Microeconomics Flashcards
What is the basic economic problem?
Humans wants are infinite, whilst resources are scarce.
Describe what a free market is and state an example.
Free market/Capitalism
- In a free market household own resources, allocated by the price mechanism ( Can you afford it? is it worth buying?)
- All production is in private hands
- Demand + Supply set wages and prices.
- Decision made by the private sector
- Resources are allocated efficiently
- Limited role of the government
Example : U.S
What is economic growth?
Economic growth = when the quantity of output produced by an economy over a period of time increases.
What is economic development?
Economic development = this refers to raising the standard of living and well-being of people, particularly in LEDCs.
What is sustanible development?
Sustainable development = this is defined as ‘development which meets the needs of the present without compromising the ability of future generations to meet their own needs’.
Describe what a mixed economy is and state an example.
In reality –> All economies are mixed –> The degree of the mix will change from country to country.
- Some resources are owned by the public sector (government) - Public healthcare or public schooling
- Decision are made by the public sector
- Some resources are owned by the private sector (Allocated by the private mechanism)
Example: England or The Netherlands
Describe what a planned economy is and state an example.
Planned economy
- The government decides what products are produced, how products are produced and who the products are for.
- Resources are owned and allocated by the state.
- Government sets targets and growth rates according to it own view of people’s wants.
- Rationing through non-price methods (Little to no market prices)
- Income and wealth distribution decided by the state
Example: Cuba
What are positive statements?
Positive statements
- Objective statements that can be tested by reffering to the avaliable audience.
- The statement can be accepted or rejected.
Example: A rise in consumer income will lead to a rise in the demand for new cars. (This can be tested)
What are normative statements?
Normative statements
- Express an opinion about what ought to be.
- They are subjective (Don’t say opinion) statements.
- They carry out value judgements (They can be debated)
Example: The government should give every unemployed person a job.
What is the definition of ceteris paribus?
This is a Latin term which means ‘all other things being equal’. Another way of saying it is that all other things are assumed to be constant or unchanged.
- It is an assumption
- Only one variable is changed at a time
What is the definition of Utility?
Utility = the benefit or satisfaction that consumers derive from consuming a good or service.
Utility is subjective – the satisfaction that you receive from a particular good depends on your own preferences.
What is the definition of opportunity cost?
Opportunity cost = this is the value of the next best alternative that must be given up as a result of your choice.
(What are you giving up as a result of your choice)
Example: With 3$ at the cafe you can either buy a sandwich or a drink. The opportunity cost of buying the sandwich is the drink.
Note - Opportunity cost is never expressed in monetary terms.
What is a Free good?
Free goods
- This is any good that is not scarce.
- Has zero opportunity cost.
- The quantity supplied is greater than the quantity demanded and the price is zero.
What is a Economic good?
- Anything that is scarce
- Naturally occuring or produced by scarce resources
- Oppertunity cost greater then 0
What is a PPF diagram?
Production Possibility Frontier (PPF) –> Shows all the combinations of two goods that can be produced when all resources are fully and efficiently employed
- The diagram shows the concept of opperunity cost (If I poduce this good, how much less of the other good will i give up)
- Points on the line - Productive efficiency (Using all available resources)
- Points inside the line - unemployed resources
- Points outside the line - not possible with current resources
- Axis can be labelled in several different ways
E.g - Good X and Good Y, names of the good etc.
How can the PPF show economic growth and economic development?
Economic Growth
As the curve on the PPF moves outwards, there is more output which shows economic growth. As the curve moves inwards (towards the axis) shows a contracting economy as less output is produced.
Economic development
The PPF can show economic development depending on what goods it is showing. If the PPF diagram is showing Merit and Demerit goods then an increase in the amount of Merit goods shows economic development. (More demerit –> less economic development)
What is the definition of market in economics?
Market = this is any kind of arrangement where buyers and sellers are linked together to carry out an exchange.
What is the definition of demand?
Demand - The quantity of goods and services that costumers are willing and able to buy at a given price.
What is the law of demand?
The law of the demand states that as the price of a ‘normal’ good/service rises, the quantity demanded will fall.
- The curve nomrally has a negative slope, this is becuase as one factor rises the other one is expected to fall therefore, one value will always be negative.
What are factors that affect Demand? (Shift)
Determinants of demand = these are the variables (other than price) that can influence demand, causing a shift in the demand curve.
- Price of other goods and services –> Substitutes/complements/unrelated goods.
- Consumers’ incomes / disposable income
- Consumers’ tastes and preferences
- Fashion/trends
- Seasons
- Quality
What causes a movement in the demand curve?
