Microeconomics Flashcards
What is demand?
The quantity of a good or a service that a consumer is willing and able to purchase at any given price level
What is supply?
Supply is the quantity of a good or service that a producers is will and able to sell at any given price level
What is the equilibrium price?
The intersection of supply and demand - the price at which quantity demanded is equal to the quantity supplied
What does the assumption that consumers/producers are price takers mean?
No single consumer/producer can influence the market price, hence they can only chose the quantity and take the price as given
What is consumer surplus?
Difference between the price consumers are willing to pay and the price they actually pay
What is producer surplus
Difference between the price sellers are willing to sell for and the price they actually receive
What is own price elasticity and how can it be estimated?
Own price elasticity measures the demand response of a good to a change in its price
change in quantity demanded / change in price
What does an own price elasticity of demand smaller than 1 suggest?
Inelastic demand e.g., necessities
What does an own price elasticity of demand greater than 1 suggest?
Elastic demand e.g., luxury goods
What is the cross price elasticity of demand and how is it estimated?
Cross price elasticity measures the responsiveness of the quantity demanded of one good (x) to the change in price of another good (y)
change in quantity demanded of good x / change in price of good y
If the cross price elasticity of a good is positive what type of goods are they?
substitutes
If the cross price elasticity of a good is negative what type of goods are they?
complements
What is income elasticity of demand and how is it estimated?
Income elasticity of demand measures the responsiveness of quantity demanded to a change in income
change in quantity demanded / change in income
What does it suggest if the income elasticity of a good is greater than zero?
it is a normal good
What does it suggest if the income elasticity of a good is greater than one?
it is a luxury good
What does it suggest if the income elasticity of a good is less than zero?
it is an inferior good
What causes a shift in the demand curve?
Factors that change the quantity demanded at a given price e.g., change in tastes, population, income, prices of substitutes of complement goods and expectations of future prices
What causes a movement along the demand curve?
A change in the price of the good or service
What is the budget constraint?
All possible consumption bundles the consumer can afford with their income (usually focused on two goods)
What causes a pivot in the budget constraint?
Price of one good becomes relatively cheaper
What causes a shift in the budget constraint?
Change in income
What is a consumption bundle?
A combination of different quantities of the various goods a consumer wants to consume
What is utility?
The satisfaction that a consumer derives from consuming a particular consumption bundle
What assumptions does consumer demand theory make about utility?
Completeness - bundles can be ranked in terms of their utility
Transitivity - the utility ranking of bundles is internally consistent
Preference for more over less
What is ‘diminishing marginal rate of substitution’
In order to hold utility constant, diminishing quantities of a good or service need to be sacrificed so as to obtain successive equal increases in the quantity of another good
What is the budget constraint line?
A line showing all possible consumption bundles which are affordable and exploit all the resources available to the consumer
What does the non-satiation assumption about taste imply?
Consumers will chose a point on the budget constraint and certain points will be preferred to others
What is an indifference curve?
A line that shows combinations of two goods that give a consumer the same level of satisfaction
What concept measures the slope of the indifference curve?
Marginal rate of substitution
What is the income effect?
the change in consumption that happens when a person’s income changes
What is the substitution effect?
the change in demand for a product when its price increases relative to other products
What is absolute advantage?
When one firm can produce a given quantity of a good with fewer inputs compared to another firm
What is comparative advantage?
When one firm can produce a good at a lower opportunity cost compared to another firm
How is overall output maximised according to comparative advantage?
Specialising to achieve comparative advantage and then trading
What is an isoquant?
A line showing all possible combinations of inputs that can produce a given efficient level of output
What is the isocost line?
A line showing different input combinations with the same total cost
What do we assume about how firms make production choices?
Firms wish to minimise the cost of producing their given level of output
Firms will produce an output where marginal cost equals marginal revenue
What is the marginal rate of technical substitution in production?
the rate at which one input can be replaced with another while keeping the same level of output
What is constant returns to scale?
When an equal proportionate increase in all inputs gives the same proportionate increase in output
What is decreasing returns to scale?
When an equal proportionate increase in all inputs gives a smaller proportionate increase in output
What is increasing returns to scale?
When an equal proportionate increase in all inputs gives a larger proportionate increase in output
What is short run marginal cost?
The increase in short run total cost if output increases by one unit
What is long run marginal cost?
The increase in long run total cost if the output increases permanently by one unit
Where does the marginal cost curve intersect the average cost curve?
at the minimum point
Assumptions of perfect competition (6)
Firms produce homogenous products
Firms are price takers
No barriers to entry or exit
Average cost curves eventually end up sloping upwards
Perfect information between buyers and sellers
Firms maximise profits
What level of output do firms choose in perfect competition?
