Microeconomics Flashcards
Law of marginal utility
The law of marginal utility states that as a person consumes more units of a good or service, the additional satisfaction (marginal utility) gained from each extra unit decreases.
Income effect
If the price of a good falls, the consumer’s purchasing power has increased. Therefore, as the prices falls and real incomes remain the same, quantity demanded will increase as purchasing power increases. Similarly, as prices rise and real incomes remain constant, quantity demanded falls.
Substitution effect
As the price of a good rises, consumers tend to substitute it with a relatively cheaper alternative, assuming the goods are substitutable.
Determinants of Demand
Changes in Consumer income
Changes in Tastes and Preferences
Consumer preferences and tastes
Price of related goods (substitutes and complements)
Positive or Negative Advertisement
Changes in Demographics
Future expectations
Assumption of the Law of Demand
Law of Demand
It states that, ceterus parabus, when the price of a good decreases, the quantity demanded increases, and when the price increases, the quantity demanded decreases. This creates a downward-sloping demand curve.
Allocative Efficiency
The optimal allocation of resources in an economy. It occurs when resources are distributed in a way that maximizes societal welfare.
Allocative Effecient Point
(MB = MC) the point for maximum benefits to both producers and consumers.
Define PED
Measures the responsiveness of quantity demanded of a good to a change in the price.
Factors of PED
% of Income spent on the good
Degree of Necessity
Time
Closeness of Substitutes
Equation of PED
%Change in QD / %Change in Price
Values of PED and Meaning
PED > 1 = Price Elastic Demand:
Demand is sensitive to price changes
Luxury / non-essential goods
PED = 1 Unitary Elastic
A change in price will cause an equal change in demand
Revenue stays the same when price changes
PED < 1 Price Inelastic Demand
Demand is not very responsive to price changes.
Necessity goods such as petrol
Define YED
Income Elasticity of Demand Measures the responsiveness of quantity demanded of a good to a change in a consumer’s Income.
Equation of YED
% Change in QD / % Chabge in Income
Meaning of YED Values
YED > 1 - Income Elastic demand (Normal Good - Luxury)
Demand rises sharply as income rises.
1 > YED > 0 - Income Inelastic Demand (Normal Good - Necessity)
Demand rises slowly with income
YED = 0 - No Relation
Income change has no effect on demand
YED < 0 - Inferior Good
As income increases, demand decreases.
People switch to better alternatives as they earn more
Define PES
Price Elasticity of Supply is the responsiveness of quantity supplied of a good to a change in it´s price.
Factors of PES
Ability to Store the product (Degree of Perishability)
Time
Spare Capacity of Production
Availability of Factors of Production
Cost to produce 1 additional unit
Equation of PES
% Change in QS / % Change in Price
Meaning of PES Values
PES > 1 → Price elastic supply - y-axis
PES < 1 → Price inelastic supply - x-axis
PES = 1 → Unit elastic - origin
PES = 0 → Perfectly inelastic (supply is fixed no matter the price)
PES = ∞ → Perfectly elastic (any price change = infinite supply)
Define Indirect Taxation
