Chapter 2 - The allocation of resources Flashcards
What is microeconomics?
Microeconomics is the study of individual markets and sections of the economy. It examines the different choices individuals, households and firms make, what factors influence their choices, how their decisions affect the price, demand and supply of a good or service and how governments influence consumption and production.
What is macroeconomics?
Macroeconomics is the study of economic behaviour and decision making in the entire economy. It examines the role of the government in achieving economic growth and human development through the implementation of fiscal, monetary and supply side policies, it examines the role of the government in achieving price stability, low unemployment and a stable current account balance on the balance of payments and it examines the interaction of the economy with the rest of the world through international trade.
What are economic systems?
Economic systems emerge or are created by different economic agents within the economy. These agents include consumers, produces, governments and special interest groups like trade unions. Any economic system aims to allocate the scarce factors of production.
What are the three main economic systems?
The three main economic systems are a free market system, a mixed economy and a planned economy.
What are the three basic questions when deciding resource allocation?
What gets produced? How is it produced? Who gets what is produced?
How does resource allocation change between the three economic systems?
How does a free-market system allocate resources?
A free-market system works to allocate scarce resources efficiently through the forces of supply and demand, also known as the price mechanism.
What is the price mechanism?
The price mechanism is the interaction of demand and supply in a free market. This interaction determines prices which are the means by which scare resources are allocated between competing wants and needs.
What is equilibrium?
Equilibrium in a market occurs when demand = supply.
What is disequilibrium?
Disequilibrium occurs when there is excess demand or excess supply in a market.
What is demand?
Demand is the willingness and ability to buy a product.
What is a demand curve?
A demand curve is a graphical representation of the price and quantity demanded (QD) by consumers.
What is market demand?
Market demand is the combination of all the individual demand for a product.
How do you show an increase and decrease in demand?
An increase in demand is shown by a shift in the demand curve to the right and a decrease in demand is shown by a shift in the demand curve to the left.
How do you show a contraction and extension in demand?
A contraction in demand is shown by a shift towards the left on the demand curve and an extension is shown by a shift towards the right on the demand curve.
What six factors can cause a shift in the demand curve (increase or decrease)?
A shift in the demand curve can be caused by changes in real income, changes in taste/fashion, advertising/branding, changes in the price of substitutes, changes in the price of complementary goods or changes in population size.
What is supply?
Supply is the willingness and ability to produce a product.
What is a supply curve?
A supply curve is a graphical representation of the price and quantity supplied by producers.
What is market supply?
Market supply is the combination of all the individual supply for a product.
How do you show an increase and decrease in supply?
An increase in supply is shown by a shift in the supply curve to the right and a decrease in supply is shown by a shift in the supply curve to the left.
How do you show a contraction and extension in supply?
A contraction in supply is shown by a shift towards the left on the supply curve and an extension is shown by a shift towards the right on the supply curve.
What six factors can cause a shift in the supply curve (increase or decrease)?
A shift in supply can be caused by changes in the costs of production, indirect taxes, subsides, new technologies, changes in the number of firms in the industry or weather events.
How is the prices of goods and services determined in a market system?
In a market system, prices for goods and services are determined by the interaction of demand and supply. Based on this interaction with buyers, sellers will gradually adjust their prices until there is an equilibrium price and quantity that works for both parties.
How are prices for goods and services determined in a market system?
In a market system, prices for goods and services are determined by the interaction of demand and supply. Based on this interaction with buyers, sellers will gradually adjust their prices until there is an equilibrium price and quantity that works for both parties.
What is equilibrium?
Equilibrium in a market occurs when demand = supply.
What is equilibrium?
Equilibrium in a market occurs when demand = supply.
What is disequilibrium?
Disequilibrium occurs whenever there is excess demand or excess supply.
What is disequilibrium?
Disequilibrium occurs whenever there is excess demand or excess supply.
How are price changes caused?
Price changes are caused by a change in supply and demand.
What are the two consequences of price changes?
Consequences of price changes include an inward shift of the supply curve will increase prices and vice versa and an inward shift in the demand curve will decrease prices.
What is price elasticity of demand?
Price elasticity of demand shows how responsive the change in quantity demanded is to a change in price. The values will always be negative so you can ignore the sign.
How can you calculate price elasticity of demand?
What is perfectly inelastic demand?
Perfectly inelastic demand has a value of 0. The quantity demanded is completely unresponsive to a change in price.
What is relatively inelastic demand?
Relatively inelastic demand has a value of 0-1. The percentage change in quantity demanded is less than proportional to the percentage change in price.
What is unitary elastic demand?
Unitary elastic demand has a value of 1. The percentage change in quantity demanded is exactly equal to the percentage change in price.
What is relatively elastic demand?
Relatively elastic demand has a value of 1 to infinity. The percentage change in quantity demanded is more than proportional to the percentage change in price.
What is perfectly elastic demand?
