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OCR economics > Econplusdal Theme 1 > Flashcards

Econplusdal Theme 1 Flashcards

1
Q

Basic Economic Problem

A

How to allocate scarce resources (factors of production) given unlimited wants

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2
Q

Factors of Production

A

Capital (manmade aids to production e.g. machinery, factories, schools etc.)
Enterprise (people who innovate)
Land (farmland, rainforest etc. - where goods can be produced and resources can be taken)
Labour (workers who produce goods and services)

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3
Q

Choices in allocation of resources and how markets decide

A

What to produce (businesses decide based on consumer demand)
How to produce (businesses decide based on what’s most cost-effective)
For whom to produce (who has the highest income)

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4
Q

Opportunity Cost

A

The cost of the next best alternative foregone when a choice is made
Measures if choices are good or bad

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5
Q

Production Possibility Frontiers

A

Maximum possible production of 2 goods/services with given factors of production
The various combinations of 2 goods/services that can be produced with given factors of production

Macro PPF shows maximum possible output of all goods and services, or consumer goods and capital goods

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6
Q

Curved PPF

A

Increasing opportunity cost
As a firm moves towards heavy specialisation in Good A, remaining factors of production are more suited to Good B, so they have to give up more of Good B to make Good A

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7
Q

Straight-line PPF

A

Constant opportunity cost

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8
Q

Efficiency on PPF curve

A

Productive: points on the curve (maximum output/use of resources). Inside the curve is productively inefficient (unemployment on a macro scale)
Allocative: not shown
Pareto: points on the curve (someone can only be made better off if someone is made worse off)

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9
Q

PPF - increasing production

A

1) Shift point from within curve further out
2) Reallocating factors of production (move along curve)
3) Shift curve outwards (improve quality or quantity of factors of production - Q2CELL)

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10
Q

Reasons for PPF shifting outwards

A

Technology
Investment/Immigration
Government Training
Education
Resources

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11
Q

Reasons for PPF shifting inwards

A

Natural Disaster
War
Emigration
Recession

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12
Q

Demand

A

The quantity of a good/service consumers are WILLING AND ABLE to buy at a given price in a given time period

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13
Q

Law of Demand

A

There is an inverse relationship between price and quantity demanded. As price increases, Qd decreases and vice versa assuming CETERIS PARIBUS
Income Effect: when prices rise, income doesn’t stretch far enough for us to afford the same amount of the good (less able)
Substitution Effect: when prices rise, other goods and services become more price competitive, so we switch

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14
Q

Factors shifting the demand curve

A

Population
Advertising
Substitute’s Price
Income
Fashion/tastes
Interest Rates
Complement’s Price
(Legislation)

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15
Q

Supply

A

The quantity of a good/service producers are willing and able to produce at a given price in a given time period

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16
Q

Law of supply

A

There is a direct relationship between price and quantity supplied. As price increases, Qs increases and vice versa, assuming CETERIS PARIBUS (because of profit motive)

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17
Q

Factors shifting the supply curve

A

Productivity
Indirect tax
Number of firms
Technology
Subsidy
Weather
Costs of production (Transport, Labour, Oil, Raw materials, Utilities, Regulation)

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18
Q

Market

A

Any place where buyers meet suppliers to exchange goods/services

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19
Q

Equilibrium (market clearing price/quantity)

A

Where demand = supply in a market

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20
Q

Functions of the Price Mechanism

A

Allocates scarce resources (4)
Rations excess demand/supply (3)
Signals that price is too high/low (1)
Incentives to change price and increase profit (2)

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21
Q

Consumer Surplus

A

The difference between the price consumers are willing to pay for a good/service and the price they actually pay
Triangle below the demand curve

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22
Q

Producer Surplus

A

The difference between the price producers are willing to supply a good/service for and the price they actually receive
Triangle above the supply curve

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23
Q

Society Surplus

A

CS+PS

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24
Q

Joint Demand (complements)

A

Goods that are usually bought together e.g. Printers/Ink, Razors/Blades, Coffee Machines/Capsules
When price of one increases, demand for it contracts, causing demand for the other to shift to the left (and vice versa)

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25
Q

Competitive Demand (substitutes)

A

Goods that can be bought instead of the other e.g. Coke/Pepsi, Big Mac/Whopper, iPhone/Galaxy
When price of one increases, demand for it contracts, causing demand for the other to shift to the right (and vice versa)

