Microeconomics Flashcards
Opportunity cost
The loss of other alternatives when one alternative is chosen. Next best opportunity forgone.
Actual output
Current rather than potential level of production (real GDP) in an economy. When actual output is rising, the output gap is often declining and an economy is moving closer to their production possibility frontier by increasing the level of capacity utilisation.
Potential output
The highest level of real gross domestic product that can be sustained over the long term.
PPF (Production possibility frontier)
A graph that shows all the different combinations of output of two goods that can be produced using available resources and technology.
Factors of production:
List and define
Land Resources: not man made: land, minerals, wood, fish
Labour: human resources determined by population, age, skill and training
Capital: man made tools such as buildings, equipment, and machinery
Entrepreneurship: undertake the risk of organising and combining factors for production
Traditional economy
Resources and production systems are owned by the community
Production takes place using traditional technology
Allocation is based on long established patterns of community sharing.
The production possibility boundary tended to expand and contract slowly as population grew, there were climatic changes, and new tools were invented
Advantages of traditional systems:
Resources are protected and the systems have proven to be sustainable over long periods of time
Losses and profits are shared by the whole community, peer pressure forces decision makers to be careful
Disadvantages of traditional system:
Growth is very slow
Command economy
A market where the government or some central authority decides where to allocate resources
Advantages:
The government can influence the distribution of income.
The government can determine which goods are supplied.
Disadvantages:
In order to function well, requires an enormous amount of information which is difficult to obtain.
No real incentive for individuals to be innovative. Goods are of poor quality since there is a lack of profit motive.
May NOT lead to allocative efficiency or productive efficiency due to lack of competition and profit motives.
Corruption - the government has the ability to abuse its absolute power.
The economy does not respond as well to supply and demand, firms are simply told to produce a certain number of goods or services
Central planning:
Resources and production systems are owned by the central government which allows the government to determine what is produced, how and for whom.
Enormous information is required due to centralised planning and control. Government planners must:
Predict patterns of consumer demand
Estimate technological possibilities and production capabilities
Estimate the opportunity cost of resources in alternative uses.
Producers are motivated to underestimate their capability
Advantages of central planning:
The govt. can make the distribution of income more equal
The govt. determines what goods are produced and can prevent production of socially undesirable goods.
Initially higher growth rates for Russia and China would suggest that as a system of organising economic activity, central planning is successful in the early stages of economic development
Disadvantages of central planning:
Requires large amounts of information: forecasting people’s desires is difficult and the lack of incentives have led to a number of problems:
Decision makers do not experience profits and losses and are not strongly motivated to make the right decisions
Incentives to falsify production information lead to poor production decisions and massive pollution,
A reluctance to change with the market in forecasting demand:
There are queues when there are shortages (quantity rationing), and stockpiles if there are surpluses.
State owned enterprises are managed inefficiently.
There is no incentive for individuals and firms to be innovative. With no profit motive goods are often of poor quality and choice is very limited.
Free market
The forces of supply and demand decide the economic questions and therefore where to allocate resources
Advantages:
Resources allocated more efficiently by the price mechanism.
The profit motive is a great incentive, and forces producers to reduce costs and be innovative.
With no imperfections, the free market maximises community surplus.
market system relies on a number of factors to ensure that it works efficiently.
The profit motive - the incentive for a reward for enterprise •Good levels of information being available to both producers and consumers •Price accurately reflecting the costs and benefits of consumption and production •The ease with which resources can move to different uses At the heart of the market system is the profit motive.
Disadvantages:
Instability
Market failure- see Chapter 2.
Monopolies and corruption - The natural goal of all firms is to attain monopoly, as this eliminates competition, eliminating the associated costs and thus maximising profit. If the market structure does not include limiting social forces, financial forces will cause firms to externalise costs such as pollution to gain monopoly. Union Carbide’s gas leak in Bhopal is an example of such an externalised cost.
Free market
Resources and production systems are owned by individuals and the allocation of resources, what, how and for whom, is left to the forces of supply (production) and demand (consumers) operating in a relatively free market.
Producers attempt to maximise profits, but if they are poor at predicting:
They produce too much (surpluses) and will lose money.
They underestimate (shortages), will miss the potential profit and a competitor will make the profit instead.
Only those firms which can predict most closely what consumers will want will earn adequate money to stay in business.
Advantages of free market:
Resources are allocated by market forces and the price mechanism without govt. intervention.
Profits provide an incentive to reduce costs and be innovative.
The free market maximises community surplus if there are no failures and imperfections.
Disadvantages of the free market:
Market failures and imperfections occur because of public goods, merit goods, externalities and lack of competitive markets.
The system of profits and losses is thought to be unfair, substantial government intervention is needed to cope with income redistribution problems.
The wealthy are taxed to reduce profits
Those marginalised by the system, are supported with tax money
The system is incapable of controlling pollution and producing sustainable growth, planning has been introduced to correct for this problem.
Mixed economy
An economy consisting of both free market and command economies - some decisions are made by market forces while some other decisions are made by the government or some central authority
Most countries in the world have moved gradually toward a mixture:
Free markets are used to allocate resources to achieve efficiency.
Government planning is used where markets fail to operate successfully, and to redistribute income to those who are marginalised by the market system.
Category
Limited Liability
Financial liability is limited to a fixed value, commonly a person’s investment in a company/partnership established with limited liability
Multinational/Transnational companies/Multinational enterprise
Enterprise/firm that manages production or delivers services in more than one country
Cost theory
Law of diminishing marginal utility
Substitute goods
Complementary goods
