Microeconomics year 1 Flashcards
what is the basic economic problem
how to allocate scarce resources when there are unlimited wants but finite needs
another word for resources
factors of production
what are the four factors of production
- land - areas where goods can be produced
- labour - human resources which can produce goods and services
- capital - man made aids to production like machinery, schools
- enterprise - risk takers who are innovative in order to make profit
what choices are made in order to scarce resources
manufacturers choose:
- what to produce
- how to produce
- for whom to produce for
what is opportunity cost
the cost of the next best alternative forgone when a choice is made
what does a PPF tell you
the maximum possible production of all goods and services that can be produced with the level of the factors of production in the economy
labels on a macro ppf
- Goods, services
what does the shape of ppf show
the law of increasing opportunity cost,as we move further along the curve, factors of production are more suitable towards one thing than they are towards another thing
what does a linear PPF show
a constant oppurtunity cost
what is demand
the quantity of a good/service consumers are willing and able to buy at a given price in a given time period
what is the law of demand and what does it mean
there is an inverse relationship between price and quantity demanded, meaning that as price increases, Qd decreases
what do we assume when looking at a demand curve
ceteris paribus - meaning all other factors remain unchanged
- meaning when we increase price, we MOVE along the curve
whats it called when we MOVE along the curve
a contraction of demand, as price increases
whats it called when we decrease price
there is an extension of demand
what explains the inverse relationship between price and demand
the income effect - as prices go up, income cant stretch as far, therefore we are less able to buy, maybe our income doesn’t allow us to purchase the quantity of goods and services we couldve before
substitution effect - as prices go up, other goods and services become more price competitive, so we switch consumption to buy those goods and services instead, which is why demand contracts
what do non price factors do to the demand curve
they SHIFT it
examples of non price factors which will shift demand to the right
- population - higher population = higher demand for a particular good or service
- good advertising
- price of substitutes - eg if the price of pepsi goes up, more ppl are gonna be willing and able to buy coke
- income(normal and inferior goods)
- fashion/taste - if fashion moves towards a particular good/service, demand for it will be higher
- interest rates - if consumers need to borrow before buying it, lower IR make it cheaper for consumers to borrow, increasing demand for these items
- complements price - if the price of one of the complementary goods increase, the demand for both the goods shift left and vice versa
what is a substitute
a good that is a rival good to something else
what are normal goods
goods where, as incomes rise, demand for them will increase, eg fine dining and vice versa
what are inferior goods
goods where, as incomes rise, demand for them decrease and vice versa, eg fast food, public transport
what is a complementary good
a good which is often bought with another
what is supply
the quantity of a good or service producers are willing and able to produce at a given price in a given time period
what is the law of supply
there is a direct relationship between price and quantity supplied. as price increases, Q increases and vice versa, ceteris paribus
explain the law of supply
private producers have a profit motive
- as price increases for a good/service, there is more profit to be made if they can produce and sell more, so there’s a stronger need incentive to produce more when prices go up
- when quantity goes up, cost of production goes up. therefore suppliers want a higher price to cover the cop to allow them to maintain their profit margin
non price factors that may shift supply
productivity (output per worker) - if workers become more productive, they produce more, this will reduce cost of production and shift supply to the right
indirect tax - increased tax like corporation tax may increase cost of production and shift supply left
number of firms - the more firms that enter the market, the more supply in a market, supply shifts left
technology - improvements in technology may reduce cop, eg robotics ai , increasing supply
subsidy - reduced cop and shifts supply right
- weather - good weather shifts supply, for example if it’s sunny, more crop
- cost of production - oil, transport, regulation
- availability of land
how would cost of production impact supply
lower cost of production = high willingness to supply more at the same price
higher = less willing to supply at the same price when it’s more expensive to produce
what is a subsidy
a money grant given by the government to producers to lower cost of production and to encourage an increase in output
what is a free market
an economy where the market mechanism allocates resources so consumers and producers make decisions abt what is produced, how to produce and for whom
what is equilibrium
Where demand is equal to supply - represents allocative efficiency, because the resources that firms are using to make goods and services, are perfectly following consumer demand
What is disequilibrium?
Where is demand is not equal to supply
adam smiths views
- Specialisation & Division of Labour
- Smith argued that dividing production into specialized tasks increases efficiency, as workers can focus on specific activities they excel in. This specialization allows for greater skill development and faster production.
- Higher productivity from specialization leads to economic growth and lower costs of goods, making products more accessible to a broader population. - Free Market & Invisible Hand
- Smith believed in the “invisible hand” of the free market, where individuals pursuing their self-interest inadvertently contribute to society’s economic well-being. He felt that competition and self-interest would naturally regulate markets.
- Without government interference, resources are allocated efficiently, leading to innovation, competitive prices, and choices, thus benefiting consumers and fostering economic growth. - Critique of Command Economies
- Smith argued that command economies, where governments control resources and production, are inefficient, as central planners lack the information and flexibility to meet consumer needs effectively.