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26
Q

Derived Demand

A

When the demand for a good/service comes from the demand for something else e.g. Cars/Aluminium, G&S/Labour, Holiday/Airline Travel
When demand for one good shifts, demand for the other shifts correspondingly

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27
Q

Composite Demand

A

Two goods require the same goods to make them e.g. Bread/Livestock (Wheat), Cheese/Butter (Milk)
If demand for one good shifts to the right, production increases, reducing the availability of the input for the other good, causing supply to shift to the left (and vice versa)

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28
Q

Joint Supply

A

When one good is produced, another good is also produced e.g. Honey/Beeswax, Crude Oil/Petroleum
If demand for one good shifts to the right, production increases, which directly increases the production of the other good (and vice versa)

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29
Q

Price Elasticity of Demand

A

The responsiveness of quantity demanded to a change in price (%changeQ/%changeP)
Always negative

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30
Q

PED/PES=0

A

Perfectly inelastic

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31
Q

PED/PES<1

A

Inelastic

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32
Q

PED/PES=1

A

Unitary elastic

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33
Q

PED/PES>1

A

Elastic

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34
Q

PED/PES=∞

A

Perfectly elastic

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35
Q

Factors affecting PED

A

Substitutes (number)
Percentage of income
Luxury or necessity
Addictive/habit forming
Time

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36
Q

Relationship between PED and Revenue

A

Elastic Opposite, Inelastic Same
(Elastic only irritates skin)

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37
Q

Elasticity along the demand curve

A

Top half is elastic (%changeQ always > %changeP), bottom half inelastic (%changeQ always < %changeP), midpoint unitary elastic (maximum revenue) - if curve is linear

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38
Q

Price Elasticity of Supply

A

The responsiveness of quantity supplied to a change in price (%changeQ/%changeP)
Always positive

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39
Q

Factors affecting PES

A

Production Lag
Stocks
Spare capacity
Substitutability of FoPs
Time
(Barriers to entry)

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40
Q

XED

A

The responsiveness of quantity demanded of a good/service to a change in price of another (%changeQa/%changePb)
Positive Substitutes Negative Complements (Party Season Near Christmas)

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41
Q

XED>1

A

Elastic (strongly related)

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42
Q

XED<1

A

Inelastic (weakly related)

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43
Q

XED=0

A

Unrelated goods

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44
Q

YED

A

The responsiveness of quantity demanded to a change in income

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45
Q

Positive YED >1

A

Normal luxury

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46
Q

Negative YED >1

A

Inferior luxury

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47
Q

Positive YED <1

A

Normal necessity

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48
Q

Negative YED <1

A

Inferior necessity

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49
Q

PED Business use

A

Pricing decisions for total revenue
Predictions e.g. if they know Q will rise –> Employment, Stocks, Output

50
Q

PES Business use

A

Find ways to make supply price elastic (flexibility)

51
Q

XED Business use

A

Pricing decisions (Epson cut printer prices, hike ink prices)
Non-price competition (avoids price war; reduce similarities)
Employment, Stocks, Output

52
Q

YED Business use

A

Plan for recessions/booms
Pricing decisions
Employment, Stocks, Output

53
Q

Problems with using elasticity

A

Figures are only ESTIMATES (surveys, competitors collect information, past data)
Assume Ceteris Paribus
PED varies along the demand curve

54
Q

Impact of indirect taxation on the market

A

S curve shifts up
Price increases, Quantity decreases
Government generates revenue
Consumer burden on top, Producer burden on bottom
Producer revenue falls
Consumer and producer surplus fall
Lower output –> unemployment
Creates Deadweight Loss (triangle to right of tax box)

55
Q

Impact of subsidies on the market

A

S curve shifs down
Price decreases, Quantity increases
Government loses money (Opportunity cost)
Consumer income on bottom, Producer income on top

Consumers don’t benefit fully because firms keep a lot of money
Distorts the free market
DWL to society (triangle above new supply curve)

56
Q

Minimum price

A

A price floor below which the price of a good or service is not allowed to decrease

57
Q

Impact of a minimum price on the government

A

Intervention Buying (can store but expensive, can destroy but wasteful, can dump but makes foreign countries unhappy)
Substantial opportunity cost when intervention buying
Lowers popularity with voters
DWL to society (triangle below demand curve)

58
Q

Impact of a minimum price on producers

A

Revenues rise because of intervention buying (protects them) –> greater investment/employment?
Excess supply if not bought up

59
Q

Impact of a minimum price on consumers

A

Higher prices
Less consumption of harmful goods e.g. alcohol
Minimum wage reduces exploitation
Hardship for those on low incomes

60
Q

Maximum price

A

A ceiling price set by the government on a good or service, above which it cannot rise. It may be enforced through government legislation.

