How Markets Work - T1 Flashcards
What does rational decision making rely on
Perfect information
Judgement skills
Interdependent from others decisions
Sufficient time to make decision
Why is the demand curve downwards sloping
As marginal utility decrease, consumers will only buy more of a good if the price decreases
Factors shifting demand
Price of substitutes/complimentary goods Income tax Advertisement Fashion Income rises
What is PED
Price elasticity of demand- the responsiveness of demand to a price change
%change in demand / % change in price
Values of PED and that effects elasticity
If PED>1 - elastic If PED<1 - inelastic If PED = 1 - unitary elasticity If PED=0 - inelastic (drugs) If PED = Infinite - elastic
How will firms total revenue change depending on elasticity of good
Firms total revenue will increase as price level moves towards midpoint
If good is elastic a decrease in price will lead to higher revenue
If good is inelastic and increase in price will lead to higher revenue
What determines price elasticity of demand
Availability of substitutes- more = more elastic
Luxury: elastic
Necessity : inelastic
%of income spent on good, if high % elastic
Addictive- inelastic
Time Period- less elastic in short run
Branding- Inelastic
Income elasticity
Responsiveness of demand for a good or service to a change on real income
%Change in demand / %change in income
Income elasticity of different types of goods
Normal: +YED, YED>1 luxury good elastic , YED<1 inelastic
Inferior goods: negative YED, people buy higher quality of goods as income increase so inferior goods are bought less
Cross elasticity
The responsiveness of demand for good B to a change in price of good A
% change in demand for good B / %change in price of good A
How does the price of other goods effect the demand of good B (XED)
Substitutes goods are in competitive demand:
If price of coffee increase so will demand for tea
XED is positive
Complementary goods:
XED is negative
Price of tennis rackets goes up,demand for balls goes down
XED=0 if goods are unrelated
Supply
Quantity of goods that firms are willing to sell
What will shift the supply curve
- improvements in technology
- reduction in labour/ transport/ capital costs
- discovery of new oil, reduction of oil prices
- decrease in external market influence
PES
The responsiveness of supply to a change in price
%change in supply / % change in price
What do the PES values means
PES >1 elastic PES<1 inelastic PES = 1 unitary elasticity PES =0 perfectly Inelastic PES = infinite
What determines PES
Level of spare capacity, high spare capacity = elastic
State of economy, in recession spare capacity is high
Level of finished stock, high = elastic
Perishability of product, cannot be stocked piled = inelastic
High barriers to entry= inelastic
Time period, inelastic in short run
Equilibrium price
When quantity demanded = quantity supplied
Function of price mechanism
Resources allocated to those willing to pay the most
Rise in price = incentive for firms to supply more/ new firms to enter the market since profit is higher
Consumer surplus
The amount of money a consumer is willing to pay above the amount they actually paid for a good
Producer surplus
Extra amount of money paid to producers above what they would of accepted
What shifts in demand or supply would change consumer/producer surplus
Increase in demand will increase both
Decrease in supply will reduce both
Indirect taxes
Specific taxes - set amount added to price e.g £1
Ad valorem tax - % of goods price added on top e.g 20%
Who does the burden of tax fall onto
Consumers usually
Unless PED is elastic and PES is inelastic
Problems with Economists assumptions of consumer activity
People do not buy to maximise utility
Economic models are created on how consumers should behave
Consumers are influenced by each other “herd mentality”
Habitatal behaviour
Consumers: stick to what they know, think short term, have imperfect knowledge, do not know what they want
