Micro Flashcards
Define price elasticity of demand
The responsiveness of quantity demanded for a good or service to changes in its price
What is considered inelastic price elasticity of demand
Anything less than 1, often goods that are necessities, don’t have many substitutes, are addictive or are a small portion of total spending. This is because people have to buy them, even if the price increases, so the quantity doesn’t change too much due to a change in price
What is considered elastic price elasticity of demand?
Anything greater than 1, often goods that are luxuries, have many substitutes and represent a high portion of households total spending. This is because they can find something cheaper, and they can forgo buying it if the price increases as they don’t actually need it.
Define the “incidence” of a tax
Who actually pays the tax
What type of price elasticity of demand results in the tax falling mainly on:
a) consumers
b) producers
a) inelastic
b) producers
Why does the incidence of the tax fall on consumers when there in inelastic demand
The producers can pass more of the tax onto their customers as it will have a less than proportionate decrease in the quantity demanded since it is inelastic.
Why does placing a tax on an inelastic good raise higher tax revenue than on one with elastic price elasticity of demand
Because the quantity decreases less than proportionately due to the price rise, resulting in a relatively large number of goods and services on which the tax is imposed and therefore greater tax revenue is collected
Define price elasticity of supply
The responsiveness of the quantity supplied of a good or service to changes in its price
Describe momentary, short run and long run elasticities of supply
momentary - right now - they can’t change their factors much so supply is perfectly inelastic
short-run - firms are restricted in their ability to change output, so it is a little sloped but still relatively inelastic
long-run - firms have time to expand and change their factors, which means they can change their supply - it is elastic
Define equilibrium
A balance between the forces involved, where quantity supplied = quantity demanded, and both parties are completely satisfied and the market is clear
How are the equilibrium price and quantity in a market determined?
By the interaction of the forces of demand and supply
what does ceteris paribus mean
all other things unchanged/held constant
Where can the equilibrium be found on the graph
Where the demand and supply curves intersect
Define a surplus
Excess supply, occurring at any point above the equilibrium where the quantity supplied by producers is greater than the quantity demanded by producers
How will the market react to a surplus
Firms are willing to accept a lower price to sell unsold stock. As the price decreases, the good or service becomes less profitable for producers (decrease quantity supplied) and more affordable for consumers, making them more willing and able to buy it (increase quantity demanded). This happens until equilibrium is reached and the market is cleared
Define a shortage
Excess demand at any price below equilibrium where the quantity demanded is greater than the quantity supplied
How will the market react to a shortage
Consumers bid up the prices - more profitable for producers (increase quantity supplied), less affordable for consumers (decrease quantity demanded) until the equilibrium quantity is reached and the market is cleared
Define consumer surplus
the difference between the maximum amount that a person is willing to pay for a good or service and its current market price. this represents the benefit consumers receive over and above what they pay for it
Where do you find consumer surplus on a graph
the area above the equilibrium price paid (pe) and below the demand curve
Define producer surplus
The difference between the total earnings of suppliers for a product and the total cost required to put that quantity on the market. This occurs because firms are willing to supply each unit at lower than the equilibrium price they currently receive in the market
Where can you find producer surplus on a graph
Area below the price firms receive (pe) and above the supply curve
What assumptions do we draw the production possibility frontier with?
There are two goods only, a fixed level of resources and a given level of technology
What does the PPC (production possibility curve) actually show
the maximum output combination of two goods that can be produced given that existing resources and technology are used fully
How can the production possibility curve shift outwards
By developing new resources or finding new resources
Can you have a point outside the PPC curve and what does this mean
No, this is impossible given the current level of technology and resources
Can you have a point inside the PPC curve and what does this mean
Yes, it means the market is producing inefficiently - resources are not being fully utilised or put to their best possible use
Can you have a point on the PPC curve and what does this mean
Yes, all points on the curve are production efficient, but only one can be allocatively efficient - the position that represents what the customers actually want
Define allocative efficency
This requires production efficiency, and it is not possible for one person to be made better off without making someone else worse off - the most efficient socially desirable use
Where on a regular graph would allocative efficiency occur
At the free market equilibrium where the total consumer surplus and producer surplus are maximised
Define an indirect tax
An indirect tax is a tax collected by firms and then passed on to the government
What immediate effect does an indirect tax have on the market, and how is this shown on the graph
It will decrease supply, causing the price to rise and the quantity to decrease. Move the supply curve vertically upwards by the amount of the tax
To what extent to consumers pay the tax
The amount of the price rise, and any amount not covered by the price increase has to be absorbed by the firm
When there is a tax imposed, how do you find the price each of these groups receives/pays:
a) consumers
b) producers
a) the new equilibrium price
b) from the new equilibrium, dot down until you reach the old supply curve, then go across to find the price at this point
Where and why does the deadweight loss exist when there’s a tax
This is the loss of allocative efficiency because part of the consumer surplus and part of the producer surplus are not picked up by the tax. It is found on the graph as the triangle to the right of the box that represents the tax. It is between the new equilibrium price and the price producers receive, as well as between the two equilibrium quantities
What is a subsidy
A payment by the government to firms to keep their costs down and as a result, firms will increase supply
How do you show the effect of a subsidy on a graph
Move the supply curve down by the amount of the subsidy (down because supply is increased as costs are decreased)
To what extent do each of these groups take the impact of the subsidy
a) consumers
b) producers
a) to the extent of the price decrease
b) the price per item the firm receives will be higher, and their costs will be reduced. they will increase supply, meaning a quantity supplied at each and every price
Where is the deadweight loss of a subsidy found on the graph?
