Demand, supply, and elasticities Flashcards
State the law of demand
as the price of a product falls, the quantity demanded will increase (ceteris paribus)
assumptions of the law of demand
Law of diminishing marginal utility:
As we consume more of a good, the satisfaction received from the additional good consumed decreases. For the consumers to want to buy an additional unit, the price will need to decrease.
Substitution effect:
As the price of a good rises, consumers substitute (buy more) of a less expensive good.
Income effect:
As the price of a good falls, the consumer’s “real income” (purchasing power) increases. In other words, you can buy more with the same amount of money.
non-price determinants of demand
Income:
– Normal goods: as our income rises we tend to spend more on them
– Inferior goods: as our income rises we demand less of them
Price of other goods:
– Substitutes: the increase in the price of one will lead to an increase in demand for the other
– Complements: the increase in price of one will lead to a decrease in demand for another
Preferences and tastes:
If there is a positive change towards a product them demand will increase.
Population:
– As a population grows/reduces, the demand for products like food, housing, public transit etc. increases
– As a popiulation ages, demand for more age-appropriate products (e.g. healthcare) increases
Income distribution:
A redirection of wealth from the rich to the poor may increase demand for basic goods.
movements along vs shifts of the demand curve
Along the curve: represents a change in price only (results in a change in quantity demanded)
Shift of the curve: represents a change in any other factor (results in a change in demand)
state the law of supply
As the price of a product rises, the quantity supplied will increase (ceteris paribus)
assumptions of the law of supply
Law of diminishing marginal returns:
As more units of variable input are added to one or more fixed inputs, the marginal product of the variable at first increases, but there comes a point when it begins to decrease.
Increasing marginal costs: as more and more of something is consumed, marginal costs increase over the short-run.
non-price determinants of supply
Cost of factors of production:
As the price of resources increases, so does the cost of making the product. Assuming cost increases cannot be passed onto the consumer in the short term, firms will cut back production.
Prices of related goods:
– Competitive supply: As profits incresase for one product, production is moved away from the product that uses similar resources
– Joint supply: If the production of a product increases, the production of another good found in the same place would also increase
Future price expectations:
If firms expect the future price of a product to increase, the firm will likely start to increase the supply of the product.
Taxes and subsidies:
– As taxes increase, firms will reduce supply.
– The introduction of a subsidy leads to an increase in supply.
Technology:
New technologies usually reduce production costs, thus making production more profitable (increase in supply).
Number of firms:
More firms mean an increase in supply.
Shocks or unpredictable events:
For example, a war would lead to an decrease in supply.
movements along vs shifts of the supply curve
- A movement along the curve is caused by a change in price (called a “change in quantity supplied”)
- A shift of the supply curve is caused by a change in a determinant of supply (called a “change in supply”)
what is consumer surplus
the difference between what consumers paid and the price they were willing to pay.
also said to represent the utility gained by consumers.
what is producer surplus
the difference between the price suppliers were willing to accept and the price the market cleared at.
what is social/community surplus
the sum of consumer and producer surpluses.
allows economists to model social welfare.
allocative efficiency at the competitive market equilibrium means that:
- social/community surplus is maximized
- marginal benefit = marginal cost
assumptions of rational consumer choice
Consumer rationality:
- consumers can rank their preferences (completeness assumption)
- consumers are consistent with their preferences [if a>b and b>c then a>c] (transitivity assumption)
- consumers always prefer more (satiation assumption)
Utility maximization:
Consumers will seek to maximize their utility with the financial resources they possess (underpins the laws of marginal utility and iminishing marginal utility)
Perfect information:
Consumers know all possible products, product qualities, and prices.
limitations of the assumptions of rational consumer choice
(behavioral economics)
Biases:
Systematic errors in thinking or evalutaing that depart from normal standards of thought or judgement. Biases that affect consumer choices include:
- Rules of thumb: simple guidelines based on experience and common sense, simplifying complex decisions that would have to be based on the complex consideration of every possible choice (e.g. one portion of salad is equal to 2 handfuls)
- Anchoring: the use of irrelevant information to make decisions, which often occurs due to it being the first piece of information that the consumer happens to come across (e.g. you find a pair of jeans that cost $150, then you find a similar one for $100 and you buy it thinking it’s a bargain, but then you discover you could’ve gotten the same thing elsewhere for $50)
- Framing: how choices are presented (framed) affects our perception of them, even though the rational consumer should be indifferent to this (e.g.1. framing via language – sonsumers prefer beef described as 80% lean rather than 20% fat, even though they are the same thing) (e.g.2 framing via the seller’s environment – consumers could be willing to pay a higher price for jeans in a boutique than for the identical pair of jeans in a discount store)
- Availability: information that is most recently available, which peple tend to rely on mopre heavily, though there is no reason to expect that this information is any more reliable than other information that was available at an earlier time.
Bouned rationality:
Consumers are rational only within limits, as consumer rationality is limited by consumers’ insufficient information, the costliness of obtaining information, and the limitations of the human mind to process large amounts f information. As a consequence, rather than maximize, consumers seek to satisfice, meaning that they seek a satisfactory outcome rather than an optimal one.
Bounded self-control:
People exercise self-control only within limits, which means they often do not have the self-control required of them to make rational decisions.
Bounded selfishness:
People are selfish only within limits. The assumption of self-interested behavior underlying the maximisation principle cannot explain the numerous accounts of selfless behaviour and willingness to contribute to the public good even at the cost of reduced personal welfare.
Imperfect information:
Consumers do not and cannot have such full access to information, which meansthey are unable to maximize utility as they make choices based on faulty and incomplete information.
nudge theory
a method designed to influence consumers’ choices in a predictable way, without offering financial incentives or imposing sanctions, and withot limiting choice
profit maximization
(business objective)
Profit maximization means maximizing the profit earned by a business.
A firm’s output would therefore be determined by the profit maximizing point.
corporate social responsibility
(business objective)
Self-interest of a firms can lead to negative environmental problems and societal issues, which can in turn lead to a poor image and possible government regulation, incentivizing firms to display corporate social responsibility:
- avoidance of polluting activities
- supprt human rights (no child labour, gender equality, etc.)
- support the arts and athletics
- donate either money, supplies, or staff time to charities
There is no evidence that CSR reduces profits. It costs money, but may help gain consumers and investors.
market share maximizing
(business objective)
Market share refers to thhe % of total sales in a market that is earned by a single firm. A large markewt share means you sell many units and thus can achieve economies of scale. Some firms measure their success by market share.
If you maintain your market share, as the market grows so does your revenue. However, to increase maket share means lowering prices (reduces profit) or spending money on R&D (expense that lower profit).
satisficing
(business objective)
Firms that have this as an objective try to achieve a satisfactory level of profits together with satisfactory results for many more objectives, rather than optimal results for any one objective.
growth
(business objective)
Some firms opt for expanding the size of their business rather thhan profits. Benefits:
- a growing firm can achieve economies of scale and lower average costs
- allows for diversification by market and products (reduces risk)
- increases market power
- reduces the corporate risk during poor economic times
functions of the price mechanism
As signals, prices communicate information to decision-makers.
As incentives, prices motivate decision-makers to respond to the information.
what is price elasticity of demand
How sensitive quantity demanded is to a change in price