61
Q

Impact of a maximum price on the government

A

Deal with excess demand (shifting supply)
…but huge opportunity cost
Could create a black market (e.g. Venezuelan food, black market from foreign countries) –> government failure
DWL to society (triangle under demand curve)

62
Q

Impact of a maximum price on producers

A

Lower prices
Lower quantities (Fewer jobs)
Lower revenue –> lower investment
Lower supply worsens the market in the long term - fewer houses being built etc.

63
Q

Impact of a maximum price on consumers

A

Salary cap reduces inequality
Lower prices e.g. for essentials - housing (reduces monopolistic exploitation)
…but excess demand creates waiting lists that makes them unhappy

64
Q

Allocative Efficiency

A

S=MPC=MSC; D=MPB=MSB
Maximisation of society surplus (CS/PS) - D=S
Maximisation of net social benefit - MSB=MSC
Resources perfectly follow consumer demand - D=S

Allocational or allocative efficiency is an efficient market whereby all goods and services meet the needs and wants of society.

65
Q

Assumptions underpinning free market equilibrium being allocatively efficient

A

Many buyers/sellers
Perfect information
No barriers to entry/exit
Firms are profit maximisers
Consumers are utility maximisers

66
Q

Market Failure

A

When the free market fails to allocate scarce resources at the socially optimum level of output
On diagram, welfare loss points towards social optimum

67
Q

Causes of market failure

A

Positive/Negative externalities (firms/consumers act in self-interest, ignoring these)
Merit/Demerit goods (Information failure, so consumers make irrational decisions)
Public goods (Free rider problem & Profit motivated firms)
Common Access Resources/Tragedy of the Commons (negative externalities, self-interest)
Income inequality (inequity)
Monopoly power (exploits consumers)
Factor Immobility
Information gaps

68
Q

Negative Externalities

A

Detrimental third party effects as a result of actions of another agent

69
Q

Positive Externalities

A

Positive third party effects as a result of actions of another agent

70
Q

Merit Goods

A

Goods deemed more beneficial to consumers than they realise (Imperfect information - information failure; asymmetric information)
Positive externalities in consumption
e.g. healthcare, education, exercise

71
Q

Demerit Goods

A

Goods deemed more harmful to consumers than they realise (Imperfect information - information failure, asymmetric information)
Negative externalities in consumption
e.g. cigarettes, alcohol, gambling

72
Q

Public Goods

A

Non-rival (quantity does not diminish upon consumption) and non-excludable (no price can be charged for the good [the benefits of consuming the good cannot be confined to the individual that has paid; there is no cost efficient way to price])
e.g. flood defences, road signs, street lights, roads, beaches
Free rider problem; missing market

73
Q

Free rider problem

A

The rational consumer would wait until someone else pays for the good as once a public good is provided, it is automatically provided for everyone. Therefore, there would be lack of demand for them and lack of supply as it would not be a profitable market. This would therefore be market failure as the goods would be underprovided

74
Q

State Provision of Public Goods

A

Due to the free-rider problem, the government will intervene and provide public goods using taxes e.g. flood defense, criminal justice system, refuse collection

75
Q

Quasi-Public Goods

A

Shows some, but not all, characteristics of public goods
e.g. Roads (tolls; diminishing road space), Beaches (access restricted by hotel; diminishing beach space)

76
Q

Information gap

A

Where consumers, producers or the government have insufficient knowledge to make rational decisions e.g. second-hand cars

77
Q

Symmetric Information

A

Where consumers and producers have access to the same information about a good or service in the market

78
Q

Asymmetric Information

A

Where producers and consumers have unequal access to information about a good or service e.g. second-hand car market and cosmetic surgery market or insurance market

79
Q

State Provision of Information

A

Government may intervene to prevent/reduce information gaps e.g. through social media, TV adverts, newspapers, school education; Drink driving/smoking ads, seat belt ads, anti-drug ads, cigarette packets