Movements along the demand curve are due to changes in price (ONLY PRICE).
Movement is caused by a shift in supply.
What is the definition of supply?
Supply = The quantity of a good or service that a producer is willing and able to supply onto the market at a given price in a given time period.
What is the law of supply?
Law of supply
States that there is a positive relationship between the quantity of a good supplied and its price. (As price goes up/ quanity supplied goes up - visa versa)
- A normal supply curve is therefore upward sloping.
What are the determinants of supply?
Determinants of supply
Variables (other than price) that can influence supply, causing a shift in the supply curve
- Changing cost of production (natural resources)
- Fall in the exchange rate
- Changes in technology
- Government indirect taxes/subsidies
- Timeframe
- Expectations –> What will happen with demand in the future.
- Changes in climate
- Increase in workers/labour
What causes a movement in the supply curve?
Movements along the supply curve –> caused by a change in price.
Caused by a shift in demand
What is the equilibrium point?
Equilibrium = also known as market clearing price, where the quantity supplied is equal to the quantity demanded. There are no shortages or surpluses. This is where the market settles.
- If price is too high, there will be a surplus.
- If the price is too low, there will be a shortage.
What is the importance of price within the market?
Tip –> signalling, incentive and rationing.
Prices have a role in signalling and incentive. Signals communicate information to decision makers. Incentives motivates decision makers to respond to the information.
- Shortage of supply acts as a signal to increase production
- An increase in price acts like an incentive for producers or it is an incentive for consumers to buy less since prices have increased.
The thrid function is rationing –> When there is a shortage of a product, price will rise and deter some consumers from buying the product.
This is when demand for a product increases which causes a shortage in the market. The price of the good increases. Then suppliers will respond by increase supply (Signalling and incentives). The raise in price will deter some costumers therefore leaving the people that actually need the product.
What is consumer surplus?
Consumer surplus –> The extra satisfaction/utility gained by consumers from paying a price that is lower than that which they are prepared to pay.
This is the difference between the total amount that consumers are willing and able to pay for a good or service (indicated by the demand curve) and the total amount they do actually pay (the actual price).
- Indicated by the area above the market prive and below the demand curve.
What is the producer surplus?
Producer surplus –> Measure of producer welfare which is measured as the difference between the amount producers are willing and able to supply a good for and the price they receive.
- Producer surplus is the area under the equilibrium price and above the supply curve.
What is allocative efficiency?
Allocative efficiency = this is defined as the best allocation of resources from society’s point of view.
It occurs at competitive market equilibrium. This is when economic welfare is maximised.
(marginal benefit = marginal cost).
What is price elasticity of demand?
Definition of PED: the responsiveness of demand to a change in price.
PED = (%change in Qd) / (%change in price)
The range of values PED can be between 0 and infinity. The value is usually a negative number, but we usually ignore the sign. (Demand is a negative sloping curve)
Note –> Don’t forget it is a PERCENTAGE CHANGE.
What type of good is it if the PED is between 0 and 1?
If Ped is between 0 and 1 then demand is inelastic. Change in price results in a proportionally smaller change in QD.
The product is inelastic –> Producers can increase the price to receive more revenue.
Examples:
Essentials with no alternatives - Medicine
Luxury itens/products - Bugatti
Addictive products - cigarettes
Necesities - Petrol, tooth paste
What do you call a good that has a PED of 1
If Ped = 1 (i.e. the percentage change in demand is exactly the same as the percentage change in price), then demand is said to unit elastic. (Unitary elasticity)
Change in price doesn’t lead to a change in revenue.
What do you call a good with a PED of 0? What do you call a good with a PED of ∞?
If Ped = 0, demand perfectly inelastic. (Demand does not change at all when the price changes – the demand curve will be vertical) - E.g Heroine
If PED = ∞, demands is perfectly elastic (Quantity demand is infinite –> however, any deviation in price –> Qd will fall to zero)
What do you call a good with a PED of greater then 1?
If Ped > 1, change in demand is proportionately greater than the change in price i.e. demand is elastic.
For example, a 20% increase in the price of a good might lead to a 30% drop in demand. The price elasticity of demand for this price change is –1.5.
Producer sells a product with elastic demand –> Shouldn’t increase price.
Examples
- Products with good substitutes
- Products that are bought frequently –> Change in price will have a greater effect on consumers.
What is the definition and formula of cross elasticity of demand?
XED = the responsiveness of a change in demand for good X as a result of change in price of good Y.
Formula CED = (𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑑𝑒𝑚𝑎𝑛𝑑 𝑓𝑜𝑟 𝑔𝑜𝑜𝑑 𝑋) / (𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑔𝑜𝑜𝑑 𝑌 )
The sign (either positive or negative) IS important when considering cross elasticity of demand.
