Economics Flashcards
Factors that impact demand elasticity:
Substitutes
Portion of income spent on good
Time
Substitution effect
P↓ QD ↑
Income effect
P↓ QD ↑ or ↓ (normal / inferior goods)
Giffen good
P↑ QD ↑ (low income goods)
Veblen good
P↑ QD ↑ (luxury goods)
Factors of production
Land
Labour
Capital
Materials
Production function
relationship between output and the size of labour force / capital stock / productivity
Total revenue is greatest in the part of a demand curve that is:
unit elastic
Total revenue is maximized at the quantity at which own-price elasticity equals –1
A distinction between Giffen goods and Veblen goods is that:
Giffen goods are inferior goods, while Veblen goods are not inferior goods.
Shutdown point
P = AVC
The firm is only just covering its variable costs
Impact of increased demand in perfect competition
- In SR: there is an increase in price
- In LR: new firms will enter the industry when profits >0 and leave when profits <0.
When a firm operates under conditions of pure competition, marginal revenue always equals:
Price
When a firm operates under conditions of pure competition, MR always equals price. This is because, in pure competition, demand is perfectly elastic (a horizontal line), so MR is constant and equal to price.
In which market structure(s) can a firm’s supply function be described as its marginal cost curve above its average variable cost curve?
Perfect competition only.
The supply function is not well-defined in markets other than those that can be characterized as perfect competition.
Is monopolistic competition effiecient?
Not clear
Due to advertising costs, product innovation, excessive producers,
The demand for products from monopolistic competitors is relatively elastic due to:
the availability of many close substitutes. If a firm increases its product price, it will lose customers to firms selling substitute products at lower prices.
Cournot model:
- Duopoly, both firms have identical MC curves
- Both firms produce the same quantity in equilibrium
- Price is defined by the other firm’s price in the previous period
- Price is lower than a monopoly but higher than perfect competition.
Stackelberg model:
- Duopoly, one firm is the leader and chooses the price
- Other firm sets price according to this price
- In equilibrium, the ‘leader’ charges the higher price and receive greater proportion of total profits
When is price discrimination within a monopoly possible?
Two identifiable groups of consumers with different demand elasticities
No potential for resale of good between the groups
Characteristics of a natural monopoly
Significant economies of scale
- ATC declines as output increases
- High fixed costs, low marginal costs
e.g. Utilities
Two ways of regulating monopolies
Average cost pricing:
- Price is charged where ATC=AR.
- Output and social welfare ↑
- economic profit = 0
Marginal cost pricing:
- Price is charged where MC=AR.
- May lead to a loss / require govt. subsidies if MC < ATC.
When can you describe a firm’s supply curve?
Only in perfect competition - where supply is equal to the marginal cost curve above the AVC curve. It is constructed by simply summing the quantities supplied at each price across all firms in the market.
In monopolistic competition, oligopolies and monopolies there is no well-defined supply function.
N-firm concentration ratio
Sum of the percentage market shares of the N largest firms in an industry
- market share = firm sales / total market sales
- lower ratios = more competitive market, higher ratios indicate oligopoly
Disadvantages:
- Ignores barriers to entry
- Largely unaffected by mergers
Herfindahl-Hirschman Index (HHI)
Sum of the squared market shares of N largest firms in a market
- 0.1 - 0.18: moderately competitive
- 0.18+ : uncompetitive
Advantages:
- More sensitive to mergers than N-firm ratio and widely used by regulators.
Disadvantages:
- Ignores barriers to entry and demand elasticity
In a perfectly competitive industry, the short-run supply curve for the market is the:
sum of the individual supply curves for all firms in the industry.
The short-run supply curve for a firm is its marginal cost curve above the average variable cost curve. The short-run supply curve of the market is the sum of the supply curves for all firms in the industry.
GDP
Sum of the final market values of goods and services produced in that period.
Includes only the purchases of newly produced goods and services. The sale or resale of goods produced from previous periods is excluded.
Transfer payments made by the Govt. (e.g. unemployment, retirement and welfare benefits) are not economic output and are not included.