80
Q

Common Access Resources

A

Natural resources over which no private ownership has been established
e.g. Forests, Seas, Air

81
Q

Tragedy of the Commons

A

The unsustainable exploitation of common access resources because it cannot be controlled
Self-interest –> Resource depletion (overproduction)

82
Q

Government Failure

A

When the costs of intervention outweigh the benefits. The end result is a worsening of the allocation of scarce resources harming social welfare

83
Q

Indirect Tax

A

A tax levied on goods/services. They increase a firm’s costs of production BUT can be transferred

84
Q

Indirect Tax to correct Market Failure

A

Increases costs of production
Internalises the externalities (polluter pays)
Solves overconsumption/production
Promotes allocative efficiency whilst generating government revenue
BUT
Price inelastic demand
Setting tax at right level
Regressive
Black markets

85
Q

Types of Government Failure

A

Information Gaps (Valuing externalities is difficult; what’s the right level of policy required?)
Administration and Enforcement costs very high (Regulation, Subsidies, State Provision, Price Controls)
Unintended Consequences (Black Markets, Impact on Poor, Impact on Firms, Employment)
Regulatory Capture (when regulating monopoly power)
Distortion of price signals

86
Q

Distortion of price signals (Government Failure)

A

The action of government which distort the price mechanism and so misallocate resources
Minimum Price causes excess supply (Government may have to buy these - opportunity costs, wastage of products)
Maximum Price causes excess demand e.g. in rental market leaving many people homeless

87
Q

Unintended consequences (Government Failure

A

Indirect taxes may lead to illegal markets e.g. smuggling alcohol and tobacco. This leads to an increase in crime which will result in using taxpayers’ money to deal with this crime
Subsidies may lead to firms becoming too dependent on them and therefore more inefficient
Maximum wage could lead to a shortage of highly skilled workers as they move to other countries e.g. workers in the banking sector
Increase in unemployment as if minimum wage increases employees become too expensive for firms to employ

88
Q

Excessive Administration Costs (Government Failure)

A

Admin costs incur in order to implement taxes, subsidies, regulation, pollution permits
Employees need to be paid to implement these
Is it worth these extra costs to the government?

89
Q

Information gaps (Government Failure)

A

This is when the government has insufficient knowledge to take a rational decision e.g. fishing quotas were set too high by EU and so fish depletion is still an issue
Increased tax might lead to tax evasion which might lead to less tax in the long run

90
Q

Specific Tax

A

Doesn’t change with the value of the goods but with the amount/volume of the goods purchased

91
Q

Ad Valorem Tax

A

The tax levied increases in proportion to the value of the tax base (price of the good). Most goods in the UK carry a 20% VAT charge

92
Q

Subsidy

A

Money grant given to producer by the government to lower costs of production and encourage an increase in output

93
Q

Subsidy to correct Market Failure (benefits and costs of subsidies)

A

Lowers costs of production
Reduces price, increases quantity
Solves underconsumption/production
Allocative efficiency, welfare gain
Boosts employment
Protect infant industries
BUT
COST FOR TAXPAYER/OC
Setting subsidy at the right level
How will firms use subsidy?
No certainty of success
Price inelastic demand
Distortion of free market
Risk of fraud
Cannot discriminate between firms

94
Q

Regulation

A

Rule/Law enacted by the government that must be followed by economic agents to encourage a change in behaviour

95
Q

State Provision to correct Market Failure

A

Resource allocation improves
No price exclusion
All social benefits are likely to be considered
BUT
Opportunity cost
State run organisations tend to be wasteful (no profit motive)
Ignores the private sector completely

How to ration the excess demand? (Bring in the private sector?)

96
Q

Tradable Pollution Permits

A

Government sets level of pollution allowed
Permits are issued to match this level
If permits aren’t used, they can be sold
If a firm breaks the pollution limit, they’re fined

Costs of production for firms increase
Effectiveness depends on level of information government has; number of firms able to reduce pollution

97
Q

Regulation to correct Market Failure

A

Easy to understand and enforce
Revenue from fines can be used to compensate victims
Reduce asymmetric information (age restriction)
Non-Market based approach
Command & Control approach
Incentive to change behaviour
Solve issues in free market
Allocative efficiency; Welfare gain
BUT
Very expensive (Admin costs, enforcement costs)
Setting the right regulation
Black Markets; Unintended consequences e.g. cheating the system
Equity between firms e.g. pollution caps
Very paternalistic
Makes firms uncompetitive (higher CoP)

