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Microeconomics Theme 1 > How markets work > Flashcards

How markets work Flashcards

1
Q

What is rational decision making ?

A

A range of assumptions are made about the rationality of economic agents involved in the transactions.

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2
Q

Define utility

A

The amount of satisfaction obtained from consuming a good or service.

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3
Q

What is the consequence of consumers not having enough income to buy all goods/services they want

A

They have to make a choice about what goods and services to buy and in what quanitites

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4
Q

Define rational decision making for firms

A

Where producers allocate their resources to maximise profits from the goods/services produced.

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5
Q

Define rational decision making for consumers

A

Where consumers allocate their expenditure on goods and services to maximise utility

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6
Q

Define demand

A

The quantity of a good/service purchased at a given price over a given time period

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7
Q

Why does the demand curve for a good, slope downwards from left to right

A
  • As price falls, the good becomes cheaper compared to substitute goods.
  • More goods can be purchased with a given level of income
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8
Q

When is there a movement along a demand curve

A

Only when there is a price change.

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9
Q

Extension in demand cause

A

A fall in price

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10
Q

Contraction in demand cause

A

A rise in price

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11
Q

Factors that cause a shift in the demand curve

A
  • Real incomes
  • Trends
  • Size of the population
  • Prices of substitutes or complements.
  • Interest rates
  • Advertising
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12
Q

Define marginal utility

A

The satisfaction obtained from consuming one extra unit of a good or service

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13
Q

Example of the law of diminishing utility

A
  • E.g at a buffet, the first meal may give a high level of utility if you are hungry.
  • However a second meal will not provide as much utility as the first as you would be less hungry.
  • The more meals consumed, the less utility gained
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14
Q

Define diminishing marginal utility

A

As successive units of a good are consumed, the utility gained from each extra unit will fall

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15
Q

Define total utility

A

the total satisfaction gained from the total amount of a product consumed.

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16
Q

How can the concept of diminishing marginal utility explain the downward-sloping demand curve

A
  • As marginal utility falls from each extra good consumed:
  • Consumers will only buy more of the good if price falls
  • This explains the downward-sloping demand curve
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17
Q

Define price elasticity of demand(PED)

A

The responsiveness of demand for a good or service to a change in price

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18
Q

Calculate % change

A

new value - old value / old value times 100

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19
Q

PED formula

A

% change in Q.D / % change in Price

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20
Q

What does it mean if a good is relatively price elastic

A

*PED is greater than 1
*% change in demand is greater than % change in price

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21
Q

What does it mean if a good is relatively price inelastic

A

*PED is less than 1
*% change in demand is less than % change in price

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22
Q

What does it mean if a good has unit elasticity

A

*PED is equal to 1
*% change in demand is equal to % change in price

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23
Q

What does it mean if a good is perfectly inelastic

A

*PED is equal to 0

*A change in price has no effect on the quantity demanded

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24
Q

What does it mean if a good is perfectly elastic

A
  • PED is equal to infinity
  • A rise in price causes demand to fall to zero
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25
Q

Determinants of PED

A
  • Availability of substitutes- higher value of PED (elastic)
  • Addictiveness of the product-turns products into necessities, low value of PED ( inelastic).
  • price of product as a proportion of income- lower proportion=low value = inelastic.
  • Time period- short term=inelastic, long term= elastic.

-Brand Image= inelastic= willing to pay a premium price.

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26
Q

Define total revenue

A

The total payments a firm receives from selling a given quantity of goods or services.

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27
Q

Relationship between price elasticity of demand and total revenue

A
  • Elasticity falls as you move along the curve from top left to bottom right.

-

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28
Q

Elastic demand on total revenue

A

If demand is elastic:
*A cut in price increases total consumer spending
*This will increase revenue to the firm
*A rise in price reduces total consumer spending
*This will decrease revenue to the firm

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29
Q

Inelastic demand on total revenue

A

If demand is inelastic:
*A increase in price increases total consumer spending
*This will increase revenue to the firm
*A fall in price reduces total consumer spending
*This will decrease revenue to the firm

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30
Q

Define income elasticity of demand

A

The responsiveness of demand for a good or service to a change in real income

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31
Q

Formula for YED

A

% change in Q.D / % change in income

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32
Q

What does it mean if YED is positive?

A
  • product is a normal good
    *A rise in income causes a rise in quantity demanded
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33
Q

Define normal good

A

A good with a positive income elasticity of demand:

*As income rises, demand for the good RISES

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34
Q

What does it mean if YED is negative

A
  • product is an inferior good
  • as income rises, demand for the good falls.
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35
Q

What is the value of normal necessity good, and explain.

A
  • 0 to 1
  • Demand increases when income increases
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36
Q

What is the value of normal luxury good, and explain.

A
  • YED > 1
  • demand increases when income increases.

-income elastic = relatively responsive to a change in income.

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37
Q

What is the value of an inferior good, and explain.

A
  • YED < 0
  • Demand decreases when income increases.
38
Q

Factors that influence YED

A
  • Recession= wages fall = demand for inferior good rises = luxury good falls.
  • Economic growth = luxury good increases = inferior good falls.
39
Q

Define cross elasticity of demand

A

reveals how responsive the change in quantity demanded

40
Q

XED formula

A

% change in Q.D of good A / % change in price of good B

41
Q

what does the negative sign of the XED value mean?

