Exam Flashcards
Economic models (hot hands)
Simplified representation of economic reality to better understand our choices and their effect
Types of economy
- command/planned = all gov
-mixed = lots of gov intervention
-free market = Australia, no gov
What to produce, how and who
Substitution effect
If price of good up, consumers will sub for another good. Demand for good decrease, demand for sub increase
Income effect
Price of normal good down, demand up. Price of inferior good down, demand down. (Veblen)
Law of diminishing marginal utility
Each additional good consumers buy, happiness down *applies equally to inferior and normal
Factors that shift overall demand
- tastes and preferences
- number of consumers
- price of related goods
-income
-expectations
Consumer surplus
- the benefit consumers get when the price of a good is less than what they were willing to pay.
- CS = (consumers max price - actual price) x quantity bought
- area under demand curve and above price paid, up to quantity boight
Law of supply
- costs producers more money to produce higher quantity so higher price is needed to be eonomically viable
- increased demand signals producers can change higher price and earn more profit
5 factors that shift supply
- technology
- number of producers
- price of resources
- taxes and subsidies
- expectations
*- natural disasters
Market equilibrium
Occurs when buying decisions of households and selling decisions of producers are equaled.
Importance of equilibrium
- market is maximising total surplus
- market is efficient
- price in market will naturally move to reach equilibrium
- equilibrium price is stable
Shortage
EXCESS DEMAND
- quantity demanded = more than supply given
- competition amongst buyers bids price up until equilibrium is reached
Surplus
EXCESS SUPPLY
- quantity demanded = less than quantity supplies
- competition amongst producers eventually bids down price until equilibrium price is reached
Producer surplus
PS = (quantity produced x price producers receive x 0.5)
Total subsidy
Quantity produced/consumed x size of subsidy
Productions probability frontier (PPF model)
Model showing all possible production combinations, with a set amount of resources / technology.
PPF model illustrates trade-offs, opportunity cost, efficiency in economy, economic growth.
Coefficients
Inelastic - elasticity less than 1
Elastic - elasticity more than one
Unitary - elasticity is ome
PED
Measure of how responsive consumers are to a change in price
Determinants of PED
- availability of close substitutes
- necessities v luxuries
- proportion of income spent
- definition of market (broad / narrow)
- time horizon
Total revenue
Amount a firm earns by selling goods / services
Percentage change method
Percentage change in quantity demanded DIVIDED by percentage change in price
Mid point method
(Change in quantity DIVIDED by average quantity) x (average price DIVIDED by change in price)
PES
Price elasticity of supply measures the responsiveness of quantity supplied to a change in price
Determinants PES
-time: if producer can respond quickly supply will be elastic
-nature of industry: manufactured goods are more elastic as its easier to increase production
-ability to store inventories : perishable v non perishable
Income elasticity of demand
Refers to the responsiveness of demand to a change in consumer income
(Percentage change in quantity DIVIDED by percentage change in income)
Normal good: positive coefficient or more than one
Inferior = opposite
Cross elasticity of demand
Measures the responsiveness of demand for one good (a) to a change in the price of a related good (b). Can reveal whether goods are substitutes or compliments
(Percentage change in Qa DIVIDED by percentage change in Qb)
Substitute = positive
Gov setting taxes
Gov sometimes sets taxes on specific goods to counteract unseen costs to society
BUT gov doesn’t want tax burden on producers as this leads to unemployment and a low economic growth
Market efficiency
The allocation of resources to maximise total surplus
Price ceiling
A legislated maximum price that sellers are allowed to charge. Must be set BELOW equilibrium. ALWAYS leads to a shortage
Price floor
A legislated minimum price that sellers are allowed to charge. Must be set ABOVE equilibrium price. ALWAYS leads to a surplus
Market restrictions
Regulation of a quantity of a good/service supplied e.g. taxi licenses. Causes high prices and excess demand.
Taxes
Gov sets a tax on specific goods that have an unseen cost to society that gov pays for.
Inelastic goods will have a smaller DWL after tax
Subsidies
Gov often subsidises to producers to increase production. Cost of supply paid for by tax payer, DWL represents taxpayers money that didn’t boost economic benefit.
DWL
Lost value of transactions that do not occur due to poor allocation of resources.
Market failure
An instance where the market does not naturally allocate resources efficiently therefore the market fails
Market power
Firms can use market power to exploit market by varying output and changing prices. Monopoly = one
Firms with market power have incentive to reduce competition to grow market power ANTI COMPETITIVE BEHAVIOUR
-leads to higher PS but lower CS resulting in DWL
Externality
Anytime economic activity affects someone outside market its called an EXTERNALITY
Negative externality
Market produces MORE than efficient quantity because costs to society aren’t reflected in price consumers pay.
Solution = tax
Positive externality
Market produces LESS than efficient quantity because benefits to society aren’t reflected in price consumers willing to pay
Solution = subsidy
Rival
The consumption of the good prevent another consumer from consuming
Excludable
A non-payer can be excluded from consuming it
Public goods
-non-excludable/non-rival
-private producers wont produce these goods because of no profit even though they are often essential
Free rider problem
-public goods
-non tax payers enjoying benefit of good
-to avoid it gov imposes universal taxes so they have enough revenue to fund these goods and make them universally accessible
Common property goods
Non excludable but it is rival.
Lack of price tag consumers are incentivised to overuse
Tragedy of the commons
Overuse of common property goods I.e fishing
To avoid this - gov uses regulations such as licenses and quotas to avoid depletion
Opportunity cost
Choosing one option over another and giving up the opportunity to get benefits of the other option
Production possibility frontier
-model showing all possible production combinations, wth a set amount of resources/technology. Illustrates trade-offs, opportunity cost, efficiency in the economy, econ growth.
-points inside/on are attainable, inside inefficient and outside unattainable
Anti competitive behaviour
Incentive to reduce competition to grow market power e.g price fixing, collective boycotts, collusion
