Micro Theme 1 Flashcards
What is Production Possibility Frontier
The maximum output combinations produced by a economy using all given resources
What are the 4 F.O.Ps
Land - Rent
Labour - Wages
Capital - Taxes
Entrepreneurship - Income
Summarise the key ideas of Adam Smith in 2-3 sentences:
-Developed market economy
-Ideas of division of labour and importance of specialisation
-Invisible hand ensure people got what they need based on their needs
What is the definition of opportunity cost?
Opp. Cost (y) = gain in x/loss in y
Explain opportunity cost
Benefit gained when one good is given up
A positive statement can be…
Verified by data/real life (True or False)
Normative statements are based on…
Value judgement
Summarise Karl Marx’s key ideas:
- disagreed with Adam smiths ideas and believed in one central power to assign the distribution of resources.
- though the bourgeoisie exploited the proletariat and gave unfair wages. - planned economy
What is the basic economic question?
How can available scarce resources be used to satisfy peoples infinite needs and wants as effectively as possible
-what should we make/do
-how should we make/do
-who should benefit
What are diminishing marginal returns
-shown by concave graph
-increase opp cost
-normally seen on larger scale
What are the key ideas of Hayek?
-Favoured market economy but believed there is a bottom line that should not be crossed
-some public goods should be distributed as Marx outlines
-believed mix economy is the best option
-believed Marxism would leave to dictatorship
What are renewable resources?
-Resources that are replenished at as rate that is equal than or greater than the rate that they are depleted at
What is division of labour?
-observed by Adam smith
-splitting work into small tasks and allocating them to the individuals who specialise in them
-reduces transition time
-increases productivity as people are more skilled
-specialisation allows tools to be created
What is ceteris paribus
How one economic variable affected another assuming all variables remain the same
3 ways which division of labour helps reduce unit costs
-produce far more output
-reduces time taken to produce as transition time reduces (more goods produced in smaller time frame)
-smaller set of skills required
-development of specialised tools
-lowers supply cost per unit
What are three disadvantadges of specialisation
-leave people jobless once their skill set is replaced by machinery
-boring - more prone to mistakes
How are resources allocated in the market economy?
Due to interactions between buyers and sellers via the price mechanism
How is money useful in transactions?
-medium of exchange
-unit of account
-store of value
-method of deferred payment
What are the behaviours of rational agents?
-know their preferences
-maximise own personal welfare
What are the behaviours of real economic agents?
-less cognitive ability to know/rank preferences
-use techniques to make decisions
-rules of thumbs used to help
-copycat
What does Ceteris paribus mean?
- assuming other variables remain constant
What is the basic economic problem?
- that resources are scarce
- infinite wants but finite resources
What are production possibility frontiers?
- PPFs help economists to analyse trade-offs.
- They show the maximum possible combination of goods/services that can be produced using all available resources
What is an opportunity cost?
- the production of two more consumer goods incurs an opportunity cost of one capital good
How is economic growth modelled on the PPF graph?
- outward shift in the PPF
What is a free market?
- an economic system in which prices are determined by unrestricted competition between privately owned businesses
Describe a command economy
- a centralised government controls the means of production and determines output levels
What does a supply curve show?
The quantity of a good/service that producers are able and willing to sell of a given price
Why is the supply curve modelled upwards
Law of decreasing marginal returns
What is producer surplus?
-The difference between the price that a producer receives for a good/service and the price they were able and willing to supply it at
What assumption do we make about producers objectives?
Maximising producer surplus
What is the law of diminishing marginal returns?
Diminishing marginal returns occur when there is a decrease in the additional output generated by adding additional units of a variable F.o.P to a fixed F.o.P
-> marginal cost of good increases while returns decrease
What are the factors that affect supply?
GTECC
-Government regulations (Taxes/Subsidies)
-Technology
-Expectations
-Cost of input
-COmpetition
What does a demand curve show?
The quantity of goods or services that consumers are willing and able to buy at a given price
Why do we model a demand curve down?
-Diminishing marginal utility
What is diminishing marginal utility?
