Micro Flashcards
Opportunity Cost
The next best alternative foregone
Why is Demand downwards sloping
Income effect
Substitution effect
Diminishing marginal utility
What is the Income effect
Ceteris Parabus As the price decreases consumers spending power increases
What causes a movement along the D curve
A change in Price
What causes a shift of the D curve
Non-price determinants
4 non-price determinants of Demand
Change in P of substitute - eg bikes+cars
Derived Demand - eg Flour+Bread
Change in tastes - eg parka coats are popular
Changes in incomes
Supply definition
Quantity of a good or service that producers are willing+ able to sell at any given price
Why is Supply upwards sloping
Profit incentive
Covering the costs of production
Attracting new entrants to the market (As P increases, the profit incentive attracts new firms to the market)
4 Non-Price determinants of Supply
Costs of FOP’s (If costs increase then production costs increase so Supply shifts inwards)
Technology (Makes production cheaper so developments shift S outwards)
Joint Supply (Beef and Leather, increased price in one leads to increased supply in the other)
Competitive supply (When producer has a choice between two goods so chooses the more profitable one)
Expectations (If a firm expects P to rise then they’ll hold back some so S curve shifts inwards)
4 FOP’s
Land
Labour
Capital
Enterprise
Three functions of the Price Mechanism
Signalling
Incentive
Rationing
What is signalling (PM)
An increase in the price conveys to the consumers and producers of the increased market value of a good
What is incentive (PM)
Higher prices encourage sellers to produce more of the good due to high demand
What is rationing (PM)
Limited supply will be rationed to those consumers who are prepared to pay a high enough price
Consumer Surplus definition
The difference between the total amount that consumers are willing and able to pay for a good or service and the price they actually end up paying
What is the area of Consumer Surplus
Area under the demand curve and above the market price
Producer Surplus definition
The difference between the price that producers are willing and able to sell a certain good or service for and the price they do actually end up selling it for
What is the area of Producer surplus
Area above the supply curve and below the market price
Price elasticity of demand (PED) definition
the responsiveness of demand to a change in the price
Price elasticity of demand (PED) formula
PED= %∆ in QD/ %∆ in price
PED is always _______
NEGATIVE
IF |PED| >1 then..
% |∆QD| > |%∆P| so is elastic
IF |PED| <1 then..
|%∆QD| < |%∆P| so is inelastic
IF |PED| =1 then..
|%∆QD| = |%∆P| so has unitary elasticity
IF |PED| =0 then..
the good is perfectly inelastic
IF |PED| = ∞ then..
the good is perfectly elastic
Determinants of PED
Availability of substitutes (more available=more elastic)
Width of market definition (pasta v food)
Time (eg petrol)
Proportion of income spent on them
As you go along the demand curve PED becomes
More elastic
If a firm’s revenue increases when the price increases is dependent on..
PED.
If PED is >1 i.e elastic then revenue will fall
If PED is <1 i.e inelastic then revenue will increase
Price Elasticity of Supply (PES) definition
The responsiveness of supply to a change in the price for a good or service
Price Elasticity of Supply (PES) formula
PES= %∆ in QS/ %∆ in price
PES is always _______
POSITIVE
Determinants of PES
Efficiency of supply chain Availability of FOP's Availability of stockpiles to store the good Speed of production process Time Spare capacity in production
Cross Price Elasticity of Demand (XED) definition
The responsiveness of demand for one good to a change in the price of another good
XED= 0 to 1
Distant substitutes
XED= 1+
Close substitutes
XED= 0 to -1
Distant complements
XED= -1 +
Close complements
Who pays tax when Demand = Elastic
Producer
Who pays tax when Demand = Inelastic
Consumer
Who pays tax when Supply = Elastic
Consumer
Who pays tax when Supply = Inelastic
Producer
Positives of an Indirect tax
- Taxes raise revenue for gov projects- good things like education/health
- Taxes can discourage consumption of harmful goods like Petrol and Cigarretes
Negatives of an Indirect tax
- Consumers and producers both ‘pay’ and are worse off
- Producer and consumer surplus btoh shrink causing a welfare loss to society
- Indirect taxes are regressive- increase income inequality.
Impact of an indirect tax depends on…
- Price elasticity of Demand, when PED is inelastic gov revenue is higher
- Incidence of a tax , which is determined by PED for a good
- How firms react to the tax
- What is being taxed.