Perfectly elastic demand has a value of infinity. The percentage change in quantity demanded will fall to zero with any percentage change in price.
What are the 4 determinants of price elasticity of demand?
Availability of substitutes, addictiveness of the product, price of the product as a proportion of income and time period.
How does the availability of substitutes impact price elasticity of demand?
Availability of substitutes: good availability of substitutes results in a higher value of PED (relatively elastic)
How does addictiveness of the product impact price elasticity of demand?
Addictiveness of the product: addictiveness turns products into necessities resulting in a low value of PED (relatively inelastic)
How does price of the product as a proportion of income impact price elasticity of demand?
Price of product as a proportion of income: the lower the proportion of income the price represents, the lower the PED value will be. Consumers are less responsive to price changes on cheap products (relatively inelastic)
How does time period impact price elasticity of demand?
Time period: In the short term, consumers are less responsive to price increases resulting in a low value of PED (relatively inelastic). Over a longer time period consumers may feel the price increase more and will then look for substitutes resulting in a higher value of PED (relatively elastic)
How does changing price elasticity of demand impact revenue?
Revenue is the total amount of money a firm receives from selling its goods and services. Total revenue + price x quantity. The total revenue rule states that in order to maximise revenue, firms should increase the price of products that are inelastic in demand and decrease the prices on products that are elastic in demand.
What is price elasticity of supply?
Price elasticity of supply shows how responsive the change in quantity supplied is to a change in price.
How do you calculate price elasticity of supply?
What is perfectly inelastic supply?
Perfectly inelastic supply has a value of 0. The quantity supplied is completely unresponsive to a change in price.
What is relatively inelastic supply?
Relatively inelastic supply has a value of 0 to 1. The percentage change in quantity supplied is less than proportional to the percentage change in price.
What is unitary elastic supply?
Unitary elastic supply has a value of 1. Any supply curve that starts at the origin will have a PES value of one. When the percentage change in quantity supplied = the percentage change in price.
What is relative elastic supply?
Relative elastic supply has a value of 1 to infinity. The percentage change in quantity supplied is more than proportional to the percentage change in price.
What is perfectly elastic supply?
Perfectly elastic supply has a value of infinity. The percentage change in quantity supplied will fall to zero with any percentage change in price.
What are the five determinants of price elasticity of supply?
Mobility of the factors of production, availability of raw materials, ability to store goods, spare capacity and time period.
How does the mobility of the factors of production impact price elasticity of supply?
Mobility of the factors of production: if producers can quickly switch their resources between products, then the PES will be more elastic. For example, if prices of hiking boots increase & shoe manufacturers can switch resources from producing trainers to boots, then boots will be price elastic in supply
How does the availability of raw materials impact price elasticity of supply?
Availability of raw materials: if raw materials are scarce then PES will be low (inelastic). If they are abundant, PES will be higher (elastic)
How does the ability to store goods impact price elasticity of supply?
Ability to store goods: if products can be easily stored then PES will be higher (elastic) as producers can quickly increase supply (for example, tinned food products). An inability to store products results in lower PES (inelastic)
How does spare capacity impact price elasticity of supply?
Spare capacity: if prices increase for a product & there is capacity to produce more in the factories that make those products, then supply will be elastic. If there is no spare capacity to increase production, then supply will be inelastic
How does time period impact price elasticity of supply?
Time period: In the short run, producers may find it harder to respond to an increase in prices as it takes time to produce the product (e.g., avocados). However, in the long run they can change any of their factors of production so as to produce more
What is a market economy?
A market economy is an economy that has no government intervention in the allocation of resources and distribution of goods and services. This is also called a free market economy.
What are seven advantages of a market economy?
Profit incentive motivates people to work or develop entrepreneurial ideas
Greater variety of goods/services
Competition leads to better quality of goods/services
Competition leads to lower prices of goods/services
Competition encourages innovation and product development
Profits, income and wealth are unlimited resulting in better standards of living
More efficient use of scarce resources
What are seven disadvantages of a market economy?
Wealth gets concentrated in the hands of the few as they are able to keep buying up the scarce factors of production
This increases inequality such that the gap between the rich and the poor continues to grow
Sometimes product quality falls as firms’ lower quality standards in order to increase profits
Workers get exploited
Resource depletion and environmental degradation are often ignored
Monopolies develop as firms increase market power through mergers and acquisitions
This leads to exploitation of consumers and supply chains
What is market failure?
Market failure is when there is a less than optimum allocation of resources from the point of view of society.
What are demerit goods?
Demerit goods have harmful impacts on consumers/society.
What are merit goods?
Merit goods are beneficial to society.
What are public goods?
Public goods are beneficial to society.
How do external costs occur?
External costs occur when social costs of an economic transaction are greater than the private costs.
What are private costs?
Private costs for a producer is what they actually pay to produce or consumer a good.
What are external costs?
External cost is the damage not factored into the market transaction.
What are social costs?
Social cost includes both the private cost and the cost to society.
How do you calculate social costs?
