All economics flashcards
What is demand?
Demand is the quantity of a good or service that customers are willing and able to purchase at a given price during a specific time period, ceteris paribus.
What does ceteris paribus mean?
Ceteris paribus assumes that everything apart from the price of goods remains the same.
What does the law of demand state?
As price decreases, demand increases and vice-versa.
Name 3 non-price determinants of demand
Possible answers:
Changes in income
Changes in the price of other goods
Tastes and preferences
Demographic changes
Future expectations
Number of potential buyers
Government policy
Seasonal shifts
Will a non-price determinant of demand cause a movement along or a shift in the demand curve?
A shift in the demand curve.
What are subsituted goods? State an example.
Substituted goods are goods which have similar characteristics and uses to consumers.
E.g. If there is a decrease in the price of the iPhones and thus an increase in the demand, there is less need for Samsung phones and thus an inwards shift of the demand curve as demand decreases.
What are complimentary goods? State the two types and name an example.
Definition:
- Complementary goods are goods which are consumed together, an increase of price in one good leads to the decrease of demand for both goods.
Types:
- Close compliment
- Remote compliment
Example:
- If the price of ink cartridges increases, there is less demand for printers.
What are unrelated goods? Name an example.
Definition:
- Unrelated goods are goods that share no characteristics or uses to the consumer. A rise/decrease in the price of one good will not affect the demand for another good.
Example:
- E.g. a decrease in the price of cigarettes will not lead to an increase in the demand of table clothes, as they have no relation.
What is supply?
Supply is defined as the quantity of a good or service that producers are willing and able to offer at a given price during a specific time period, ceteris paribus.
What does the law of supply state?
The law of supply states that as the price of a good increases the supply of the good will increase, ceteris paribus.
Name 3 non-price determinants of supply.
Possible answers:
Costs of production.
Technological change.
Price of related goods.
Future expectations.
Government intervention.
What is competitive supply?
Competitive supply is when the production of one good uses similar resources and processes as the production of another good.
This means that if the price of one good falls, producers can substitute that good for another, whose price is higher, for not much effort.
What is joint supply?
Joint supply occurs when two products are derived from the same resource. This makes it impossible to produce more of one without producing more of another. For example, animal products, specifically cow products, show joint supply. You cannot produce more meat without also increasing the quantity of cow skin (for leather).
What is market equilibrium?
Market equilibrium refers to a situation where price is adjusted until the quantity supplied and quantity demanded are equal.
What is market disequilibrium?
Market disequilibrium occurs when at a given price, the quantity demanded and the quantity supplied of a product is not the same quantity.
What is a shortage?
A shortage occurs when there is more demand for a good than supply of the same good, at any given price.
What is a surplus?
A surplus occurs when there is more supply for a good than demand for the same good at any given price.
What will happen to market equilibrium if demand increases?
If a non-price determinant of demand increases demand, the demand curve will shift outwards (to the right).
There will be a shortage of goods because at P1, the producer is willing and able to supply less of the good than is demanded.
In order for the market to re-establish equilibrium, the price has to increase to P2.
What will happen to market equilibrium if demand decreases?
If a non-price determinant of demand decreases demand, the demand curve will shift inwards (to the left).
There will be a surplus of goods because at P1, the producer is willing and able to supply more of the good than is demanded.
In order for the market to re-establish equilibrium, demand has to be increased and the price has to be lowered to P2.
What will happen to market equilibrium if there is an increase in supply?
If a non-price determinant of supply increases supply, the supply curve will shift outwards (to the right).
There will be a surplus of goods because at P1, the producer is willing and able to supply more of the good than is demanded.
In order for the market to re-establish equilibrium, demand has to be increased and the price has to be lowered to P2.
What will happen to market equilibrium if supply decreases?
If a non-price determinant of supply decreases supply, the supply curve will shift inwards (to the left).
There will be a shortage of goods because at P1, the producer is willing and able to supply less of the good than is demanded.
In order for the market to re-establish equilibrium, demand has to be decreased and the price has to increase to P2.
What is the price mechanism?
The price mechanism refers to the way in which price changes affect quantity demanded and quantity supplied.
What are the three functions of the price mechanism?
Signalling functions.
Rationing functions.
Incentivising functions.
What is a signalling function?
If the price of the market changes, then it signals to consumers/producers what to do with the resources they have.
For example, if the price mechanism lowers the price, it signals to firms that demand is decreasing and they should not produce more of that good.
What is PED?
PED is a measure of the responsiveness of the quantity demanded of a good or service to change in its own price.
What is the formula for PED?
