EconPlusDal Micro Y1 Flashcards
Basic economic problem?
How to allocate scarce resources given unlimited wants.
What is opportunity costs
The cost of the next best alternative forgone when a choice is made.
If next best alternative forgone is better than current choice = bad choice.
Allocate resources towards opportunity cost instead of current choice.
What does a PPF curve show?
1) Maximum possible production of 2 goods/services with given factors of production.
2) The various combinations of 2 goods/services that can be produced with given factors of production
What does a linear (diagonal) PPF curve mean?
Constant opportunity cost
What does a concave (curved) PPF curve mean?
Law of increasing opportunity cost
What is productive, allocative, and Pareto efficiency?
Productive: all resources being used at maximum productive capacity.
Allocative: resources being used to match consumer demands.
Pareto: cannot make someone better off, without making someone worse off. Any point on curve is Pareto efficiency.
How can a business improve its productive capacity?
Q²CELL
Increase QUANTITY and QUALITY of factors of production.
However, may favour one good/service over the other depending on materials required to produce.
What is Demand?
the quantity of a good/service consumers are willing and able to buy at a given price in a given time period.
What is the law of demand?
There is an inverse relationship between price and quantity demanded.
As price increases, quantity demanded decreases and vice versa assuming ceteris paribus.
What is ceteris paribus?
Ceteris paribus means all other things remaining equal.
Why is there a downward sloping demand curve?
Income effect
Substitution effect
What is the income effect
As prices go up, purchasing power falls, less able to buy the same quantity
What is the substitution effect?
As prices go up, substitute goods become more price competitive.
What non-price factors effect demand?
PASIFIC
Population
Advertising
Substitute’s price
Income
Fashion/Tastes
Interest Rates
Complement’s price
What shifts a demand curve and what causes a shift ALONG the demand curve?
Shift:
Non-price factors (PASIFIC)
Shift ALONG:
- Price levels & Law of demand
What is the definition of supply?
The quantity of a good/service producers are willing and able to produce at a given price in a given time period.
What is the law of supply?
There is a direct relationship between price and quantity supplied. As price increases, quantity supplied increases and vice versa according to ceteris paribus.
What will cause supply curve to shift.
Non-price factors, effect COSTS of production.
PINTS WC
Productivity
Indirect tax
No. of firms
Technology
Subsidy
Weather
Costs of production
What is the free market?
any place where buyers meet suppliers to exchange goods and services, free from government intervention.
What is equilibrium?
Where demand = supply, (market clearing)
What is disequilibrium?
Where demand ≠ supply
What does equilibrium in a free market represent?
- Allocative efficiency
supply is perfectly equal to demand
What’s another name for a free market?
Price mechanism
What do prices do at disequilibrium in a free market? Price mechanism (ARSI)
Prices:
4) Allocate scarce resources efficiently
3) Ration scarce resources by encouraging/discouraging consumption
1) Signal excess demand/supply and need for increase/decrease in resources
2) Incentivise producers to increase/decrease output to increase profit
What is consumer surplus?
Consumer surplus is the difference between the price consumers are willing and able to pay for a good/service and the price they actually pay.
- Found below the demand curve and above the price line
What is producer surplus?
The difference between the price producers are willing and able to supply a good/service for and the price they actually receive
- Found above the supply curve and below the price line
How is society surplus calculated?
Consumer surplus + Producer surplus
What is joint demand?
Complimentary goods
e.g.
printers & ink
razors & blades
coffee machines & capsules
What is competitive demand?
Substitute goods
e.g.
Coke & Pepsi
Iphone & Galaxy
Big Mac & Whopper
What is derived demand?
Input demand
e.g.
Cars & Aluminium
Airlines & Holidays
What is composite demand?
Same inputs for a good, opportunity costs.
Bread & Livestock
Cheese & Butter
What is joint supply?
Increase in supply of one good will increase supply of another.
e.g.
Honey & Beeswax
Crude oil & Petroleum
What is Price Elasticity of Demand (PED)?
