Classical Economics Flashcards
What is a market?
A structure that allows buyers and sellers to exchange goods or services
Draw the market demand graph
.
Draw the market supply graph
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Draw the competition pricing graph, showing consumer surplus and producer surplus
.
Where on the competition pricing graph is the market equilibrium price p*?
Where the supply and demand curves cross
What is the meaning of market equilibrium price p*?
– Supply has exhausted all the demand willing to pay up to p* and demand has exhausted all supply willing to offer for at least p*
– The demand curve faced by each firm is zero at any price above p, but the firm would face all the demand for any price below p
What is market demand?
The willingness and ability of customers in a market to purchase a given good. Sum of demand over consumers
What is marginal cost?
The change in total cost that arises from producing one additional item
What is market supply?
The total amount of an item producers are willing and able to sell
What is consumer surplus?
The total amount people saved on their reservation price
What is a reservation price?
The highest price a buyer is willing to pay
What is producer surplus?
Total amount firms saved on their marginal costs
What is a monopoly?
Where one seller or producer of a particular good or service dominates and controls the entire supply. They make decisions based on marginal revenue
What power does a monopolist have?
Significant market power and the power to set prices
What is marginal revenue?
The additional profit the seller can make for every additional item sold
Draw the monopoly pricing graph (add marginal revenue to the competition pricing graph). What monopolist behaviour might this suggest?
That monopolists might restrict supply - selling less goods at a higher price can make them more revenue than more goods at a lower price
Add the consumer surplus, producer surplus and deadweight loss to the monopoly pricing graph
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What does the sum of consumer and producer surplus represent, and when might this be diminished?
Social welfare. This is diminished when a monopolist restricts prices in order to get increase their marginal revenue
What is a Pareto improvement?
A way to make some people better off without making anyone worse off
What is a Pareto efficient allocation?
An allocation such that no Pareto improvement is possible
What is a Pareto efficient allocation for a monopolist?
Charge everyone their reservation price
How does a monopolist charging everyone their reservation price impact producer surplus? Show this on the competition pricing graph
Producer surplus is maximised. The monopolist captures all the consumer surplus
What is utility?
How much consumers value a good/service. Can be used to measure overall satisfaction from consuming multiple goods
What is marginal utility?
The additional satisfaction or value that an individual derives from consuming an additional unit of good/service
State the Law of Diminishing Marginal Utility
As an individual consumes more of a particular good, the additional satisfaction from each successive unit tends to decrease
What is market price?
The amount of money a good/service can be sold for in a market
Draw the supply graph
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Explain the supply graph
– Firms have fixed costs and variable costs, so the average cost of goods initially falls with output.
– The variable costs rise at some point and eventually rise sharply due to capacity constraints
Give two examples of a fixed cost
- Rent
- Utility bills
Give two examples of a variable cost
- Raw materials
- Labour costs
Draw the cost evolution graph
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Explain the cost evolution graph
– In the long run, firms can fix capacity constraints by building more factories.
– This gives nearly constant fixed costs and so constant returns to scale as the firm expands
How does a firm maximise its profit?
By setting output so that its marginal cost equals equilibrium price p*
What is partial equilibrium analysis?
Studying supply and demand for one good
What is general equilibrium analysis?
Studying supply and demand for multiple goods including other factors such as labour/leisure, capital etc.
State the First Theorem of Welfare Economics
Market equilibrium is Pareto optimal
State the Second Theorem of Welfare Economics
Any Pareto optimal allocation can be achieved by market forces provided preferences are convex
Give 4 technical conditions for these welfare theorems
- Rational actors
- Complete information
- No transaction costs
- No externalities
Give 3 violations of these welfare theorems
- Monopoly can set prices
- Production can lead to negative externalities eg. environmental pollution
- Behavioural economics: people often make mistakes, or are not just selfishly profit-maximising, so may not be acting rationally
Why do some sectors have large companies and others small ones?
Large companies because external transaction costs are higher than internal ones
Give 3 examples of transaction costs
- Time
- Effort
- Policing
What is utilitarian welfare?
W = sum(Ui) (Ui is utility of individual i)
ie. the welfare of a society is the sum of the utilities of all citizens
Does Pareto efficiency imply justice?
No. Giving all the money to the king is Pareto efficient
What is Rawlsian welfare?
W = min Ui (Ui is utility of individual i)
ie. the welfare of a society is the utility of the most miserable citizen
What did Pigou say?
Diminishing marginal utility of money means that transferring £1 from a rich man to a poor one will generally increase welfare
