chapter 2 Flashcards
Demand definition
the quantity of well-defined g&s that consumers are both willing and able to buy at each and every price given a period of time, ceteris paribus
Law of Diminishing Marginal Utility
as an individual consumes more & more of a good, the additional satisfaction he derives from each additional unit of the good decreases
Law of Demand
in a given period, the quantity demanded of a product is inversely related to its price, ceteris paribus
Law of Supply
in a given period, the quantity supplied of a product is directly related to its price, ceteris paribus
Types of Demand & Supply Determinants
- price determinants
- non-price determinants
Non-Price Determinants of Demand
change in :
- income
- taste & preference
- substitutes/complements in consumption
- consumers’ expectation
- number/composition of consumers
- government policies
Supply definition
the quantity of well-defined g&s that producers are both willing and able to produce at each and every price given a period of time, ceteris paribus
Non-Price Determinants of Supply
- changes in cost of factors of production
- changes in substitutes/complements in consumption
- changes in supply shocks
- changes in producers’ expectations
- changes in technology
- changes in number of sellers
- government policies
Shortage definition
demand exceeds supply
Surplus definition
supply exceeds demand
Revenue definition
total amount of money earned by a firm from the sales of the g&s produced
Price Adjustment Process
the surplus/shortage leads to a downward/upward pressue on price until a new market equilibrium (Qs = Qd) is achieved.
Types of Elasticites
- price elasticity of demand (PED)
- income elasticity of demand (YED)
- cross elasticity of demand (XED)
- price elasticity of supply (PES)
PED definition
the degree of responsiveness of quantity demanded of a good to a change in its price, ceteris paribus
Coefficient of PED
- 1 < lPEDl < infinity : price elastic
- 0 < lPEDl < 1 : price inelastic
- lPEDl = 1 : unitary price elastic
- lPEDl = infinity : perfectly price elastic
- lPEDl = 0 : perfectly price inelastic
Factors affecting PED
- availability & closeness of substitutes
- degree of necessities
- proportion of income spent on g&s
- time period
YED definition
the degree of responsiveness of demand of a good to a change in income, ceteris paribus
Types of Goods
- inferior goods
- normal goods :
- necessities
- luxury goods
Coefficient of YED
- YED < 0 : inferior goods
- YED > 0 : normal goods
- 0 < YED < 1 : neccesities
- YED > 1 : luxury goods
Factors affecting YED
- type of goods
- initial level of income
XED definition
the degree of responsiveness of demand of a good A to a change in price of good B, ceteris paribus
Coefficient of XED
- XED > 0 : substitutes
- XED < 0 : complements
Factors affecting XED
- closeness of substitute / complement
PES definition
the degree of responsiveness of quantity supplied of a good to a change in its price, ceteris paribus
Coefficient of PES
- PES > 1 : price elastic
- PES < 1 : price inelastic
- PES = 1 : unitary price elastic
- PES = infinity : perfectly price elastic
- PES = 0 : perfectly price inelastic
Factors affecting PES
- time period
- existance of spare capacity
- availability & durability of stocks
- length of production period
- factor mobility
- proportion of marginal cost of production as output changes
Limitations of elasticity capacity
- assumption of ceteris paribus
- reliability and accuracy of elasticity data
- interactions between demand & supply
Direct Price Controls
- price ceiling
- price floor
Price Ceiling definition
the maximum legal market price set & allowed by the government (usually set below current market price level)
Purpose of Price Ceilings
- increase affordibility & fairness
- to protect consumers’ SOL
Problems with Price Ceilings
- emergence of black markets
- inefficient resource allocation
- increased opportunity cost due to more time spent searching and waiting for the good
Price Floor definition
the minimum legal market price set & allowed by the government
Purpose of Price Floors
- protect producers’ incomes
- protect producers’ SOL
Problems with Price Floors
- can be ineffective
- might be unneccesary
Direct Quantity Controls
- quota
Quotas examples
- tradable permits
Quota definition
the legal limit set by the government on the quantity on a good that can be transacted in a market
Purpose of Quotas
- reeduce consumption of certain goods
- protect domestic industries from foreign competition
Taxes definition
involuntary payment of funds to the government by a household / firm for which they receive no g&s in return
Types of Taxes
- direct taxes
- indirect taxes
- specific taxes
- ad valorem
- lump-sum
Direct Taxes definition
- taxes on income & wealth
- by households to the government
Indirect Tax definition
- taxes on expenditure
- by firms to the government
Specific Tax definition
when a fixed amount is taxed per unit of good sold
Ad Valorem Tax definition
when a percentage of the good’s value is taxed
Lump-Sum Tax definition
when a fixed amount is taxed regardless of output level / revenue
Subsidies definition
the payment of money to a household / firm by the government for which it receives no g&s in return
Types of Subsidies
- direct subsidies
- indirect subsidies
Direct Subsidies definition
subsidies that increase households’ income & wealth
Indirect Subsidies definition
subsidies on expenditure, paid directly to the producers of the g&s
Income analysis
for demand
increased/decreased purchasing power
