MicroEconomics Flashcards
bun a zot; bun a lot
Define Economics
The study of financial systems and how markets work in society
Define the basic economic problem
Wants are infinite and resources are scarce. Therefore societies are forced to make a decision on what to produce, how to produce and for whom to produce to, to maximise efficiency and make the best use of their scarce resources.
Describe the problem of what to produce
Due to the problem of scarcity, we are unable to produce everything we want. Economies need to make a list of priorities of what to produce and in what quantities. If an economy decides to produce more of one good, it will be able to produce less of another.
Describe the problem of how to produce
Limited economic resources need to be used as efficiently as possible, without causing harm to the environment. Therefore, we need to decide the best method to maximise output and not waste limited factors of production
Describe the problem of for whom to produce to
Economies have to decide who is going to receive the final goods and services and in what proportion.
What are the factors of production?
Capital, Enterprise, Land, Labour
Remember ‘CELL’
What are factor endowments?
The amount of Land, Labour, Capital and Entrepreneurship an economy possesses and is able to exploit.
What is ‘Land’?
All natural resources. Everything that is above the Earth and below. Eg. mineral deposits, forests, the sea etc.
What is ‘labour’?
The Human resource of an economy. It is also called ‘Human capital’. The labour force of a country can be skilled or unskilled
What is ‘capital’?
Man-made goods. Used to produce more goods and services in the economy. Also called ‘producer goods’
What is ‘enterprise’?
To organise the other three factors of production and to take the risks of production. In large companies there is a divorce between risk-taking and the running of the firm.
Consumer goods can be two things…
Single use
OR
long use/durable goods
What is a single use consumer good?
A consumer good that can only be used once. eg. bread
What is a long use/durable consumer good?
A consumer good that can be used many times eg. a car
What are basic wants?
Needs of the consumer that keep us alive eg. food, water, shelter, clothing
what is notional demand?
When consumers desire something irrespective of whether they have the resources available to purchase them
What is specialisation?
The process by a firm, region or nation to specialise in the production of a certain good or service which they hold a comparative advantage over others at.
What is division of labour?
The division of work so all workers perform different tasks and become particularly specialised at an individual task
What sort of economy does specialisation lead to?
An economy based on exchange, as we thus need exchange to receive the variety of goods that we need
What is the barter system?
The direct exchange of goods for goods.
What are the benefits of specialisation? (6)
- Increased productivity as they are more skilled in their area of production
- Leads to exchange and thus a greater variety of goods and services
- Allows workers to improve their skills in their area
- Allows nations to specialise in the goods they are best at producing as they have the comparative advantage over other nations
- Creates a larger global market
- Increases competitiveness and lowers prices
What is comparative advantage?
When a nation has a ‘margin of superiority’ over others. In other words, the cost of their factors of production are less than other countries in relation to the production of their specialised good
What are the cons of specialisation?
- Over-specialisation can lead to unemployment. People become highly skilled in only their one specialty and if the demand for them decreases, they become redundant and find it hard to find work in other sectors
- If a whole nation specialises in one good and the demand falls, the national economy can suffer greatly and nationwide unemployment can occur
What is productivity?
The measure of efficiency. The amount of time taken for a good-quality product to be produced
What is a subsidy?
a sum of money granted by the state or a public body to help an industry or business keep the price of a commodity or service low
How can specialisation reduce the problem of scarcity?
Countries can obtain specialised goods that are in abundance elsewhere but are scarce where they are. Specialisation allows a wider variety of good and services.
Benefits of division of labour?
- Increased productivity and output per worker
- Workers become more skilled by ‘learning through doing’
What are the limitations of division of labour? (4)
- Boring, repetitive work decreases motivation and reduces productivity in the long run
- Boring work leads to a high worker turnover
- Some workers receive little training and thus cant find work elsewhere as they have limited skills
- Mass produced goods tend to lack variety for consumers
What are the issues with barter?
- Indivisibility of goods (cant trade half a cow)
- Need for a common desire for exchange
- Difficult to value certain goods
What is ‘opportunity cost’?
The real cost of giving up the next best alternative foregone. Eg. If we have £20 and we buy a CD instead of a concert ticket, the opportunity cost in the concert ticket
What is a free good?
