A-Level Economics A: THEME 1 GENERAL KNOWLEDGE Flashcards

Question

1.2.3 Price, income and cross elasticities of demand Explain why PED is significant? (long response)

Answer 1

- Determines the effects of the imposition of indirect taxes and subsidies. - The more elastic, the lower the incidence of tax on the consumer. Tax would only lead to a small increase in price and the supplier will have to cover the majority of the cost of the tax. - When inelastic, the will be passed to the consumer. Since consumers are relatively unresponsive to the prices, quantity demanded will not fall by large. This means that the tax will be ineffective in reducing company output. - However, it means revenue for the government. The more inelastic, the higher the tax revenue for the government.

Answer 2

The price elasticity of supply measures how the quantity of supply reacts to a change in price.

Answer 3

PES = % change in quantity supplied ÷ % change in price

Answer 4

Firms aim for high elasticity of supply so that they can react rapidly to changes in price and demand.

Answer 5

- Improve their technology - Introduce flexible working patterns. - Have excess production capacity.

Answer 6

- Elastic supply, PES > 1 So a higher PES value means more elastic supply. - Inelastic supply, 1 > PES > 0 So a smaller PES value means more inelastic supply. - Unit elasticity of supply, PES = 1 Percentage change in quantity supplied = percentage change in price.

Answer 7

- Time - Stocks - Availability of factors of production - Ease of entry into the market - Availability of substitutes

Answer 8

- During periods of high unemployment, we tend to see a more elastic supply. - This is because if a firm tried to expand their production, they would have a larger pool of labour to hire. - Their ability to attract this labour is also high.

Answer 9

- Products that are likely to perish because of weather conditions will have a more inelastic supply. - E.g crops and agriculture.

Answer 10

- Firms that are agile keep high levels of stock. - This makes supply price elastic as they can quickly respond to increases in demand by releasing more stock. - More generally, firms with agile factor mobility will be more price elastic in supply.

Answer 11

- Capacity is fixed. - One or more factors of production are fixed (usually capital). - Often hard to increase production in this period. - Supply = inelastic.

Answer 12

- No factors of production are fixed - all are variable. - Firms are able to increase capacity. - Supply = more elastic than in the short run. - Firms have more time to react to price and demand shifts.

Answer 13

- In the immediate term, a supplier can only sell the amount of product they have. So supply is perfectly inelastic. - In economics, the short-term is the period of time when at least one factor of production is filed and the long term is when all factors of production are variable. - In the short term, they could sell more products but will still be restricted by the factors of production. Meaning it will still be inelastic.

Answer 14

If a business has a stockpile of goods when the price goes up, they will simply decide to use up some or all of their stockpiles and therefore supply will be more elastic.

Answer 15

- If a good has a lot of producer substitutes, it will have high elasticity. - One model of cars is a substitute for another mode of car producers can easily switch between the two meaning suppliers can alter the pattern of production if price rises or falls so supply will change.

Answer 16

- Market failure is when the price mechanism leads to a misallocation of resources. - Resources are misallocated when they are not devoted to the use that will give society the most welfare.

Answer 17

- Complete market failure happens where, unless the good or service is provided outside the mechanism, there wouldn't be a market for it (e.g a country's military services). - Partial market failure happens when the private sector may partially provide it but at the wrong price or quantity (e.g private healthcare vs NHS).

Answer 18

- Externalities - An externality is the cost or benefits a third party receives from an economic transaction outside of the market mechanism. In other words, it is the spillover effect of the production or consumption of a good or service. - The under-provision of public goods - Public goods are non-excludable and non-rival, and they are underprovided in a free market because of the free-rider problem. - Information gaps - It is assumed that consumers and producers have perfect information when making economic decisions. However, this is rarely the case, and this imperfect information leads to a misallocation of resources.

Answer 19

- The benefits of a good can be separated into private and external benefits. - The costs are also separated into private and external. - Private benefits are observed and accounted for by the market. - But, because of asymmetry of information, the external consequences of a good are often ignored. - So we see over/underconsumption/production of some goods in the free market. - This is a source of market failure.

Answer 20

- The social benefit is equal to the sum of the external and private benefits. - The socially optimal quantity is where it is allocatively efficient to produce and consume. - This is a different quantity to what is often observed in the free market.

Answer 21

The difference between the social benefit and the private benefit is the external benefit.

Answer 22

Externalities are the effects that producing or consuming goods have on other third parties or society as a whole.

Answer 23

- Buyers or producers do not consider externalities when making decisions. - This can lead to market failure because goods or services can be under or over consumed.

Answer 24

- Positive Consumption - This is a 'good' externality created in the consumption of a good. - Negative Consumption - This is a 'bad' externality created in the consumption of goods/services (e.g cigarettes). - Positive Production - These are externalities incurred when producing a good or service. - Negative Production - These are externalities created when producing a good or service.

