BA1 Fundamentals of Business Economics - The market system and the competitive process Flashcards
How do we calculate PED?
PED= (Q2−Q1)/Q1 divided (P2-P1)/P1
Q1 = Initial quantity demanded
Q2 = New quantity demanded
P1 = Initial price
P2 = New price
What is elastic demand?
Elastic demand occurs when the percentage change in quantity demanded is greater than the percentage change in price (PED > 1).
What is inelastic demand?
Inelastic demand occurs when the percentage change in quantity demanded is smaller than the percentage change in price (PED < 1).
When should a business lower its price?
A business should lower its price if demand is elastic because the increase in quantity sold will be greater than the decrease in price, leading to higher revenue.
When should a business raise its price?
A business should raise its price if demand is inelastic because the decrease in quantity sold will be smaller than the price increase, leading to higher revenue.
What happens to demand elasticity when there are more close substitutes for a good?
The demand becomes more elastic because consumers can easily switch if the price of one product changes relative to others.
How do switching costs affect demand elasticity?
Higher switching costs make demand more inelastic, as consumers face barriers to changing products or services.
How does the degree of necessity affect price elasticity of demand?
Necessities tend to have inelastic demand, while luxuries have more elastic demand since consumers can cut back on them during economic downturns.
How does the percentage of income spent on a good affect its price elasticity?
Goods that take up a large share of income tend to have more elastic demand, as price changes significantly impact affordability.
What happens to price elasticity over time after a price change?
Demand tends to be more elastic in the long run because consumers have more time to adjust their purchasing decisions.
How does habitual consumption impact price elasticity?
Goods that are habitually consumed (e.g., cigarettes, alcohol) tend to have inelastic demand because consumers are less sensitive to price changes.
How does peak and off-peak demand affect price elasticity?
Demand is more inelastic at peak times, allowing suppliers to charge higher prices. Off-peak demand is more elastic, leading to lower prices.
How does the breadth of a good’s definition affect price elasticity?
Broadly defined goods (e.g., petrol or meat) have inelastic demand, while specific brands (e.g., Shell petrol, Angus beef) have more elastic demand.
Perfectly Inelastic Demand
An extreme situation where a change in price will
have no effect on quantity demanded
Perfectly Elastic Demand
An extreme situation where a market participant is
a price taker and has to accept the market price. If
they raise their price they will sell nothing.
Unitary Elastic Demand
The elasticity of demand is 1 at any point on the
demand curve (known as a rectangular hyperbola).
A change in price will have no effect on revenue i.e.
Price × Quantity = constant.
How can total revenue indicate demand elasticity?
If total revenue increases after a price cut, demand is elastic.
If total revenue increases after a price rise, demand is inelastic.
What does price elasticity of supply (PES) measure?
PES measures the relationship between a change in quantity supplied and a change in price of a good.
How does spare capacity affect price elasticity of supply?
If a firm has spare capacity, it can increase output quickly without raising costs, making supply more elastic.
How do stock levels influence supply elasticity?
High stock levels allow firms to respond quickly to demand changes, making supply more elastic.
What is the impact of factor substitution on supply elasticity?
If capital and labor can be easily switched to produce different goods, supply is more elastic. If not, supply is inelastic.
How does time affect the price elasticity of supply?
Short-run: Supply is often inelastic as firms cannot easily adjust production.
Long-run: Supply is more elastic as firms have time to adapt.
What is the “momentary time period” in supply?
A short period where supply cannot respond at all to demand changes, making supply perfectly inelastic.
What does it mean if the supply curve passes through the origin?
The supply curve has unit elasticity, meaning PES = 1.
What happens when supply is perfectly elastic?
A firm can supply any amount at the same price, meaning demand changes affect quantity but not price.
What happens when a price ceiling (Pmax) is set below the equilibrium price (Pe)?
Demand rises to Qd (due to lower price).
Supply falls to Qs (since producers are less willing to supply at a lower price).
This creates excess demand (Qd - Qs).
What problems can arise from excess demand caused by price ceilings?
Queuing for in-demand goods.
The emergence of a black market, where goods are sold at high prices.
What is a common example of a minimum price control?
The minimum wage, which sets a legal floor on wages to ensure workers receive a fair income.
What happens to employment when a minimum wage (Pmin) is set above the equilibrium wage (Pe)?
Demand for labor falls to Q low (fewer jobs available).
Supply of labor rises to Q high (more people willing to work).
This creates excess labor supply (Q high - Q low), leading to unemployment.
What is a potential downside of imposing a minimum wage?
It can lead to unemployment, as businesses may not be able to afford as many workers at the higher wage.
What is an externality?
An externality is an impact (positive or negative) on a third party who is not directly involved in a transaction.
What is an example of a negative externality?
