Microeconomics Flashcards
ad valorem taxes
- taxes calculated as a fixed percentage of the price of the good or service
- amount of taxes increases as the price increases
cap and trade scheme
- a scheme in which a government authority sets a limit or ‘cap’ on the amount of pollutants that can be legally emitted by a firm, set by an amount of pollution permits distributed to firms
- firms that want to pollute more can buy more permits, while firms that want to pollute less can sell their excess permits
capital
- one of the factors of production
- also known as “physical capital”, including machinery, equipment, buildings, etc.
- “human capital” refers to skills, abilities, knowledge and levels of good health acquired by people
- “natural capital” has to do with the factor of production ‘land’
- “financial capital” includes stocks and bonds
ceteris paribus
- “other things being equal”
- all other things are assumed to be constant or unchanging
circular flow of income model
model showing the flow of resources from consumers (households) to firms, and the flow of products from firms to consumers, as well as money flows consisting of consumers’ income arising from the sale of their resources and firms’ revenues arising from the sale of their products
clean technology
technology that is not polluting, associated with environmental sustainability; includes solar power, wind power, hydropower, recycling, etc
closed economy
an economy that has no international trade
common access resources
resources that are not owned by anyone, do not have a price, and are available for anyone to use (ex. lakes, fish in open seas, ozone layer); their depletion leads to environmental unsustainablity
Competitive market
a market composed of many buyers and sellers acting independently, none of whom has any ability to influence the price of the product
competitive supply
two goods compete with each other for the same resources
ex) if a farmer can produce wheat or corn, producing more of one means producing less of the other
complements (complementary goods)
- two or more goods that tend to be used together
- an increase in the price of one will lead to a decrease in the demand of the other
ex) a bike and a bike helmet
consumer surplus
the difference between the highest prices consumers are willing to pay for a good and the price actually paid
consumption
spending by households on goods and services (excludes spending on housing)
cross-price elasticity of demand (XED)
- a measure of the responsiveness of the demand for one good to a change in the price of another good; measured by the percentage change in the quantity of one good demanded divided by the percentage change in the price of another good
- if XED>0, two goods are substitutes
- if XED<0, two goods are complements
demerit goods
- goods that are considered to be undesirable for consumers and are overprovided in the market
- reasons for over provision: goods have negative externalities, or consumers are ignorant of harmful effects
direct taxes
taxes paid directly to the gov’t tax authorities by the taxpayer, including personal income taxes, corporate income taxes and wealth taxes
distribution of income
concerned with how much of an economy’s total income different individuals or different groups in the population receive, and involves answering the ‘for whom’ basic economic question
economic efficiency
condition that arises when allocative efficiency is achieved
economics
the study of choices leading to the best possible use of scarce resources in order to best satisfy unlimited human needs and wants
elasticity
a measure of the responsiveness or sensitivity of a variable to changes in any of the variable’s determinants
entrepreneurship
- one of the factors of production
- involves a special human skill that includes the ability to innovate by developing new ways of doing things, to take business risks and to seek new opportunities for opening and running a business
equilibrium
a state of balance such that there is no tendency to change
equilibrium level of output
the level of output (real GDP) where the aggregate demand curve intersects the aggregate supply curve
equilibrium price
the price determined in a market when quantity demanded is equal to quantity supplied, and there is no tendency for the price to change
equilibrium quantity
the quantity that is bought and sold when a market is in equilbrium
equity
condition of being fair or just; should be contrasted with “equality”
excise taxes
taxes imposed on spending on particular goods or services
ex) gasoline/petrol
excludable
a characteristic of goods according to which it is possible to exclude people from using the good by charging a price for it
externality
occurs when the actions of consumers or producers give rise to positive or negative side-effects on other people who are not part of these actions, and whose interests are not taken into consideration
factors of production
all resources or inputs (land, labor, capital, entrepreneurship) used to produce goods and services
free rider problem
- occurs when people can enjoy the use of a good without paying for it, and arises from non-excludability: people cannot be excluded from using the good, because it is not possible to charge a price
- is often associated with public goods, which are a type of market failure: due to the free rider problem, private firms fail to produce these goods
income elastic demand
- relatively high responsiveness of demand to changes in income
- YED (income elasticity of demand) > 1
income elasticity of demand
- measure of the responsiveness of demand to changes in income
- percentage change in quantity demanded divided by the percentage change in price
income inelastic demand
-relatively low responsiveness of demand to changes in income
YED<1
inferior good
-a good the demand for which varies negatively (or indirectly) with income
-as income increases, the demand for the good decreases
Ex) McDonald’s coffee
luxuries
- goods that aren’t necessary or essential