Between the price producers receive and the new equilibrium price and between the two equilibrium quantities.
Between the two supply curves but to the right of the demand curve and in line with the new equilibrium quantity
Where do you shade the subsidy on the graph
The box between the price producers receive and the new price, all the way out to the new quantity
Where does the incidence of the subsidy fall when demand is:
a) inelastic
b) elastic
a) mainly on consumers, large decrease in the price paid by consumers, the consumers benefit more
b) on producers, the decrease in the price paid by the consumer is relatively small, benefits the producer or seller more
Where on the graph can the incidence of a subsidy for consumers and producers be found
Consumers - the box from the left bottom corner up to the old equilibrium
Producers - the box from the bottom left corner outwards until the vertical downwards line goes through the new equilibrium, minus the consumer bit (should just be an upside down L shaped area outside of the consumer incidence area but surrounding it)
Define a maximum price control
price ceiling control set by the government, prohibiting producers from charging a higher price than this
Why would the government impose a maximum price control
To protect the consumers from paying unreasonably high prices for essential goods and services for example housing, petrol or certain food items such as bread and milk
How do you show a maximum price
A straight line, somewhere below equilibrium, resulting in a shortage
What happens to where you show producer and consumer surplus and deadweight loss due to a maximum price control
Producer surplus is the same, just underneath the maximum price but above the supply curve.
The consumer surplus is above the maximum price, and to the left of the quantity supplied
The deadweight loss is the triangle from the edge of consumer surplus at quantity supplied to the original equilibrium
Define a minimum price control
floor price, a price control set by the government where the market price is not allowed to fall below a certain minimum, resulting in a surplus
Why would the government use a minimum price
To protect producers in volatile markets and ensuring they are not receiving an unreasonably low price
How do you show a minimum price
A straight line at the price, which will be above the equilibrium
What happens to where you show producer and consumer surplus and deadweight loss due to a minimum price control
Consumer surplus is the same - above the minimum price and below the demand curve
Producer surplus is below the minimum price but above the supply curve, but only to the left of the quantity demanded
Deadweight loss is the triangle from the edge of the producer surplus until the original equilibrium
What can arise to sell goods above a maximum price or below a minimum price in response to the shortages and surpluses these situations create
Black markets
International free trade is more allocatively efficient than not trading, because the area of total surplus increases. TRUE OR FALSE
All very true
Where is the producer and consumer surpluses on a free trade exports graph
consumer surplus is above the world price and below the demand curve
producer surplus is below the world price and above the supply curve
Where is the producer and consumer surpluses on a free trade imports graph
Consumer surplus is above the world price and below the demand curve
Producer surplus is below the world price and above the supply curve
Is there a deadweight loss in the free trade graphs (either export or import)
nope, trading is very allocatively efficient, the surpluses both increase
What is protectionism, give examples
Government measures to limit international trade, resulting in a loss of allocative efficiency as the market equilibrium is altered. Examples are tariffs and quotas
what happens to the surpluses, deadweight losses and tax collected areas on a protectionism graph
Consumer and producer are the same as in the free trade graphs, except above and below the price with the tariff
A new section is created between the free trade price, the tariff price and between the demand and supply curves, made up of three parts
There are triangles of deadweight loss on either side of this area and a rectangular area of tax collected in the centre
The tax rectangle is in between where the demand and supply curves hit the tariff price
The deadweight losses (yes two of them) are on either side of this box, out to the demand and supply curves themselves
Where is the new price and quantity shown on the graph when a tariff has been imposed?
The new price is PwT at the price + tariff line
The new quantity is where the demand curve meets the tariff price, and is called QdT
Where are the change in imports shown on the free trade graph with a tariff
Original imports is the whole distance from QsF (where the supply curve meets the free trade price line) to QdF (where the demand curve meets the free trade price line)
The new imports is shown between QsT (where the supply curve meets the tariff price line) and QdT (where the demand curve meets the tariff price line)
How do you work out the total spend on that good from the free trade protectionism graph and also how do you find the imports $ amount
Total spend is the QdT (where the demand curve meets the tariff price) multiplied by the PwT (tariff price)
The import $ is the amount of imports (between QsT and QdT ie between where the two curves cut the tariff price) multiplied by the tariff price. This amount makes up part of the total spend calculated above
