Microeconomics Flashcards
What are the 3 main types of Market Failure?
- Externalities
- Under-provision of public goods
- Information Gaps
What is an Externality?
An externality is the cost or benefit a third party receives from an
economic transaction outside of the market mechanism. In other words, it is the spillover effect of the production or consumption of a good or service.
What is Under-Provision of public goods?
Public goods are non-rivalry and non-excludable, meaning they are underprovided by the private sector due to the free-rider problem. The market is unable to ensure enough of these goods are provided.
-One of the best examples of a public good is streetlights
What are Information Gaps?
Economic agents do not always make rational decisions and so resources are not allocated to maximise welfare. For example, consumers do not know the quality of second hand products, such as cars, and pension schemes are complex so it is difficult to know which one is best.
What is Homo Economicus?
The term Homo economicus is the portrayal of humans as agents who are consistently rational and narrowly self-interested, and who pursue their subjectively defined ends optimally.
What are Public Goods?
Non-rivalrous and non-excludable
What are Private Costs/Benefits?
Private costs/benefits are the costs/benefits to the individual participating in the economic activity. The demand curve represents private benefits and the supply curve represents
private costs.
What are Social Costs/Benefits?
Social costs/benefits are the costs/benefits of the activity to society as a whole.
What are external Costs/Benefits?
External costs/benefits are the costs/benefits to a third party not involved in the economic activity. They are the difference between private costs/benefits and social costs/benefits.
What are the parts of STRIPS?
Subsidise
Tax
Regulate
Inform
Pollution Permits
State Control
What is the Free-Rider Problem?
This says that you cannot charge an individual a price for the provision of a non-excludable good because someone else will gain the benefit from it without paying anything. A free rider is someone who receives the benefits without paying for it.
What is Symmetric Information?
Symmetric information occurs where buyers and sellers have potential access to the same information; this is perfect information.
What is Asymmetric Information?
Asymmetric information is when one party has superior knowledge compared to another.
What are the 3 main assumptions of rational economic decision making?
- Consumers aim to maximise utility.
2.Firms aim to maximise profit (Profit Motive).
- Governments aim to maximise social welfare.
What are some factors that could cause the demand curve to shift?
- Population
- Income
- Related Goods
- Advertising
- Taste / fashion
- Seasons
- Expectations
What is Diminishing Marginal Utility?
The Law of Diminishing Marginal Utility states that the satisfaction derived from the consumption of an additional unit of a good will decrease as more of a good is consumed.
What is the formula for Price Elasticity of Demand (PED)?
% change in quantity demanded / % change in price
What is the PED value for unitary elastic PED?
PED = 1
What is the PED value for relatively elastic PED?
PED > 1
What is the PED value for relatively inelastic PED?
PED < 1
What is the PED value for perfectly elastic PED?
PED = infinity
What is the PED value for perfectly inelastic PED?
PED = 0
What are factors influencing PED?
- Availability of substitutes
- Time
- Necessity
- Addictive
- % of income
What is the formula for Income Elasticity of Demand (YED)?
% change in quantity demanded / % change in income
What is the YED value for an inferior good?
YED < 0
What is the YED value for a normal good?
YED > 0
What is the YED value for a luxury good?
YED > 1
What is the formula for Cross Elasticity of Demand (XED)?
% change in quantity demanded of A / % change in price of B
What is the XED value for substitute goods?
XED > 0
What is the XED for complementary goods?
XED < 0
What is the XED value for unrelated goods?
XED = 0
What are some of the factors influencing supply?
- Costs of Production
- Price of other goods
- Weather
-Technology
- Legislation
- Taxes and subsidies
- Producer cartels
What is the formula for Price Elasticity of Supply (PES)?
% change in quantity supplied / % change in price
What is the PES values for unitary elastic PES?
PES = 1
What is the PES value for relatively elastic PES?
PES > 1
What is the PES value for relatively inelastic PES?
PES < 1
What is the PES value for perfectly elastic PES?
PES = infinity
What is the PES value for perfectly inelastic PES?
PES = 0
What are some of the factors affecting PES?
- Time
- Stocks
- Working below full capacity
- Availability of factors of production
- Availability of substitutes
What is Consumer Surplus?
The difference between the price the consumer is willing to pay and the price they actually pay.
What is Producer Surplus
The difference between the price the supplier is willing to produce their product at and the price they actually produce at.
What is an Indirect Tax?
A tax on expenditure where the person is ultimately charged the tax is not the person responsible for paying the sum to the government. E.g. VAT.
What is the Incidence of Tax?
The tax burden on the taxpayer.
