Microeconomics Flashcards
Benefits of free market
Efficient
Entrepreneurship
Choice
Cons of a free market
Inequalities
Non profitable goods not produced
Monopolies - successful businesses can become the only supplier of a product
Pros of a command economy
Maximise welfare
Low unemployment
Prevent monopolies
Cons of a command economy
Poor decision making - lack of info means poor or slow decisions on what needs to be produced
Restricted choice - firms told what to make
Lack of risk taking and efficiency - no incentives to create efficiency or take risks as they don’t need to make profit
What is a mixed economy
Public and private sector
Government - public
Privately owned businesses - private
What is marginal utility
The benefit gained from consuming one additional unit of good
What is total utility
Overall benefit gained from consuming a good
What is the law of diminishing marginal utility
For each additional unit of a good thats consumed, the marginal utility gained decreases
What does Adam smith believe in
Believer in free market
Invisible hand will allocate resources
consumers and producers motivated by self intrest leading to price levels set at a point which benefits them both.
Couldnt be any monopolies and low barriers of entry to maximise competition
specialisation and division labour
What does Karl Marx believe in
critical of the free market
creates a situation where a small ruling class of producers exploited the larger working class
Eventually, the working class will rise up in revolution then lead to workers controlling production and everyone having a share in the ownership of resources.
led to rise in communism
What did Hayek believe in
A supporter of free market
Critical of command economy
Government shouldnt intervene because of lack of information
Indivisual consumers and producers have the best knowledge of what they want or need so they can allocate resources.
Price mechanism
Why do firms want to maximise profit
profit means firms can survive
Greater profits allow fims to offer better rewards to the owners pr shareholders or staff
Can be reinvested to make more profit later eg to expand
why do firms want to maximise market shares
lead to monopoly power
firms can charge higher prices as a lack to competition
why do the government want to maximise public interest
economic growth
full employment
equilibrium in the balance of payments - balance between payments into the country and the payments out
low inflation
Characteristics of economic agents
Utility maximisers
Rational
How do economic agents maximise utility
Comparing the costs and benefits of alternatives, then choosing the option that maximises their net utility.
What are the problems with assuming economic agents are rational and utility maximisers based on the information given
May have imperfect information - can lead to market failure
Asymmetric information - one party has more information than the other in a transaction
Why don’t economic agents act rationally
Time available to make a decision is limited
Not all information is available or correct
Might not be able to process and evalute vast amount of data involved in making a decision
May not be good at calculating the goods of alternatives (computation weakness)
How are individuals influenced by biases (5)
Rules of thumb Anchoring Availability bias - Judgements made about the probability of events occurring based on how easy it is to remember such events occurring Social norms Habitual behaviour
What are normal goods
good where, if price rises, demand will
fall.
What does a more equal distribution of income mean for demand
Fewer rich people means fewer luxury goods sold
What is derived demand
Demand for a good or a factor of production used in making another good or service.
Factors influencing price elasticity of demand
Substitutes - the more substitutes the more price elastic
Type of good - essential, habit forming, several uses
Percentage income spent on tax
Time - long run becomes more price elasticity
Why is YED useful for firms and government
Can be used in sales forecasting if YED and changes in income are known.
Can be used in pricing policy - reduction in price for a normal good if there’s an expected fall in income
Why is XED useful for firms and governments
Tell them how to react to changes in the price of related products to ensure they maximise demand
Factors causing shift in supply curve
Changes to cost of production Technology Productivity Indirect taxes and subsidies Changes to the price of other goods Number of suppliers
Why is a high PES important to firms
Aim to respond quickly to changes in price and demand to make their supply as elastic as possible
How to firms make their supply as elastic as possible
Flexible working patterns
Latest technology
Spare production capacity
Why is supply price inelastic in the short run
Firms capacity may be fixed and at least one factor of production is fixed
Firm can recruit more workers and buy more materials but it takes time to build additional production facilities.
Can be difficult to increase production
Why is supply more price elastic in the long run
In the long run all factors of production are variable so is able to increase its capacity in the long run
Price mechanism
Allocated goods/services in an impersonal way.
Prices will change until equilibrium is achieved and supply equals demand.
Free from biases and opinions
3 functions of price mechanism
Acts as an incentives to firms - higher prices allow firms to produce more and increase production
Signalling device- changes in price show changes in supply/demand and act as a signal
Ration- high demand and supply is limited price will be high
Price mechanism advantages
Resources allocated efficiently to satisfy wants and needs
Can operate without cost of employing ppl to regulate it
Prices kept to the minimum as resources are used as efficiently as possible
Price mechanism disadvantage
Inequality in wealth and income
Under provision of merit goods and an over provision of demerit gods
Unemployment
Public goods not produced
Consumer surplus
Difference between price that a consumer is willing to pay and the price they actually pay
Producer surplus
Difference between the price that a producer is willing to supply and a good or service at and the price they actually receive
Subsidies meaning
Money paid by government to the producer of a good to make it cheaper than it would be otherwise
What is division of labour
Type of specialisation where production is split into different parts and specific people are allocated to each task.
