Market Mechanism Flashcards
Equilibirum Market
The point where the supply curve of a good or service crosses the demand curve, at the price where the quantity demanded equals the quantity supplied.
Price Mechanism
The way in which price changes affect quantity demanded and quantity supplied, thus determining scarce resesource allocation in a market.
Shortage occurs when (2)
Increase in demand
Decrease in supply
3 functions of the price mechanism
- signaling (WHAT)
- incentives (HOW)
- rationing (FOR WHOM)
Signaling
information is provided to consumers and producers about what should be consumed and produced. WHAT
What does it signals producers and consumers when there is a shortage
A shortage makes prices rise
Consumers –> less
Producers –> more
Wha does it signal producers and consumers when there is a surplus
surplus makes prices decline
consumers –> more
Producers –> less
Why prices are an incentive to reallocate resources
Asuumprion that consumers and producers are rational and that they will behave according to the laws of demand and supply.
Incentive function
HOW
The function of the price mechanism where motivation is provided to consumers and producers to reallocate resources in a market.
It brings the market back to equilibrium
What incentive does higher prices give to consumers and producers
Consumers –> maximize utility so buy less of it
Producers –> maximize profits so produce more. of it
Rationing
The function of the price mechanism where the economic question of ‘for whom’ is determined
Prices help to ration scarce resources
How are resources rationed when prices are high
Prices are high because shortage
low supply will be given to those consumers who are willing and able to pay
Efficiency
Efficiency refers to improved resource use. It is where a firm can produce the same good, but with fewer resources.
Allocative Efficiency
Producing the optimal combination of goods from a society’s point of view; achieved when the economy is allocating resources so that no one can be better off without making somebody else worse off.
‘what to produce’
MSC=MSB
Productive efficiency
refers to producing goods by using the fewest possible resources, which implies producing at the lowest possible cost it is nececary for allocative efficiency
‘How to produce’
Community Surplus
The sum of the consumer surplus and producer surplus; the total benefit gained by society when the market is at equilibrium.
Consumer surplus
The difference between the price that consumers pay and the price that they are willing to pay. It is the extra benefit consumers receive for paying a lower price than the one they were prepared to pay.
the consumer surplus is larger when
the prices are lower
competition in free markets is an advantage because t lowers the prices
Producer surplus
The difference between the price producers are willing and able to sell it and the price earned from selling the good at the market price.
there is allocative efficiency when
the market is in equilibrium
social surplus is maximized
most efficient way from societys pount of view
Under what assumtion allocative efficiency could be achieved
both consumers and producers are making perfectly rational choices and have perfect information about their own utility and costs.
rational behavior
economic theory, behaviour of a consumer or producer that seeks to maximise utility or profit, respectively; behaviour that exhibits stable preferences over time.
4 assumptions of rational consumers
- prefer goods that are stable and transive over time
- have analytical skills in terms of costs and utiliy
3.perfect information - maximizes utility
Dual process model
A theory of human thinking that proposes that people have two broad ways of thinking, often called System 1 and System 2. System 1 thinking comes automatically, with little effort and little or no control. System 2 thinking is conscious, reasoned, and deliberate.
Cognitive biases
A way that human thinking and decision-making deviates from rationality.
heuristic
An approach to solving a problem that uses a practical method that may not be particularly rational, but is sufficient to reach a goal.
Anchoring
Tendency to rely to heavily on the first piece of information given, therefore influencing the perception of the next information given
Framing
form of cognitive bias where human thinking and decision-making is affected by the way in which a problem is stated, or framed.
Availability
A mental shortcut that relies on immediate examples that come to a given person’s mind when evaluating a specific topic, concept, method or decision.
Bounded rationallity
The idea that human rationality is limited in predictable ways.
Consumers maximize marginal utility when
marginal utility = 0
then, it begins to decline
Bounded self control
The idea that human beings have some self-control, but that it is limited.
Hyperbolic discounting
The tendency for people to increasingly choose a smaller-sooner reward over a larger-later reward as the delay occurs sooner rather than later in time.
Bounded selfishness
The idea that human beings, while somewhat selfish, also act as conditional cooperators.
Choice arquitecture
The way choices are structured for consumers.
Default choice
A situation where an option is automatically set for consumers, but that they can change it if they wish.
nudge
Any arrangement of the choice architecture that alters people’s choices without limiting choices or significantly changing incentives.
profit maximization
The process by which a firm determines the price, input, and output levels that result in the highest profit.