-As consumers consume more of a good the utility they derive from an additional unit decreases
what is consumer surplus?
The difference between the price that a consumer is able/willing to pay and the price they acc pay
What assumption do we make about consumers objectives?
-They are motivated by maximising their consumer surplus and utility
What is marginal benefit?
The benefit of consuming an extra unit of a good
What are the factors that affect demand?
PIPED
-Preferences
-Income
-Price of related goods
-Expectations
-Demand
What does PES measure?
The ability of suppliers to respond to a change in price
What does PED measure?
The ability of suppliers to respond to a change in price
What is marginal revenue?
The increase in revenue if you sold one more unit
-change in TR/Change in Qs
What are the factors which affect PED?
NASBIT
1.Necessity
2.Addiction
3.Substitues
4.Brand loyalty
5.Proportion of INcome
6.Time period (short run = inelastic)
What factors effect PES
TEASS. 1.Time Period
-Short run: Period of time when at least 1 FoP is fixed (inelastic)
-Long run: All fops can be changed (elastic producers can respond)
2.State of Economy
-Bad state - more FoPs available = elastic
3.Availability of FOP
4.Stockpile & Perashability
-Easily stockpiled items are easier for producers to respond to a change in price
5.Spare capacity
-Lots of spare capacity - elastic (can increase quantity supplied by a larger %)
How does rationing in the price mechanism work?
- due to scarcity, not everyone is able to buy everything they want; when demand is greater than supply, prices will rise so that the good/service is rationed out only to those who can afford to pay for the items.
How does incentive work in the price mechanism?
when the price of a product rises it creates an incentive for firms to shift production towards those products that help generate higher profits. Likewise falling prices may create an incentive for firms to move away from the production of a product
How does signalling work in the price mechanism?
when the price of a product rises it signals to producers that the demand for that product is probably high and firms should increase production. Prices are helping to determine where and how resources should be allocated
An indirect tax is a…
Indirect tax is a levy imposed by the government on the consumption or production of a good or service. It has the effect of increasing the cost of supply for producers. Although producers cannot pass on the legal burden, producers can pass on the economic burden of indirect tax by increasing the costs for consumers in order to account for taxes (P1 to P2.) Therefore this discourages consumption, decreasing demand ( Q1 to Q2 ) This also discourages production as producer total revenue decreases.
VAT is
-imposed on the ……..
-Taxation at point of …….
Producer
Sale
Excise Duties:
-Taxation at point of ………..
Production
Indirect Tax shifts the….
Supply curve
Indirect Tax is inflationary and …
Encourages saving
What is ad valorem tax?
-When government increases price of a product by a specific percentage
VAT is an example of?
Ad Valorem Tax
A direct tax is a
Levy imposed by the government on the income/wealth generated by an activity. It often discourages the activity
-DIscourages working/investment if too high
What are examples of Direct Tax?
-Income Tax
-Corporation Tax
Direct Tax always shifts…
Demand curve to the left
Direct tax causes prices to go down and is…
Deflationary
Income tax:
-leaves people with less money in their pockets
-t.f less likely to spend money on the product
What is regressive tax?
-Hurts people with lower income more than higher
-Indirect tax
-2% or 20p of EVERYONES incomes
Proportional tax is…
Corporation tax
Direct tax
Progressive tax:
-Hurts people with higher income more than lower income
-Direct tax
Incidence of tax depends on…
PED and PES
IF PED is more elastic than PES burden of taxation is greater on…
Producer
Welfare loss:
-occurs when a market fails to allocate resources efficiently
-only applicable is resources were allocated efficiently
What are the 4 canons of taxation?
CEEC
-Efficient
-Equitable (asking tax payers to pay something they can afford)
-Convenient (easy to transfer to gov)
-Certain
What is a subsidy?
A subsidy is a grant given by the govt to producers (sometimes consumers). It has the effect of lowering costs for producers which in turn reduces the price of the good and encourages the consumption of it. It also has the effect of increasing revenues for producers encouraging the production of it.
What are the benefits of unit tax?