- have a price elastic demand (PED>1) and income elastic demand (YED>1)
marginal benefit
the extra or additional benefit received from consuming one more unit of a good
marginal cost
the extra or additional cost of producing one more unit of output
marginal private benefits (MPB)
the extra benefit received by customers when they consume one more unit of a good
marginal private costs (MPC)
the extra costs to producers of producing one more unit of a good
marginal social benefits (MSB)
- the extra benefits to society of consuming one more unit of a good
- same as MPB when there are no consumption externalities
marginal social costs (MSC)
- the extra costs to society of producing one more unit of a good
- same as MPC when there are no production externalities
market
any kind of arrangement where buyers and sellers of a particular good, service or resource are linked together to carry out an exchange
market failure
occurs where quantity demanded is equal to quantity supplied, and there is no tendency for the price or quantity to change where too much or too little goods or services are produced and consumed from the point of view of what is socially most desirable
maximum price
- a legal price set by the government, which is BELOW the market equilibrium price
- doesn’t allow the price to rise to its equilibrium level determined by a free market (aka price ceiling)
merit goods
- goods that are held to be desirable for consumers, but which are underprovided by the market
- reasons for underprovision can be that the good has positive externalities, or consumers with low incomes can’t afford it, or consumer ignorance about the good’s benefits
minimum price
- a legal price set by the government which is ABOVE the market equilibrium price
- this doesn’t allow the price to fall to its equilibrium level determined by a free market (aka price floor)
minimum wage
a minimum price of labor set by governments in the labor market, in order to ensure that low-skilled workers can earn a wage high enough to secure them with access to basic goods and services
necessities
- goods that are necessary or essential
- have a price inelastic demand (PED<1)
- have income inelastic demand (YED<1)
negative externality
- a type of externality where the side-effects on third parties are negative or harmful
- known as “spillover costs”
negative externality of consumption
a negative externality caused by consumption activities, leading to a situation where MSB
negative externality of production
a negative externality caused by production activities, leading to a situation where MSC>MPC
non-excludable
- a characteristic of some goods where it’s not possible to exclude someone from using a good, because it’s not possible to charge a price
- one of the two characteristics of public goods
non-price rationing
the apportioning or distributing of goods among interested users/buyers through means other than price
- often necessary when there are price ceilings
ex) waiting in line, underground markets
non-rivalrous
- a characteristic of some goods where the consumption of the good by a person doesn’t reduce consumption by someone else
- one of the two characteristics of public goods
competition
when there are many buyers and sellers acting independently, so that no one has the ability to influence the price at which a product is sold in the market
monopoly
- also known as “market power”
- seller can control the price of the product it sells
- greater competition between sellers means smaller market power
demand
various quantities of a good or service the consumer is willing and able to buy at different possible prices during a particular time period, ceteris paribus
law of demand
there is a negative casual relationship between the price of a good and its quantity demanded over a particular time period, ceteris paribus
Why does the demand curve slope downward?
-the principle of decreasing marginal benefit: since marginal benefit falls as quantity consumed increases, the consumer will be induced to buy each extra unit only if its price falls
marginal benefit (marginal utility)
extra benefit you get from each additional unit of something you buy
market demand
sum of all individual demands for a good
List the non-price determinants of demand.
- income in the case of normal goods
- income in the case of inferior goods
- preferences and tastes
- prices of substitute goods
- prices of complementary goods
- demographic changes
Income in the case of normal goods (as a non-price determinant of demand)
- normal good: the demand for it increases in response to an increase in consumer income
- increase in income leads to a rightward shift in the demand curve, and vice versa
Income in the case of inferior goods (as a non-price determinant of demand)
- inferior good: demand for good varies inversely with income
- as income increases, consumers switch to more expensive alternatives (new clothes, new cars), so the demand for the inferior goods fails
preferences and tastes (as a non-price determinant of demand)
If preferences and tastes change in favor of a product, demand increases and the demand curve shifts to the right.
If preferences and tastes change against the product, demand decreases and the demand curve shifts to the left.
prices of complementary goods (as a non-price determinant of demand)
- complementary goods tend to be used together (like DVDs and DVD players)
- a fall in the price of one leads to an increase in the demand for the other
prices of substitute goods (as a non-price determinant of demand)
- substitutes satisfy a similar need (ex. coca-cola and pepsi)
- A fall in the price of one results in a fall in the demand for the other. This is because as the price of coca-cola falls, some consumers switch from pepsi to coca-cola, and the demand for pepsi falls.
demographic changes (as a non-price determinant of demand)
- An increase in the number of buyers (demanders), demand increases and the market demand shifts to the right, and vice versa.