What is Ceteris Paribus?
All sciences make assumptions when developing models and theories, and this allows them to simplify the problem. Economists use the term ‘ceteris paribus’ meaning all other things remaining equal
What is a Positive Statement?
A positive statement is a statement which is objective and made without any obvious value judgements or emotions. They can be tested to be proven or disproven
What is a Normative Statement?
A normative statement is one which is subjective and based on opinion, so cannot be proven or disproven. It often includes words such as ought, maybe, unwise or should
What is Value Judgement?
A statement about how good or bad you think something is, based on personal opinion rather than facts
What is the problem of Scarcity?
The basic problem of economics is that of scarcity . People have finite needs, but infinite wants. Although wants are infinite, resources are finite and limited.
What are Renewable Resources?
A renewable resource is resource of economic value that can be replenished or replaced on a level equal to consumption. As long as the rate of consumption is less than or equal to the
rate of replenishment, the stock will not decrease.
- For example, oxygen, solar power and fish are renewable.
What are Non-Renewable Resources?
A non-renewable resource is a resource of economic value that cannot be readily replaced by natural means on a level equal to consumption. This includes fossil fuels such as coal, oil and gas.
What is Opportunity Cost?
The cost of the next best alternative foregone.
What are the 4 Factors of Production?
- Land - All natural resources used in production e.g. raw materials, land or minerals.
- Labour - All productive human effort, both physical and mental, paid and unpaid.
- Capital - All man-made aid to manufacture.
- Enterprise - The willingness and ability to take the risks of combining the other 3 factors in order to make a product or service.
What are Production Possibility Frontiers?
The PFF shows the maximum possible combinations of capital and consumer goods that the economy can produce with its current resources and technology.
- A movement along the curve indicates a change in the combination of goods produced.
- A shift of the curve indicates a change in the productive potential of the economy.
What are Consumer Goods?
Consumer goods are goods that are demanded and bought by households and individuals.
What are Capital Goods?
Capital goods are goods that are produced in order to aid the production of consumer goods in the future.
What is Specialisation?
Specialization refers to the concentration of individuals, firms, or nations on producing a limited range of goods or services.
What is the Division of Labour?
The division of labour is a form of specialization where tasks are divided among workers.
What economist stated specialisation and the division of labour allowed firms to increase labour productivity, efficiency and lower their costs of production?
Adam Smith
What are the 4 functions of money?
- A medium of exchange: It can be used to buy and sell goods and services and is acceptable everywhere.
- A measure of value: It can compare the value of two goods, such as a table and a skirt. It is also able to put a value on labour.
- A store of value: It is able to keep its value and can be kept for a long time
- A method for deferred payment: Money can allow for debts to be created. People can therefore pay for things without having money in the present, and can pay for it later. This relies on money storing its value.
What is a Free Market Economy?
In a free market economy, individuals are free to make their own choices and own the factors of production without government interference. Resources are allocated through the price mechanism.
- Laissez faire approach from the government.
What economist believed in the Free Market Economy?
Adam Smith
What did Friedrick Hayek believe?
Friedrich Hayek (1899-1992) argued that state control of the economy leads to the loss of freedom. He believed that the poor in free market (or freer market) countries were better off than those in command economies because at least they had personal freedom.
What is a Command Economy?
In a command (planned) economy, all factors of production, except labour, is owned by the state and labour is directed by the state. There is no private property and everyone is assumed to be selfless, working for a common good. Resource allocation is carried out by the government, rather than the price mechanism.
What did Karl Marx believe?
Karl Marx (1818-1883) believed in the command economy and criticised capitalism. Marx believed that capitalist’s profit came from exploiting labour as they underpaid workers for the value that they actually created. He wanted remove the difference between the incomes of owners and workers and believed that capitalism would collapse leading to communism.
What is a Mixed Economy?
Both types of economies have benefits but also major problems so most economies have tried to move towards some form of compromise economy , called a mixed economy. This is an economy where both the free market mechanism and the government planning process allocate a significant amount of the total resources in the country.
What is the government’s role in a Mixed Economy?
- Creating a framework of rules: Regulation and consumer protection.
- Supplements and modifies the price system: They produce public and merit goods, such as emergency services and transport, and limit the production of demerit goods.
- Redistributes income: They move income from one group of people to another, from the rich to the poor. They use tax, such as income tax, to take money away from one group then give the money to the poor.
- Stabilises the economy: The government will attempt to manage the level of demand in the economy to prevent extremes of too much or too little demand. They do this through fiscal and monetary policy.
What is a Maximum Price?
