Markets Flashcards
Identify factors that cause a decrease in supply.
- Decreased price of substitute goods
- Certain technology no longer available
- Increased cost of FOP
- Decreased quantity of all resources available
- Regulations restricting sales
- Climatic and seasonal influences
Differentiate between a contraction in demand and a decrease in supply?
- Contraction in demand is a decrease in the price of a good lowering demand
- Decrease in supply is a decrease in factors other than the price itself
Differentiate between the Law of Demand and Law of Supply?
- Law of Demand: increase the price while decreasing quantity demand (more expensive the good, the more sales decrease)
- Law of Supply: increase price in certain products, increase in supply (more profitable a good means an increase in supply by increasing production)
Identify 5 factors that cause an increase in demand?
- Price of other goods and services
- Expected future prices
- Consumer taste and preference
- Consumer income
- Size and age distribution of population
Outline factors that influence elasticity of supply?
- Time lags after price change
- Ability to hold and store stock
- Excess capacity
Explain the ways the Government can intervene in the market?
• Price Intervention (price ceiling and price floor) • Quantity Intervention - Externalities - Market-based policies - Legislation - Govt provision of goods + services
Explain reasons for Government Intervention in the market and how they do it.
1) Equilibrium price may be too high for merit goods/too low for demerit goods
2) Social costs arise from production/consumption (positive externality)
3) Social benefits (negative externality)
4) Goods not produced by the private sector (public goods)
5) Goods not produced in enough quantity (community + merit goods)
Addressed by:
Setting price ceiling (max price for a product to be sold at) and floor (minimum price product can be sold at)
Explain how the market will return to equilibrium following an increase in demand?
- Increase in demand causes the level of demand to be higher than the supply
- Consumers bid up prices of products (as price rises, demand falls)
- Equilibrium price at a higher level
Explain how the market will return to equilibrium following a decrease in demand?
- Excess supply to build up
- Firms will decrease prices to clear excess stock, contract in the supply
- As price falls, demand increases
- New equilibrium lower than before
Explain how the market will return to equilibrium following an Increase in supply?
- Surplus of supply
- Firms decrease the prices of products
- Demand increases as the price lowers
- New equilibrium at a lower level
Explain how the market will return to equilibrium following a decrease in supply?
- Shortage of supply
- Consumers will bid up prices, causing contraction in demand
- Suppliers supply more at a higher price
- Equilibrium higher than before
What is the Law of Demand?
Ceteris paribus, the higher the price of a good, the lower the quantity demanded
How does the Law of Demand occur?
- Substitute effect
* Income effect
When does the movement along the demand curve occur?
Arise from only changes in the price itself
What is the Expansion of Demand?
When the price of the good falls, quantity demand increases
What is the Contraction of Demand?
When the price of the good rises, quantity demand falls
When does the movement of the demand curve occur?
Result from any change other than a change in the price of the good itself
What are the factors that affect the Elasticity of Demand?
- Whether the good is a luxury or a necessity
- Whether the good has any substitute goods
- Whether the good is habit forming
- The expenditure on the product as a proportion of income
- The length of time subsequent to a price change
What is Perfect Inelasticity and provide an example?
• Regardless of change to price, quantity demand will not charge e.g. insulin
What is Perfect Elasticity and provide an example?
• Demand will only occur at one price e.g. minimum wage
Define the Law of Supply?
• Ceteris Paribus as the price of a certain product rises, the quantity supplied by producers will rise.
Why does the Law of Supply occur?
- Existing firms – more profitable to produce the good (Production Increase)
- Attract new producers into the market
When does the movements along the supply curve occur?
• Ceteris Paribus, any change in the price of the good itself will lead to a change in the quantity supplied in the same direction as the price changes.
What does the Elasticity of Supply measure?
• Measures the responsiveness of the quantity supplied of a product to change in price
What is the Price Mechanism?
• The interplay between demand and supply to establish the price of a good and quantity of the good at that price.
How does price mechanism attempt to solve the economic problem?
Through interaction between demand and supply, the market will determine which goods/services are produced and at what quantity, hence where resources are located. Thus, addresses the economic problem of scarcity of resources to unlimited wants.
How do governments combat negative externalities?
- Govt imposes a tax on producers
- Cost considered by suppliers when producing product
- Cause a decrease in supply
- Consequent increase to equilibrium price
- Reduction in quantity sold in the market
- Reduces social costs that arise from production or consumption of a good
- Excluded by price mechanism
What is a positive externality and how can the government encourage it?