PED measures the responsiveness of quantity demanded given a change in price.
%△Qd/%△P
PED always negative due to law of demand, but what does each value mean?
> 1 = Demand is elastic
<1 = Demand is price inelastic
0 = Demand is perfectly price inelastic
∞ = Demand is perfectly price elastic
1 = Demand is unit price elastic
What shape is a perfectly inelastic demand curve?
Vertical
What determines price elasticity? SPLAT
Substitutes (no.)
Percentage of income
Luxury/Necessity
Addictive/Habit forming
Time period
What should firms do when PED changes? Remember, Elastic Only Irritates Skin (EOIS).
Elastic
Opposite
Inelastic
Same
Demand is price elastic
- Price increase, TR falls
- Price falls, TR increases
Demand is price inelastic
- Price rises, TR rises
- Price falls, TR falls
What is price elasticity of supply (PES)?
PES measures the responsiveness of quantity supplied given a change in price.
PES =
%change in Qs
/%change in P
YOU Q BEFORE YOU P
PES is always negative because of law of supply, but what does each value mean?
> 1 = supply is price elastic
<1 = supply is price inelastic
0 = supply is perfectly
price inelastic
∞ = supply is perfectly price elastic
1 = supply is unit price elastic
What determines supply elasticity? PSSST
Production lag
Stocks
Spare capacity
Substitutability of FoPs
Time
What is Cross Elasticity of Demand (XED)?
XED measures the responsiveness of quantity demanded of a good/service given a change in price of another.
XED = %changeQd/%changeP
What does each value of XED mean?
Party, Season, Near, Christmas
Positive, Substitute, Negative, Compliment
+ number = substitutes
- number = compliments
> 1 = Demand between the goods is price elastic
(strongly related)
<1 = Demand between the goods is price inelastic
(weakly related)
0 = Demand between the goods is perfectly price inelastic
(no relationship)
What does the demand curve of a XED compliment good look like?
Downward sloping
> 1 elastic
<1 inelastic
What does the demand curve of a XED substitute good look like?
Upward sloping
> 1 elastic
<1 inelastic
What does income elasticity of demand measure?
YED measures the responsiveness of quantity demanded given a change in income
Formula: Q before you P (Y)
What does the value of each YED mean?
+ = Normal good
- = Inferior good
Normal Good
>1 Demand is income elastic, normal luxury
<1 Demand is income inelastic, normal necessity
Inferior Good
>1 Demand is income elastic
<1 Demand is income inelastic
0 = Demand is perfectly income inelastic
What does the demand curve of a YED Inferior good look like?
Downward sloping:
<1 = inelastic
>1 = elastic
What does the demand curve of a YED normal good look like?
Upward sloping:
<1 = inelastic
>1 = elastic
How does PED value help a business?
- Pricing decisions for TR (EOIS)
- Employment, Stocks, Output
How does PES value help a business?
- Find ways to make supply price elastic (PSSST)
How does XED value help a business?
- Pricing decisions
- Non-price competition
- Employment, Stocks, Output
How does YED value help a business?
- Pricing decisions
- Employment, stocks, output
- Plan for recession and booms
Why are elasticity values not always helpful for businesses?
- Elasticity figures only estimates from: surveys, past data, competitors
- Assumes ceteris paribus
- PED varies along the demand curve
What are the 2 reasons for indirect taxes?
- Raise government revenue
e.g. VAT - Solve market failure
e.g. alcohol duty
Indirect tax definition
Expenditure tax that increases costs of production for firms but can be transferred to consumers via higher prices
Direct tax definition
Tax on income that can’t be transferred
e.g. income tax, NI, corp. tax
What are the two types of indirect taxes?
- Specific
- Ad Valorem
What do specific indirect taxes do to the supply curve?
Shifts the supply curve parallel to S1 + tax
What is a specific tax?
Tax per unit price
What is an Ad Valorem tax?
Tax as a % of Price, e.g. VAT 20%
What does an Ad Valorem tax do to the supply curve?