A good that costs nothing to produce
A good that has no opportunity cost
What is a PPC?
A product possibility curve
What does a PPC show?
- All the possible combinations of consumer and producer goods that an economy is able to produce, assuming that all it’s limited economic resources are fully utilised
- The maximum productive capacity of an economy over a given period of time, assuming that the quality and quantity of resources as well as the state of technology does not change
What does a point within the PPC show?
Underproduction or unemployment as the economy is producing below it’s full capacity.
What causes the PPC to shift outwards?
- Improved technology and innovation
- Increased factor endowments.
- Increased population/immigration
- New found land resources
What does a shift right on the PPC show?
An increase in a country’s productive capacity and in growth in the GDP of that country
What does a shift left on the PPC show?
A decrease in a economy’s productive capacity.
What causes a shift left on the PPC?
- Exhaustion of a nations natural resources
- A fall in a country’s working population
What is gross investment?
The total quantity of of capital goods produced
What is capital consumption/depreciation?
The use of capital goods during production
What are the 3 different economic systems?
- market economy
- Planned economy
- Mixed economy
What is an economic system?
An economic system is the system of producing and distributing of goods and services and allocating resources in a society
What is a price system?
The allocation of resources into a system of wealth
eg. our price system is money
What is a positive statement?
A statement that can be proved right or wrong and therefore is based on factual evidence
What is a normative statement?
A statement based on opinion
What is a market?
Any situation where a buyer and seller come together in order to complete a transaction of a good or service
How does the price mechanism work?
Prices respond to shortages and surpluses. Shortages ( demand exceeds supply) causes prices to rise. Surpluses (when supply exceeds demand) cause prices to fall.
In a competitive market, what do consumers aim to do?
To maximise satisfaction from their purchases. To maximise their utility.
In a competitive market, what are the aims of the producer?
To maximise profits
What is a factor market?
Where factors of production are bought and sold
What are the determinants of demand?
Population (demographic) Income Related goods Advertisement Tastes & preferences External events Seasons
How does the price of a product effect demand?
Assuming that other things remain unchanged (ceteris paribus) a change in price creates movements along the demand curve.
A fall in price will increase the quantity demanded, whilst an increase in price will lower the demand
What is the demand schedule?
It is on the demand curve and shows the relationship in price between price and quantity demanded at any given period of time.
What is consumer surplus?
The difference between what a consumer was willing to pay for a good or service and what they actually paid
How do consumer surpluses arise?
When consumers are prepared to pay a price which is higher than the market price.
Who do consumer surpluses benefit
The consumer: they are paying less than they would be willing to!
What is the real income effect of a price rise?
When an increase in price results in less income left over
What is the substitution effect of a price rise?
When an increase in price leads to a consumer searching for an alternative
What are the main determinants of demand?
- Consumer’s disposable income
- Consumer’s tastes and preferences
- The prices of other related goods substitutes or complements
- Changes in population and age distribution of population
- Weather conditions
- Changes in legislation
What is elastic demand?
If PED > 1, it is called elastic demand. It means a change in price leads to a greater than proportional increase in quantity demanded.
What is inelastic demand?
If PED < 1, it is called inelastic demand. It means a change in price leads to a less than proportional change in demand.
What is the 1st law of demand?
The higher the price, the lower the quantity demanded. The lower the price, the higher the quantity demanded.
What happens if the demand curve shifts inwards?
A decrease in demand at each and every price
What happens if the demand curve shifts outwards?
An increase in demand at each and every price
What causes an outwards shift in the demand curve? (Determinants of Demand)
- Increase in income
- A rise in the price of a substitute
- A fall in the price of a complement
What causes an inwards shift in the demand curve? (Determinants of demand)
- A decrease in income
- A fall in the price of a substitute
- A rise in the price of a complement
What causes a good to have inelastic demand?
- Lack of a substitute
- Shortage of time
- Good is a necessity
- Good is habit/forming
- Small percentage of total expenditure
What causes a good to have elastic demand?
- Plenty of substitutes
- Plenty of time
- Good is not a necessity or habit forming
- Makes up reasonable percentage of total expenditure
What is a monopoly?