• Benefit to society that will arrive from consumption or production of a good
• Considered by price mechanism
1) Govt will provide a subsidy (cash payment)
a. To encourage more consumption and production
2) Subsidy can pay for some of production costs for suppliers
a. ↑ in supply
b. More being produced for lower price
c. More quantity used in market
What is a Price Ceiling?
The maximum price that can be changed
What is the purpose of market based policies?
• Govt intervention to address market failure
• Intervene with price mechanism
○ Internalise social costs
○ Social benefits
• Taxes and subsidiesWhat is a Price Floor?
The minimum price that can be charged
What are the price intervention methods and when do they occur?
- Price Ceiling - occur when market price is too high
* Price Floor - occur when market price is too low
What is legislation and why is it used?
- Laws, regulations and policies set out by government
- Exists to address market failure and reduce negative externalities
- Example: The banning of illicit drugs help to reduce social costs.
What are the outcomes for a Price Ceiling?
- Reduce price
* Create quantity shortage
What are the characteristics of a public good?
- Non excludable
- Non rival
- Not produced by private market
- Govt will supply
What are the characteristics of a community/merit good?
- Private sector may not supply enough as it is largely unprofitable
- Govt must also supply directly
What are the outcomes for a Price Floor?
- Increase price
* Create excess in quantity
What is competition in an economy affected by?
- Market structure – number and relative size of firms in industry
- Nature of product being sold
- Ease in which new firms can enter industry
What are market based policies?
Govt. intervention to address MF where they intervene within PM to internalise social costs (neg extern.) and social benefits (pos extern.) that arise from production or consumption of goods.
What quantity intervention strategy can the government take when the market quantity is too high?
Taxes or Regulation
What quantity intervention strategy can the government take when the market quantity is too low?
Subsidies
What quantity intervention strategy can the government take when the market does not provide goods and services?
The Govt. provides the goods and services
What are the outcomes of using taxes and regulations?
- Increase equilibrium price
* Reduce equilibrium quantity
What are the outcomes of using subsidies?
- Reduce equilibrium price
* Increase equilibrium quantity
How can the government afford to provide goods and services?
Govt. collects tax revenue to finance supply of public goods
What are the characteristics of pure competition?
- Many small buyers, none with market power
- All firms sell same product
- No barriers to entry
- No restrictions on quantity
- Firms are price takers
What are the characteristics of Monopolistic Competition?
- Many small firms
- Product differentiation
- Firms have some degree of price setting power
- Some barriers to entry such as brand loyalty
What are the characteristics of an oligopoly?
- Small amount of large firms, hold significant share of market
- Sell similar but differentiated products
- Significant barriers to entry
What are the characteristics of a monopoly?
- Only one firm selling product
- No close substitutes
- Big entry barriers
- Monopolist is price setter
What is the substitute effect?
When the price of a good rises, the substitute good remains constant, people buy less of that good and more of the substitute.
What is the Income Effect?
Goods whose price has increased, and income remains constant, the good with increased price is bought less or not bought entirely.
What is the elasticity of demand and explain how the total outlay method can work out the relative ‘elasticity’ of a good?
• Elasticity of demand is how responsive demand is after a price change.
• Total Outlay Method is a method of calculating the relative elasticity of a good (Price x Quantity Demand)
o Relatively elastic - P+R move in same direction after change
o Relatively inelastic - P+R move in opposite direction after change
o Unit elasticity - change in P but no change in R (QD will not change enough to impact R)
Explain why knowing the elasticity of demand is important for firms and governments.
- Governments want to know how certain goods/services react to price changes in order to form government policies such as taxation or subsidies.
- Taxing inelastic demand will earn the government more revenue while reducing tax on elastic demand.
Differentiate between the sectors of the economy that demand and supply when referring to:
a) A factor market
b) A product market
a) the factor market is the market for any input into the production process (FOP). When there is high demand, there is an increase in demand for FOP e.g. labour. (D+S determine price paid for FOP)
b) the product market is the interaction between demand an supply of the outputs of production (G+S)
Define a negative externatlity
Negative Externalities are social costs that arise from the production or consumption of a good and are not taken into account by the price mechanism
What is an example of a monopoly in the Australian Economy
Sydney Waters and Sydney Trains
What is market failure?
When the economy experiences severe inflation or high unemployment during fluctuations in the business cycle.