Where marginal cost equals marginal revenue, under perfect competition the marginal revenue is always equal to the price
Under perfect competition, how should firms respond when marginal cost is less than marginal revenue?
increase output to increase profits
Under perfect competition, how should firms respond when marginal cost is less than marginal revenue
reduce output to increase profits
Characteristics of a monopoly (4)
One firm supplies the whole market
Significant barriers to entry
Firm is price maker
No close substitutes
How do price and output differ between perfect competition and monopoly market structures?
Price is higher and output is lower under a monopoly
Characteristics of monopolistic competition (3)
Many firms
Free entry and exit
Differentiated product but high degree of substitutability
Characteristics of an oligopoly (4)
Market power held by a few firms
High barriers to entry
Product differentiation
Interdependence of firms
What is a ‘Game’ in the context of game theory?
A situation in which decision by rational agents are necessarily interdependent
What is a ‘Strategy’ in the context of game theory?
A detailed game plan describing how the agent will act or move in every conceivable situation
What is a ‘Dominant Strategy’ in the context of game theory?
Where an agent’s best strategy is independent of those chosen by others
What is the Prisoners’ Dilemma?
A paradox that shows how two rational people making decisions in their own self-interest can lead to a worse outcome for both - highlighting the incentive for collusion
What is a cartel?
An agreement between a group of producers to control supply or manipulate prices
Why are cartels unstable?
It is the dominant strategy for all firms involved to cheat the agreement by reducing their price and then increasing their market share
Example of perfect competition
Agricultural markets
Example of monopolistic competition
Soft drinks industry
Example of an oligopoly
Airlines
Example of a natural monopoly
Public utilities
Example of a monopoly
Amazon
Why is the supply curve upward sloping?
The law of supply says that as the price of a good or service increases, the quantity supplied will increase
Why is the demand curve downward sloping?
The law of demand says that as the price of a good or service decreases, the quantity demanded will increase
How does tax affect the supply curve?
Shifts it upwards
How does tax affect the demand curve?
Shifts it downwards
What is marginal utility?
The benefit derived from consuming an additional unit of a good or service
When are markets in equilibrium?
When the supply and demand curves are equal
What are economies of scale
cost advantages realised through an increased level of production
What is a natural monopoly
a monopoly that occurs due to high barriers of entry
What is asymmetric information?
When one party has more information on the transaction than the other
How do firms demand labour?
labour is a derived demand which means that it depends on the demand for the firm’s good or service
How do competitive firms determine their demand for labout
Firms will employ labour until the marginal revenue product of labour equals the wage rate
What is the marginal revenue product of labour (MRPL)?
the extra revenue obtained from one unit of labour - it is the product of marginal revenue and marginal product of labour
What is the shape of the MRPL curve?
downward sloping - determined by diminishing marginal returns to labour
What is the labour force?
all individuals in work or seeking employment
What is labour supply?
the number of hours people are willing and able to supply at a given wage rate
What does the backward bending labour supply curve mean?
after a certain point, higher wages can lead to a reduction in hours worked
What is the shape of the labour supply curve?
Upward sloping - as the wage increases people are incentivised to work more
How does a change in wages of one industry affect another?
labour is incentivised to move into the industry with higher wages which shifts the labour supply curve left in the other industry
What is a monopsony labour market?
When there is a single employer dominating the hiring of labour in a particular market - allowing them to better control the wage
Example of a monopsony labour market
NHS
What does the Lorenz curve measure?
Inequality
What is the elasticity of labour supply in the short run?
Often inelastic as it is difficult for people to switch markets in the short-run
What does human capital theory suggest?
If the rate of return on human capital (investment into education) is greater than the rate of return on alternatives people will take up educational opportunities
What causes wage differentials in the labour market?
skills
discrimination
job characteristics
trade unions
What does risk averse mean?
a reluctance to take risk
Why is there demand for insurance?
Most people are risk averse
Why is there supply for insurance?
Profits can be made through risk pooling and risk sharing
What is moral hazard?
When one participant does not know what the other participant is doing (behaviour)
What is adverse selection?
When one participant does not know what the other participant is like (characteristics)
What is productive efficiency
an economy or entity can no longer produce additional amounts of a good without lowering the production level of another product
What is pareto efficiency?
when an allocation of resources cannot be changed without making somebody worse off
Criticism of pareto efficiency
it does not consider inequality
What is a market failure?
where there is an inefficient allocation of goods and services in a market
Causes of market failures
public goods
externalities
imperfect competition
missing markets
imperfect information
What is a public good
a good that is non-rivalrous and non-exclusive
why is there no incentive for the free market to provide public goods
cannot charge people for it
What is an externality
where production or consumption directly impacts a third party which is not considered by the party producing or consuming