PED =
Percentage change in quantity demanded/ Percentage change in price.
What is inelastic demand? What is the PED of inelastic demand?
Inelastic demand occurs when the change in price is greater than the change in the quantity demanded.
PED = 0-1
What is unitary elastic demand? What is the PED of unitary elastic demand?
Unitary elastic demand occurs when the change in the quantity demanded is the same as the change in price.
PED = 1
What is elastic demand? What is the PED of elastic demand?
Elastic demand occurs when the change in price leads to a proportionally greater change in the quantity demanded.
PED < 1
What is perfectly inelastic demand? What is the PED of perfectly inelastic demand?
Perfectly inelastic demand occurs when there is no change in quantity demanded after a price change.
PED = 0
What is perfectly elastic demand? What is the PED of perfectly elastic demand?
Perfectly elastic demand occurs when a change in price would lead to an infinite change in quantity demand. It is hypothetical, and would only occur in perfectly competitive markets.
PED = Infinity.
Name 3 factors that impact price elasticity of demand.
The number/closeness of substitutes.
The neccesity of the product.
Length of time.
Proportion of income spent on a good.
What is revenue?
Revenue is the total amount of money that goes into a firm when a good is sold.
What is the formula for revenue?
Price x Quantity Sold
What is the formula for total revenue?
TR2 - TR1
What happens to total revenue if the Price Elasticity of Demand (PED) is greater than 1 (elastic) and the firm increases prices?
If PED is greater than 1 (elastic), increasing prices leads to a decrease in total revenue. This is because consumers are highly responsive to price changes, reducing their consumption significantly, resulting in the firm selling less and making less revenue.
What is the impact on total revenue when a firm increases the price of products with a Price Elasticity of Demand (PED) less than 1 (inelastic)?
If PED is less than 1 (inelastic), an increase in the price of products leads to an increase in total revenue. This happens because inelastic goods make consumers less responsive to price changes, and they do not significantly decrease their quantity consumed. Thus, the firm’s total revenue has the potential to increase or remain unchanged.
What effect does a price change have on total revenue when the Price Elasticity of Demand (PED) equals 1 (unit elastic)?
When PED equals 1 (unit elastic), total revenue remains unchanged despite changes in price. This is because the proportional change in quantity demanded exactly offsets the proportional change in price, leaving total revenue constant.
What is PES?
PES is a measure of the responsiveness of the quantity supplied of a good or service to change in its own price.
What is the formula for PES?
PES =
Percentage change in quantity supplied / Percentage change in price.
What does a Price Elasticity of Supply (PES) equal to 0 indicate? What does the supply curve look like?
A PES of 0 indicates a perfectly inelastic supply, where changes in price do not lead to any change in the quantity supplied.
The supply curve in this case is a vertical line.
What does a Price Elasticity of Supply (PES) between 0 and 1 signify? What does the supply curve look like?
A PES between 0 and 1 signifies a price inelastic supply, where the change in price is greater than the change in the quantity supplied.
The supply curve for this is a sloped line that intersects with the x-axis.
What does a Price Elasticity of Supply (PES) equal to 1 represent? What does the supply curve look like?
A PES of 1 represents a unitary elastic supply, where the change in price leads to an equal change in the quantity supplied.
The supply curve in this case is a sloped line that intersects with the origin.
What does a Price Elasticity of Supply (PES) greater than 1 represent? What does the supply curve look like?
A PES greater than 1 denotes a price elastic supply, where a change in price leads to a greater change in the quantity supplied.
The supply curve for this is a sloped line that intersects with the y-axis.
What does a Price Elasticity of Supply (PES) equal to infinity represent?
A PES of infinity symbolizes a perfectly elastic supply, where any change in price would lead to an infinite change in the quantity supplied. The supply curve in this case is a horizontal line.
Name 3 factors that impact PES
Length of time.
Mobility of the factors of production.
Ability to store stock.
Unused capacity.
What is XED?
XED means cross elasticity of demand.
It is the measurement of the sensitivity of quantity demanded for one good to the change in the price of another good.
E.g. how the demand for coffee creamer would be impacted by a change in price in coffee.
What is the formula for XED?
XED =
Percentage change in demand for good x/ Percentage change in price for good y.
What does it mean if the Cross Elasticity of Demand (XED) is positive?
A positive XED, greater than 0, indicates that goods X and Y are substitutes. If the price of good Y increases, consumers will switch their demand to good X, increasing its demand.
For instance, a price rise for Samsung phones will increase the demand for iPhones, leading to an outward shift in the demand curve for good X.
