Microeconomics PT2 Flashcards
when does the income elasticity change
when the demand for the good decreases as incomes increase
when is a good inferior
a good whose demand drops when people’s incomes rise
when is a good normal
when the demand for the good increases as incomes increase
is the value of an inferior good positive or negative
negative
is the value of an normal good positive or negative
positive
what is the elastic value of a necessity good
between 0 and 1
what is the elastic value of a luxury good
between 1 and infinity
when is a good income inelastic
when the value is between -1 and 1, when the responsiveness of quantity demanded is proportionally less than the change in income
when is a good income elastic
when the value is between -1 and infinity and 1 and infinity, when the responsiveness of quantity demanded is proportionally more than the change in income
when does YED = 0
when there is no relationship between income and quantity demanded
when is YED important for a business
helps firm predict how changes of economic cycle affects what to produce
luxury goods see more price volatility
important to have a diverse product range
high value products increase profit margins, high YED and low PED
cross price elasticity of demand
responsiveness of quantity demanded for one good due to a change in the price of another
cross price elasticity formula
% change in quantity demanded of good X / % change in price demanded of good Y
when two goods are substitutes
XED is positive because a rise in the price of one good leads to a rise in demand for the other
when two goods are complements
if a decrease in the price of one good causes an increase in the demand for the other
the relationship between XED and the products
the relationship between XED and the products
if XED is 0
the products are unrelated
when is XED inelastic
the value is between -1 and 1, when a change in demand of good X creates a less than proportionate change in demand for good Y
when XED is elastic
the value is between -1 and infinity and between 1 and infinity
when is XED useful to a firm
firms will have to look at substitutes its product has, if there are no substitutes the firm will raise its prices - firms spend on advertising to reduce substitutes and differentiate the product
can use knowledge of complements to increase overall revenue if firms produce both
price elasticity of supply
responsiveness of quantity supplied due to a change in price
PES formula
% change in quantity supplied / % change in price
when is PES 0
supply is perfectly inelastic - there is a completely fixed capacity
value of inelastic PES
when PES is between 0 and 1
PES inelastic
PES inelastic
unitary PES value
1
PES is unitary
a change in price leads to a proportionate change in quantity supplied
elastic PES value
between 1 and infinity
PES is elastic
a change in price leads to a more than proportionate change in quantity supplied
perfectly elastic PES value
infinity
PES is perfectly inelastic
a firm can sell any quantity at a given price - if prices rise above then the business will lose all sales
factors affecting PES
spare capacity
level of stock available
ease of employing factors of production
time period
perishable
substitution of capital for labour
why is PES important to firms
firms want to respond quickly to changes in price and demand
they want to make supply as elastic as possible
using knowledge of PED
price discrimination - demand varies between consumers
tax incidence - if demand is inelastic, higher tax leads to higher prices - the tax incidence will be mainly borne by consumers, if demand is elastic the tax will be mainly borne by producers
why is PED useful to firms
many factors to take into account PED is one of them
other measures of elasticity may be more important
in oligopoly situations firms might be more concerned about other firms through advertising and competition
allows for revenue increase - differences of PED can allow for price discrimination and convert consumer surplus into producer surplus
margin principle
individuals make decisions based on considering the impact of small changes from the existing situation
utility
the satisfaction received from consuming a good or service
marginal utility
the additional utility from consuming an additional unit of a good or service
total utility
total satisfaction gained from consuming a good or service
diminishing marginal utility
the more of a good you consume, the less satisfaction is gained from the consumption of the extra unit
marginal utility formula
change in total utility / change in quantity of units
explain marginal utility demand curve
as the consumer consumers larger quantities of good x its marginal utility diminishes, therefore at diminishing price, the quantity of the good x increases the consumer must consider the utility of the commodity with the price they are paying for it - the consumer will demand as many units until marginal utility is equal to price
concept of the margin for society
the social optimum is derived from marginal social benefit - marginal social cost
market failure
when the free market mechanism does not leads to an optimal allocation of resources efficiently and society suffers as a result
externality
a cost or benefit that is external to a market transaction and is not reflected in market prices - impacts a third party
why does market failure occur
the price mechanism only takes into account private costs and benefits
private cost
cost incurred by an individual as part of its production or consumption
external cost
cost associated with individuals’ production or consumption which is borne by third parties
social cost
private cost + external cost - full cost borne by society of a good or service
private benefit
benefit given to an individual as part of its consumption or production
external benefit
benefit that is associated with an individual’s production or consumption which is borne by third parties
social benefit
private benefit + external benefit - full benefit society receives from a good or service
marginal private benefit
benefit from an additional unit of a good or service that the consumer receives - represented through demand