Subsidy definition
A grant given by the gov to encourage the production or consumption of a good
Why would a gov subsidise a certain good/industry
- necessities promote affordability
- Incentivise consumption of merit goods
- To support local industries
Impact of a subsidy depends on…
- Incidence of the benefit of a subsidy depends on PED
-
Overall both subsidies and taxes lead to a..
Welfare loss
Positive impacts of a Subsidy
- Can encourage consumption/production of a certain good
- Firms sell more + receive higher price.
- Consumers buy more + pay a lower price
- Politically popular
Negative impacts of a subsidy
- Welfare loss as increase in CS and PS is less than cost of gov spending on subsidy
- Opp. cost of gov spending and budget suffers
Price ceiling (max price) definition
A maximum price for the market imposed by the gov above which it’s illegal to sell. Must be imposed below minimum market price to be effective.
Price floor (min price) definition
A minimum price imposed by the gov below which it is illegal to sell the good or service. Must be imposed above the minimum price to be effective.
Effect of Price ceiling on a market
Creates excess demand as QD>QS
Effect of Price floor on a market
Creates excess supply as QS>QD
Positives of maximum prices
- helps consumer by increasing affordability (makes price cheaper)
- In housing; Prevents gentrification. Ensures key workers can afford to live in city.
Negatives of maximum prices
- Creates excess demand which leads to non-price rationing. E.g ‘choosy’ sellers
- Lower incentive to provide a good service
- Quantity sold falls, less available
- Welfare loss
Positives of minimum prices
- Effectively raises price of units so benefits producers
- Reduce Q sold so can influence consumer habits like cigarettes/alcohol
Negatives of minimum prices
- However, fewer units are sold so producer revenue may fall- in the cae os minimum wage there are fewer jobs available, leads to real wage unemployment
- Regressive way of reducing Q sold of de-merit goods like cigarettes and impacts those with low incomes
- Welfare loss created
Market failure defintion
When the free market fails to bring about an optimal allocation of goods + services
Externalities are created when …
Social costs and benefits differ from private costs and benefits
Externalities definition
When the production/consumption of a good/service has an impact (+/-) on a third party not involved in the production/consumption of the good/service
Marginal private cost definition
The cost to the firm of producing one extra unit of output
Marginal social cost definition
The cost to society of the production of one extra unit of output
Marginal Private benefit definition
The benefit gained by the consumer of consuming one extra unit. (D CURVE)
Marginal social benefit definition
The benefit gained by society from the consumption of one extra unit of output
Social welfare is increased by transactions where
Social benefit> Social cost
Social welfare is decreased by transactions where
Social cost> Social benefit
Negative production externality
If firms considered MSC the supply curve would shift in.
Positive consumption externality
If consumers considered MSB then demand curve would shift out.
Example of Negative production externality
solvent factory pollutes river
Example of Positive consumption externality
Vaccinations Deodorant
Evaluation of taxes to correct neg production externality
- Indirect taxes. Effectivity based on;
- how easily measurable the externality is
- elasticity and magnitude of the tax
- How well the tax can be targeted
- Political will of gov
- Whats actually being taxed e.g pollution/output
Examples and Evaluation of regulation to correct neg production externality
EXAMPLES;
- Ban products/processes
- Price controls
- Subsidise clean alternatives
- Regulate hours of production
EVAL;
- Finding appropriate level of regulation
- Cost to firms of meeting the regulations
- Impact on international competitiveness
Evaluation of Tradeable pollution permits to correct neg production externality
Pro’s
- Increase cost of production for the firms that wish to pollute (like a tax)
- Creates a market mechanism as they are sold- positive incentives to those who sell to develop greener alternatives
Con’s
- Largest companies are most able to afford the permits - bad for small business
- Difficult to distribute initially, open to corruption
- Could harm international competitiveness if global agreements are reached
- Arbitrary to set an optimum cap for pollution.
Gov intervention to tackle pos externality consumption
- Subsidies, shift S outwards to increase QD. Depends on; Gov ability to measure per unit externality and get it right. The willingness of tax payer to pay for the subsidy. Opp cost of spending.
- Legislation e.g nudge economics with vaccines. Opt in not opt out
- Advertising
- Direct gov provision of a good
Public goods definition and example
Ones which are not provided on the free market because they are non-excludable and non-rivalrous.