The supply curve will shift pivoted from S1 to S1 + tax
How to analyse the effect of an indirect tax on graph?
Describe:
1) S curve
2) P & Q
3) Gov. Revenue
4) Consumer Burden
5) Producer Burden
6) Producer Revenue
7) DWL
What is a subsidy?
A subsidy is a money grant to firms by the government to reduce costs of production and encourage an increase in output
What is the goal of subsidies, why are they used?
- Solve market failures
- Increase affordability
How to analyse the effect of a subsidy on a graph?
Describe:
1) S curve
2) P & Q
3) Gov. Cost
4) Producer Revenue
5) Consumer Savings
6) DWL
What is a minimum price?
A fixed price (price floor) enacted by the government usually sat above the equilibrium market price
What is the aim of enacting a minimum price?
- Protect producers from price volatility
- Solve Market Failure
How to analyse a graph with a minimum price
Describe:
1) Price
2) Qd
3) Qs
4) Excess supply
5) Cost of intervention buying (IB)
6) Producer revenue,
with IB: All supply bought
without IB: Only consumers
7) DWL
What is intervention buying?
When the government buy excess supply in the market
What is a maximum price/price ceiling?
A fixed price (price ceiling) enacted by the government usually sat below the equilibrium market price
What is the aim of setting a maximum price?
Aims to increase the affordability of necessity goods/services
How to analyse the effect of a maximum price graph?
1) Price:
2) Qd
3) Qs
4) Excess demand
5) Producer revenue
6) DWL
What are private costs (PC)?
Producer’s cost of production
What are social costs?
Social costs = PC + EC (external costs)
What are private benefits (PB)?
Individual consumer benefit upon consumption
What are social benefits (SC)?
PB + EB (external benefits)
What three things happen at allocative efficiency?
- Maximisation of society surplus (CS + PS), where demand = supply
- Maximisation of net social benefit, where MSB = MSC
- Where resources perfectly follow consumer demand, where demand = supply
What are the assumptions made when there is allocative efficiency in a free market?
- Many buyers and sellers
- Perfect information
- No barriers to entry
- Firms profit max
- Consumers utility max
What is the social optimum?
Where MSC = MSB
What is the private optimum?
Where MPC = MPB
What is market failure?
When the free market fails to allocate scarce resources at the socially optimum level of output
What are 6 reasons for market failure?
- Self interest
negative externalities
positive externalities
tragedy of the commons - Information failure
de-merit goods
merit goods - Free rider problem & Profit
motivated firms
(public goods) - Inequity
income inequality - One dominant seller & High barriers to entry
(monopoly power) - Factor immobility
What are negative externalities in production?
Costs to 3rd parties as a result of the actions of producers
Examples of negative externalities in production?
Air pollution, resource depletion, deforestation
How are negative externalities in production shown on a graph?
MSC > MPC
marginal social cost > marginal private cost
How to analyse a negative externality in production
- Firms act in self interest
- Over production/consumption
- Price too low
- Misallocation of resources
What is a negative externality in consumption and examples?
Costs to 3rd parties as a result of the actions of consumers
Smoking
Excessive alcohol
Fast food
How to show a negative externality in consumption on a graph?
MSB < MPB
marginal social benefit < marginal private benefit
How to analyse a negative externality in consumption on a graph?
- Self interest
- Over consumption/production
- Misallocation of resources
What is the definition of positive externalities in consumption?
Benefits to 3rd parties as a result of the actions of consumers
Examples of positive externalities in consumption?
Healthcare
Education
Exercise
Healthy eating
How can positive externalities in consumption be shown on a diagram?
MSB > MPB
marginal social benefit > marginal private benefit
What are the effects of positive externalities in consumption in a free market?
- People act in self-interest
- Leads under-consumption/production
- Results in a misallocation of resources
What are positive externalities in production?
Benefits to 3rd parties as a result of the actions of producers.
Examples of positive externalities in production?
In-work training
R&D
Other firms being able to capitalise on trained workers
How can positive externalities in production be shown on a diagram?