Answer 25

- The marginal social benefit is the total benefit of consuming a good or service to society. MSB = MPB + Externality. - If the consumption externality is positive, then the marginal social benefit is more than the marginal private benefit. - Consumers do not account for the benefit of the externality and this goodwill be under-consumed. - E.g. school education is a positive consumption externality because students become more productive for employers.

Answer 26

- The marginal social benefit is the total benefit of consuming a good or service to society. It is equal to the marginal private benefit plus the value of the consumption externality. - If the consumption externality is negative, then the marginal social benefit is less than the marginal private benefit and the good will be overconsumed (vs the socially optimal level).

Answer 27

- Marginal social cost = Marginal private cost - Production externality. - MSC is the total cost of producing a good or service to society. - If the production externality is positive, then the social cost is less than the private cost and the goodwill be underproduced.

Answer 28

- If the production externality is negative, then the social cost is greater than the private cost and the goodwill be overproduced (vs the socially optimal level). - E.g a factory producing noise and air pollution is likely to have a social cost larger than the private cost.

Answer 29

- Private cost - The cost to an individual in the market. - External cost - A cost put on a third party due to a negative externality. - Social cost - The cost to society due to a negative externality. Social cost = private cost + external cost.

Answer 30

- Private benefit - The benefit to an individual in the market. - External benefit - The benefit a third party receives due to a positive externality. - Social benefit - The benefit to society due to a positive externality. Social benefit = private benefit + external benefit.

Answer 31

- Under consuming merit goods - Overconsuming demerit goods - Irrationality - Meeting basic needs

Answer 32

- It internalises the externality- the market now produces at the social equilibrium position and social welfare is maximised. - It raises government revenue, which could be used to solve the externality in other ways such as through education. This may help goods to become more elastic in the long run. The effect will depend on what the government does with the revenue they raise.

Answer 33

- There could be a conflict between the government's goal of raising revenue and solving the externality, which makes setting the tax difficult. - It could lead to the creation of a black market - If demand for the good is inelastic, then the tax will be ineffective at reducing output. - Taxes are politically unpopular and so governments may be reluctant to introduce them. - They are regressive, meaning the poor spend a larger proportion of their income on indirect taxes than the rich do.

Answer 34

Examples used for externalities are landfill taxes fuel duties, alcohol duties, tobacco duties, and sugar taxes.

Answer 35

- Society reaches the social optimum output and welfare is maximised. - They can have other positive impacts , such as encouraging small businesses, bringing about equality and encouraging exports.

Answer 36

- The government has to spend a large amount of money, which will have a high opportunity cost. - As with taxes, they are difficult to target since the exact size of the externality is unknown. - Subsidies can cause producers to become inefficient, especially if they are in place for a long time. - Once introduced, subsidies are difficult to remove.

Answer 37

Examples include the UK subsidising biofuels, solar panels, apprenticeship schemes, wind farms and rail industries.

Answer 38

- This corrects market failure by providing important goods which would otherwise not be provided. It will lead to improved social welfare. - It can help to bring about equality, by ensuring everyone has access to basic goods. - There will be benefits of the goods themselves, for example by providing healthcare, the government ensures that the workforce is healthy and so this can improve economic growth. - By using competitive tenders, the government can ensure efficiency.

Answer 39

- This is expensive and represents a high opportunity cost for the government. Administration costs are a problem are similar to their own. - The government may be inefficient at production since they have no incentive to cut costs. - Government officials may suffer from corruption and conflicting objectives.

Answer 40

- In the UK, the government provides a number of goods including roads, education and healthcare. - The NHS suffers from severe underfunding and many schools are having their budgets cut. - Moreover, more money is spent on improving railways than roads, even though 92% of all journeys in the UK are made on roads, suggesting incorrect resource allocation.

Answer 41

Government failure is the unintended worsening allocation of resources as a consequence of a policy the government has implemented to correct a market failure. It produces a net welfare loss.

Answer 42

- In a world of perfect information, governments should be able to make the right decisions to improve allocation. - Asymmetric information limits the governments ability to critically assess market failures and possible solutions. - So the right decision isn't always made and government failure can arise.

Answer 43

- The private sector has the incentive to maximise profits, but individuals working for governments rarely get the benefits. - Governments are also very large and may suffer from material diseconomies of scale.

Answer 44

- Government failure is the result of a policy trying to correct a market failure that has led to a misallocation of resources. - This means there is a welfare loss to society. - For example, the council might charge people for some forms of waste disposal. - This may increase fly-tipping, which is a worsening of the initial pollution externality.

Answer 45

- Resources are needed to implement government intervention. - If the cost is too high, the intervention may not be worthwhile. - Daniel Kahneman's inside view explains why governments may frequently underestimate the cost of their projects.

Answer 46

The Scottish parliament in Holyrood was forecast to cost £10-40M but cost £414M.

Answer 47

The inefficiency caused by state officials making decisions when they don't have a profit incentive?