- follows simply from the fact that market demand is the sum of all individual demands
Movement along a demand curve vs. shifts of the demand curve
- When the price of a good changes, it leads to a movement along the demand curve. A fall in price leads to an increase in quantity demanded.
- Any change in a non-price determinant of demand leads to a shift in the entire demand curve.
supply
various quantities of a good or service a firm is willing and able to produce and supply to the market for sale at different price levels, during a particular time period, ceteris paribus.
law of supply
there is a positive casual relationship between the quantity of a good supplied over a particular time period and its price, ceteris paribus
Why does the supply curve slope upward?
Higher prices generally mean that the firm’s profits increase, and so the firm faces an incentive to produce more output. Lower prices mean lower profitability, and the incentive facing the firm is to produce less.
Market supply
sum of all individual firms’ supplies for a good
What does a vertical supply curve mean?
-It means that even as price increases, the quantity supplied can’t increase; it remains constant. The quantity supplied is independent of price.
List two reasons why vertical supply can occur
- there is a fixed quantity of the good supplied because there’s no time to produce more of it (ex. there is a fixed quantity of theatre tickets in a theatre)
- there is a fixed quantity of the good because there is no possibility of ever producing more of it (ex. original antiques and original paintings)
List the non-price determinants of supply.
- costs of factors of production (factor or resource prices)
- technology
- prices of related goods: competitive supply
- prices of related goods: joint supply
- producer (firm) expectations
- taxes (indirect taxes or taxes on profits)
- subsidies
- the number of firms
- shocks
costs of factors of production (as a non-price determinant of supply)
If a factor price rises, production costs increase, production becomes less profitable and the firm produces less; the supply curve shifts to the left. vice versa
technology (as a non-price determinant of supply)
A new improved technology lowers costs of production, thus making production more profitable. Supply increases and the supply curve shifts to the right.
prices of related goods: competitive supply (as a non-price determinant of supply)
Competitive supply refers to production of one or the other by a firm; the goods compete for the use of the same resources, and producing more of one means producing less of the other. (ex. wheat and corn)
prices of related goods: joint supply (as a non-price determinant of supply)
Joint supply of two or more products refers to production of goods that are derived from a single product.
ex) Butter and skimmed milk are both produced from whole milk. An increase in the price of one leads to an increase in its quantity supplied and also to an increase in supply of the other joint product.
producer expectations (as a non-price determinant of supply)
- if firms expect the price of their product to rise, they’ll withhold some of their current supply from the market, with the expectation that they’ll be able to sell it at higher price in the future –> a fall in supply in the present results –> leftward shift in the supply curve
- if firms expect their product’s price to fall, they increase their supply in the present to take advantage of the current higher price –> rightward shift in the supply curve
taxes (indirect taxes or taxes on profits) (as a non-price determinant of supply)
- firms treat taxes as if they are costs of production
- the imposition of a new tax or increase of existing tax represents an increase in production costs, so supply will fall and the supply curve shifts to the left. Vice versa
subsidies (as a non-price determinant of supply)
- Subsidy is a payment made to the firm by government.
- introduction of a subsidy or an increase in an existing subsidy means a fall in production costs, and gives rise to a rightward shift in the supply curve
the number of firms (as a non-price determinant of supply)
increase in the number of firms producing the good increases supply and gives rise to a rightward shift in the supply curve, and vice versa
shocks
- shocks are unpredictable events (ex. weather conditions, oil spills, earthquakes)
- shocks lead to a decrease in the supply. There’s a leftward shift in the supply curve.
movement along a supply curve vs. shift of the supply curve
- any change in price produces a change in quantity supplied, shown as a movement on a supply curve
- any change in a non-price determinant of supply produces a change in supply, represented by a shift of the whole supply curve
surplus
There is excess supply; if quantity demanded for a good is smaller than quantity supplied
shortage
There is excess demand; if quantity demanded of a good is larger than quantity supplied
market equilibrium
quantity demanded equals quantity supplied, and there is no tendency for the price to change
market disequilibrium
there is excess demand (shortage) or excess supply (surplus), and the forces of demand and supply cause the price to change until the market reaches equilibrium
Using diagrams and reference to excess demand or excess supply, explain how changes in the determinants of demand result in a new market equilibrium.
(Diagram in p.31)
- Consider a change in a determinant of demand causes the demand curve to shift to the right from D1 to D2. Given D2, at initial price P1, there is a movement to point b, which results in excess demand equal to the horizontal distance between points a and b.
- Point b represents a disequilibrium, exerting an upward pressure on price.
- Price starts to increase, causing a movement up D2 to point c, where excess demand is eliminated and new equilibrium is reached.