When one company controls 100% of the market
What is an oligopoly?
When there are a few large firms that control the market
In a monopoly, who has control?
Firms have control as they can set their prices and consumers have no choice as there are no substitutes
In an oligopoly, who has control?
Consumers have control as companies compete over prices, quality and special debts
What are characteristics of a perfectly competitive market?
Many suppliers
Homogeneous products
No ability to set prices
What is marginal utility?
How useful a product is to the consumer per unit (eg. the first kit kat will be very useful but the 5th will have little use)
How does opportunity cost change with a change in the allocation of resources?
The opportunity cost increases the more the allocation of production changes.
Why does the opportunity cost increases the more the allocation of production changes?
Because of limited mobility of factors of production. eg. shears used for sheepskin cannot be used for wheat
Therefore, at first, all the FOP’s that are not mutually exclusive (eg land) are given up but when we run out of that, we have to use things that are not as useful
How would limited spending on capital goods affect the PPC
Would cause the PPC to shift inwards in the long run (however, would be better for consumers in the short run)
How does high spending on capital affect the PPC?
Causes the PPC to shift outwards (however, would be worse for consumers in the short run)
NOTE: Spending on military and defence (under capital goods) does not necessarily increase future productivity
What does a PPC show?
- The productive capacity when the economy is working at maximum efficiency
- The choice an economy is forced to make between two goods and all maximum combinations of either good
What causes Long run economic growth?
- Increase in quantity and quality of factors of production
- New technology and innovation
In a market economy, what is the government responsible for?
Legislation only
In a mixed/planned economy, what is the government responsible for?
Legislation and spending
What are public goods?
Goods unavailable in the market (eg. defence)
What are merit goods?
Goods that are underproduced in the market
What is standardisation?
Having the same company in any country.
Eg Mcdonalds is available in every country
Benefits of standardisation?
Global brand and everyone knows what theyre going to get
Cons of standardisation?
Lack of regional/local differences
How is the issue of what to produce solved in a planned economy?
All firms are owned and run by the government and government sets output targets of how much to produce
How is the issue of what to produce solved in a market economy?
Resources are allocated in terms of the price mechanism and supply and demand. Thus, the more something is wanted, the more it is produced.
How is the issue of how to produce resolved in a planned economy?
Government provides factories, farms and resources
How is the issue of how to produce resolved in a market economy?
- The method of production that has the lowest cost is used to maximise profit
- The method of production that attracts the most attention (eg. environmentally friendly(
Advantages of a planned economy?
- Zero unemployment
- Very few homeless
- More equality of wealth
- Profit can be put back into society by gvt
advantages of market economy?
- Allows the most demanded good to be the most produced
- Allows competition between firms which increases efficiency
- Large variety of consumer goods
- More innovation (to find cheaper methods)
Disadvantages of planned economy?
- Lack of choice for consumer
- Lack of profit = inefficiency as firms have no incentive
- Lots of planning and administration is expensive and slow
- Output targets cannot correctly identify consumer goods: too many of some goods, not enough of others
Disadvantages of market economy?
- Firms dont care about environment
- Wealth goes towards what will make profit rather than what is actually needed
- Leads to the exploitation of workers for less money and harder work
- Growing unemployment due to (cheaper/more efficient) mechanisation
- Increased gap between rich and poor
- Cost of goods doesnt reflect its true value
What two assumptions are made in the 1st law of demand (increase in price=decrease in demand)?
- Consumers are perfectly rational
- Ceteris Paribus
What causes a shift in the demand curve?
A change in the determinants of demand
What is the acronym for determinants of demand?
PIRATES
What are the determinants of demand?
Population (demographic) Income Related goods (substitutes and complements) Advertisement & promotion Tastes & preferences Externalities Seasonal
What is a substitute?
A good that can be used as a replacement for another
What is a complement good?
Goods that go together or are needed for one another eg. Fish and chips/ DVDs and DVD players
What makes a perfectly competitive market? (5)
- Many suppliers
- Many consumers
- Homogenous products
- Perfect information
- No externalities
What are the different ways a monopoly can be formed? (3)
- State produced monopoly, where it is illegal to produce competition
- When there is a new invention and the inventor has patented the good
- When there is an ‘economic barrier to entry’ (eg. too expensive to produce a competition)
What is a duopoly?