E.G street lamps
Non excludable definition
Can’t prevent consumers who haven’t paid for the good from using it.
Non rivalrous definition
One person using a good/service doesn’t reduce the amount available for others to use the good.
Free-rider problem definition
Occurs due to the fact that public goods are non rivalrous and non excludable. People figure that they can enjoy the good without paying for it and so aren’t willing to pay for the good. This means there is no demand for the good because everyone thinks in this way.
Should the gov provide public goods. For and Against
For;
- Economies of scale, the gov can far more effectively implement something than everyone doing it for themselves. EG Police
- Brings about a social benefit + increases social welfare
- If they don’t, no one will
Against;
- Govs have to ‘guess’ which goods they provide. Difficult to measure how much benefit a good brings about.
- Unfair because everyone pays (through taxes) for a good/service they may not use
Alternatives to public goods: Examples and Evaluation
Regulation to make goods/services excludable
- Lighthouses, only fishermen and boats. boating licence ensures only boat owners pay for the benefit of light house owners.
- Road taxes, helps to pay for the roads maintenance by only road users
Lack of information definition
When decisions are based on imperfect information and aren’t the decisions that would have been made if there were perfect information
Asymmetric information definition
When one side in a transaction has more information than the other side, which they exploit to their own advantage
Merit goods definition
Goods which are under-consumed because the full benefits are not known or the long-run benefits aren’t fully taken into account
Types of information failure/information gaps
- Merit and Demerit goods
- Asymmetric info by the seller e.g Dentistry, Car mechanic
- Asymmetric info: adverse selection, Lemons and Insurance markets
- Principal - Agent problem, when the principal appoints the agent to make decisions on their behalf
Examples of Government failure
- Unintended consequences- Black markets forming, harder to regulate and untaxed e.g cannabis, prostitution
- Info failure- opportunity cost of all gov spending. Hard to know what brings most benefit
- Incentive effects- e.g tax dis-incentivises working
- Political factors- Goal is to be re-elected
- Disrupt market mechanism- leads to unemployment
- Administrative costs
Why is Labour demand downwards sloping
Marginal revenue product theory - MRP decreases -Diminishing marginal productivity
Capital substitutability
Factors shifting the demand curve
- Derived Demand
- Increases in productivity
- Increases in price for the final good
- Changes in capital/technology prices
Factors affecting elasticity of demand for labour
- Proportion of total costs spent on Labour
- PED for final good/service
- Time
- Degree of substitutability between labour + capital
Why is the Individual Labour Supply curve backwards c shaped
- Substitution effect: as wages go up leisure time becomes more expensive (opp. cost wise)
- Income effect: As wages go up workers can afford the luxury of leisure time. So as wages go up people will work less.
HOWEVER;
In the real world workers don’t have such a say over the hours they work. BUT they can decide holidays and retirement.
Some workers are willing to work overtime
Determinants of labour supply to a particular industry
- wages in other industries
- Location, transport house prices
- Non-monetary factors
- working hours
- job security
- travel
- company car etc
Factors affecting elasticity of supply of labour
- Time needed to train for it
- Do the skills have substitutes
- Enjoyment, (enjoy more, supply will be more elastic)
What are labour market rigidities and the problems
- Labour market rigidities are when wages won’t fall due to them being kept artificially high
Problems; - Creates real wage unemployment due to excess supply of labour
- Firms are unable to hire as many workers
- Increase in loss of production for firms
- Loss of jobs to lower wage countries
Occupational immobility of Labour definition
- Your skills/ abilities are so narrow you can’t move industry
Geographical immobility of Labour definition
Workers are unable to move to where there are jobs available.
Other issues with Labour markets
- Monopsony exploitation of workers
- Inequality due to low equilibrium wages
- Information asymmetry issues
- Low labour productivity
Impact of minimum wage depends on
- PED of Labour
- level at which min wage is set compared to previous market equilibrium
Arguments for Min Wage
- Increase productivity, Efficiency wages argument
- Tackle poverty and income inequality
- Tackle monopsony power
Arguments against min wage
- Have far more impact on young and inexperienced workers
- Affect businesses, increase costs, less money for investment
Eval: Forces them to invest in technology and Capital