Social cost = private cost + external cost
How do external benefits occur?
External benefits occur when the social benefits of an economic transaction are greater than the private benefits.
What are private benefits?
Private benefit for a consumer is what they actually gain from producing or consumer a good or service
What are external benefits?
External benefit is the benefit not factored into the market transaction.
What are social benefits?
Social benefit includes both the private and the external benefit to society.
How do you calculate social benefits?
Social benefit = private benefit + external benefit.
What are demerit goods and what are the consequences of them?
Explanation of demerit goods:
These are goods which have harmful impacts on consumers/society
They are often addictive
E.g. Gambling, alcohol, drugs, sugary foods/drink
Consequences of demerit goods:
They are over-provided in a market and their consumption often creates external costs
Governments often have to regulate these goods in such a way that they raise the prices and/or limit the quantities consumed
What are merit goods and what are the consequences of them?
Explanation of merit goods:
These are goods that are beneficial to society, but consumers under-consume them as they do not fully recognise the private or external benefits
E.g. Vaccinations, education, electric cars
Consequences of merit goods:
They are under-provided in a market & their consumption generates both private and/or external benefits
Governments often have to subsidise these goods in order to lower the price and/or increase the quantities consumed
What are public goods and what are the consequences of them?
Explanation of public goods:
Public goods are beneficial to society but would be under-provided by a free market as there is little opportunity for sellers to make profits from providing these goods/services as they are non-excludable and non-rivalrous in consumption
Good examples include national defence, parks, libraries and lighthouses
Consequences of public goods:
Non-excludability refers to the inability of private firms to exclude certain customers from using their products. In effect, the price mechanism cannot be used to exclude customers e.g. street lighting
Non-rivalry refers to the inability of the product to be used up, so there is no competitive rivalry in consumption to drive up prices and generate profits for firms
Therefore, governments will often provide these beneficial goods themselves, and so they are called public goods
What is abuse of monopoly power and what are the consequences of it?
Explanation of abuse of monopoly power:
The development of monopoly markets is a natural outcome of a market system
Firms seek to eliminate competition by buying out competitors & increasing their ownership of factors of production
With less competition, firms can raise prices, reduce the choice available to consumers, or limit the supply
Consequences of abuse of monopoly power:
The outcome is that goods/services are purposely under-provided in order to raise prices and profits
Governments often intervene to ensure that there is healthy competition in markets & sufficient provision of goods/services
What is factor immobility and what are the consequences of it?
Explanation of factor immobility:
Factor immobility occurs when it is difficult for factors of production to move or switch between different uses/locations
The two main types of factor immobility are the geographical & occupational immobility of labour
Consequences of factor immobility:
Factor immobility results an inefficient allocation of resources in a market (usually under-provision)
Governments often implement programs to reduce the factor immobility in order to raise production & output
What are external costs and benefits and what are the consequences of them?
Explanation of external costs and benefits:
Externalities occur when there is an external cost or benefit on a third party not involved in the economic transaction
These impacts can be positive or negative
The price mechanism in a free market ignores these externalities
If these external costs/benefits were acknowledged, then the price and output in the market would be different
Consequences of external costs and benefits:
A positive externality of consumption occurs when there is a positive external benefit in consumption, such as when electric vehicles are consumed CO2 emissions fall
A positive externality of production occurs when there is a positive external benefit in production, such as when managed pine forests produce timber but also increase CO2 absorption
A negative externality of consumption occurs when there is an external cost in consumption such as when the consumption of alcohol increases anti-social behaviour
A negative externality of production occurs when there is an external cost in production such as when the production of electricity increases air pollution
What is a mixed economic system?
A mixed economic system is a blend of a market and planned economy.
What are the five reasons for government intervention?
To support firms, promote equity, correct market failure, support poorer households and collect government revenue.
How does government intervention into a mixed economic system support firms?
Support firms: in a global economy, governments choose to support key industries so as to help them remain competitive.
How does government intervention into a mixed economic system correct market failure?
To correct market failure: in many markets there is a less-than-optimal allocation of resources from society’s point of view in maximising their self-interest, firms & individuals will not self-correct this misallocation of resources & there is a role for the government Governments often achieve this by influencing the level of production or consumption.
How does government intervention into a mixed economic system promote equity?
Promote equity: to reduce the opportunity gap between the rich and the poor.
How does government intervention into a mixed economic system support poorer households?
Support poorer households: poverty has multiple impacts on both the individual & the economy Intervention seeks to redistribute income (tax the rich & give to the poor) so as to reduce the impact of poverty.
How does government intervention into a mixed economic system earn government revenue?
Earn government revenue: governments need money to provide essential services, public and merit goods Revenue is raised through intervention such as taxation, privatisation, sale of licenses (e.g. 5G licenses), & the sale of goods/services
What are four addition methods of government interventions into mixed economic systems?
Additional methods of intervention include regulation, nationalisation, privatisation and the state provision of public goods.