When there are two firms that control the market of a good or service
What is called when there are two firms that control the market of a good or service
a Duopoly
What are the factors that affect supply?
- Costs of production
- Size of industry
- Government legislation
How can Land affect supply? (4)
- Discovery of new land resources
- Depletion of natural resources
- Good/Bad harvests
- Natural disasters
How can labour affect supply? (4)
- Change in productivity
- New training schemes
- More/Less labour
- Changes in wages
How can Enterprise affect supply? (3)
- Commercialisation
- Innovation
- Privatisation
How can Capital affect supply? (2)
- New/better machinery
- Mechanisation
What is cross elasticity of demand?
The responsiveness of demand of good A to a change in the price of Good B
What is the relationship of two goods if their XED is positive?
They are substitutes
What is the relationship of two goods if their XED is negative?
They’re complements
What is the relationship of two goods if their XED is zero
They’re independent
What is the equation for cross elasticity of demand?
%change in QD of Good A
——————————-
%change in P of Good B
What are inferior goods?
When YED is negative
These include: home-brand items and public transport
If PED is elastic, what is the best pricing policy?
To decrease the price:
The loss in TR from price is less than the TR gained from the increase in demand- therefore the TR is overall greater
What is the relevance of YED to businesses? (3)
- can be useful when a firm plans changes in output and productive capacity
- estimates of YED enable a firm to forecast future market demand
- in an economic boom, firms can expect a rise in demand for normal goods, and a fall in demand in a recession
What is the relevance of XED to businesses?
- useful when a firm is planning changes in output, employment and stocks in response to changes in the price of other goods
- knowledge of XED allows businesses to find what goods their products are highly sensitive to (in terms of price and demand)
What are normal goods?
Goods that have a positive YED
What is supply?
The quantity of a good or service that a supplier is both willing and able to offer for sale at a given price in a given time period
What is the supply schedule?
What shows the relationship between price and quantity supplied
What is producer surplus?
The benefit gained by the producer
Measured by the difference between the market price and the minimum price that a producer is willing to supply at
What are the main determinants of supply
Costs of production Related goods (substitutes and complements) Expectations Entry of new firms into industry Weather Subsidies and indirect tax (government policies) New Technology Remember CREEWS(n)
What is PES?
The responsiveness of quantity supplied to a change in price
What is socially optimum output?
Where MSC = MSB
Where marginal social cost = marginal social benefit
What is MSC/ marginal social cost?
Marginal private costs + external costs (negative externalities)
MPC + MEC
What is MSB/ marginal social benefit?
Marginal private benefits + external benefits (positive externalities)
What is ‘marginal cost of production’?
The extra cost of producing one extra output (the private cost to the supplier)
What is an externality?
An effect resulting from business activity which impacts on a third party
When does a negative externality occur?
When the cost of an economic activity is greater than the private costs
What is a major problem in calculating the value of externalities?
It is difficult to place monetary values on the cost to the third party (eg. What is the value of noise pollution)
What is a deadweight welfare loss?
A negative externality
In terms of the supply curve, what happens when there is a negative externality?
Shift inwards in the supply curve:
Less quantity supplied at a higher price
From two supply curves, how can we work out the value of the negative externality?
The vertical distance of one supply curve to the next shows the total externality
When there is a negative externality, what will occur if the the supply is left to the free market?
Allocative inefficiency would occur as there would be an over allocation of resources, and more would be produced than the socially optimum output
When the market is working efficiently, what will occur? (5)
- Quantity demanded = quantity supplied
- Where the market responds immediately to changes in price
- when economic efficiency is met:
- Productive efficiency met: producer surplus maximised
- Allocative efficiency met: consumer surplus maximised
What is the effect on economic and Pareto efficiency if allocative and productive efficiency are not met?
Economic and Pareto efficiency cannot be met
What is an information failure?
