How Markets Work Flashcards
In classical/ neoclassical Econ what are decision makers required to be?
In classical and neoclassical economics, decision makers are assumed to be rational.
What does rational decision making mean for consumers and producers?
For consumers it means buying products that maximise utility. Where utility is the satisfaction or benefit derived from consuming a good.
For producers it means maximising their profits.
How is maximum profit achieved for firms?
Maximum profit is achieved through producing as efficiently as possible and making products that consumers both want and can afford.
To make rational decisions what do economic agents require?
- time
- information
- ability to process information
What does rational mean?
Selecting the option which presents the highest utility (benefit)
What is behavioural economics?
A school of economic thought based on evidence and observation to develop assumption of economic decision making. This used an inductive rather than deductive approach.
What does behavioural economics assume individuals to have?
Assumes individuals have bounded rationality, where individuals wish to maximise utility but are unable to do due to a lack of time, information and ability to process information.
What aspects of human behaviour prevent rational decision making?
- habitual behaviour (used to a habit)
- consumer inertia (fear of the unknown)
- people influenced by others behaviour
- consumer weakness at computation (don’t understand data, unable to calculate)
What is demand?
Demand is the quantity of goods and services purchased (consumers are able and willing to buy) at a given price over a given period of time.
Describe the relationship between demand and price level.
As the price level increases demand decreases as less people are able to afford it.
As the price level decreases demand increase as more people are able to afford it.
What causes movement along the demand curve?
Only changes in price causes movement. An increase in price causes a contraction in demand. A decrease in price causes an expansion in demand.
What causes demand curve to shift?
Demand curve will shift with an increase or decrease in the factors of demand.
What factors affect demand?
- the age in structure
- income
- advertising
- population
- changes in prices of related goods
- consumer tastes/ preferences
What are substitute goods?
Two alternative products that could be used for the same purpose. (e.g pencil and pen)
What are complement goods
Complement goods are products that are used together
E.g. notebook and pen
What is revenue and total revenue?
Revenue is the income that a government or company receives
Total revenue = price x quantity
What is the firms role in a market?
Firms in a market supply goods and services
What is supply?
Supply is the quantity of a good/ service that firms are willing to sell at a given price over a given period of time
What happens to supply as the price of a good Changes?
As the price of a good increases quantity supply increases
As the price of a goof decreases quantity supply decreases
What causes movement along the supply curve?
Changes in price causes movement along the curve. Increase in price causes expansion in supply. Decrease in price causes a contraction in supply
What factors affect supply?
- changes in production cost
- improvement in technology/ innovation
- no. of firms
- weather conditions
- prices of related goods changing
- firm speculating price changing (going up)
What markets are mostly affected by the weather?
Agricultural and farms as they depend on crops and there quality/ quantity depends on weather
What is excess demand?
Excess demand is when the quantity of demand is greater than the quantity supplied at the given prices
QD>QS (Below the market equilibrium)
What is excess supply?
Excess supply is when the quantity supplied is greater than quantity demanded
QS>QD (above the market equilibrium)
What is the equilibrium price?
When QD=QS when price has no tendency to change, also known as market clearing price
Why is the equilibrium price also known as market clearing priced?
Because at this price the exact quantity that producers take to market will be bought by consumers and there should be no left over.
What is direct tax?
A direct tax is a tax levied directly on an individual or organisation
what is an indirect tax?
An indirect tax is a tax levied on a good or service.
What is a specific tax?
A specific tax is an indirect tax which have a fixed amount of tax added on to the market price of a good or service
- causes parallel shift in the supply curve
- the tax is the same fixed amount at all prices
E.g. fuel duty , beer duty
What is an Ad valorem tax
It is an indirect tax which is a tax based on the value of a good/ service rather than the quantity/ weight.
- causes a non- parallel shift in the supply curve
- the tax increase as the amount sold rises
E.g. VAT, implicit tariffs
What is a subsidy?
A subsidy is a payment from the gov to a producer to lower their costs of production and to encourage production
Why are taxes imposed by the government?
- generates revenue as funding for public services (e.g roads, healthcare, education)
- it raises production cost (good to decrease production of demerit good)
What are the two types of indirect taxes?
