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Economic A Level > Free Markets > Flashcards

Free Markets Flashcards

1
Q

What is a free market economy also known as

A

The market mechanism/the price mechanism

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2
Q

What is the market mechanism

A

It is a system of allocating scarce resources by allowing consumers and producers to come together freely to agree what to exchange and for what price

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3
Q

What are the 3 functions of a price mechanism

A

The signalling function
The incentive function
The rationing function

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4
Q

What is the signalling function

A

That prices provide information to buyers and sellers about the scarcity of a good and shows them about the cost of their actions

Consumers that pays a high price for a good has a high opportunity cost
Producers that is selling a cheap good has a high opportunity cost

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5
Q

What is the incentive function

A

Firms are incentivised by potential profit and as prices change the profitability of production changes
The function refers to movements along the supply curve

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6
Q

What is the rationing function

A

It is the method of changing prices to decide who gets the limited good by increasing prices if there is too much demand and vise versa
This refers to extensions and contractions along the demand curve

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7
Q

What 3 problems exist in a free market

A

What to produce
How to produce it
For whom to produce

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8
Q

How is the problem of what to produce solved

A

Private firms compete against each other to meet consumer demand and earn profit
The firms which meet consumer preferences will make the lost profit
Consumers decide what to produce by deciding what to buy
This is called Consumer Sovereignty

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9
Q

How is the problem of how to produce goods decided

A

Firms engage in free and open competition and are motivated by profits
The firm which uses its resources most effectively are able to sell at the lowest price and earn the most profit
This is known as competition

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10
Q

How is the problem of for whom to produce solved

A

Prices are set at a price so quantity demanded equals quantity supplied and so price acts as a rationing mechanism and the goods given to people able to pay

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11
Q

What are externalities

A

They are a type of allocative inefficiency when external effects are placed on third parties who are not involved in the production or consumption of the good or service
This causes too many or too few resources to be used bu over or under producing

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12
Q

What do externalities cause

A

Partial market failure

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13
Q

What happens when only the seller and buyer are effected

A

Then all the costs and benefits are private and internal

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14
Q

What will cause a rational buyer and seller to by or sell

A

If their private benefits exceed their private costs

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15
Q

What types of externalities are there

A

Externalities can be positive or negative e.g. perfume and alcohol
They can also happen when the good is being produced or consumed

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16
Q

What are the two reasons for market failure

A

Public goods and externalities

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17
Q

What are public goods

A

They are non-rivalry - consumption of the good doesn’t leave any less for others

There is non-excludability - No one can be prevented from enjoying the benefits of the good if they didnt pay - Free Riders

There is non-rejectability - Consumers cant decide whether to consume the good or not

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18
Q

What are examples of public goods

A

Street lighting
Firework displays
Flood barriers

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19
Q

What problem does public goods cause

A

They have the free rider problem which means private firms cant force people to pay so providing the good isnt profitable so isnt produced

This causes the good to not be produced at all and a market goes missing

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20
Q

What are Quasi-Public goods

A

Non pure public goods
Goods that meet all the characteristics of a public good some of the time
Meet some of the characteristics of a public good

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21
Q

When is a market allocatively efficient

A

When the market is at equilibrium
No shortages or surpluses
Social Welfare is maximised

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22
Q

What is social welfare

A

The sum of consumer surplus and producer surplus

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23
Q

What is the demand curve also know as

A

Marginal Private Benefit
MPB

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24
Q

Why is the new demand curve named like that

A

Because a rational buyer will be assessing the extra benefits, or marginal utility, that he will receive from consuming the good

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25
Q

What is another name for the supply curve

A

Marginal private cost

26
Q

Why is the new supply curve named like that

A

A rational seller will think how much it costs to make the next unit of output and whether it can be sold profitably

27
Q

Where is free market welfare maximised on a MPB and MPC graph

A

At the equilibrium where MPB = MPC
Move to far too the right and there is more cost than benefit

28
Q

What are the names of the demand and supply curve changed to when they take into account externalities

A

Marginal Social Costs
Marginal Social Benefits

29
Q

How do you measure the size of an externality

A

It is the vertical distance between the new supply or demand curve and the old one

30
Q

What curve will move when the externality happens at the point of production

A

The MPC

Supply

31
Q

What curve will move when the externality happens at the point of consumption

A

The MPB
Demand

32
Q

When externalities are present what point is most allocatively efficient

A

MSB = MSC

33
Q

What is the welfare or deadweight loss on an allocativly inefficient graph

A

The triangle that represents the net benefit to society that is lost because not enough or too many resources were produced
Triangle connects the three lines together
Triangle points left when the externality is negative
Triangle points right when the externality is positive