MSC < MPC
What are the effects of positive externalities in production in a free market?
- People act in self-interest
- Under - production/consumption
- Results in misallocation of resources
Where does the welfare loss triangle point to?
Always points towards the social optimum
What are merit goods?
Goods deemed more beneficial to consumers than they realise
There is imperfect information
- info. failure
- asymmetric info
Generate positive externalities in consumption
They are under-consumed/produced
Examples of merit goods?
Healthcare
Education
Exercise
What are de-merit goods?
Goods deemed more harmful to consumers than they realise
Imperfect information
- info. failure
- asymmetric info.
Generates negative externalities in consumption
They are over-consumed/produced
Examples off de-merit goods?
Cigarettes
Alcohol
Gambling
What are the two characteristics of a pure public good?
Non-excludable
- no price can be charged for the good
- benefits of consuming the good cannot be confined to the individual that has paid
- there is no cost efficient way to price
Non-rival
- the quantity of good doesn’t diminish upon consumption
Examples of pure public goods?
Flood defences
Road signs
Street lights
Roads
Beaches
What is the free-rider problem?
People believe that others will pay for the good and so they free ride of that idea, this results in nobody paying for the good.
Leading to complete market failure and a missing market.
What is the solution to free rider problem?
Quasi Public goods
sometimes shows the characteristics of a pure public good and sometimes of a private good, e.g. can sometimes be excludable or rival.
e.g. toll roads
What are common access resources?
Natural resources over which no private ownership has been established.
e.g.
- forests
- seas
- air
Lack of private ownership leads to the tragedy of the commons.
What is the tragedy of the commons?
An economic problem where the individual consumes a resource at the expense of society by acting in their best interest, leading to over-consumption.
What is government failure?
When the costs of intervention outweigh the benefits of intervention
The end result is a worsening of the allocation of scarce resources harming social welfare
What are the four reasons for government failure?
Information failure
- valuing externalities the right level of policy required
Regulatory capture
- When regulating monopoly power
Admin & enforcement costs very high
- regulation
- subsidies
- state provision
- price controls
Unintended consequences
- Black markets
- Impact on poor
- Impact on firms
- Employment
What does indirect taxation do to a firms costs?
Indirect tax increases a firm’s costs of production BUT can be transferred
How does indirect tax promote allocative efficiency?
- Increase cost of production
- Internalises externality
(polluter pays) - Solves overconsumption/production
- Promotes allocative efficiency whilst generating gov. revenue
Why may implementing an indirect tax on producers not work, when trying to achieve allocative efficiency?
- Price inelastic demand
- Setting tax at right level
- Regressive
- Black markets (over-tax)
How do subsidies help fix market failure?
- Lowers costs of production
- decrease price, increase quantity
- solves underconsumption/production
- allocative efficiency, welfare gain
Why may providing a subsidy to producers not always be beneficial when trying to fix market failure?
- Cost
- Setting subsidy at the right level
- How will firms use subsidy
- Price inelastic demand
Regulation definition
Rule/law enacted by the government that must be followed by economic agents to encourage a change in behaviour
Examples of regulations and laws, or command/control?
Command:
- Bans
- Compulsory (cig. packaging)
- Limits
- Caps
- Innovative regulations
Has to be control:
- enforcement
- punishment
What are the benefits of implementing regulations?
- Non-market based approach
- Incentive to change behaviour
- Solve issues in free market
- Allocative efficiency & welfare gain
What are the negatives of implementing regulations?
- Cost
- Settling the right regulation
- Black markets & unintended consequences
- Equity
How do tradable pollution permits work?
1) Cap set at Q*
2) Permits issued to match the cap
(market for permits is created)
3) Firms make decision based on least cost
4) Enforcement
5) Pollution falls to social optimum, allocative efficiency
Always LR incentive to invest in green tech, because:
- profits from permit sale
- not burdened when permit prices rise
What are the negatives of tradable pollution permits?