What is wrong with the barter system
Very inefficient, takes lots of time and effort
Three functions of money
Measure of value
Store of value
Method of deferred payment - money paid later
When does market failure occur
Allocates resources efficiently
Price mechanism fails to allocate scarce resources effeciently
Externalities meaning
third party effects arising from production and consumption of goods and services for which no appropriate compensation is paid
Factors influencing demand
The price of the good Consumer income Prices of other goods and services - substitutes,complimets Consumer tastes and fashion Other factors e.g. advertising
Which factors cause a shift in the demand curve
Changes in the price or availability of substitutes
Changes in the price or availability of complements
Changes in consumer income
Changes in taste
What does the government do in a command economy
Reduce negative externalities
Provide public goods
Control demerit goods
Supply merit goods
Factors affecting supply
The price of the good
The impact of changing costs of production
Technological progress
Prices of other goods and services
Government policy e.g. taxes and subsidies
Price elasticity of supply is determined by:
Price - an increase in price of a good, more supplied
Substitutes - easier it is to switch production
Time - at least one fix factor of production
Allocative efficiency meaning
consumer satisfaction is maximised in the production of goods and services
What are private costs
costs of consuming or producing goods or services that have to be paid for by third parties e.g. the individual or a firm
What are social costs
costs of consuming or producing goods or services that are paid for by society
When do we have negative externalities
When social costs are greater than private costs
Why may markets be inefficient
Externalities
Missing Markets
Under-provision of public goods
Information gaps
2 characteristics of a public good
Non-rival
Non-excludable
What is a public good
one where its use by an individual does not stop
others from using it whilst its consumption does not reduce the amount available for consumption by others
When does market failure occur with public goods
A free-rider is someone who benefits from a good or service without paying for it
With little incentive for firms to supply public goods, the government is likely to intervene
What is a private good
one where its use by an individual stops others
from using it whilst its consumption reduces the amount available for consumption by others
What is a quasi-public good
a private good that is similar to a pure public good but there is an ability to stop non-paying consumers from
using it.
What is the intellectual property rights
By granting patents, copyright etc. the good becomes protected and therefore excludable
How can monitoring and control systems stop public goods
Restricting the use of a good by monitoring usage e.g. congestion charging or digital television
What is government failure
Costs of an intervention outweigh the benefits of intervention causes allocative inefficiency
Causes of government failure
Information failure
Administrative costs too high
Unintended consequences
Regulatory capture
How subsidies may lead to government failure
If firms become used to receiving a government subsidy, they may have fewer incentives to cut costs and transform the business – they become reliant on subsidies and the government ends up wasting public funds on supporting inefficient firms. In the long-run, consumers end up paying higher taxes and higher prices
Tax meaning
compulsory contribution to state revenue, levied by the government
Benefits of indirect tax
Creates revenue which was be used of offset externalities
it will change the price immediately and allows the one functions of price to work ( eg consumers may ration)
Disadvantage of indirect tax
May have inelastic demand - eg price of fuel
Monetary value of negative externality can be hard to measure.
Advantage of subsidies
- In the long term, subsidies for a good will help change preferences. It will encourage firms to develop more products with positive externalities.
- Enables greater social efficiency. Consumers end up paying the socially efficient price which includes the external benefit.
Disadvantage of subsidies
Difficult to estimate the extent of the positive externality. Therefore the government may have poor information about the service and how much to subsidise.
Why is there a dead weight loss of taxation
Reduces standard of living
prevent ppl from buying more
Tax incidence meaning
how the burden of a tax is distributed between firms and consumers
What are the reasons for government intervention
correct market failure
achieve a more equitable distribution of income and wealth
To improve the performance of the economy
Stabilise prices
Avoid excessive prices for goods with PE
How does factor immobility cause market failure and what do the government do
Structural unemployment, state investment in education and training
How does demerit goods cause market failure and what do the government do
overconsumption of products with NE
Information campaigns, minimum age from consumption
How does imperfect information cause market failure and what do the government do
Damaging consequences for consumers from poor choices
Statutory information / labeling
How does relative high poverty cause market failure and what do the government do
Low-income families suffer social exclusion, negative externalities
Taxation and welfare to redistribute income and wealth
How does monopoly power in a market cause market failure and what do the government do
Higher prices for consumers causes loss of allocative efficiency
Competition policy measures to encourage new firms into a market
Forms of government intervention in markets
Minimum prices
Maximum prices
Nudges/Behavioural unit
Assumptions of rational choice model
Consumers choose independently (not influenced)
The consumer has fixed and consistent preferences
They gather full information on alternatives
Always make an optimal choice given prefrences
