Chapter 7: Prices, resource allocation and concept of the margin Flashcards
Define the marginal principle
The idea that economic agents may take decisions by considering the effect of small changes from the existing situation
Define rational decision making
A decision that allows an economic agent to maximize their objective, by setting the marginal benefit of action equal to its marginal cost
What’s an important element in making choices
Opportunity cost
How are decisions often taken?
By considering small changes to existing behavior
What does the marginal principle underpin?
The notion of rational decision making
What does the assumption of rationality enable?
Economists to model the behaviour of economic agents
What type of circumstances may occur?
Circumstances in which decisions do not reflect this rational approach
Define utility
The satisfaction received from consuming a good or service
Define marginal utility
The additional utility gained from consuming an extra unit of a good or service
Define the law of diminishing marginal utility
States that the more units of a good that are consumed, the lower the utility from consuming those additional units
Name one way of interpreting the marginal utility that you receive from consuming a good
It informs your willingness to pay for it
What will the decision to consume more of one good effect?
The consumption of complementary and substitute goods
What does marginal utiltiy theory rest on?
The crucial assumption that consumers act rationally in taking decisions about their spending and consumption by setting out to maximize their utility
Define price signal
Where the price of a good carries information to producers or consumers that guide the market towards equilibrium and assists in resource allocation
What may happen in the long run if firms in a market are seen to be enjoying producer surplus?
This may attract other firms to enter the market which would be seen as an increase in supply at the market level, so that price would fall until there was no further incentive for firms to join the market
If market forces are to allocate resources effectively, what do consumers need to do?
To be able to express their preferences for goods and services in such a way that producers can respond
Why do consumers express their preferences through prices?
Prices will adjust to equilibrium levels following a change in consumer demand
Producers have an incentive to respond to changes in prices. How does this occur in the short run?
Output adjustments of existing firms (movements along the supply curve)
Producers have an incentive to respond to changes in prices. How does this occur in the long run?
Firms will enter the market (or exit from it) until there are no further incentives for entry or exit
Illustrate productive efficiency on a PPF
Figure 7.5
Define allocative efficiency
Achieved when society is producing the appropriate bundle of goods and services relative to consumer preferences - this occurs when price equals marginal cost
Define economic efficiency
A situation in which both productive efficiency and allocative efficiency have been reached
Evaluation points of economic efficiency and society (3)
- Would the position of economic efficiency, would that always be the ideal position?
- There may be issues surrounding equity
- Economic efficiency is not the only objective of the society
What’s the government’s role in a free economy?
A basic framework of property rights is essential, together with a basic legal framework
What assures the incentives for the owners of capital?
Secure property rights
Name 2 factors that Adam Smith felt interfered with the free market system
- Over protectionism
2. Restrictions on trade
What does an individual market exhibit aspects of?
Allocative efficiency when the marginal benefit received by society from consuming a good or service matches the marginal cost of producing it - when the price is equal to marginal cost
What may a society also need to consider?
The distribution of resources in society, balancing equity with efficiency