- At c, there is higher equilibrium price, P2, and greater equilibrium quantity, Q2, given by the intersection of D2 with S.
(exactly the opposite if the determinant of a demand shifts the demand curve to the left. ‘excess supply’ instead of excess demand.)
Using diagrams and reference to excess demand or excess supply, explain how changes in the determinants of supply result in a new market equilibrium.
- An increase in supply (ex. improvement in technology) shifts the supply curve to S2. With S2 and P1, there is a move from point a to b, where there is disequilibrium due to excess supply.
- Price begins to fall, and there results a movement down S2 to point c where a new equilibrium is reached. At c, excess supply has been eliminated, and there’s a lower equilibrium price, P2, but a higher equilibrium quantity, Q2.
Scarcity
forces societies to make choices about the “what to produce” economic question, which is a resource allocation question
Opportunity cost
sacrificed alternatives that could have been chosen instead
producer surplus
the price received by firms for selling their goods minus the lowest price that they are willing to accept to produce the good
allocative efficiency
- producing the combination of goods mostly wanted by the society
- answers the “what to produce” question in the best possible way
- means that productive efficiency is also achieved (answering “how to produce” question)
social surplus
- sum of consumer plus producer surplus
- is maximized at the point of market equilibrium where MB=MC
welfare
- the well-being of the society
- refers to maximum social surplus
price elasticity of demand (PED)
- measure of the responsiveness of the quantity of a good demanded to changes in its price
- PED=(percentage change in quantity demanded)/(percentage change in price)
price inelastic demand
quantity demanded is relatively unresponsive to price
0
price elastic demand
quantity demanded is relatively responsive to price
1
unit elastic demand
percentage change in quantity demanded equals percentage change in price
PED=1
perfectly inelastic demand
quantity demanded is completely unresponsive to price
PED=0
perfectly elastic demand
quantity demanded is infinitely responsive to price
PED=∞
How does PED change along the demand curve?
PED gets higher as we move up the demand curve.
-at high prices and low quantities, the percentage change in Q is relatively large while the percentage change in P is relatively small. –> A large PED (elastic demand)
Determinants of PED
- number and closeness of substitutes
- necessities vs luxuries
- length of time
- proportion of income spent on a good
PED determinant: number and closeness of substitutes
- The more substitutes a good has, the more elastic is its demand. Consumers can switch to other substitute products, resulting in a relatively large drop in quantity demanded (large responsiveness).
- The closer two substitutes are to each other, the greater the responsiveness of quantity demanded to a change in the price of the substitute, hence the greater the PED (consumers can easily switch from one product to another).
PED determinant: necessities vs. luxuries
- Demand for necessities is less elastic than the demand for luxuries. We can’t live without necessities.
- Special case of necessity is a consumer’s addiction to a good (ex. drugs). The greater the addiction, the more inelastic is the demand.
PED determinant: length of time
The longer the time period in which a consumer makes a purchasing decision, the more elastic the demand. As time goes by, consumers can consider whether they really want the good, and get info on the availability of alternatives to the good.
PED determinant: proportion of income spent on a good
The larger the proportion of one’s income needed to buy a good, the more elastic the demand. (ex. pen takes a small proportion of one’s income, whereas summer holidays take up a larger proportion)
PED and steepness of the demand curve
PED can be compared to the steepness of the demand curve ONLY when the demand curves share a price and quantity combination. (diagram in p.54)
Total revenue
- the amount of money received by firms when they sell a good or service
- equal to price x quantity
What happens to TR when demand is elastic?
- increase in price causes a fall in total revenue
- decrease in price causes a rise in TR
What happens to TR when demand is inelastic?
- increase in price causes increase in TR
- decrease in price causes a fall in TR
What happens to TR when demand is unit elastic?
no change
primary commodities and PED
- have low PED b/c they’re necessities and have no substitutes (ex. food, oil)
- for farmers, b/c low PED means higher TR when the price is higher, selling bad crops is better for them b/c they lead to higher prices
PED and indirect taxes
-The lower the PED for the taxed good, the greater the gov’t tax revenues
Formula for XED (cross-price elasticity of demand)
(percentage change in quality demanded of good X) / (percentage change in price of good Y)
XED values and its meanings
XED>0 is when two goods are substitutes.
XED<0 is when two goods are complements.
XED=0 is when two products are unrelated.
Formula for YED (income elasticity of demand)
(% change in quantity demanded) / (%change in income)
YED values and its meanings
YED>0 when the good is normal.
YED<0 when the good is inferior. As income increases, the demand for these goods falls as consumers switch to consumption of normal goods.