What does a Cross Elasticity of Demand (XED) of zero imply?
If XED equals zero, it suggests that there is no relationship between goods X and Y.
Changes in the price of good Y have no impact on the quantity demanded for good X.
Their demand curves are independent of each other.
What does it mean if the Cross Elasticity of Demand (XED) is negative?
A negative XED, less than 0, indicates that goods X and Y are complements.
If the price of good Y increases, the demand for both goods X and Y decreases.
What is YED?
YED stands for income elasticity of demand.
It measures the responsiveness of demand to changes in income.
What is the formula for YED?
YED =
Percentage change in quantity demanded / Percentage change in income.
What does a positive YED indicate?
If the YED is positive, it indicates that the good is a normal good.
This means that as income increases, demand for the good increases.
What does a YED greater than one indicate?
If the YED is greater than one, it indicates that the good is a luxury.
Luxurious goods are goods that are not essential but are highly desired and associated with higher income levels.
As income increases, the demand for the good increases.
What does a negative YED represent?
If the YED is negative, it indicates that the good is an inferior good.
An inferior good is one such as instant noodles.
What does a YED less than one indicate?
If the YED is less than one, it indicates that the good is a necessity.
Necessities are essential goods required for basic living and whose demand remains constant regardless of income changes.
As income increases, demand will remain stable.
Name 3 reasons that governments intervene in markets.
To earn government revenue.
To support firms.
To support households on low incomes.
To influence the levels of consumption/production.
To correct market failure.
To promote equity.
Name 3 methods of government intervention in markets.
Price controls.
Indirect taxes.
Subsidies.
Direct provision of services.
Command/control regulation and legislation.
Consumer nudges.
What is a price ceiling?
The government can set a maximum price, known as a price ceiling below the equilibrium price to prevent consumer exploitation.
What are the aims of price ceilings?
Increase the consumption of a good/service that are neccesary/socially beneficial.
Reduce the price of certain goods/ services for low income consumers.
Prevent exploitation by monopolies.
Name and explain 3 consequences of price ceilings.
Possible answers:
Shorages.
Rationing.
Black markets.
Lack of efficiency.
Welfare loss caused by the loss in efficiency.
How can the government correct the shortages caused by a price ceiling?
Increase the supply of the good by directly provisioning it.
Grant subsidies to producers.
Store stock of the good and release it into the market.
What are price floors?
Price floors are the opposite of price ceilings, in which the government sets a minimum price, above the equilibrium price, of the good or service.
What are the aims of a price floor?
To increase the income of producers of goods/services that the government deems important.
To protect workers, and ensure they have a minimum wage.
Name 3 consequences of price ceilings.
Potential answers:
Surplus’s.
The creation of parallel markets.
Firm inefficiency.
Welfare loss.
What are indirect taxes?
Indirect (pigouvian) taxes are taxes paid to the government from the firm that produces the goods being taxed.
What are the two forms of indirect taxes?
A specific tax is a fixed tax per unit sold of the taxed good (E.g. For every apple sold, there is a $0.40 tax).
A percentage tax (Ad Valorem tax) is a tax that is a percentage of the price of the good (E.g. 10% of the revenue of apples are taxed).
How will an indirect tax look like on a graph?
Inward shift of the supply curve.
What are subsidies?
Subsidies are a payment per unit of output given to firms by the government.
What two forms can subsidies come in?
Direct cash grants, where a set amount of money is given to firms by the governments.
Tax breaks, where certain industries are exempted from certain taxes.
What would a firm subsidy look like on a diagram?
Outwards shift of the supply curve.
What are the two ways governments can indirectly intervene in a market?
Command and Control legislation.
Consumer nudges.
Give an example of command/control legislation.
Age restrictions.
Advertising bans.
Quotas.
What four basic principals do consumer nudges need to employ in order to be efficient?
Easy, attractive, social, timely nudges.
What are the advantages and disadvantages of consumer nudges?
The advantages of consumer nudges are that they’re inexpensive and easy to implement.
The disadvantages of consumer nudges is that they can be perceived as manipulative.
What is market failure?
Market failure can be defined as a situation in which the free market fails to allocate resources efficiently.
What are negative externalities of production?
A negative externality of production refers to a situation in which the production of a good negatively affects an uninvolved third party.
How can the government correct a negative externality of production?
Imposing indirect taxes.
Legislation.
Tradable emission permits - cap on how much firms can pollute that can be bought/sold.
What are negative externalities of consumption?
Negative externalities of consumption refers to a situation in which the consumption of a good leads to negative consequences for an unrelated third party, such as the consumption of cigarettes and the effect on bystanders (second-hand smoke).
