markets and market failure (paper 1) DONE Flashcards
what is the process of developing economic models? (including the need for assumption)
The process of developing models – economics studies human interactions, this interaction is complex and is influenced by many factors. Therefore, economists create models, as they’re simpler versions of reality, and make it easier to analyse.
^The need for assumption: assumptions allow for the problem to be simplified, and thus making it easier to solve. Assumptions work well, as there are often patterns in human behaviour, which provides a foundation for predictions.
what does Ceterius parabius mean?
“all other things remain the same”. This is a form of assumption. Due to its simplicity, an economist can focus on specific variables without having to worry about others.
what is the inability in economics to make scientific experiments?
scientific experiments are achievable in natural sciences as there is a “control group”, meaning observations can be made with a level of certainty. Whereas economists collect data in the real world where variables are constantly changing. This makes it harder to tell whether your evidence supports or denies your hypothesis – meaning scientific methods cannot take place in economics.
what is the difference between a positive and normative statement?
Positive statement – are objective statements based on evidence and have a truth value. For example, “The unemployment rate is 4%”.
Normative statement – focuses on value judgement, based on opinion. Evidence helps build this statement, yet it only acts as a guideline. For example, “the best way to tackle unemployment is to increase education”.
what is the role of value judgement in economics?
a value judgement weighs up what ought to be the case, based on what we perceive as good and bad. Therefore, value judgements are usually needed in areas of high moral concern – like the healthcare system.
what is the problem of scarcity within economics?
The problem of scarcity – unlimited wants and finite resources. Economic agents need to therefore make decisions on how goods should be allocated – this is achieved through the price mechanism. Scarcity in an economy means there’s excess demand for a good. Resources which are scarce are called 2economic goods2 as they have a price which is used to ration the product. Whereas goods that are not scarce are called free goods. There is no need to ration free goods as there’s an abundance of them – for example, air, sunlight, etc.
what is the difference between a renewable and non-renewable good?
Renewable good – can naturally replenish itself overtime. This is good cannot be used up in the same way non-renewable goods can. For example: solar energy.
Non-renewable good – cannot replenish itself overtime. Once it is used, it is gone. For example: coal.
what is an opportunity cost?
an opportunity cost is the benefit foregone when making an economic decision. For example, if I buy a laptop, the opportunity cost is I could’ve brought a new phone instead. Every choice involves a range of alternatives. Therefore, we weigh up opportunity costs by evaluating the utility gained by each option.
what does a production possibility frontier show?
A production possibility frontier shows all the possible options of output for two economic good, if all factors of production were used. A point on the curve therefore shows full employment.
draw a PPF diagram between wine and cotton
A – prioritising wine instead of cotton.
^The opportunity cost here, is the cotton foregone.
C – shows prioritising Cotton over wine.
^The opportunity cost here, is the wine foregone.
X – shows the economy is not at full employment.
^If more resources became employed, X would move closer to the curve.
Y – shows an unachievable output with the economy’s current resources. Y would be achievable if economic growth took place, and the curve shifted right. This is because the PPF line shows the maximum level of output with your current resources. Any point on the PPF shows resources fully employed – this is unrealistic, as workers need to go home, and machinery needs to be turned off.
what does it mean if the PPF moves left or right?
If the curve moves left – this is economic decline. This is because there’s a decrease in the economies potential. For example: spread of a virus.
If the curve moves right – this is economic growth. This is because there’s an increase in the economies potential. This can occur when the quantity of resources increases. For example: more people joining the workforce.
what is the distinction between a consumer good and capital good?
Distinction between capital and consumer good: A capital good is one used for the production of other goods. For example, machinery. Whereas a consumer good are goods used by consumers to satisfy their needs/wants - it has already gone through all its stages of production and is now ready for consumption. For example, an iPhone.
what does specialisation mean?
Specialisation – concentrating labour and resources on the production of a specific type of good, in order to be more efficient.
what is the division of labour?
The division of labour - specialisation by individuals. Adam smith described the division of labour by his pin worker’s example. He stated if each individual specialised in a specific role in the pin factory (like one purpose drawing the wire and another cutting the metal) then more pins would be produced overall. This increase in productivity comes from more output per worker.
what are the advantages to specialisation?
Advantages to specialisation:
Allows for greater productive efficiency - It is cost effective as workers are only provided the specific tools they need and It is less time consuming as workers are not constantly changing tasks.
As greater efficiency means more output per worker, the cost of production is lower, and thus more profit and revenue will be generated. This extra profit maube passed back onto workers, boosting real wages and thus living standards.
As more output is present in the economy, the PPF will move right.
Economies of scale
what are the disadvantage to specialisation?
Disadvantages to specialisation:
Can cause unemployment if your specific skill is no longer in demand.
Can become repetitive and boring, resulting in an unproductive workforce, as workers feel alienated from their tasks.
Specialisation creates a reliance on other companies or countries. For example, the Uks once reliance on Russia for the majority of our oil, and therefore more exposed to external shocks.
what are the 4 functions of money?
The function of money – specialisation calls the need for exchange, as specialising makes us reliant on other people’s goods.
- Medium of exchange – for money to act as a medium of exchange it must be accepted by everyone to hold value. It is for this reason goods can be traded without the need for a barter system. A barter system relies on two people both demanding each other’s goods.
- Measure of value – money is a consistent denominator in the exchange of goods, so it can be used to measure the value of one product in comparison to another.
- Store of value – money holds its purchasing power over time. This means we do not need to spend our money straight away when we receive it, as it’ll be worth the same tomorrow. This allows for us to save up for more expensive goods.
