CHAPTER 5 & 6 EXAM REVISION Flashcards
Define consumer surplus
The difference between what consumers are willing to pay and what they actually pay.
Define efficiency
When is it maximised?
- Producing the goods society wants at the lowest possible price
- Maximised when total surplus maximised
What is producer surplus?
The difference between what the producer is willing to receive and what they actually receive in the market.
Define total surplus
The measure of the net benefits to society from the production and consumption of goods.
What are the characteristics of an inefficient market?
4
- externalities
- market power
- price restrictions and quantity restrictions
- taxes and subsidies
Define externality
The side effects of economic activity.
What does an inefficient market lead to?
Either an overproduction or underproduction of goods
What is a dead weight loss?
Decrease in total surplus that results from an inefficient allocation of resources.
Price floor (definition, examples and effects of policy)
- It is the minimum price that is set by the government
- used to increase producer surplus
- e.g. Tarriff on imported car to support domestic car sales
Price ceiling (definition, examples, and effects of policy)
- A maximum price set by the government
- used to increase consumption, make more essential goods affordable
- creates shortages
- (e.g. Water, health care, electricity)
What is vertical equity?
Redistribution of income from the rich to the poor
What is horizontal equity?
Providing opportunities, regardless of income, the opportunity to earn a higher income
What is the trade off between efficiency and equity?
- efficiency is expanding the size of the economy
- equity is about everyone having the same level of social benefit
What are the characteristics of market failure? (5)
- market power
- externalities
- public goods
- common property goods
- merit and demerit goods
What is market power?
Market power occurs when there are just a few dominant firms in the market
Characteristics of industries with market power (5)
- barriers to entry
- control over resources
- few firms
- No substitutes
- control over price
Example of positive consumption externality
Trees and gym membership
Example of positive production externality
Research
When does market failure occur?
When resources are not allocated efficiently
- when total surplus is not being maximised
Examples of negative consumption externality
(E.g. Smoking, driving a car)
Example of negative production externality
Mining pollution
What is a tax?
A cost imposed on producer that equals the external cost
What is a subsidy?
Consumer receives money from the government equal to the external benefit
What is a public good? (Give example)
Non- rival, non-excludable
- footpaths, light house, national defence
What is a common property good?
A good that is rival but non-excludable
E.g. Environmental resources; forests, fish stocks, atmosphere
What is the theory and effectiveness of assigning property rights?
- creating a market for an environmental resources
- makes someone responsible for the environmental resource
- can be difficult to assign property rights to a large resource (e.g. Ocean or atmosphere)
What is microeconomics?
The study of economy from the individual’s POV
What is scarcity?
Not enough resources to meet the unlimited wants of society
What is the opportunity cost?
The value of that which has been foregone.
Assumptions of the PPF (4)
HINT: tech, fixed, economy, transferable
- no change in technology
- fixed resources
- economy only produces two goods
- resources transferable between two goods
Why is the PPF curved?
Because of the law of increasing opportunity cost.
- as more of one good is produced, the opportunity cost increases since resources are not equally productive at producing both cars and pizzas
What is the law of demand?
What relationship between price and demand
As price increased the quantity demanded decreases
How do movements occur in demand?
What is expansion?
What is contraction?
Movements in demand occur when there is a change in price.
An expansion occurs when price decreases and there is a rightward movement along the curve.
A contraction occurs when price increases and there is a leftward movement along curve.
When do shifts occur?
Shifts occur when there is a change in a non- price factor
What are the non- price factors that result in a shift of the demand curve?
Non- price factors
- income
- demographic
- complements and substitutes (related goods)
- tastes and preferences
- expectations of change in price
What is supply?
Supply is the willingness of a firm to produce a good at a particular price and particular point in time.
What is a demerit good?
Goods associated with significant negative externalities
- overproduced and underpriced
What are merit goods?
Goods or services that generate positive externalities.
- people should consume but generally under consumed
- underproduced and overpriced
What is the law of supply?
As price increases the quantity supplied increases
How does expansion occur in supply?
Expansion occurs with the increase in price
How does a contraction in supply occur?
It occurs when price goes down
Non-price factors that cause a shift in supply: (5)
Related goods, tech, production cost, expection, number
Non-price factors of supply:
* change in cost of producing related goods
- an improvement in technology
- a decrease/ increase in production cost
- producer expectations
- increase in numbers of producers
Why is producer expectations a non-price factor of supply?
If a higher price is expected in the future, firms will decrease their current supply to take advantage of future higher prices.
- firms will decide on investing in plant and machinery on expected future price
- high oil prices= increased exploration
What is the equilibrium? What does it indicate?
Market equilibrium occurs when demand = supply
- means total surplus is maximised
- indicates a market is at it’s most efficient point
Price elastic?
>, <, =
PRICE ELASTIC
Ed > 1 (sensitive to change)
Price inelastic?
>, <, =
PRICE INELASTIC
Ed < 1 (not sensitive to change)
Unitary elastic
UNITARY ELASTIC
Ed = 1
(Price and quantity change in exactly the same proportion)
What is the price elasticity of demand?
Responsiveness of quantity demanded to a change in price.
What are the factors that affect price elasticity? (4)
Factors that affect price elasticity of demand:
- the availability of substitutes
- necessity or luxury
- the proportion income spent on a good
- Time
What is the price elasticity of supply?
The responsiveness of quantity supplied to change in price
Determinants of supply elasticity: (2)
DETERMINANTS OF SUPPLY ELASTICITY
- time
- nature of industry
Why is time a determinant of DEMAND elasticity?
Consumers won’t have time to adjust consumption or find substitute if short period of time
Why is the availability of substitutes a factor affecting price elasticity of DEMAND?
If the price of a good rises and it has many close substitutes, then consumers will be sensitive to price because easily switch to other products
What is cross elasticity?
Related goods
The responsiveness of the quantity demanded to the change in the price of related goods
What is income elasticity?
The responsiveness of the quantity demanded by the change in income
Define marginal benefit
The maximum amount a person is willing to pay to consume that additional unit of a good or service
What does an increase in consumer surplus mean for the consumer?
That the consumer is better off and economic welfare has increased.