What does a positive XED indicate?
If XED is positive, then the goods are substitutes
A change in demand for one good is in the same direction as the change in price of the other good. When the price of Y increases, the demand for X also increases. When the price of Y falls, the demand for X also falls. E.g. of X and Y could be coffee and tea.
Increase in price of Coffee - drop in demand
More poeple end up buying tea (substitiute coffe) and therefore demand increases.
What does a negative XED indicate?
If CED is negative, then the goods are complements
A change in demand for one good and the price of another good, change in the opposite directions. This occurs when the two goods are complements for each other. Eg strawberries and cream.
If price of strawberries drops (better/cheaper harvesting) then more people will buy it. Since cream is a compliment (joint demand) they will also buy cream with their strawberies. (Demand for cream increases)
What does a XED of zero indicate?
No connection between the products.
What is the definition and formula for income elasticity of demand?
YED = the responsiveness of demand to changes in income.
Formula YED = (𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑑𝑒𝑚𝑎𝑛𝑑 𝑓𝑜𝑟 𝑔𝑜𝑜𝑑 𝑋) / (𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑖𝑛𝑐𝑜𝑚𝑒)
What do you call a product with a YED between -1 and 1?
Demand is inelastic (unresponsive to change in income) when the YED is between -1 and 1.
Examples:
Necessities - Low value, routine purchases have a positive low YED. (Toothpaste)
What do you call a product with a YED of less than -1 and greater than +1?
The product is elastic when the YED is less than -1 and greater than +1. This means that the products demand is responsive to a change in income.
Examples:
- Normal goods- Positive YED (elastic) - More disposable income.
- Inferior goods have a negative YED. If income increases, demand is lowered.
- Luxury goods - very elastic –> high positive YED.
Define and state the formula for PES?
Definition = the responsiveness of supply to changes in price
PES = (𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑠𝑢𝑝𝑝𝑙𝑦 𝑜𝑓 𝑔𝑜𝑜𝑑 𝑋 ) / (𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 )
What are the possible range of values that can be obtained using the formula for PES?
Define Taxes and explain why they are used?
Taxes are payments made by businesses to the governments which increase their cost of production.
Reason:
This is done in order to reduce comsumption of demerit goods or increase government revenue.
-Taxes increase costs of production (inward shift)
What is a flat rate tax?
Flat rate tax (Unit tax) = these are taxes calculated as an absolute amount per unit of the good or service sold.
For example all wine bottles can be taxed 50 cents.
What is an ad valorem tax?
Ad valorem tax = these are taxes calculated as a fixed percentage of the price of the good or service.
The amount of tax increases as the price of the good/ service increases
For example - BTW (21%)
What is the incidence of tax?
The incidence of a tax refers to the extent to which an individual or organisation suffers from the imposition of a tax.
Elastic demand curve –> Greater burden on producers
Inelastic demand curve –> Greater burden on consumers
Burden on consumers + Burden on producers = total revenue for government.
Deadweight loss –> quantity in supply lost as a result of tax on producers.
What is the equation for revenue?
Price x Quantity = Revenue
List and describe the different types of taxes?
Progresive tax - A higher proportion is payed in tax by higher income earners. Example: Income tax in the Netherlands
Regressive tax - a higher proportion is paid in tax by lower income earners. For example BTW in The Netherlands. (Poorer people have to pay a larger percentage of their income)
Proportional tax - Same proportion of income paid in tax regardless of earnings.
Indirect tax - An indirect tax is imposed on producers. It is seen when products are purchased (BTW).
Direct tax - They are paid directly to the government by the individual tax payer - “usually pay as you earn”. For example income tax.
What is the equation for Profit?
Profit = revenue - costs
What are subsidies and what are they used for?
A subsidy is a payment from the government to firms to encourage production of a good/service. (merit goods).
It reduces buisnesses costs. Therefore, it shifts the supply curve away from the axis –> Cost of production decreases, they can supply more at a lower price.
Example: Governments might subsidies firms in the solar panel industry as solar panels are seen to be a merit good.
Is it better to tax inelastic or elastic goods in order to increase revenue? Where does the burden fall when a tax is added?
It is better to tax inelastic goods to make more revenue becuase if there is a large change in price due to the tax, there will only be a small change in quantity demand simply due to the inelastic nature of the curve.
For buisnesses a inelastic good places more of the burden on the consumers.
A tax on a elastic good places a larger burden on the producers.
What are price controls?
Price controls are controls that governments (or other authorities) put in place to try to influence the outcome of a market.
What is a maximum pirce (price ceiling)?