marginal social benefit
MPB of consuming an additional good plus external benefits resulting from consuming that good
marginal private cost
the marginal cost of producing that good - represented through supply
marginal social cost
extra cost to society of producing an additional unit of output, including MPC and external costs
why is there market disequilibrium with externalities
allocative efficiency is not achieved as MSB does not equal MSC
explain allocative efficiency
Allocative Efficiency refers to the extent to which resources are allocated to their most valued use
where is allocative efficiency on a graph
P = MC at the equilibrium, maximising producer and consumer surplus
what graph can be shown to represent productive efficiency
PPF - anywhere on the curve is productive efficiency
three functions of the price mechanism
signalling, rationing, transmission of preferences
signalling
prices adjust to demonstrate where resources are needed, providing information about changing market conditions
rationing
ration scarce resources when demand is in excess, leaving only those who are the most willing and able to pay
transmission of preferences
through their choices, consumers send information to producers about their needs and wants, higher prices encourage more output
private good characteristics
excludable, rivalrous, rejectable, has a marginal cost
public good characteristics
non-excludable, non-rivalrous, non-rejectable, no marginal cost
non-excludable
potential consumers cannot be prevented from consuming a good without paying for it
non-rivalrous
the consumption of one good does not prevent consumption by another person
non-rejectable
consumption cannot be prevented by a consumer
zero marginal cost
the production of an additional unit does not add extra costs to the business
quasi-public good
shares characteristics of private and public goods
free-rider problem
those who benefit from a good or shared resource without paying for it and can continue to access it
evaluating public goods
would not be provided in a free market - have positive externalities or are merit goods leading to market failure if underprovided
opportunity cost of providing the good
cost of the provision
risk of under-provision
public perception
political perspective
information failure
information failure
causes of information failure
misunderstanding the true costs or benefits of a product
uncertainty about future costs and benefits
complex information
inaccurate or misleading information
addiction
lack of awareness
asymmetric information
when information is not shared equally between parties in a market transaction
symmetric information
in competitive markets it is assumed consumers have perfect information, assuming rationality this will allow the efficient allocation of resources
moral hazard
the party with more information alters their behaviour, causing extra costs to the other party eg. insurance
merit good
more beneficial to the consumer than third parties yet still can provide positive externalities - underconsumed
demerit good
more harmful to the consumer than society, yet can still provide negative externalities - overconsumed
pollution permits
involves giving firms the legal right to pollute a certain amount, supply shifts in over time
government failure
policies may have damaging long term consequences for the economy or society, may be ineffective at meeting stated aims, may do more harm than good
what can government failure cause
distortion and interference with markets
causes of government failure
political self-interest, poor value for money, policy short-termism, regulatory capture, conflicting objectives, bureaucracy, unintended consequences
what can government failure be
inequitable, ineffective and misplaced
key points surrounding government failure
free market economists believe the price mechanism should be used, we can only accuse government failure in hindsight, limited imperfect information, government may make decisions on behalf of special interest groups - loss of equity
tackling government failure
- initiating target setting
- introducing competition into state-controlled markets
- minimal state intervention
indirect taxation
tax levied on producers levied on expenditure, which is passed onto consumers
how does indirect taxation solve market failure
how does indirect taxation solve market failure
how does indirect taxation work
increases costs of production raises price, moving output closer to the socal optimum
limitations of indirect taxation
Regressive nature of indirect taxes. Indirect taxes tend to take a higher percentage of income from those on low income.
evaluation of use of indirect taxation
PED, whether tax is used alongside other policies, ay lead to unintended consequences ie. increased inequality, may not raise prices, cost of collection
evaluation of use of indirect taxation
PED, whether tax is used alongside other policies, ay lead to unintended consequences ie. increased inequality, may not raise prices, cost of collection
tax incidence
the burden of a tax, shared amongst participants in a market
when is tax burden mainly on the consumer
when demand is inelastic
when is tax burden mainly on the producer
when demand is elastic
Determinants of PES
- number of producers
- spare capacity
- ease of switching
- ease of storage
- length of training time
- factor monbility
What is meant by market failure?
The inefficient distribution of resources by the free market.
How do incentives of consumers signal resource allocation?
They may be responsive to price. If price is too high for consumers then the product will not be bought. Therefore resources are allocated elsewhere.
How do incentives of firms signal resource allocation?
Firms may be responsive to price. If the price paid for the good/ service they are producing is not enough then they will allocate their resources elsewhere.
How do government incentives affect resource allocation.
Government want to maximise welfare. If resources aren’t allocated accordingly then they may impose taxes or subsidies to re-allocate resources.