Air pollution from manufacturers
Accidents caused by alcohol or drug abuse
Noise pollution from loud music
What are demerit goods?
Goods that have negative externalities affecting society as a whole, such as alcohol, tobacco, and pollution-producing products.
How can governments correct market failure caused by negative externalities?
Sales tax on harmful goods
Fines for environmental damage
Regulations to limit production of harmful goods
How does a sales tax reduce negative externalities?
Increases costs for producers, shifting the supply curve upward
Raises prices (from Pe to P1)
Reduces demand & supply (from Qe to Q1)
How does elasticity affect tax burden?
Inelastic demand → Consumers bear more of the tax
Elastic supply → Producers bear less of the tax
What is a merit good?
A merit good is a product with positive externalities, meaning its benefits extend beyond those who purchase or consume it.
Give examples of merit goods.
Education → Increases efficiency and productivity
Healthcare → Reduces absenteeism & extends life expectancy
Attractive gardens → Improve neighborhood property values
What is the effect of a subsidy on supply and price?
Shifts supply curve from S0 to S1
Lowers price (from Pe to P1)
Increases quantity supplied (from Qe to Q1)
How does elasticity affect the impact of a subsidy?
Inelastic demand or elastic supply → More of the subsidy is passed to consumers as a lower price.
Elastic demand or inelastic supply → Producers retain more of the subsidy.
What are public goods?
Public goods are goods that would not be provided in a market economy without government intervention.
What are the two key properties of public goods?
Non-excludability → One person’s use does not prevent others from benefiting (e.g., street lighting).
Non-diminishability (non-rivalry) → More people using the good does not reduce its availability.
What is the free rider problem?
The free rider problem occurs when people can benefit from a public good without paying, leading to underfunding.
What is a barrier to entry?
A factor that makes it harder for new firms to enter a market.
What is product differentiation, and how does it act as a barrier to entry?
Firms distinguish their products from competitors.
Reduces price elasticity of demand.
Creates brand loyalty, making it harder for new entrants.
What is an absolute cost advantage, and how does it prevent new entrants?
Existing firms have lower costs due to:
Cheaper raw materials.
Exclusive knowledge or skills.
How do legal barriers act as a barrier to entry?
Patent protection prevents copycat products.
Government-protected monopolies restrict competition.
Common in new technology industries.
How do economies of scale create barriers to entry?
Large firms benefit from lower average costs.
New firms lack scale, making it hard to compete.
Seen in utilities like water & electricity.
What are economies of scale?
Economies of scale occur when a business reduces average costs by increasing the scale of production.
What are internal economies of scale?
Bulk buying (trading)
Use of larger, more efficient machinery (technical)
Cheaper finance for lower loan costs (Finance)
Management specialization (managerial)
What is perfect competition?
In perfect competition, no producer or consumer can influence prices. Prices move to economic equilibrium instantly.
What does atomicity mean in perfect competition?
Atomicity refers to a market with many small producers and consumers, each having no significant impact on others. Firms are price takers, meaning they accept the market price.
What is homogeneity in perfect competition?
Homogeneity means goods are identical across firms, with no product differentiation. All firms sell the same product at the same price.
What does perfect and complete information mean in perfect competition?
It means that all firms and consumers know the prices set by all firms, allowing for informed decision-making.
What is a monopoly?
A monopoly occurs when there is only one supplier of a good or service with no close substitutes
What does it mean that buyers and sellers act independently in perfect competition?
It means there is no collusion or cartels. Buyers and sellers do not coordinate to change prices. Each acts on their own without influencing the market.
What are the characteristics of a monopoly market?
One supplier dominates the market.
No close substitutes for the product.
High barriers to entry for new firms.
What defines an oligopoly market structure?
A few suppliers dominate the market.
Effective barriers to entry.
Strong interdependence between market participants.
Producers offer similar goods, often acting in collusive or non-collusive ways.
What conditions are necessary for a cartel to be created?
Firms must be able to control supply to the market.
Firms must agree on a price.
Firms must agree on how much output each should produce.
What is the difference between outsourcing and off-shoring?
Outsourcing: External parties perform certain activities or functions for a business.
Off-shoring: Part or all of a business is transferred to another country with a lower cost base.
What are search and information costs in transaction cost theory?
Search and information costs are the costs associated with finding out whether a product is available, identifying suppliers, and comparing prices.
What are bargaining and decision costs in transaction cost theory?
Bargaining and decision costs are the costs related to formulating an agreement, such as the costs of drawing up contracts, legal fees, and negotiating terms.
What are policing and enforcement costs in transaction cost theory?
Policing and enforcement costs are the costs involved in ensuring that the other party sticks to the terms of a contract, including monitoring quality, service, and delivery.