A legally-imposed maximum price in a market that suppliers cannot exceed.
What is a Minimum Price?
Minimum prices or price floors are the minimum legally allowed prices for a good set by the government.
What is a Pollution Permit?
A Pollution Permit allows the owner to pollute up to a specific amount of pollution and the government controls how many permits there are so limits the maximum amount of pollution.
Why does the government provide public goods?
Public Goods are non-excludable and non-rivalry and so the free rider problem says they will be under-provided by the free market.
Why does the government provide information?
To allow people to make informed decisions. They may also force companies to provide information.
What is Government Failure?
When government intervention leads to a new/deeper market failure.
What are Unintended Consequences?
When a government intervention causes effects which the government did not intend to happen.
What is the Profit Maximisation point?
MC = MR
Why might a firm Profit Maximise?
- Neo-classical economics assumes that the interests of owners or shareholders are the most important and therefore the goal of firms is to profit maximise in the short run, in order to maximise owners’ returns.
- By short-run profit maximising, firms can also generate funds for investment and to help them survive a slowdown during a recession.
What is the Revenue Maximisation point?
MR = 0
Why might a firm Revenue Maximise?
- William Baumol suggested managers are most interested in their level of revenue since this is what their salary depended on.
- Even when their salary is not directly connected to sales revenue, they knew that a growth in revenue was always likely to be a positive for the business. It increases their prestige and is used as a justification to shareholders for managerial rewards.
- A fall in revenue would be negative as it would not only reduce their salary but could signal the start of a downward spiral for the company.
- As a result, many firms may aim to revenue maximise as long as they provide some profit for the owners.
What is the Sales Maximisation point?
AC = AR
Why might a firm Sales Maximise?
- Robin Marris suggested that managers aim to maximise the growth of their company above any other objective. This is because their salary may be linked to the size of the company.
- It is often easier for people to judge the level of growth achieved rather than the level of profit. This will increase the prestige of the business.
- Growth will also increase market share, and may push other firms out of business. It will enable a firm to have more market power and more power over prices.
- This tends to be a short term strategy , and in the long term firms are more likely to profit maximise.
What is Profit Satisficing?
- Due to the principal-agent problem, owners and directors will have different goals. Directors will want to maximise their own benefits but will need to make a certain amount of profit in order to keep their jobs, receive benefits and avoid criticism from
shareholders/the press. - Therefore, managers are likely to follow the objective of profit satisficing: they will make enough profit to keep owners happy whilst following other objectives and not profit maximising.
Why do some firms decide to remain small?
Some remain small because of constraints on growth: the size
of the market, access to finance, owner objectives and regulation. Not all firms want to grow.
Why do some firms grow?
- By growing, a firm will be able to experience economies of scale which helps them to decrease their costs of production.
- A larger firm will hold a greater share of their market. This will give them the ability to influence prices and restrict the ability of other firms to enter the market, helping them to make profits in the long run.
- A larger firm will have more security as they will be able to build up assets and cash which can be used in financial difficulties
What is the Principal Agent Problem?
The principal–agent problem refers to the conflict in interests and priorities that arises when one person or entity (the agent) takes actions on behalf of another person or entity (the principal).
What is the Public Sector?
The public sector refers to that part of the economy which is owned or controlled by local or central government.
What is the Private Sector?
The private sector refers to that part of the economy that is owned and run by individuals or groups of individuals, including sole traders and PLCs.
What is a Not-for-Profit Organisation?
Some private sector organisations are not-for-profit. Any profit they do make is used to support their aim of maximising social welfare and helping individuals and groups. These organisations include charities and smaller organisations who aren’t large enough to be classified as charities.
What is Organic Growth?
Organic growth is the process by which a company expands on its own capacity, increasing output and enhancing sales internally.
What is Vertical Integration?
Vertical integration is the integration of firms in the same industry but at different stages in the production process.
What is Forward Vertical Integration?
Forward integration is when the firm is moving towards
the eventual consumer of a good (up the supply chain).
What is Backwards Vertical Integration?
If the merger takes the firm back towards the supplier of a
good, it is backwards integration (down the supply chain).
What is Horizontal Integration?
This is where firms in the same industry at the same stage of production integrate.
What is Conglomerate Integration?
This is where firms in different industries with no obvious connections integrate.
What are some constraints of Business Growth?
- Size of the market
- Access to finance
- Owner objectives
- Regulation
What are some reasons for Demergers?
- Lack of synergies
- Value of the company/share price
- Focussed companies
- Avoid attention from competition authorities
What is Total Revenue (TR)?