98
Q

Benefits of TPPs

A

Incentive to reduce pollution (can sell permits for profit)
Reduces level of pollution to social optimum (welfare rises, more allocative efficiency, Q=Q*)
Can be adjusted over time e.g. in 2008 the EC cut them by 5%
Market based solution
Efficient and equitable for firms

99
Q

Problems with TPPs

A

Deciding level of pollution allowed?
High admin costs; difficult to enforce
Fines may not be strict enough
Geographical distribution (after Kyoto, pollution concentrated in USA)
Need for international cooperation

100
Q

Minimum Price to solve Market Failure

A

Contracts demand from Q to Q*
BUT
Price inelastic demand
Regressive
Black Markets
Set at right level?
EXCESS SUPPLY NOT RELEVANT BECAUSE GOV DOESN’T BUY IT UP

101
Q

Maximum Price to solve Market Failure

A

Reduces prices, promoting equity e.g. rent prices
BUT
Shortage
Black markets
Enforcement
Setting the right level
Cost

102
Q

Property Rights to solve Market Failure

A

Incentive not to exploit common access resources
Negative externalities internalised
If enforced, will reduce quantity to the socially optimum level
BUT
Can property rights be efficiently distributed?
Enforcement needed - COST
Equity - who gets the rights? e.g. chemical factory vs villagers rights to a river

103
Q

Specialisation

A

The concentration of a worker, firm, region or country to produce a narrow range of goods and services

104
Q

Advantages of specialisation

A

Reduces problem of scarcity
Larger range of goods and services
Greater output & greater quality
Trade and growth
Economies of scale

105
Q

Disadvantages of specialisation

A

Requires trade to be successful
Finite resources (overdependence)
Over-reliance on good weather
Changing tastes/fashions –> structural unemployment
Nation interdependence
De-industrialisation

106
Q

Division of Labour

A

Occurs when specialisation has taken place where the production process is broken down into separate tasks

107
Q

Advantages of DoL

A

Increased productivity as worker becomes skilled in one particular task due to repetition (increased output; feel valued)
No time is wasted moving from one task to another
Capital Equipment can be used
Less time is required for training as workers only need to be trained in one particular task
Consumers benefit via lower prices

108
Q

Disadvantages of DoL

A

Repetition may lead to boredom (higher staff turnover & higher recruitment costs and higher absenteeism; feel devalued –> quality suffers)
Workers could be easily replaced with machines to do these respective jobs - this could lead to structural unemployment
Payments are low
Working conditions are poor
Too much reliance on other countries

109
Q

Functions of Money

A

A Medium of Exchange
A Measure of Value
A Store of Value
A Method of Deferred Payment

110
Q

Money as a Medium of Exchange

A

Money is used to buy goods and services
There is no money in a barter (swapping one good or another) economy, making it difficult to trade
Without trade there would be no specialisation and without specialisation there would be little or no increase in living standards

111
Q

Money as a Measure of Value

A

Money acts as a Unit of Account. It allows a comparison to be made between goods and services in order to value them
At times of very high inflation e.g. Germany in 1923 and Zimbabwe, money fails to act as a unit of account as prices may change by the hour

112
Q

Money as a Store of Value

A

Money not spent can be saved for future spending which means money can be saved for the future
However, high inflation can destroy this link as money can become less valuable over time

113
Q

Money as a Method of Deferred Payment

A

Money can be used to settle a debt. Money links different time periods e.g. Mortgage loans
If money stops to have this function credit and borrowing collapses and this can damage investment and economic growth

114
Q

Total Utility

A

The total satisfaction from a given level of consumption

115
Q

Utility

A

A measure of the satisfaction that we get from purchasing and consuming a good or service

116
Q

Marginal Utility

A

The change in satisfaction from consuming an extra unit

117
Q

Diminishing Returns

A

Marginal utility declines as more is consumed

118
Q

Reasons why consumers may not behave rationally

A

Influence of other people’s behaviour - “social norms”
The importance of habitual behaviour
Consumer weaknesses at computation

119
Q
A
120
Q

Accelerator effect

A

The accelerator effect happens when an increase in national income (GDP) results in a proportionately larger rise in capital investment spending.

OCR economics (25 decks)

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