A
  • two products are complements
  • a high value suggests they are strong complements.
42
Q

If XED < 0

A
  • Complementary goods
  • negative value indicates two goods are complements
43
Q

If XED > 0

A
  • Substitutes
  • positive value indicates two goods are substitutes
44
Q

If XED = 0

A
  • Unrelated goods
  • the closer to zero the weaker the relationship is.
45
Q

Define supply

A

amount of a good/services that a producer is wiling and able to supply at a given price in a given time period.

46
Q

Why does the supply curve slope upwards from left to right ?

A
  • positive relationship between price and quantity supplied.
  • profit maximising producers would want to supply more as prices increase in order to maximise their profits.
47
Q

When is there a movement along a supply curve

A

prices changes

48
Q

What causes an extension in supply

A

A rise in price causes an increase in the quantity supplied

49
Q

What causes a contraction in supply

A

A fall in price causes a decrease in quantity supplied.

50
Q

What does an increase in supply refer to

A

price rises = producers have an incentive to increase production

51
Q

What does a decrease in supply refer to

A

price falls = less profitable to supply a product = reduce output

52
Q

What factors cause a shift in the supply curve of a good

A
  • Costs of production = raw materials, wages
  • Indirect taxes = supply curve shift to the left.
  • Subsidies = grants = supply curve shift to the right
  • New technology = increase in productivity = supply curve shifts to the right.

-Productivity of the workforce = rise = shift to the right

53
Q

Define price elasticity of supply (PES)

A

reveals how responsive the change in quantity supplied is to a change in price.

54
Q

PES formula

A

% change in Q.S / % change in Price

55
Q

What does a positive PES indicate

A

price and quantity move in the same direction

56
Q

When is PES perfectly inelastic

A
  • =0
  • The QS is completely unresponsive to a % change in P.
57
Q

When is PES relatively price inelastic

A
  • 0<1
  • % change in QS is LESS THAN proportional to the % change in P.
  • e.g agricultural products
58
Q

When is PES relatively price elastic

A
  • 0 > 1
  • The % change in QS is MORE THAN proportional to the % change in Price.
59
Q

When is PES perfectly elastic

A
  • infinity
  • % change in QS will fall to zero with any % change in price.
60
Q

Determinants of price elasticity of supply

A
  • Mobility of the factors of production :
  • Availability of raw materials:
  • Ability to store goods:
  • Spare capacity
  • Time period:
61
Q

Define equilibrium price

A

When the quantity supplied is equal to the quantity demanded at the market clearing price point.

62
Q

Define excess supply

A

quantity supplied is greater than the quantity demanded at the existing price.

63
Q

Define excess demand

A

quantity demanded is greater than the quantity supplied at the existing price.

64
Q

Price and the equilibrium position in a free market

A

determined by the interaction of demand and supply in a market.

65
Q

What do producers do if there is an excess supply

A
  • lower prices to generate more revenue
  • cleared the excess supply
66
Q

What do producers do if there is an excess demand

A
  • raise prices to generate more revenue.
67
Q

Define the price mechanism

A

interaction of demand and supply in a free market

68
Q

What is the objective of the price mechanism

A

determines prices which are the means by which scarce resources are allocated between competing wants/needs.

69
Q

What are the 3 functions of the price mechanism

A
  • Rationing
  • Signalling
  • Incentive
70
Q

How does the rationing device work

A
  • Market forces ensure ; amount demanded is exactly equal to the amount supplied.
  • When resources become scarcer = price will rise further.
  • If surplus = prices fall = more affordable.
71
Q

How does the signalling device work

A

prices provides information to producers & consumers where resources are required (price increase) and where they are not ( price fall ).

72
Q

How does the incentive device work

A

the prospect of making a profit acts as an incentive to firms to produce goods and services.

73
Q

Define consumer surplus

A

difference between the amount the consumer is willing and able to pay for a product and the price they actually paid

74
Q

Define producer surplus

A

difference between the amount that the producer is willing and able to sell for a product for and the price they actually do.

75
Q

Define tax

A

mandatory contributions levied on individuals or corporations by a government

76
Q

What are the two types of tax

A
  • Direct taxes
  • Indirect taxes
77
Q

Define direct tax

A

a tax that a person or organization pays directly to the entity that imposed it

78
Q

Define indirect tax

A
  • paid on the consumption of goods and services
  • usually levied on demerits good to reduce Q.D.
79
Q

What are the two types of indirect tax

A
  • Ad valorem
  • Specific tax
80
Q

Define specific tax

A

set amount per unit of the product

81
Q

Define ad valorem tax

A

percentage of the price of the product

82
Q

How does an indirect tax affect a good or service

A
  • increase in the cost of supply
  • supply curve shift to the left
83
Q

What does a specific tax cause on the diagram

A

supply curve shift to the left

84
Q

What does an ad valorem tax cause on the diagram

A

supply curve shift to the left and become steeper

85
Q

Define incidence of tax

A

relates to how the burden of a tax is distributed between different groups e.g producers and consumers.

86
Q

Impact of subsidies to consumers

A

decrease in price

86
Q

Define subsidy

A

a grant from the government that has the effect of reducing costs and increase quantity of production.

87
Q

What do economists assume about consumers and rationality

A

people act rationally and aim to maximise utility.

88
Q

Define behavioural economics

A

psychological insights into human behaviour to explain economics decision-making.

88
Q

Three reasons why consumers may not behave rationally

A
  • consideration of the influence of other peoples behaviour
  • habitual behaviour
  • Inertia

Microeconomics Theme 1 (4 decks)

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