Markets in action Flashcards
Price elasticy of demand
The responsiveness of quantity demanded to a change in price
Elastic demand
Where quantity demanded changes by a larger percentage than price. Ignoring the negative sign, it will be a value greater than 1
Inelastic demand
Where quantity demanded changes by a smaller percentage than the price. Ignoring the negatice sign, it will be a value less than 1
Unit elastic demand
Where quantity demanded changes by the same percentage as price. Ignoring the negatice sign, it will be a value equal to 1
Total revenue (TR) (per period)
The total amount received by firms from the sale of a product, before the deduction of taxes or any other costs. The price multiplied by the quantity sold: TR= P*Q
Price elasticity of supply
The responsiveness of quantity supplied to a change in price
Formula for price elasticity of demand
The percentage(or proportionate) change in quantity demanded divided by the percentage(or proportionate) change in price: %ΔQd÷ %ΔP
Total consumer expenditure on a product(TE) (per period of time)
The price of product multiplied by the quantity purchased: TE= P*Q
Formula for price elasticity of supply (arc method)
ΔQs/(average Qs)÷ ΔP/(average P)
Income elasticity of demand
The responsiveness of demand to a change in consumer incomes
Normal goods
Goods whose demand increases as consumer incomes increase. They have a positive income elasticity of demand. Luxury goods will have a higher income elasticity of demand than more basic goods.
Inferior goods
Goods whose demand decreases as consumer incomes increase. Such goods have a negative income elasticity of demand.
Speculation
Where people make buying or selling decisions based on their anticipations of future prices.
Self-fulfilling speculation
The actions of speculators tend to cause the very effect that they had anticipated
Stabilising speculation
Where the actions of speculators tend to reduce price fluctuations
Destabilising speculation
where the actions of speculators tend to make price movements larger
Short selling (or shorting)
Where investors borrow an asset, such as shares of foreign currency; sell the asset, hoping the price will soon fall; then buy it back later and return it to the lender. Assuming the price has fallen, the short seller will; make a profit of the difference (minus any fees)
Risk
When an outcome may or may not occur, but its probability of occurring is known. It is a measure of the variability of that outcome.
Uncertainty
When an outcome may or may not occur and its probability of occurring is not known
Expected value
The predicted of average value of an outcome over a number of occurrences, calculated by taking each of the possible outcomes and multiplying it by its probability of occurrence and then adding each of these values
Risk neutral
When a person is indifferent between a certain outcome and a gamble with the same expected value
Risk averse
Where you would require a gamble to have a higher expected value than a certain outcome before being willing to take the gamble. The more risk averse you are, the higher the expected value you would require(i.e. the better would have to be the odds).
Risk loving
Where you would be willing to take a gamble even if its expected value was lower than that of certain outcomes. The more risk-loving you are, the lower the expected value you would be prepared to accept(i.e. the worse the odds would need to be)
Diminishing marginal utility of income
Where each additional unit of income earned yields less additional utility than the previous unit.
Future price
A price agreed today at which an item(e.g. commodities) will be exchanged at some set date in the future
Spot price
The current market price
Adverse selection
The tendency of those at greatest risk to take out insurance
Moral hazard
The temptation to take more risk when you know that other people(e.g. insurers) will cover the risk.
Asymmetric information
Where one party in an economic relationship has more or better information than another
Pooling risk(for an insurance company)
The more policies an insurance issues and the more independent the risk from these policies are, the more predictable will be the number of claims
Ław of large numbers
The larger the number of events of a particular type, the more predictable will be their average outcome
Independent risks
Where two risky events are unconnected. The occurrence of one will not affect the occurrence of the other
Minimum price
A price floor set by the government or some other agency. The price is not allowed to fall below this level(although it is allowed to rise above it)
Maximum price
A price ceiling set by the government or some other agency. The price is not allowed to rise above this level(although it is allowed to fall below it)
Rationing
Where the government restricts the amount of a good that people are allowed to buy.