When a lack of or incorrect information forces a consumer to make decisions that do not maximise their welfare
What are the different types of information failure? (5)
- asymmetric information
- out of date information
- non existent information
- misinformation
- cant process (understand) information
What is the relationship between information and prices?
Information is power to have greater control over prices
When is misinformation and asymmetric information most common?
When a consumer has to trust the producer as they have more experience in the field
Eg. Trust a doctor to know about your health
What are the advantages of an indirect tax? (4)
- internalises the externality (the firms pay the full cost of the externality)
- ‘polluter pays’ principle: the consumer who causes the cost has to pay
- reduces output to socially optimum output
- market solution
What are the disadvantages of indirect tax?
- tax needs to be equal to negative externality and it’s hard to put a monetary value on some externalities
- a tax increases the price of a good
- where demand is inelastic, reduction in output/consumption is limited
What is the effect on the elasticity of a good on it’s incidence of taxation?
- The more inelastic the good, the more the consumer has to pay
- the more elastic good, the more the producer has to pay
How do pollution permits work?
- firms buy permits that allow them to produce a certain amount of pollution
- the more permits a firm buys, the more it can pollute
What are the advantages of pollution permits? (3)
- The permits are tradable so that clean firms can reap financial benefits by selling their permits
- they encourage firms to cut down on polluting as they face more private costs the more they pollute
- the level of pollution can be controlled by the government as they can change the number of permits available
What are the disadvantages of pollution permits?
- sanctions must be in place for it to work for firms that exceed their pollution permits
- it is not clear how many permits would be needed to lower pollution levels
- allows firms who can afford it to pollute a lot, and poorer firms are forced to become clean
When does cost push inflation occur?
When wages rise at a higher rate than productivity
What are forms of regulation? (5)
- Permanent and impermanent bans
- Licences/permits
- Compliance with strict rules/laws
- Caps on output (quotas)
- Criminal laws
How can the government/agencies enforce regulation? (3)
- Fines
- Temporary/civil fines
- Criminal conviction- prison
How effective are fines? (3)
- Only effective if high enough to act as a deterrent
- If low, companies may take the fine as a private cost and continue to break regulation (if fine is cheaper than regulation)
- If low, it internalises only some of the externality and firms may not pay the full cost of a negative externality
why is the socially optimum output of pollution unlikely to be zero?
If there is zero pollution, that means there would be zero output in some industrys. It is not beneficial to produce nothing so the socially optimum output of pollution would not be zero.
What are the advantages of indirect taxes? (3)
- Polluter pays principle so it internalises the negative externality
- A market solution to the externality so the market is corrected through the price mechanism rather than through external intervention
- Provides revenue for the gvt
Disadvanatges of indirect taxes? (8)
- The tax has to be equal to the negative externality and it is hard to place a monetary value on externalities
- Administrative costs of collecting the tax
- May not decrease CO2 emmissions as firms may pollute and pay
- Higher prices of goods may be inflationary
- If the good is inelastic (eg. habit forming), a change in price will have little effect on production or consumption
- Firms may relocate or evade the tax
- Politically unpopular decision
- Indirect taxation is regressive so falls more heavily on lower income households
Disadvantages of regulation/legislation? (3)
- Needs strong enforcement
- Firms may evade regulation if they think there is a low chance of getting caught
- Firms may evade regulation if they think the punishment is light
What is market concentration ratio?
The amount the market is owned by main, large firms
eg. 75% of the supermarket industry is made of Tesco, Sainsburys, Asda and Morrisons
What is the relationship between market ratio and market failure?
The higher the market ratio, the higher the chance of market failure as there are less firms and they have greater control over prices
What is the problem with pollution permits if there is an underproduction in the market?
There will be lots of spare permits as there is an underproduction and thus a lack of pollution. This will create a surplus of permits in the market, which will lower their price. As the price of permits decreases, there is a lack of incentive to lower pollution.
What is a rivalrous good?
If someone uses it, it restricts someone elses ability to use it
What is an excludable good?
It is possible to stop people from consuming the good if they dont pay for it
What is the free-rider problem? (2)
- When someone benefits from a good but does not contribute towards its provision
- When external benefits > private benefits
Can non-excludabe items be charged for?
