Micro L12 - 18 Flashcards
Price elasticity of demand/supply
Measures the responsiveness of demand/supply given a change in price
Price elastic
Change in price causes a proportionately larger change in demand/supply
Price inelastic
A change in price causes a proportionately smaller change in demand/supply
Determinants of PED:
- Number of substitutes
- Necessity/Luxury
- Addictiveness
- Time
- Proportion of income spent on product
How does the number of substitutes affect PED?
Greater the number of substitutes, greater degree of consumer switching during a price change (more elastic)
How does whether the product is a luxury/necessity affect PED?
If a product is a necessity people will buy it regardless of the price change, therefore more inelastic
How does addictiveness affect PED?
The more addictive a product is the more inelastic demand will be
How does time affect PED?
Consumers are given the opportunity to find alternatives making price more elastic
How does the proportion of income spent on a product affect PED?
Greater the proportion of income spent, the less able consumers will be to afford any further price increases, therefore more elastic
Determinants of PES:
- Time required to produce product
- Level of spare capacity
- Number of stocks of finished goods/services
- Time
- Perishability of product
How does time required to produce the product affect PES?
Greater amount of time needed, slower firm will be able to respond to price changes therefore price inelastic
How does level of spare capacity affect PES?
Greater the spare capacity, quicker firms will be able to respond by utilising available factors of production therefore more price elastic
How does the number of stocks/finished goods affect PES?
Greater this number, quicker firms will be able to respond by releasing these stocks, therefore price elastic
How does time affect PES?
Greater time period, firms are given opportunity to expand/reduce production, more price elastic
How does perishability of product affect PES?
More perishable a product, harder it is to build stocks, therefore more price inelastic
Calculation for PED:
% change in quantity demanded/percentage change in price
Calculation for PES:
% change in quantity supplied/% change in price
What is PED/PES defined as at different values and what are these?
- Below 1 is elastic
- Between 0 and 1 is inelastic
- Equal to 1 is unitary
Derived demand:
Demand for a good/service which is the consequence of demand for something else eg. Demand for Labour is derived from demand for goods + services
Effective demand:
Demand for good/service which occurs when purchasers are constrained in a different market eg. Demand for the cheaper bread brand increases due to lower disposable income preventing the purchase of the more expensive bread
Joint demand:
Demand of one good/service is directly and positively relative to another good/service eg. if demand of good X increases, demand of good Y increases
Composite demand:
Good/service has more than one use so the increase in demand for one use eg. oil for plastics leads to fall in supply for another use eg. oil for petrol
What law of demand do Veblen goods follow?
- Veblen goods = Goods perceived to be of better quality if they cost more.
- They are exceptions to the law of demand: as price increases, demand increases
Speculative goods
Goods which are purchased because consumers believe the price will rise after
Giffen goods
Goods where a rise in price actually leads to an increase in demand eg. basic food staples
Consumer surplus:
- Extra amount of money consumers are prepared to pay for good/service above what they actually pay
- Extra utility gained from good/service for amount paid for it
Producer surplus:
- Extra amount of money consumers paid to producers above what they’re willing to accept to supply a good/service
- Profit gained by a producer above the minimum required for them to supply the good/service
As price falls, what happens to consumer and producer surplus?
- Consumer surplus increases
- Producer surplus decreases
How is consumer surplus calculated on a supply and demand curve?
Area of triangle above market equilibrium
How is producer surplus calculated on a supply and demand curve?
Area of triangle below market equilibrium
Income effect
Assuming a fixed level of income, income effect means that as price falls, amount consumers can afford increases, so demand increases
Marginal utility
Utility obtained from consuming one extra unit of good/service
Diminishing marginal utility
As successive units of a good are consumed, marginal utility gained from each extra unit (the difference) will fall
Cross price elasticity of demand (XED):
Measures the responsiveness of demand for one good to changes in the price of another good
XED of substitute goods
Positive
XED of complement goods
Negative
XED of unrelated goods
Zero
Calculation for XED:
% change in quantity demanded of product A/ % change in price of product B
Is the value higher or lower if the substitute/complement is strong?
Higher
Income elasticity of demand: (YED)
% change in quantity demanded/ % change in income
Normal goods:
When income increases demand increases
Inferior goods: (give an example)
When income rises, demand decreases eg. value brand products
Is the value positive or negative for a normal and inferior good?
Normal good: Positive
Inferior good: Negative
What are normal goods that have a YED between 0 and 1 classed as?
- Income inelastic
- Necessity
What are normal goods that have a YED between above 1 classed as?
- Income elastic
- Luxury
What are normal goods that have a YED equal to 1 classed as?
- Unitary elastic
Functions of Price Mechanism:
1) Signalling
2) Incentive
3) Rationing
Describe the signalling function:
Changes in price provides info to both producers and consumers about changes in market conditions
Describe the incentive function:
- Increase in demand
- Leads to a rise in prices
- Encourage firms to increase production
Describe the rationing function:
- Shortage of product
- Causes prices to rise
- Deters some consumers from purchasing products
When demand is price elastic, what happens to total revenue when price increases and decreases?
Opposite always happens:
- Price increase causes decrease in total revenue
- Price decrease causes increase in total revenue
When demand is price inelastic, what happens to total revenue when price increases and decreases?
Same thing happens:
- Price increase causes increase in total revenue
- Price decrease causes decrease in total revenue
Market failure:
- Too much/too little of a good is produced/consumed compared w/ socially optimal level of output
- Price mechanism leads to inefficient allocation of resources
Negative externality (external cost):
Cost to a third party that is not involved in making, buying/selling and consumption of specific good/service
Positive externality (external benefit):
Benefit to a third party that is not involved in making, buying/selling and consumption of specific good/service
Non-rival w/ example:
Consumption of a product doesn’t prevent another person from consuming that product eg. radio programme because one listening to it doesn’t stop anyone else from doing so
Rival w/ example:
Consumption of a product prevents another person from consuming that product eg. radio, as when one person is using it, another can’t
Non-excludable w/ example:
Once a good is provided, it is impossible to stop people from using it eg. Lighthouse
Excludable w/ example:
Once a good is provided, people can stop themselves from using it if they wish eg. people can be excluded from purchasing a new model of car if they cannot afford it
Merit goods:
Beneficial to individuals and society but are often under-consumed in the economy
Features of public good:
- Non-excludable
- Non-rival
Features of private good:
- Rival
- Excludable
Give one type of market failure, why it occurs, why it’s a problem and what it results in.
- Free rider problem
- Everyone is able to benefit from the use of public goods despite not paying for it
- Results in good being underprovided/ not provided at all (merit good)
Social benefits:
External benefits + Private benefits
Social costs:
External costs + Private costs
Positive externality:
Social benefit ≠ Private benefit, as external benefits are present
Negative externality:
Social costs ≠ Private costs, since external costs are present
Social optimal level of output:
All external benefits and external costs accounted for
In a free market, what will there be if external benefits are present?
Underconsumption/Underproduction
In a free market, what will there be if external costs are present?
Overproduction/Overconsumption
Check costs and benefits diagram for social welfare loss w/ external costs & benefits