Underground or shadow markets
Where people ignore the government’s price and/or quantity controls and sell illegally at whatever price equates illegal demand and supply
Price elasticity of demand is a measure of
the responsiveness of demand to a change in price.
It is defined as the proportionate (or percentage) change in
quantity demanded divided by the proportionate (or percentage) change in price. Given that demand curves are downward sloping, price elasticity of demand will have a negative value.
If quantity changes proportionately more than price,
the figure for elasticity will be greater than 1 (ignoring the sign): demand is elastic. If the quantity changes proportionately less than price, the figure for elasticity will be less than 1 (again, ignoring the sign): demand is inelastic. If quantity and price change by the same proportion, the elasticity has a value of (minus) 1: demand is unit elastic.
Demand will be more elastic the greater the number and closeness of
substitute goods, the higher the proportion of income spent on the good and the longer the time period that elapses after the change in price.
Price elasticity of supply measures the responsiveness of
supply to a change in price. It has a positive value.
Supply will be more elastic the less
costs per unit rise as output rises and the longer the time period.
The total expenditure on a product is found by
multiplying the quantity sold by the price of the product.
When demand is price elastic,
a rise in price will lead to a reduction in total expenditure on the good and hence a reduction in the total revenue of producers.
When demand is price inelastic,
a rise in price will lead to an increase in total expenditure on the good and hence an increase in the total revenue of producers.
Income elasticity of demand measures
the responsiveness of demand to a change in income. For normal goods it has a positive value; for inferior goods it has a negative value.
Demand will be more income elastic the more
luxurious the good and the less rapidly demand is satisfied as consumption increases.
Cross-price elasticity of demand measures the
responsiveness of demand for one good to a change in the price of another.
For substitute goods the value will be positive; for complements it will be negative.
The cross-price elasticity will be more elastic the
closer the two goods are as substitutes or complements.
A complete understanding of markets must take into account
the time dimension.
Given that producers and consumers take a time to respond fully to price changes, we can identify different
equilibria after the lapse of different lengths of time. Generally, short-run supply and demand tend to be less price elastic than long-run supply and demand. As a result, any shifts in demand or supply curves tend to have a relatively bigger effect on price in the short run and a relatively bigger effect on quantity in the long run.
People often anticipate price changes and this will affect
the amount they demand or supply. This speculation will tend to stabilise prices (i.e. reduce fluctuations) if people believe that the price changes are only temporary. However, speculation will tend to destabilise prices (i.e. make price changes larger) if people believe that prices are likely to continue to move in the same direction as at present - at least for some time.
Many economic decisions are taken under conditions of
risk or uncertainty. If we know the probabilities, we are said to be operating under conditions of risk. If we do not know the probabilities, we are said to be operating under conditions of uncertainty.
People can be divided into
risk lovers, risk averters and those who are risk neutral. Because of the diminishing marginal utility of income it is rational for people to be risk averters (unless gambling is itself pleasurable).
Uncertainty over future prices can be tackled by
holding stocks or through transactions in futures markets. Consumers may hold a buffer stock of saving because of the uncertainty around future incomes.
Insurance markets provide a way of
eliminating risk. If people are risk averse they are prepared to pay premiums to obtain insurance. Insurance companies are able to pool risk by selling a large number of policies, but require that the risks are independent.
The government may fix
minimum or maximum prices. If a minimum price is set above the equilibrium price, a surplus will result. If a maximum price is set below the equilibrium price, a shortage will result.
Minimum prices are set as a means of
protecting the incomes of suppliers or creating a surplus for storage in case of future reductions in supply. If the government is not deliberately trying to create a surplus, it must decide what to do with it.
Maximum prices are set as a means of
keeping prices down for the consumer. The resulting shortage will cause queues, waiting lists or the restriction of sales by firms to favoured customers. Alternatively, the government could introduce a system of rationing. If it does, then underground markets are likely to arise. This is where goods are sold illegally above the maximum price.