The total amount of money coming into the business through the sale of goods and services. Quantity x Price .
What is Average Revenue (AR)?
Demand is equal to AR: total revenue / output .
What is Marginal Revenue (MR)?
The extra revenue that the firm earns from selling one more unit of production: change in total revenue / change in output .
What is the formula for Total Costs (TC)?
Fixed Costs + Variable Costs
What is the formula for Average Total Cost (ATC)?
Total Costs / Output
What is the formula for Average Fixed Cost (AFC)?
Total Fixed Cost / Output
What is the formula for Average Variable Cost (AVC)?
Total Variable Cost / Output
What is the formula for Marginal Cost (MC)?
change in Total Cost / change in Output
What is the Short Run?
When at least one factor of production is fixed and cannot be changed.
What is the Long Run?
When all factors of production become variable.
What is Diminishing Marginal Productivity?
Diminishing Marginal Productivity means that if a variable factor is increased when another factor is fixed, there will come a point when each extra unit of the variable factor will produce less extra output than the previous unit.
What are Economies of Scale?
Economies of Scale are the cost advantages that firms obtain due to their scale of operation, and are typically measured by the amount of output produced per unit of cost (production cost).
What are the some types of Economies of Scale
- Technical Economies of Scale
- Financial Economies of Scale
- Risk Bearing Economies of Scale
- Managerial Economies
- Marketing and Purchasing Economies of Scale
What are Diseconomies of Scale?
Diseconomies of scale occur when an additional production unit of output increases marginal costs, which results in reduced profitability.
What is the Shut Down point?
AVC > AR
What is Allocative Efficiency?
Allocative efficiency is a state of the economy in which production is aligned with the preferences of consumers and producers; in particular, the set of outputs is chosen so as to maximize the social welfare of society.
What is Productive Efficiency?
Productive efficiency: A firm has productive efficiency when its products are produced at the lowest average cost so the fewest resources are used to produce each product. The minimum resources are used to produce the maximum output. This can only exist if firms produce at the bottom of the AC curve, in the short run this is where MC=AC.
What is Dynamic Efficiency?
Dynamic efficiency: This is achieved when resources are allocated efficiently over time. It is concerned with investment, which brings new products and new production techniques.
- Dynamic efficiency will be achieved in markets where competition encourages innovation but where there are differences in products and copyright/patent laws.
What is X-Inefficiency?
X-inefficiency is a concept used in economics to describe instances where firms go through internal inefficiency resulting in higher production costs than required for a given output.
What are the features of Perfect Competition?
- There must be many buyers and sellers.
- There must be freedom of entry and exit from the industry.
- There must be perfect knowledge.
- The product must be homogenous.
What are the features of Monopolistic Competition?
- There must be a large number of buyers and sellers.
- There are no barriers to entry and exit.
- Differentiated goods.
What type of profit can Perfect Competition make in the Long Run?
Normal Profit.
What type of profit can Monopolistic Competition make in the Long Run?
Normal Profit.
What are the features of Oligopolistic Competition?
- Differentiated goods.
- High Concentration Ratio.
- Interdependent firms.
- Barriers to entry.
What is Collusive Behaviour?
Collusion is when firms make collective agreements that reduce competition . When firms don’t collude, this is a competitive oligopoly.
What is a Cartel?
A formal collusive agreement is called a cartel, which is a group of firms who enter into agreement to mutually set prices. The rules will be laid out in a formal document which may be legally enforced and fines will be charged for firms who break these rules.
What is a Barometric Firm Price Leader?
Where a firm develops a reputation for being good at predicting the next move in the industry and other firms decide to follow their leader.
What is Game Theory?
Game theory explores the reactions of one player to changes in strategy by another player. The aim is to examine the best strategy a firm can adopt for each assumption about its rival’s behaviour and it provides insight into interdependent decision making that occurs in competitive markets.
What is First-Degree Price Discrimination?
First-degree is when a seller charges all buyers the highest price and allows for reductions.
What is Second-Degree Discrimination?
Second-degree is when a seller changes price depending on the quantity purchased.
What is Third-Degree Price Discrimination?
Third-degree is when a seller charges different prices for different consumer groups based on a specific attribute.
What is a Natural Monopoly?
A natural monopoly is a type of monopoly in an industry or sector with high barriers to entry and start-up costs that prevent any rivals from competing.
- For example, London Underground.
What is a Monopsony?
This is where there is only one buyer in the market.
- For example, the NHS.
What are the features of a Contestable Market?
- Perfect knowledge.
- Freedom of entry and exit.
- No sunk costs.
- Low product loyalty.
