Kennah economics 1.2 Rational decision making Flashcards
The underlying assumption of rational economic decision making. What to consumers aim to maximise
UTILITY which is the satisfaction gained from consuming a product
The underlying assumption of rational economic decision making. What to firms aim to maximise.
PROFIT. Economic theory assumes that firms are run for their owners and shareholders and so aim to maximise profit to keep shareholders happy
The underlying assumption of rational economic decision making. What do the government aim to maximise.
SOCIAL WELFARE. Governments are voted in by the public and work for the public so should aim to maximise the satisfaction by taking decision which increase social welfare.
What are the economic agents
Individuals.
Government.
Businesses.
What is market demand?
The quantity of goods or service that will be purchased at a given price in a given time period.
What is ‘effective demand’.
Means the ability and willingness to buy a good or service.
What is the difference between a movements and shift of the demand curve?
A movement is caused by a change in price of the good where as a shift is caused by a change in any of the factors which affect demand.
What are the factors that cause a shift in demand. ( pasific )
Population.
Advertisement.
Substitutes.
Income tax.
Fashion/trends.
Interest rates.
Compliments.
What is elasticity of demand
An attempt to measure the responsiveness of quantity demand to a change in other variables .
What is price elasticity of demand.
Responsiveness of demand to a change in prices of the good.
Change in quantity demand/change in price (%)
Factors of price elastic goods.
Very responsive to price changes.
Many substitutes.
Products widely available.
E.g cereal.
Factors of price inelastic goods.
Less responsive to price changes.
Highly branded.
Innovative.
In short supply.
Few substitutes .
Habit forming.
Factors influencing PED. SPLAT
S=subsitutes
p=%of income
L=luxury or necessity
A=addiction
T=time
What is income elasticity of demand
The responsiveness of demand to a change in REAL income.
%change in quantity demanded/%change in income
What is a normal good
Demand rises as income rises. When YED between 0-1
What are inferior goods
Demand falls as income rises. When YED is <0
What are luxury goods.
Type of normal goods when YED > 1
What is cross price elasticity of demand
This is responsive of quantity demanded for a good for a change in price of another good.
%change in quantity demanded of good a/ % change in price of good B
Values of XED
Complements=negative XED
Substitutes=positive XED
Weak relationship=<1
Close relationship=>1
No relationship=0
What is supply
The ability and willingness to provide a good or service at a particular price at a given moment of time.
PES= %change in QS/% change in price
Factors that cause a shift in supply (PINTSWC)
P=productivity
I=indirect taxes
N=number of firms
T=technology
S=subsidies(and taxes)
W=weather
C=costs
What is competitive supply
Where the production of one good prevents the supply of another
What is price elasticity of supply
This is the responsiveness of supply to a change in price of the good
Factors influencing PES
BRITS
B=barriers to entry
R=raw materials
I=inventory
T=time
S=spared capacity(land/time)
What is short term classed as
The period of time when at least one factor of production is fixed
What is long term classed as
Period of time when all factors of production are variable.
What is equilibrium
A situation in which price has reached the level where quantity supplied= quantity demanded.
What is equilibrium price
The price that balances quantity supplied and quantity demanded.
(Pe)
What is equilibrium quantity(Qe)
The quantity supplied and quantity demanded at the equilibrium price
What is the equilibrium also called
The market clearing price because at this price everyone in the market has been satisfied
What do you get if your raise prices above equilibrium
A surplus. Excess supply
What do you get if you lower prices below equilibrium.
A shortage. Excess demand
What is the rationing function
The price system is as a way of rationing goods because when prices increase some people will no longer be able to afford to buy the product and others may not have the desire to buy the good. This allows the limited resources to be rationed and allocated to the people who can afford them and value them the most highly.
What is the signalling function
The price mechanism acts as a signal where resources should be used. When prices rise producers move resources into the manufacture of that product. The change in price indicates to supplier and consumers that market condition have changed so they should change the quantity bough and sold as when price equilibrium moves so does output equilibrium.
What is the incentive function
Acts as an incentive for people to work. Buyers realise the more money they have they can buy more products. Suppliers realise that if they produce more goods they will make more money. Also low prices act as an incentive for consumers to buy more of a good and high prices act as an incentive to supplier to sell more of a good.
What is consumer surplus
The difference between the price the consumer is willing to pay and the price they actually pay set by the price mechanism.
What is producer surplus
The difference between the price the supplier is willing to produce their product at and the price they actually produce at set by the price mechanism.
Alternative views of consumer behaviour
The underlying assumptions for all rational decision making is that customers aim to maximise it utility, companies aim to Maximise profit, government aim to maximise welfare. However people do not always act rationally
What are the 3 reasons consumers don’t behave rationally?
*influences of other people
*influence of habitual behaviour
*consumer weakness at computation
Influences of other people
Rationality assumed people act individually to maximise their own benefits but sometimes people are influenced by social norms, known as bias.
“Herding behaviour” occurs when an individual copies the actions of a large group.
Influence of habitual behaviour
Habits reduce the time it takes to do something because consumers no longer have to consciously think about their actions.
Habits create a barrier to decision making since they limit or prevent customers considering an alternative. (Includes addictions)
Another habit many consumers have is buying their products at eye level so supermarkets tend to keep higher priced products near the top and lower price products lower.
Consumer weakness at computation
Many consumers aren’t willing or able to make comparisons between prices and so they will buy more expensive goods than needed. E.g buying multipack because they assume it’s cheaper but it’s not always.
Also consumers are poor at self-control and so do things they shouldn’t or make decisions without looking at the long term effects so make irrational decisions.