How can the government correct a negative externality of production?
Banning/regulating the good.
Imposing an indirect tax.
Negative advertising campaign.
What are positive externalities of production? When do they occur?
A positive externality of production refers to a situation in which the production of a good positively affects an uninvolved third party.
Positive externalities of production occur when there is an underproduction of a merit good.
How can the government correct a positive externality of production?
Subsidisation of firms.
Direct provision of goods/services.
Name a positive externality of production.
An example of a positive externality of production would occur when a company tears down an abandoned building and constructs a new office or apartment building that enhances the surrounding community.
What is a positive externality of consumption?
Positive externalities of consumption refers to a situation in which the consumption of a good leads to positive consequences for an unrelated third party, such as the consumption of vaccines which in turn, lower the chance of illness spreading through a population.
How can the government correct a positive externality of consumption?
Subsidise production - lower cost.
Positive advertising.
Government regulation - mandated consumption.
What does it mean for a good to be rivalrous? Give an example.
The consumption of the good by one person reduces the availability of that good for consumption by others.
What does it mean for a good to be excludable?
It is possible to prevent individuals who have not paid for the good from consuming it.
What are private goods and what is an example of a private good?
Private goods are goods that are excludable and rivalrous.
This means that the good, when consumed by one person, cannot be consumed by others and those that do not pay for goods cannot consume it.
An example of a private good is an iphone, because:
When you purchase an iphone, nobody else can buy the same phone. When you purchase/use an iphone, you can stop anybody that did not pay for the phone from using it.
What are public goods and what is an example of a public good?
Public goods are non-rivalrous and non-excludable goods.
This means that the good, when consumed by one person, can be consumed by others and those that do not pay for goods can consume it.
An example of a public good is national defence, because:
The protection provided by a country’s military benefits all citizens and does not diminish if more people are protected (non-rivalrous).
Individuals cannot be excluded from enjoying the benefits of national defence, regardless of whether they contribute to its funding (non-excludable).
What are club goods and what is an example of a club good?
Club goods are goods that are excludable but non-rivalrous.
This means that access to these goods can be controlled (people can be prevented from using them if they do not pay), but one person’s use of the good does not significantly diminish the ability of another person to use it as well, until the point of congestion or capacity limit is reached.
An example of a club good is subscription-based streaming service, because:
Subscribers can use the service, and one subscriber’s viewing does not affect another’s ability to watch the same content (non-rivalrous).
Anybody that does not pay for the good cannot access it (excludable).
How are common pool resources a form of market failure?
Market failure can be defined as a situation in which the free market fails to allocate resources efficiently.
Common pool resources and public goods are both non-excludable, meaning that those that do not pay for them can still access them.
As a result, prices cannot be charged and hence private provision through the market is not feasible.
What is the theory of “tragedy of the commons”?
The tragedy of the commons refers to a situation in which individuals with access to a public resource (also called a common) act in their own interest and, in doing so, ultimately deplete the resource.
Name 3 ways governments can intervene in order to increase sustainability?
Legislation and regulations.
Carbon taxes.
Elimination of environmentally harmful subsidies.
Funding for clean technologies.
Cap and trade schemes.
Government subsidies for the development of clean technologies.
How are public goods a form of market failure?
Public goods illustrate the free rider problem.
The free rider problem occurs when people use a good without paying for it.
Since it is not possible to charge a price for the good, private firms will not produce it, even though there will be demand for it.
Public goods are therefore a type of market failure because the free market fails to produce it.
What is asymmetric information?
Asymmetric information occurs when not all parties involved in a transaction have perfect knowledge to make an economic decision.
Why is asymmetric information a form of market failure?
Market failure occurs when the market fails to allocate resources successfully.
Without perfect information, markets cannot do that.
Therefore, asymmetric information is a form of market failure.
How does asymmetric information lead to an over or under allocation of resources?
Asymmetric information can lead to an over-allocation of resources when the producer has more information than the consumer.
Asymmetric information can lead to an under-allocation of resources when the consumer has more information than the producer:
If the consumer has more information than the producer, then they can and will pay below the socially optimal amount.
What are the two types of asymmetric information?
Adverse selection.
Moral hazard.
What is adverse selection?
Adverse selection refers to a situation where one party has more information before the transaction occurs than the other participant.
What is a moral hazard?
A moral hazard occurs where one participant takes on more risk because they know they will not pay the consequences of that risk. The asymmetric information changes their behaviour after the transaction has occurred.