No- as soon as an item becomes non excludable, it is impossible to charge people for it
Why wont firms provide public goods?
They do not gain private benefits from it
What is a public good?
A good that is non-rivalrous and non-excludable in consumption
How can governments fund the production of public goods? (3)
- Tax people to make them pay (eg. council tax)
- Subsidise private firms to build public goods
- Government allows private providers to charge consumers through regulation
What causes goods to be merit or demerit goods?
Information failure
eg. people dont know how good/bad they are for them
What curve does positive and negative externalities effect?
-The supply curve
What curve do merit and demerit goods effect?
-The demand curve
- There will be three curves:
- The D curve displaying the perceived private costs/benefits
- The D curve displaying the actual private costs/benefits
- The D curve displaying the costs/benefit to society
What is direct provision?
When the government steps into the production and supply of a good or service
What are the two main examples of direct provision?
- Healthcare
- Education
What are the advantages of Direct provision? (3)
-Reduces structural unemployment
- Solves equity (equality) problems
- ->creates positive externalities
-Lowers average costs of production (economies of scale)
What are Economies of Scale?
A proportionate saving in costs gained by an increased level of production
What are the disadvantages of Direct Provision? (3)
- The government could oversupply (not Qso)
- No profit motive –> Efficiency decreased
- D>S leads to shortage of supply
- ->Depending on the revenue made and the factor endowments of the economy
Direct Provision will only work if…? (2)
- The supply of the good is at the socially optimum level
- Accurate forecasting is in place
What is Compulsory consumption (regulation)?
- When the government force the consumption of a good or service
eg. Ofsted & National curriculum exams
What are the benefits of Compulsory Consumption (regulation)? (4)
- Does not require tax payers money
- Solves information failure
- Replaces market failure to maintain standards
- Low cost
Disadvantages of Compulsory Consumption? (3)
- People may defy the law
- Maintenance can be costly
- Opportunity cost for the individual consumer
- It takes time to implement and filter through to the economy
- Can be due to political bias rather than economic reasons
Compulsory Consumption will only work if…? (1)
-There is enough consumption to move to Qso
What are the advantages of a greater provision of information? (3)
- Encourages demand to equal Qso by individuals considering MPB
- Cheap to implement
- If combined with regulation, it can force the cost onto the supplier
Disadvantages of greater provision of information? (3)
- Hard to provide information to everyone who requires it
- People may chose to ignore it
- Ignorance, misinformation, out of date info etc. may occur
- May be politically motivated (propaganda)
Greater provision of information will only work if…? (2)
- Information is accurate, so government failure DOES NOT occur
- Consumers choose to listen to information
Advantages of Subsidy? (2)
-Subsidy increases QD by lowering the price
- With a subsidy, although consumers still take into account MPB, the decreased cost moves consumption closer to the Qso
- ->If the subsidy is great enough, supply & demand may be moved to the Qso
Disadvantages of Subsidy? (4)
- Doesn’t correct information failure
- Expensive for the gvt to implement: Opp Cost
- Difficult to set at Qso, due to difficulty in placing a monetary value on certain externalities
- No incentive for firms to maximise efficiency
What are the advantages of a cap on output (regulation)? (2)
- Limits the quantity consumed to the socially optimum level
- Theoretically cheap: all it needs is to implement a law
Disadvantages of cap on output (regulation)? (2)
- Can create illegal markets for the good/service which the government then has no control over
- Any increase in demand for the good will be inflationary as shifts in supply cannot occur
Caps on output (regulation) will only work if…? (1)
-Enforcement is in place, as otherwise firms will not pay attention to the regulations
What are the advantages of minimum pricing (regulation)? (1)
-Reduces consumption due to higher price
What are the disadvantages of minimum pricing (regulation)? (4)
- Increases the quantity supplied as firms can gain more revenue through a higher price
- Can lead to inflation as certain goods are in the main basket of household purchases (eg. alcohol)
- Can lead to the creation of illegal markets for certain goods
- can encourage consumers to buy cheaper products are abroad (leakage)
Minimum pricing (regulation) will only work if…?
- Policing and enforcement are available to implement the regulation
- ->This however, is expensive and has an opportunity cost