GDO (expenditure approach, ‘value-of-final-output-method’)
GDP is calculated by summing the amounts spent on goods and services produced in the period
GDP (income approach)
GDP is calculated by summing the amounts earned by households and companies during the period
GDP (‘sum-of-value-added-method’)
GDP is calculated by summing the additions to the value-added at each stage of production
Nominal GDP
GDP calculated at current market prices
Real GDP
GDP calculated using prices from a base year, removing impact of inflation
GDP deflator
A price index used to convert nominal GDP into real GDP
= (Nominal GDP / GDP calculated at base year prices) * 100
Under the income approach, GDP or Gross Domestic Income (GDI) equals
national income + capital consumption allowance + statistical discrepancy
Capital consumption allowance (CCA)
Measures the depreciation of physical capital from the production of goods and services over a period.
aka. the amount that would have to be reinvested to maintain the productivity of physical capital from one period to the next.
National income
Sum of all income received by all factors of production that go into the creation of the final output.
National income is the income received by all factors of production used in the generation of final output. Personal income measures the pretax income that households receive. Disposable income is personal income after taxes.
Total Income
C + S + T
Consumption + Savings + Net taxes
C + S + T = C + I + G + ( X - M )
Aggregate Demand
AD = C + I + G + ( X - M )
Reflects the -ve relationship when:
- Goods market is in equilibrium ( Income = Exp. )
- Money market is in equilibrium ( nominal money supply adjusted for inflation )
Why AD curve slopes downwards:
- Wealth effect: P↓, Nominal purchasing power ↑, C↑
- Interest rate effect: IR↓, P↓, C↑
- Real exchange rate effect: Exch. R↑, X↓, M↑, (X-M) ↓
Causes of a shift in LRAS curve
- Δ labour productivity
- Δ natural resources
- Δ physical capital
- Δ technology
Recessionary gap
When real GDP is less than full employment GDP
Inflationary gap
The increase in output (in the SR) following an increase in AD.
This then returns back to the equilibrium level of output as defined by the LRAS curve.
Stagflation
LRAS shifts to left
Combination of declining economic output and higher prices.
High unemployment and high inflation exist at the same time.
Five pillars of economic growth:
- Labour supply
- Human capital
- Physical capital stock
- Technology
- Natural resources
Potential GDP
aggregate hours worked * labour productivity
Growth in potential GDP
growth in labour force + growth in labour productivity
or
growth in technology + labour % share of national income + capital % share of national income
Sustainable rate of economic growth
the rate of increase in the economy’s productive capacity
An economy’s sustainable rate of growth depends on the growth rate of the labour supply and the growth rate of labour productivity. Due to diminishing marginal productivity, an economy generally cannot achieve long-term sustainable growth through continually increasing the stock of capital relative to labour (i.e., capital deepening).
The sustainable growth rate is positively affected by increases in the supply of natural resources, the supply of physical capital, or the supply or productivity of labor. An increase in government spending does not increase an economy’s sustainable growth rate.
Economic output, GDP, (Y) formula
Y = Total factor productivity (advances in technology) (A) * a Function of labour and capital f(L,K)
Y = A * f( L, K )
Labour productivity is most likely to increase as a result of:
Increase in physical capital.
Total factor productivity
Output growth in excess of that resulting from the growth in labour and capital.
Difference in values of sum-of-value added method and value-of-final-output method?
None
Business cycle
is characterized by GDP and the rate of unemployment:
- Expansion (real GDP is increasing)
- Peak (real GDP stops increasing and begins decreasing)
- Contraction or recession (real GDP is decreasing)
- Trough (real GDP stops decreasing and begins increasing).
Credit cycles
Cyclical fluctuations in interest rates and the availability of loans (credit)
Increase in the inventory-sales ratio
When an expansion is approaching its peak, sales growth begins to slow and unsold inventories accumulate.
Firms respond by reducing production leading to a contraction in the economy.
Problem with assessing the economy using just GDP growth (and not inventory-sales ratio)
Economic strength may seem strong when it is actually declining - this is because an increase in inventories counts as an increase in economic output, when it is actually a sign of falling sales.