34
Q

What are goods called with positive externalities

A

Merit Goods

35
Q

What are goods with negative externalities called

A

Demerit Goods

36
Q

What do negative externalities lead to

A

Overproduction of a good

37
Q

What does positive externalities lead to

A

Underproduction of a good

38
Q

What is information failure

A

When consumers and producers are not fully aware of all the costs and benefits of a transaction

39
Q

What does information failure cause

A

It means that it will be impossible for consumers and producers to trade the right amount of output

40
Q

What are the causes of information failure

A

Consumer ignorance of the costs and benefits
The disconnection in time between the costs and benefits being felt
Consumers are deceived
Complex Information
Asymmetric Information

41
Q

What will happen if consumers underestimate the costs or overestimate the benefits of consumption

A

They will overconsume the good
The MPB will shift inwards when they have full information

42
Q

What will happen if consumers overestimate the costs or underestimate the benefits of consumption

A

The consumers will under consume the good
The MPB would move outwards when they have the full information

43
Q

What happens when there is information failure with a demerit good

A

There is over consumption

44
Q

What happens when there are negative production or consumption externalities with a demerit good

A

Over consumption and over production

45
Q

What happens when there is information failure for merit goods

A

Under consumption and production

46
Q

What happens when there are positive production and consumption externalities with merit goods

A

Under consumption and production

47
Q

Examples of supply side policies

A

Deregulation of markets e.g. Banking, energy supply
Industry Privatisation e.g. Royal Mail
Work Visa’s for occupations like doctors, engineers, vets - Points based immigration system
Industry Regulation e.g. environmental laws affecting waste - drive innovation
Fiscal supply side policies e.g. early year childcare
Tax incentives for specific sectors - life sciences

48
Q

What are property rights

A

It is when a firm or group is given the rights to a common resource

49
Q

What are the advantages of property rights

A

It incentives the owners not to exploit common resources
The negative externalities are internalised
Will reduce the quantity to socially optimal level

50
Q

What are the problems with property rights

A

Hard to distribute efficiently
Enforcement costs money
Hard to judge equity

51
Q

What is 1st degree price disrimination

A

Charging different prices for each individual unit purchased

52
Q

What is 2nd degree price discrimination

A

Prices varying by quantity sold
Prices varying by time of purchase

53
Q

What is 3rd degree price discrimination

A

Charging different prices to groups of consumers segmented by price elasticity of demand, income, age, sex

54
Q

How do you show 3rd degree price discrimination in a diagram

A

2 different diagrams
One with elastic price elasticity of demand and one with inelastic
The MC is a flat line and the same for both diagrams

55
Q

What are the advantages of price discrimination

A

Makes better use of spare capacity - less waste and unsold stock
Helps generate cash flow for firms which can ensure they survive in recession
Can help fund cross subsidy of goods and services
Higher monopoly profit can finance research which improves dynamic efficiency and lead to social benefits

56
Q

What are the disadvantages of price discrimination

A

Price discrimination mainly benefits producers as they turn consumer surplus into profit
Can be used as a pricing tactic to reduce competition
May lead to manipulation of groups with inelastic demand
Can be perceived as unfair or inequitable to certain groups

57
Q

What is the evaluation of price dicrimination

A

Assumes the same marginal cost of supply
Impact of price discrimination depends on how the profit is used
Some buyers must pay more to cover development costs
Is a fair price only ever a fixed price - valuer judgements

58
Q

What are examples of price dicrimination

A

Coca Cola selling cans for more when its hot
Uber increasing prices during peak times
Higher prices for heavier people on airlines- Samoa airlines

59
Q

What are the conditions required for price discrimination

A

Firms must have sufficient monopoly power
Identifying different market segments
Ability to separate different groups: Requires information on the purchasing behaviour of consumers
Ability to prevent re-sale (arbitrage): No secondary markets where arbitrage can take place at intermediate prices

60
Q

What are the aims of price dicrimination

A

To increase total revenue by extracting consumer surplus
To increase total profit
To generate cash-flow especially during a recession
To increase market share and build customer loyalty
To make more efficient use of a firm’s spare capacity
To reduce waste and cut the cost of keeping products in stock / storage

Economic A Level (22 decks)

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