-Money collected can be used for advertisements and projects that will discourage harmful behaviour even before
What is consumer surplus?
- The difference between the amount consumers are willing to pay and the price they actually pay
What is producer surplus?
- the difference between the amount producers are willing to sell a good for and the price they actually receive
What is market failure?
- when too much or too little of a good is being produced and/or consumed compared with the socially optimal level of output
- or when the price mechanism leads to an inefficient allocation of resources
What is an externality?
- an external cost/benefit of an economic transaction is the cost/benefit experienced by a third party not involved in the transaction
When is an externality negative?
Social costs > private costs
- social costs = private costs + external costs
(Taking a flight)
When is an externality positve?
- when social benefits of an economic action are greater than the private benefits
Social benefits > private benefits
(Planting a tree)
What are public goods?
- non-rival and non-excludable goods
What are non-rivalrous goods
- when one person consumes a good there is no less of the good left for another person to consume
What are non-excludable goods?
- for practical purposes, producers cannot stop consumers who don’t want to pay from consuming the good
(Flood defences)
What problems occur with public goods?
Free rider problem
- occurs when firms are unable to stop consumers who dont want to pay from consumer goods/services
- leads to the missing market
- (street lighting, flood defences)
How can free rider problems be solved?
- government intervention as society will be better off if defences were put in place
- government builds it itself
- government pays the private sector on behalf of the public
What are information gaps?
- when information is asymettric and producers know more than consumers or the information is incomplete or imperfect
Give an example of an information gap
- people who are over-consuming alcohol don’t realise they are over consuming and therefore harming their health
How can information gaps be closed?
- government intervention
- packaging laws to reduce information gaps (smoking)
- these policies only work for new consumers entering the market. Long time consumers have different issues
Give an example of a cognitive gap
Time asymmetry (behaviour bias):
- rational agents
- value the present over future
- (smoking)
- (not saving enough money)
What is regulatory capture?
- occurs when the regulator acts in the interest of the industry they are regulating instead of public interest
What is principle agent problem?
- agent acting in self interest rather in the interest of the principal
What is the revolving doors problem?
- government uses specialists to make laws
- specialists go back into industry and find loopholes in these laws
How does the government affect the market when setting as minimum price?
- discourage consumption of a particular good
- set above the market price
- Scotlands minimum price for alcohol
How would the government setting a maximum price affect markets?
- encourage consumption of a particular good
- set below the market price
- contraction of supply but extension of demand
- Cyprus introducing a maximum price of milk
What is government failure?
- when the government intervenes to correct a market failure but the result is more inefficient allocation of resources and there is a net welfare loss.
What are some causes of government failure?
- distortion of price signals:
leading to unintended consequences such as smuggling and illicit production, - excessive administrative costs and information gaps
Example markets include:
- agricultural sector (Cyprus milk maximum price)
- transport policies (Mexico City and car emissions)
- housing policies (rent controls)
- tobacco and alcohol policies (taxing tobacco and alcohol, leading to smuggling)
What is YED?
- Income elasticity of Demand
- YED = % change in Q / % change in Y
- Luxury good > 1
- 1 > Normal Good > 0
- Inferior good < 0
What is a normal good?
- as income goes up you want to buy more of it
What is an inferior good?
- as income increases you want to buy less of it
What is a positional good?
- goods valued by how they are distributed amongst society (Ferrari)
What is XED?
- cross elasticity of demand
- % change in quantity demanded of A / % change in price demanded of B
- if XED is positive the two goods are substituted
- if XED is 0=0 they are unrelated
- if XED is negative they are complements
What is competitive supply?
- multiple goods come from the same supply ( milk and yoghurt)
- alternative products a firm could make with its resources
What is joint supply?
- come from the same process
XED for substitutes is…
Positives
XED for complements is…
Negative
- demand for one good increases alonng with another
What is competitive supply?
- multiple goods come from the same supply
- alternative products of a firm could make with its resources
What is joint supply?
- come from the same process (beef + leather)
What does XED measure?
- how much quantity demanded of good A will respond to a change in price of good B