A government may feel that a price is too high and so set a maximum price for the good or service. eg rent controls.The price ceiling is a maximum price, below the market equilibrium price.
Maximum prices are designed to benefit consumers
Maximum prices are often found in situations where a government wants to ensure that goods are available to the poorest people at affordable prices .
eg rice and dried milk in Sri Lanka where the government intervenes to keep prices affordable
What is a minimum price? (Price floor)
A government may feel that the market results in a price that is too low and set a minimum price. eg minimum wage.
Two reasons:
- Raise income for producers of goods/services that the governments think are important (Agricultural)
- Protect workers by setting a minimum wage.
Eg minimum wages if the government believes the market equilibrium wage is too low to provide a sufficient standard of living
What are price supports and buffer stocks?
Markets –> can be very unstable/price floor –> makes governments intervene to stabilise the markets/correct the market. Eg agricultural markets
Buffer stock schemes seek to stabilize the market price of agricultural products by buying up supplies of the product when harvests are plentiful and selling stocks of the product onto the market when supplies are low.
With a Buffer stock scheme, the government will always guarantee a price to producer.
Buffer stocks in agriculture
- Aim to stabilise prices
- Constant supply food (especially when countries don’t import)
- Prevent firms from leaving the market due to price drops
Explain what positive externalities in consumption are (graph)?
Positive externality - beneficial for society - underprovided. (Merit Goods)
MSB = this is the benefit to society as a whole. (2nd demand curve)
MPB = this is the benefit to the individual who is consuming the good, shown by their demand curve.
If MSB > MPB = the good will be under consumed if left to the market mechanism eg education/ health care. (Due to imperfect information)
MSB = MPB then the socially optimum level would be reached.
Supply curve is equal to marginal private cost - Is it worth producing? No externalities in production
Triangle from MSB equilibrium to MPB equilibrium = Potential welfare gain or wellfare loss.
Explain what negative externalities in production are (graph)?
Negative externalities occur when production and/or consumption impose external costs on third parties outside of the market for which no appropriate compensation is paid.
Represent a misallocation of societies resources –> too much paint is produced at a low price.
This causes social costs to exceed private costs. (noise pollution, industrial waste)
MSC = this is the cost to society as a whole as a result of the production of a good / service.
MPC = this is the cost to the individual firm of producing a good.
If MSC > MPC = the good will be over produced if left to the market mechanism eg. Factory - pollution.
What is the difference between Merit and Public goods?
Both these goods are underconsumed in the market.
What is a veblen good?
A Vebelen good has a snob value and as the price rises –> demand will also rise. People have the notion that “The more expensive ones, are the better ones”.
-Branded clothing/ desginer clothing.
How can one represent cross elasticity of two substitues on one graph?
How can one represent cross elasticity of compliments on one graph?
What are negative externalities in consumption?
This is when demerit goods with negative externalities are overconsumed.
- Since the MSC (cost to society) is greater than MSB, there is welfare loss to society and a market failure.
- The free market consumes at the level of MPB.
- In reality, they should consume at level MSB (Social optimum) in order to minimise external costs on third parties (spillover costs).
Examples: Cigarettes, car and air pollution.
WHat are positive externalities in production?
Production of a good or service creates external benefits for third parties.
This case the MPC is more than MSC –> because production creates external benefits.
In this case, the MSB > MSC –> Resources are under-allocated
Example:
- Firm provides education.
- Cost for th firm
- Educated employees are more skilled and can thus benefit society as a whole.
How does the price mechanism (forces of demand and supply) move the market to equilibrium?
Example –> demand and supply for aeroplane tickets
Situation
Increase in consumer income –> increase in demand for foreign holidays —> demand for aeroplane tickets increase.
Explanation
Increase in demand –> outward shift –> initially price remains at the initial level of P1 –> results in a shortage/excess demand –> upward pressure on price until… Quantity demanded equals quantity supplied.
Where does the burden fall when the demand curve is relatively more elastic than supply? What impact does this have on government and producers revenue?
Elastic demand –> larger burden falls on producers relative to consumers.
Revenue for producers drops
Government revenue increases –> equal to area of consumer + producer burden.
Where does the burden fall when the demand curve is relatively more inelastic than supply? What impact does this have on government and producers revenue?
Inelastic demand –> larger burden falls on consumers relative to producers.
Revenue for producers drops
Government revenue increases –> equal to the area of consumer + producer burden.
What areas on a subsidy diagram represent producer revenue, consumer expenditure and amount of government subsidy?
Producer revenue –> 0DWQ1
Consumer expenditure –> 0P1ZQ1
Government subsidy –> P1DWZ
