Microeconomics Flashcards
Basic economic problem
That society has infinite wants an needs, but only a finite amount of resources to accommodate this
Factors affecting demand
Income, Price of other goods, tastes and preferences, and expectations of the future.
Factors affecting supply
Costs of production, subsidies/grants, taxes, price of other goods, productivity, government legislation
examples of markets that fail due to information failure
-Houses- people may not see faults within a house which would knock their value
- Second hand cars- people may not know faults involved in certain cars
- Insurance/ health insurance- You may fail to inform to inform your insurance company of underlying health conditions.
Explaining Market Failures using an externalities diagram
- Think about whether the externalities in consumption or production
- Draw the appropriate diagram
- Be clear on what the externalities are.
-Explain why this causes a difference between MPB and MSB or MPC and MSC.
-Explain why the free market will arrive at the private optimum
-Explain why the social optimum is where it is. - Identify the welfare loss
-Explain the implications of this on consumption / production
Externalities example- the market for energy drinks
The consumption of energy drinks generates negative externalities, particularly in in the healthcare system such as the UK’s, where consumers who require treatment will seek it from the NHS, thus imposing a cost to the third party of taxpayers. As a result, the marginal private benefit of energy drinks is more than the marginal social benefit. Consumers generally act in their own interest and ignore the impact upon society. In the diagram above (Externalities), this can be seen as consumers are consuming at the private optimum, where MPB is equal to MPC., rather than the social optimum where MSB is equal to MSC, and social welfare is maximised. There is a welfare loss equal to the triangle in the diagram. There is an overconsumption equal to Q1-Q2- too many resources are allocated to energy drinks, meaning that the market is allocatively inefficient and fails.
Types of government failure
- distortion of price signals- gov intervention causes prices to change
- Conflicting objectives
- Information gaps
- Excessive admin costs
- Unintended consequences
Indirect tax diagram
Draw and then check online
Indirect tax analysis
The use of an indirect tax will increase a firms cost of production and mean that at any given price suppliers will be less able to earn profit. This means that they have less incentive to supply and the supply curve will shift leftward from S1 to S2. Excess demand at the previous market price causes the equilibrium price to increase from P1 to P2 and this causes a contraction of demand from Q1 to Q2. This reduces the quantity to the social optimum, correcting the problem of overconsumption/ production and correcting the market failure.
Indirect tax evaluative points
- It is difficult to put values on externalities
- Opportunity cost of monitoring
- Can be regressive
- Effectiveness depends on the price elasticity of demand
- Potentially inflationary
- Can be hypothecated, providing further helping to resolve the issue
Subsidy diagram
Draw diagram and then check online
subsidy analysis
A subsidy will decrease firms’ cost of production and mean that at any given price, suppliers will be able to earn more profit. This means they will have more incentive to supply and the supply curve will shift to the left, from S1 to S2. This decreases the equilibrium price from P1 to P2, and causes an extension of demand from Q1 to Q2. This extends the quantity to the social optimum, correcting the overconsumption/ underproduction, and correcting the market failure.
Subsidy evaluative points
- Difficult to accurately value externalities
- Firms may not use the subsidy to increase production or may become productively inefficient
- Opportunity cost
- Effectiveness depends on PED
Information provision diagram
Draw first then check online
Information provision analysis
The provision of information enables consumers to understand the benefits/ negatives of a good, and changes their tastes and preferences towards/ away from the good. This gives consumers less/ more incentive to buy, shifting demand leftward/ rightward from D1 to D2. This lowers/ raises the equilibrium price from P1 to P2, and causes a contraction of supply from Q1 to Q2, where Q2 is the social optimum, correcting the over/ under consumption.
