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microeconomics 1.2 - 1.2.3 Flashcards

1
Q

Reasons why rational decision making doesn’t always apply

A
  • Have limited capacity to calculate all costs and benefits of a decision
  • Are influenced by their social networks
  • Lack self control and seek immediate satisfaction
  • Could make emotional choices in cold and emotional states
  • Often fall back on simple rules of thumb when choosing
  • Satisfy rather than maximise
  • Have a strong default to maintain the status quo
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2
Q

Definition of demand

A

Demand for a good or service is the quantity that consumers are willing and able to buy at a given price in a given period of time

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3
Q

Definition of effective demand

A

Only if demand for a product is backed up by willingness and ability to pay the market price does demand become effective or actual

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4
Q

What is the basic law of demand

A

The basic law of demand is that demand varies inversely with price - the lower the price of a good, the higher the quantity demanded and vice versa, ceteris paribus

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5
Q

Rules for drawing a demand curve

A
  • label the y axis price and the x axis quantity
  • draw demand curve downward sloping from left to right and label (d)
  • draw dotted line from given price (p) to quantity (q)
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6
Q

What causes movement along the demand curve

A

Only changes in price causes movement along the demand curve
A higher price leads to a contraction of quantity demanded
A lower price leads to an expansion of quantity demanded
Shows change in quantity demanded

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7
Q

What causes a shift in the demand curve

A

A shift is caused by non price factors
Shows a change in demand

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8
Q

Definition of derived demand

A

Derived demand is the demand for a good or service that is used to produce another good or service
The demand is not for the good/service itself but for its ability to produce another good or service

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9
Q

Examples of goods or services in derived demand

A
  • The demand of steel is derived to make cars
  • The demand for minerals are derived to make components for electric products
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10
Q

Definition of joint/ complementary demand

A
  • Joint or complementary demand is when the demand for one product is directly and positively related to market demand for a related good or service
  • The demand is for two or more goods and services which are demanded together
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11
Q

Examples of things in complementary demands

A
  • Petrol and cars
  • Smartphones and apps
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12
Q

Definition of composite demands

A

Composite demands is where the demand for a good or service is for goods that have more than one use
- The demand is for a good or service to produce more than one type of product

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13
Q

Examples of things in composite demands

A
  • Milk which can be used for cheese, yoghurt, butter, cream
  • Land which can be used for farming, recreation or development
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14
Q

What are the determinants for demands in a market

A
  • The type of good
  • Consumer incomes
  • Seasonal factors
  • Consumer fashion and tastes
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15
Q

How does consumer income affect demand

A

As the income of consumers increases, demand for normal goods will increase
This is shown by a shift to the right of the demand curve

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16
Q

How do seasonal factors affect demand

A

Consumer increase and decrease their demand for certain goods depending on the season eg. demand for plants at garden centres is linked to planting seasons

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17
Q

How do consumer tastes and fashion affect demand

A
  • People’s tastes change over time and demand for fashionable products changes regularly, often manipulating by advertising
  • As some products become more fashionable there is an increase in demand
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18
Q

What other factors affect demand

A
  • Population changes
  • Advertising
  • The level of competition in the market
  • Interest rates and demand
  • Social and emotional factors
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19
Q

Describe the income effect

A
  • A fall in price increases the real purchasing power of consumers
  • Allows people to buy more with a given budget
  • For normal goods demand rises with an increase in real income
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20
Q

Define the substitution effect

A
  • A fall in the price of goods makes it relatively cheaper compared to substitutes
  • Some consumers will switch to good leading to higher demand
  • Much depends on whether products are age substitutes
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21
Q

What is the concept of utility

A

Utility is a measure of the satisfaction that we get from purchasing and consuming a good or service

22
Q

What is total utility

A

The total satisfaction from a given level of consumption

23
Q

What is marginal utility

A
  • The change in satisfaction from consuming an extra or additional unit
  • Standard economic theory believes the idea of diminishing returns i.e the marginal utility of extra units declined as more is consumed
24
Q

How does diminishing marginal utility explain the downward sloping demand

A
  • The law of diminishing marginal utility is a law of economics that states that as your consumption increases the satisfaction you derive from each individual unit decreases
  • If marginal utility is falling then consumers will only be prepared to pay a lower price
25
Q

What is price elasticity of demand?

