity and as producers are profit motivated
- Ultimately, this upholds consumer sovereignty and ensures that consumers’ demands are met –> improved living standards
How Competitive Markets Achieve Productive Efficiency
- Large number of sellers –> producers must remain price competitive so remain profitable –> must maximise outputs from inputs
- Goods/services are homogenous –> producers only compete on price –> must remain price competitive so remain profitable –> must maximise outputs from inputs
- Producers act rationally –> work to maximise profits –> maximise outputs from inputs
How Competitive Markets Achieve Allocative Efficiency
- Perfect information –> consumers are able to purchase the good/service that best suits their needs –> maximise living standards
- Act rationally –> producers aim to maximise profits –> produce goods/services that consumers demand the most –> maximise material living standards
- Large number of buyers/sellers –> producers must remain price competitive so remain profitable –> lower prices –> maximise material living standards
How Competitive Markets Achieve Dynamic Efficiency
- Low barriers to entry/exit –> producers are easily able to move between markets to respond to changes in economy
- Resources are mobile –> can be reallocated to respond the changes in economy
How Competitive Markets DO NOT Achieve Inter-Temporal Efficiency
- Large number of buyers/sellers –> producers must remain price competitive so remain profitable –> may use unsustainable/unethical practices
Market Failure
When an unregulated market does not allocate resources efficiently or maximise living standards, resulting in either an under or over allocation of resources
Public Goods
- Goods/services that are socially desirable, non excludable (available for all) and non depletable (where one’s consumption does not prevent another from consuming)
Government Interventions to Public Goods
- Subsidies: a payment or concession to a producer/consumer to increase production/consumption of a good or service by covering some of the costs involved
o Incentivises production –> address under allocation of resources so resolves market failure - Direct provision: when the government provides the good/service themselves
o The government is not motivated by profit but the welfare of the public –> increases production –> address under allocation of resources so resolves market failure
Common Access Resources
- Resources that are not owned by anyone, do not have a market price, are non excludable but are depletable
How Common Access Resources Create a Market Failure
- Lack of price –> overconsumption of resources –> not available for future generations to enjoy –> does not achieve efficient allocation of resources (intertemporal efficiency)
Government Interventions to Common Access Resources
- Government regulations: legislation to reduce consumption, such as permits, quotas or bans
o Reduces consumption –> ensures greater availability for future generations –> achieves efficient allocation of resources & resolves market failure - Indirect taxes: places a price on consumption on resource
o Reduces consumption –> ensures greater availability for future generations –> achieves efficient allocation of resources & resolves market failure - Subsidies:
o Make alternatives cheaper –> reduces consumption –> ensures greater availability for future generations –> achieves efficient allocation of resources & resolves market failure
How Public Goods Create a Market Failure
Non excludable –> free rider problem (an economic agent who receives the benefit from a public good but does not pay for it) –> low profit making opportunity for public goods –> under allocation of resources = market failure
Externality
Occurs when the wellbeing of a third party not involved in a transaction is affected by the production or consumption of a good/service
Positive Externality
Occurs when an uninvolved third party receives a benefit from the production or consumption of a good/service
How Positive Externalities Cause Market Failure
Lack of profit incentives –> under allocation of resources
Government Intervention to Positive Externalities
- Subsidies –> reduce cost of production –> greater production and allocation of resources so resolves market failure
- Direct provision –> The government is not motivated by profit but the welfare of the public –> increases production –> address under allocation of resources so resolves market failure
Negative Externalities
Occurs when a cost is imposed on an uninvolved third party as a result of production or consumption of a good/service
How Negative Externalities Cause Market Failure
Consumers/producers do not internalise cost –> overallocation of resources
Government Intervention to Negative Externalities
- Government regulations –> bans/restrictions on production/consumption –> reduced allocation of resources
- Indirect tax –> increased cost of production –> reduction of supply and contraction in demand –> reduced allocation of resources
- Subsidies of alternatives –> reduced cost of production increased supply and expansion in demand of alternative –> reduced allocation of resources towards original good/service
- Government advertising – influences taste and preferences by raising awareness around negative aspects –> decreased demand and reduced allocation of resources
Asymmetric Information
- Occurs when one party had greater information than the other in a transaction, leading to an inefficient allocation of resources as over/under allocation may occur
How Adverse Selection Causes Market Failure
Occurs when one party had greater information than the other in a transaction, leading to a party not choosing the good/service that best maximises their living standards –> overallocation of resources toward a good/service that does not meet their needs and allocative efficiency not achieved
How Moral Hazard Causes Market Failure
Occurs when economic agents adjust their behaviour without the other party being aware after the transaction has occurred = inefficient allocation of resources
Government Intervention to Asymmetric Information
- Government regulation – Consumer and Competition Act prevents producers from misleading or deceiving consumers –> prevents overallocation of resources toward a good/service that does not meet their needs
- Government advertising – raises awareness around the impacts of goods/services, when producers are unwilling to do so themselves –> prevents overallocation of resources toward a good/service that does not meet their needs
Government Failure
- Occurs when government intervention fails to improve the allocation of resources or makes the allocation of resources less efficient comparted to the free market
How Minimum Wage Causes Market Failure
- Market cannot achieve equilibrium wage –> supply is greater than demand –> inefficient allocation of resources
- Higher cost of production –> does not achieve productive efficiency
Market Evaluation - Advantages of PCM
- High levels of competition –> producers must maximise outputs from inputs to remain profitable –> productive efficiency
- Consumer sovereignty –> consumer demands are fulfilled –> maximise living standards and allocative efficiency achieved
Market Evaluation - Disadvantages of PCM
- Market failures:
o Public goods
o Common access resources
o Externalities
o Asymmetric information - Large number of buyers/sellers –> producers must remain price competitive so remain profitable –> may use unsustainable/unethical practices so allocative efficiency/inter temporal efficiency not achieved
Relative Price of Good/Service has FALLEN
Relative price of good/service being compared to has RISEN
Significance of Price Elasticity of Supply
It allows producers to make more informed decisions about how to allocate their resources to maximise profitability around price changes
Significance of Price Elasticity of Demand
It allows us to see how quickly consumers will respond to a change in price
Significance of Allocative Efficiency
Determines whether living standards are being maximised or not
Significance of Productive Efficiency
Determines whether the economy is producing at the maximum level of outputs from a given level of inputs or not
Significance of Inter-Temporal Efficiency
Determines whether future generations’ living standards are being jeopardised or not
Significance of Dynamic Efficiency
Determines whether the economy can quickly reallocate resources to respond to change
Demand Market Failure Interventions
- Advertising
- Government regulation
Supply Market Failure Interventions
- Excise Tax / Indirect Tax
- Government regulation
- Subsidies
- Direct provision