- AD VALOREM
- SPECIFIC TAX
What does subsidies do to the supply curve?
Subsidies shift the supply curve right (firms can produced more w lower costs) which lowers market price
What are some effects of subsidies?
- subsidies increase output - lowers price for consumers
- increase employment rate (increases wages, if firms have fewer costs they can afford more labour to increase production)
- could help keep inflation low with low prices
- could boost demand during periods of economic decline
What is price elasticity of demand?
Price elasticity of demand measures the Responsiveness of demand given a change in price
When is demand price inelastic?
demand is price inelastic when a change in price causes a proportionately smaller change in demand
- graph is roughly vertical
- PED<1
When is demand price elastic?
Demand is price elastic when a change in price causes a proportionately larger change in demand
- graph is roughly horizontal
- PED>1
What are the determinants of price elasticity of demand?
- Number of substitutes
- Necessity/ luxury
- Addictiveness
- Time
- Proportion of income spent on the product
Describe an elastic, inelastic demand graph
An elastic demand graph is more horizontal (greater change in QD)
An inelastic demand graph is more vertical (little change in QD)
What is the equation of PED
PED = (percentage change in QD/ percentage change in price) x 100
Describe the type of elasticity with each PED value
Elastic >1
Inelastic <1
Unitary. 1
Perfectly elastic 0
What is price elasticity of supply?
Price elasticity of supply measures the responsiveness of supply given a change in price
When is supply said to be inelastic?
Supply is inelastic when a change in price causes a proportionately smaller change in supply
What is price mechanism?
Price mechanism describes how the decision taken by consumers and producers interact to determine the allocation of scarce resources between competing uses.
What are the three functions of price mechanism?
- signalling
- incentive
- rationing
What is the purpose of price mechanism?
The main function of price mechanism is to:
- allocate resources
- signal changes in supply and demand
- provide incentive to producers and consumers
What is consumer surplus?
Consumer surplus is the extra amount of money consumers are prepared to pay for a good/ service above what they actually pay for
+
It is the utility/ satisfaction gained from a good/service in excess of the amount paid for it
What is producer surplus?
Producer surplus is the difference between the amount the producer is willing to sell a product for and the actual price they do
+
it is the extra earning obtained by a producer above the minimum required for them to supply the good/service
What is an indirect tax?
A tax levied on a good/ service imposed by the government.
What are the effects of an indirect tax?
- They increase production costs for producers
- so they supply less
- this increases market price
- so demand decreases
What are the two types of indirect tax
- Ad Valorem tax (percentages, such as VAT - it adds 20% of the unit price)
- specific taxes (set per unit, such as 58p per litre fuel duty in unleaded petrol)
Describe how specific tax/ ad valorem tax affects graph?
- specific tax causes a parallel shift in supply
- ad valorem tax causes a non-parallel shift in supply
Why do government impose taxes?
In order to raise gov revenue and/or encourage certain economic activities such as investment in human capital, infrastructure.
What is a subsidy?
A subsidy is a payment from the government to a producer to lower their production costs and to encourage production.
What are the effects of subsidies?
- increase output/ lowers prices for consumers (help families with low and fixed incomes)
- they reduce inequality in society
- help boost demand during periods of economic decline
- encourage consumption of merit goods creating positive externalities
What is irrational behaviour?
It’s when consumers make choices and decisions that go against the assumption of rational utility.
What are the two types of indirect taxes?
- Ad valorem taxes
- specific taxes
What is the difference between specific and ad valorem tax?
An ad valorem tax places a proportionately higher tax on expensive goods (meant to cause consumers to switch from expensive Dmerit goods to cheaper alternatives)
Specific tax increases the price of all equally and impacts demand more.
What is utility?
The capacity of a good/ service to satisfy some human want.
What is marginal utility?
The additional satisfaction that a consumer gains for consuming one additional unit of a product
What is diminishing marginal utility?
As successive units of a good are consumed the utility gained each extra unit will fall.
Reasons for market failure
- missing markets (merit goods & public goods)
- lack of competition
- externalities
- imperfect market information
- factor immobility
- inequality