- Method of deferred payment – money allows for someone to get a good but pay at a later date because money holds its value. This means it doesn’t matter when the person who gave out the loan receives the money back, as they haven’t lost anything in value. This allows for borrowing to take place.
what is a free market?
Free market economy – resources are allocated through the market forces and price mechanisms rather than the government.
what are the advantages to a free market economy?
Advantages: - profit incentivises motivate people to work harder as there’s higher rewards available.
-high competition leads to better quality and lower prices in order to stay in demand.
-encourages innovation and product development as there is greater rewards for such risks
-better standard of living due to the profit made
-more efficient use of scarce resources. The price mechanism will ration goods, etc.
what are the disadvantages to a free market economy?
Disadvantages:
1) marker failure - externalities, provision of public goods, asymmetric information
2) monopolies can occur - which are anti-competitive and they can raise price above market equilibrium
3) inequality - due to the meritocracy mindset of the free market, the rich get richer and the poor get poorer -> resulting in income inequality + wealth inequality
what is Adam Smiths take on the free market?
Resources would be best allocated in a free market, as individuals act in their own best interest.
Firms -> look to maximise profit
Consumers -> look to maximise utility
^these two concepts will come together to meet at equilibrium
^This is known as the “invisible hand” , as market forces allow for production to take place at equilibrium.
Supply and demand is the most efficient way of allocating resources, as if the good is in excess demand, this signals to producers to produce more, pushing down the price to equilibrium again.
what is a mixed economy?
Mixed economy – resources are allocated through market forces and the government.
This includes both government intervention and a free market
what is a command economy?
Command economy – all factors of production and resources are allocated by the state, and the government determine the scope of operation (what they’ll be producing, and what quantity).
They believe the profit incentive behind a free market does not act in the best interest of the people.
what are the advantages to a command economy?
Advantages: - encourages equality as the state allocates resources in societies best interest
-low unemployment as the state decides where people work and what they’re paid
- avoids the negatives associated with marker failure (like externalities) as the government is the one allocating them instead
what are the disadvantages to a command economy?
- less choice as workers are taxed more leaving less money for them to make their own economic decisions
-Government failure - inefficient allocation of resources will occur, leading to unexpected consequences due to asymmetric information (For example The USSR producing loads of left shoes and no right shoes)
- lack of profit incentive. Therefore there is no need to compete, and thus no need to produce at the most efficient level. Representing a high level of moral hazard.
-small economic growth as supply isn’t determined by demand, so it won’t operate at market equilibrium.
what is the underlying assumption of rational decision making?
Consumers aim to maximise utility – as resources are scarce, they must weigh up opportunity costs. Their choices are formed by what they believe to be the best outcome for them.
Firms aim to maximise profit – in a free market, firms will look to maximise their profits. If profits are not maximised, they may go out of business.
what is demand?
the quantity of goods bought at a given price
what does a movement along the demand curve show?
Movement along the demand curve – shows how price effects demand. The curve is downwards sloping as when price increases, demand falls. This is called a contraction in demand. Whereas when price falls, demand increases, this is called an expansion in demand.
what does a shift of demand show?
Shift of a demand curve – illustrates a different quantity being demanded at the same price. Movement to the right shows an increase in demand. A movement to the left shows a decrease in demand.
what are the factors that affect demand? (PIRATES)
P - population change effect
I – income effect
R – related good effects (substitutes)
A – advertisement
T – taste/trends
E – expectations (about the price of the good in the future)
S – seasonality
What is the concept of marginal diminishing utility?
The concept of diminishing marginal utility – this states the benefit from consuming a good falls, the more you consume that good. This is because the more buyers are offered, the less value they see on the last one bought.
^If there are few good available, then consumers are willing to pay a higher price, as the marginal utility gained is higher. The demand curve is downwards sloping, as the higher the quantity bought, the lower the marginal utility.
what does PED show?
Price elasticity of demand – measures how responsive demand is to a change in price
what is the equation for PED?
percentage change in quantity demanded divided by a percentage change in price
what does it mean if demand is elastic?
(PED > 1)
A change in price will lead to a bigger change in quantity demanded.
Demand is very responsive to a change in price. PED here would be larger than - this is because there has been a bigger change in demand than the initial change in price. This can occur if there are many substitutes for such good, or if it is not an essential product.
What does it mean if demand is inelastic?
(PED 0-1)
Demand is inelastic if the change in price doesn’t affect the quantity demanded that much. Change in price will be larger than the change in demand. PED = 0-1
The initial change in price is larger than the followed change in demand. Firms will exploit an inelastic PED as they can pass on more of their costs of production onto consumers, as they know they’re more willing to pay.
what does it mean if demand is unitary elastic?
Demand is unitary elastic, as a change in price leads to the exact same change in demand. Ped = 1.
^Some good are considered important to our daily life’s yet not essential, so a change in price may have a corresponding change in demand – for example, phones.
what does it mean if demand is perfectly inelastic?
(PED = 0)
Demand is perfectly inelastic if demand doesn’t change at all when price changes. Therefore PED = 0.
^These goods have no substitutes at all. For example: oil. Demand-pull inflation will occur when such goods prices rise, as the demand curve is perfectly inelastic.
What does it mean if demand is perfectly elastic?
(PED = infinity)
Demand is perfectly elastic if a change in price leads to demand falling to 0. PED = infinity. This may occur when selling a homogenous good, that is identical to any other sellers good.
^For example: foreign currency exchange. As currency is an identical good, and as there is many suppliers of it, if one firm changes its price, customers will go elsewhere - as they know they’re receiving the same good regardless. Advertisement does not work in this scenerio to distinguish the good.
This assumes however that there is symmetric, perfect information present in the market.
