Micro – Basics Flashcards
What is a market?
Any kind of arrangement where buyers and sellers of goods, services or resources are linked together to carry out an exchange.
State the Law of Demand
There is a negative relationship between the price and quantity demanded of a good or service over a particular amount of time, ceteris paribus.
What are the Non-Price determinants of Demand?
- Changes in tastes and preferences
- Changes in income
- Prices of substitute and complementary goods
- Number of consumers
What are the Assumptions underlying the Law of Demand?
1) Law of diminishing marginal utility
2) Income and substitution effects
What is the Law of Diminishing Marginal Utility?
As consumption of a good increases, marginal utility (the extra utility the consumer receives) decreases with each additional unit consumed.
What is the Income and Substitution effect?
Both show that a fall in price leads to an increase in quantity demanded. If the price of a good falls the consumer substitutes (buys more) of the good and the consumer’s purchasing power has increased.
State the Law of Supply
There is a positive relationship between the price and quantity supplied of a good or service over a particular amount of time, ceteris paribus.
What are the Non-Price determinants of Supply?
- Costs of factors of production
- Supply Shocks
- Number of firms
- Technological innovation
- Competitive supply (choosing goods to produce)
- Joint supply (goods produced by the same derivative)
- Future expectations
- Taxes and Subsidies
What are the Assumptions underlying the Law of Supply?
1) Law of diminishing marginal return
2) Increasing marginal cost
What is the Law of Diminishing Marginal Return?
As more units of a variable input (labor) are added to fixed inputs (land), the marginal product of the variable input (labor) at first increases until later decreases.
What is Marginal Cost?
The extra additional cost of producing one more unit of output.
What is the relationship between the Law of Diminishing Marginal Return and Marginal Cost?
Negative
Describe Competitive Market Equilibrium
Where quantity demanded equals quantity supplied and there is no tendency for the price to change.
What are the Functions of the Price Mechanism?
1) Resource allocation through signalling and incentive
2) Rationing
How does the Price Mechanism contribute to Resource Allocation?
Prices can act as signals and incentives in the allocation of resources. Prices act as signals to communicate information to decision-makers, and as incentives to motivate decision-makers to respond to the information.
How does the Price Mechanism contribute to Rationing?
Price mechanism determines that weather or not a consumer will get a good is determined by the price of the good. (Those who can afford the good will have it, those who cannot, won’t).
What is Consumer Surplus?
Benefit received by consumers who buy a good at a price lower than the price they are willing to pay.
What is Producer Surplus?
Benefit received by producers who sell a good at a price higher than the price they are willing to sell.
What is Social Surplus?
The sum of consumer and producer surplus.
How does the Market achieve Allocative Efficiency?
When social surplus is maximum and marginal benefits are equal to marginal costs (MB=MC).
What are the assumptions underlying Rational Consumer Choice?
1) Consumer Rationality
2) Perfect information
3) Utility maximization
What is Consumer Rationality?
Consumers make choices based on their preferences and they are:
• Able to rank goods according to preferences
• Have consistent choices
• Always prefers more rather than less
What is Perfect Information?
The state in which the consumer has access to all the information regarding all alternatives so that there is no uncertainty.
What is Utility Maximization?
Consumers will buy the combination of goods and services which maximises their utility.
What are the limitations of Standard Consumer Behavior?
1) Biases (cognitive bias)
2) Bounded Rationality
3) Bounded Self-control
4) Bounded Selfishness
5) Imperfect information
What are the types of Cognitive Bias?
Biases are systematic errors in evaluation, they include: • Rules of thumb • Anchoring • Framing • Availability
What are Rules of Thumb?
Simple guidelines based on experience and common sense which simplify complicated decisions.
What is Anchoring?
The use of irrelevant information to make a decision.
What is Framing?
How choices are influenced through the way in which they are presented.
What is Availability?
Use of information that is most recently available.
What is Bounded Rationality?
The idea that people are rational only between limits.
What is Bounded Self-control?
The idea that people exercise self-control only within limits.
What is Bounded Selfishness?
The idea that people are selfish only within limits.
What are examples of Policies inspired by Behavioral Economics?
1) Choice Architecture
2) Nudge Theory
What are Nudges?
A method designed to influence consumers’ choices in a predictable way without limiting choice or offering incentives/sanctions.
What is Choice Architecture?
The design of particular ways or environments in which people make choices.
What are the types of Nudges within Choice Architecture?
1) Default Choice
2) Restricted Choice
3) Mandated Choice
What are the advantages of Behavioral Economics?
- Simple and low-cost
- Numerous applications and likely successful
- Freedom of choice
- Overcomes weakness of consumer behavior theory
- Reliable (have been tested)
- Flexible
What are the disadvantages of Behavioral Economics?
- Cannot be accountable for each individual
- Unsystematic approach
- Risks of manipulation
- Could be used as substitutes for necessary policies
- Traditional policies may be more effective
- Choices may not be a reflection of real preferences
What are the Objectives of Businesses?
1) Profit Maximization
2) Corporate Social Responsibility
3) Expand Market Share
4) Satisficing
5) Growth maximization
What is Rational Producer Behavior?
The assumption according to which firms aim to maximise their profit.
What is Corporate Social Responsibility?
The practice of firms to avoid socially undesirable outcomes. Examples include avoiding of pollution, cruelty free products, etc.
What is Market Share?
The percentage of total sales in a market that is earned by a single firm.
What is Growth Maximization?
Making the growth of a firm as high as possible (and reaching economies of scale).
What is Satisficing?
Achieving satisfactory results instead of maximizing.