A

Price elasticity of demand (PED) measures the responsiveness of demand after a change in the goods own price

26
Q

Basic formula for calculating demand

A

percentage change in demand over
percentage change in price

27
Q

When does perfect inelasticity take place and what does this mean

A

When PED=0
A change in price will not have any effect on demand

28
Q

When does price inelasticity take place

A

When PED < 1
The percentage change in demand is less than the percentage change in price

29
Q

When does unitary price elasticity take place

A

PED = 1
The percentage change in Demand is same as the percentage change in price

30
Q

When does price elasticity take place

A

When PED > 1
The percentage change in Demand is greater than the percentage change in price

31
Q

When does perfect price elasticity take place

A

When PED is infinite
An increase in price will lead to demand falling to zero

32
Q

Factors that determine the PED of a product

A
  • Number of close products available - The more close substitutes there are the more price elastic the demand
  • Price of the production in relation to total income - when the % of budget is high, demand is usually more price sensitive
  • Cost of substituting between different products - When substitution costs are high, demand will tend to be price inelastic
    Brand loyalty and habitual consumption - High levels of brand loyalty makes demand price inelastic
  • Degree of necessity/ luxury - standard assumption is that necessities have a lower price elasticity whereas luxuries are an optional spend
33
Q

How does the coefficient of the PED reflect the revenue of the producer

A

If the coefficient of PED is <1, a rise in market price will lead to an increase in total revenue for the seller of the product. If the coefficient is >1 then the supplier will get greater revenue if they reduce their prices

34
Q

What is income elasticity of demand

A

Income elasticity of demand (YED) shows how responsive the demand for a product is to a change in real income

35
Q

Formula for calculating income elasticity of demand

A

% change in quantity demanded
% change in real income

36
Q

What does the income elasticity coefficient of demand mean

A

Normal goods - They have a positive income elasticity - Luxury goods are where the income elasticity is >1, and necessities are where income elasticity is >0 and <1
Inferior products - have negative income elasticity, they are counter cyclical goods - products whose demand varies inversely to the macroeconomic cycle

37
Q

What is cross price elasticity of demand

A

Cross price elasticity (XED) measures responsiveness of demand for good X following a change in the price of a related good Y

38
Q

Formula for calculating cross price elasticity

A

% Change in quantity demanded of good X
% Change in the price of good Y

39
Q

What are substitute goods

A
  • Products in competitive demand
  • An increase in the price of one good leads to an increase in demand of another ceteris paribus
  • The value of XED for two substitutes is always positive
40
Q

What are complementary goods

A
  • Complements are products in joint demand
  • A fall in the price of one product causes an increase in demand for the complementary product
  • The value of XED for two complements is always negative
41
Q

What are close substitutes in terms of XED

A
  • Have a strongly positive cross price elasticity of demand - small changes in a relative price causes a big switch in consumer demand of a rival products
42
Q

What are strong complements in terms of XED

A
  • When there is a strong complementary relationship, the cross elasticity will be highly negative
43
Q

What are unrelated products in terms of XED

A
  • Unrelated products have zero cross elasticity
44
Q

Uses of price elasticity of demand for producers

A
  • Firms can use PED estimates to predict
  • The price volatility in a market following changes in supply - this is important for commodity producers who suffer big price and revenue shifts from one time period to another
45
Q

What is price discrimination

A

This is where a supplier decides to charge different prices for the same product to different segments of the market

46
Q

How is total revenue effected by changes in price of goods in elastic demand

A

A price increase would decrease total revenue
A price decrease would increase total revenue

47
Q

How is total revenue effected by changes in price of goods in inelastic demand

A

A price increase would increase total revenue
A price decrease would increase total revenue

48
Q

How is total revenue effected by changes in price of goods in unit elastic demand

A

A price increase / decrease doesn’t change the total revenue

49
Q

Limitations in calculating elasticity

A
  • Problems with inaccurate or incomplete data collection
  • Consumer price sensitivity changes over time
  • Elasticity over demand varies by region / time
  • Not all businesses are profit maximisers
  • Elasticity will vary within product range
  • Rival producers will change their market strategies from time to time
50
Q
A

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