How can governments correct asymmetric information?
Legislation - making sure all relevant information is disclosed to consumers.
Regulation - monitoring industries to ensure legislation is being adhered.
Direct provision of information - ensuring customers get the relevant information.
What are the two private responses to information asymmetry?
Signalling.
Screening.
How can signalling solve asymmetric information? Use an example.
In the case of adverse selection, in which participants have asymmetric information before the transaction, the participant with more information can signal that they know more.
This occurs when a firm hires new employees.
Firms will want to hire people with particular skills.
Prospective employees have the ability to signal themselves by highlighting their particular skill sets and qualifications in their CVs (resumes).
Qualifications can be verified and there are consequences for anyone making fraudulent claims on their CVs when applying for a job.
This example of using CV’s before hiring represents signalling because it allows the more informed party (the prospective employees) to credibly demonstrate their qualities, reducing information asymmetry.
How can screening solve information asymmetry? Give an example.
In the case of adverse selection, in which participants have asymmetric information before the transaction, the participant with less information can screen in order to cause the other party to reveal their information.
An example of screening can also be seen when a firm hires new employees.
Employers can insist that prospective employees have certain qualifications before they will interview them; for example, by requiring that all applicants have degrees, and therefore limiting the amount of applicants that are eligible for the role.
What are the four principal types of competitive markets?
Monopoly.
Oligopoly.
Monopolistic competition.
Perfect competition.
What is profit maximisation?
Profit maximisation refers to the process by which a firm determines the price, input, and output levels that result in the highest profit.
When firms act as profit maximisers, they are behaving rationally.
What is the formula to calculate profits?
Total profit =
total revenue - total costs
What makes up total cost?
Fixed costs - costs that stay constant regardless of output.
Variable costs - costs that vary based on output.
Opportunity cost - costs that account for the second best alternative for the resource being used in the production of a good or service.
Give an example of injections to an economy.
Government spending, consumption, investment and exports.
Give an example of leakages from an economy.
Taxes, savings and imports.
What is GDP?
It is a measure of everything produced within a country in a specific time period (usually a year).
What is the formula for GDP?
The formula for GDP is GDP = C + I + G + (X-M), in which:
C = consumption spending on goods/services.
I = investment spending by business in order to grow. Money is spent on the factors of production (land, labour, capital, enterprise).
G = Government spending.
X-M = Net exports, money gained by exports - money spent on imports.
What is real GDP?
Real GDP is the GDP of a country at any given point after having been being adjusted for inflation.
What is the formula for real GDP?
Real GDP =
(Nominal GDP / Price deflator) x 100
What is GDP per capita?
GDP per capita shows the average economic output per person in a country.
What is the formula of GDP per capita?
GDP per capita =
Real GDP/ Population of a country.
What is GNI?
GNI is the total money made by a country’s people and businesses, including money made abroad, minus money made by foreigners in the country.
What is the formula for GNI?
GNI =
GPD + incomes flowing from other countries - incomes flowing out to other countries.
What is real GNI and what is the formula?
Real GNI is the GNI of a country at any given point after being adjusted for inflation.
The formula for real GNI is: Real GNI = (Nominal GNI/Price Deflator) x 100.
What is the formula for GNI per capita?
GNI per capita = Real GNI/ Population of a country.
Name 2 advantages of using GDP as a measure of national income accounting.
GDP allows comparison with other countries, since it is an international measurement.
Economic growth is a primary target for many governments, and thus GDP gives a relative idea of where countries stand and where they can grow.
Name 2 disadvantages of using GDP as a method of national income accounting.
GDP overestimates quality of life in a specific country, as money spent on projects such as cleaning up pollution is also counted into GDP, even if it is just restoring damage.
GDP does not factor in income inequality.
GDP relies on government agencies to collect data, and that data can be flawed or rigged for various reasons.
Companies are always attempting to improve their products/services but prices don’t change dramatically, which is something GDP does not calculate (quality of output).
What is the business cycle?
The Business Cycle is a model that shows the fluctuations in an economy over time.
Name the four phases of the business cycle.
Growth (expansion)
Boom (peak)
Recession (contraction)
Slump (trough).
Explain the phases of the business cycle.
During the growth phase, GDP is increasing and so is inflation and interest rates.
During the peak phase, economic activity, inflation and interest rates are at their highest.
During the recession phase, economic activity is decreasing, as are inflation and interest rates.
During the trough phase, economic activity, interest rates and inflation are at their lowest.
What factors alter the business cycle?
Business cycles are affected by factors such as changes in climate, natural disasters, wage levels and inflation.