- Enforcement
- Imperfect information for government
- Unintended consequences
higher prices, inflationary
moves pollution elsewhere - Need for international cooperation
What is state provision?
Direct provision of goods/services by the government, free at the point of consumption
When is state provision used?
Merit goods, both:
- under consumption/production
- inequity
e.g. Healthcare, Education
Public goods:
- missing market
e.g. roads, defences.
How does state provision work?
1) Gov. considers full SC & SB allocating resources at Q* (perfectly price inelastic)
2) Free at point of consumption
3) Solve UC/UP & inequity issues
4) Solve missing market issues
5) Allocative efficiency and welfare max.
What are the issues of state provision?
- Excess demand, because it’s free
- Cost
- Imperfect information
- Inefficiency of state organisations
What are the issues of setting a minimum price?
- Price inelastic demand
- Regressive
- Black Markets
- Set at right level?
What are the issues of setting a maximum price?
- Shortage
- Black markets
- Enforcement
- Setting the right level
- Cost
What is information provision?
Government funded information provision/advertising/education to encourage or discourage consumption
Paternalistic method, not interventionist approach.
How does information provision work?
- Demand shifts to social optimum levels (MSB or MPB)
- Consumers make rational decisions knowing true MPB
- Solve under/over consumption
- Allocative efficiency
What are the negatives of information provision?
- Cost
- No guarantee of success
- Long run not short run
How can property rights fix market failure?
- Incentive not to exploit common access resources
- Negative externalities internalised
- If enforced, will reduce quantity to the socially optimum level
What are the issues with providing property rights to avoid market failure?
- Can property rights be efficiently distributed? How will sea and air be split up?
- Enforcement needed = cost
- Equity, who gets the rights?
What is a command economy?
Run by the government, aims to maximise welfare.
What is a market economy?
Free market economy, aims to profit max.
What is a free market?
A free market is any place where buyers meet sellers to exchange goods and services, free from government intervention
Why is equilibirum in a free market allocative efficiency?
- Resources perfectly follow consumer demand
- Society surplus is maximised
- Net social benefit is maximised
What are the benefits of a free market?
- Allocative efficiency
- Encourage competition
- Dynamic efficiency - investment
- Job creation and economic growth
- Freedom, liberty and choice
- No risk of gov. failure
What are the cons of a free market?
- Markets can fail
- Inequity given inequality
- Excessive profitearing
- Creative destruction
- Price volatility
What is specialisation?
Specialisation is the concentration of production on a narrow range of goods or services
What are the advantages of specialisation?
- Higher output - increased trade and growth
- Wider range of goods/services
- Greater allocative efficiency
- Higher productivity through better use of workers
- Quality improvements
What are the disadvantages of specialisation?
- Finite resources
- Changes in fashion/tastes
- De-industrialisation
- National interdependence
What is division of labour?
Division of labour is breaking down the production process into separate tasks upon specialisation
What are the advantages of division of labour?
- Workers highly productive
- Specialist capital for workers
- Lower prices, higher quality/choice and quality for consumers
What are the disadvantages of division of labour?
- Demotivation of workers
- High worker turnover
- Risk of long term u/e
- Highly standardised goods/services
What are primary commodities?
- Oil
- Wheat
- Metals (copper)
etc.
Why are prices for primary commodities so volatile?
- Price inelastic demand
(lack of substitutes)
(necessities) - Price inelastic supply
(hard to store)
(large production lag) - Regular demand & supply shifts
(weather)
(macro performance)
What is the affect of price on primary commodities?
Demand is price inelastic
Supply is price inelastic
Price rises
- suppliers happy, supply less
- demand hardly changes
Price falls
- demand hardly changes
- Total Revenue falls
- Supply concerns
- Gov. Revenue & growth falls
- Investment falls
What is natural science?
Natural science is when scientists observe aspects of the universe
What is social science?
Social science is the observation of human behaviour
What is a positive statement?
Positive statements can be tested with evidence
What are normative statements?
Normative statements is a personal opinion, can’t be proved as a fact