- This misallocation leads to resource waste, scarcity of goods, and a lack of incentive for innovation, ultimately stalling economic progress and reducing individual freedom.
what do prices do
- allocate scarce resources efficiently
- ration scarce resources by encouraging / discouraging consumption
- signal excess demand or supply
- incentivise producers to increase or decrease output to increase profit
When will excess demand occur? and what’s the impacts
If prices are below equilibrium
- long queues of ppl desperate to buy a certain good or service, eg toilet paper during covid
- huge waiting lists, eg NHS
- competition between buyers
- naturally, prices will rise because of high demand
- new firms may be attracted by the increase in price and join the market, increases supply
When will excess supply occur? and what’s the impacts
- when the price level is higher than equilibrium
- Warehouses and shelves would be over stocked, restaurants empty
- prices fall
- less need for resources in a market
- incentivises firms to decrease their output, sell their stocks, shown by a contraction along the supply curve, firms may leave market
- rationing of scarce resources eg by encouraging consumption
what do price mechanisms do when there is excess demand
Shortage Identified
- Excess demand occurs when the quantity demanded exceeds the quantity supplied at the current price.
- This creates upward pressure on prices as consumers compete for limited goods.
Rationing Effect
- Higher prices reduce the quantity demanded as some consumers are priced out of the market. This limits the demand to match the available supply.
Signaling Effect
- Rising prices signal to producers that there is strong demand for the good.
- This incentivizes them to increase production to meet the higher demand.
Incentivizing Effect
- Higher prices attract new entrants or firms from other markets to produce the good, as they see an opportunity to earn greater profits.
Equilibrium Restored
- As prices rise, the quantity demanded decreases, and the quantity supplied increases until they equalize at the new equilibrium price and quantity.
what do price mechanisms do when there is excess supply
Surplus Identified
- Excess supply occurs when the quantity supplied exceeds the quantity demanded at the current price.
- This creates downward pressure on prices as sellers struggle to sell their goods.
Rationing Effect
- Lower prices increase the quantity demanded as consumers find the product more affordable.
- This reduces the surplus in the market.
Signaling Effect
- Falling prices signal to producers that there is too much supply relative to demand.
- Producers respond by reducing output to avoid further losses.
.
Incentivizing Effect
- Lower prices discourage some firms from entering or remaining in the market, particularly those with higher production costs, as profitability decreases.
Impact: This natural adjustment ensures that only the most efficient producers remain, promoting productive efficiency
what is consumer surplus
the difference between the price consumers are willing and able to pay and the price they actually pay. usually a triangle found BELOW DEMAND CURVE and ABOVE PRICE LINE
What is producer surplus
the difference between the price producers are willing and able to supply a good/service for and the price they actually receive
- usually a triangle found ABOVE THE SUPPLY CURVE and BELOW THE PRICE LINE
how to find society surplus
consumer surplus + producer surplus
how to find surplus when there are shifts
take the original surplus away from the new one
complement goods are
goods that are in joint demand, goods that are bought together. if the price of one of the goods go up, the demand for both the goods decrease
substitutes are
- goods that are in competitive demand, eg coke and pepsi. as the price of one substitute increases, demand for the other substitute shifts left
what is derived demand
when demand for a good or service comes from the demand for something else
eg - cars and aluminium, labour and goods and services
what is composite demand
the idea that two goods require the same input to make them. therefor, if there is an increase in the production of one good, there will be a decrease in the supply of another, because there is less of the input available to make the other
eg bread and livestock, cheese and butter (milk needed to make these)
karl marx views
- specialisation and division of labour
- Marx argued that these alienate workers from their work and their own potential
- workers perform repetitive and fragmented tasks, limiting their skills
- making their work feel monotonous and disconnected from the end product
- this could lead to resentment and dissatisfaction and high employee turnover - Marx viewed free markets as exploitative , profit over ppls wellbeing
- in a free market, competition drives down wages and increase worker exploitation, as businesses aim to maximise profits
- this relentless drive for profit caused class divisions, incomes inequality due to overproduction and underconsumption - Marx advocated for a command economy
- with centralised planning, the state could allocate resources based on societal needs rather than profit, promoting fairness and equity
- Marx believed this would reduce inequality and alienation, ultimately leading to a classless society where workers have control over their labour and its outcomes - Marx labour theory of value argues that value is derived from the labour invested in goods, not from market dynamics
- under capitalism, capitalists exploit workers by paying them less than the value of their work, pocketing the surplus as profit
- this “surplus values is inherently exploitative and unsustainable as it widens the gap between capitalists and workers, leading to economic instability
john Maynard Keynes beliefs
Specialisation and Efficiency
- Keynes acknowledged the efficiency gains from specialisation and division of labour in boosting productivity and economic growth.
- By allowing workers to focus on specific tasks, production processes become streamlined, output per worker rises, and firms can achieve economies of scale.
- This contributes to higher aggregate supply and potentially greater economic output, but Keynes was cautious about its implications on aggregate demand and employment.
Vulnerability to Economic Shocks
- Keynes highlighted that excessive specialisation could make economies vulnerable to disruptions.
- If industries are highly specialised and dependent on external trade, a decline in global demand or trade restrictions can lead to unemployment and reduced incomes.
- This aligns with Keynes’ emphasis on the importance of managing aggregate demand to prevent economic downturns and unemployment.
Division of Labour and Worker Welfare
- Keynes expressed concern over the potential social consequences of extreme division of labour.
- While it improves efficiency, it can lead to monotonous work, worker alienation, and reduced job satisfaction, ultimately harming long-term productivity and welfare.
- These issues could lower aggregate demand due to reduced worker morale and consumption, which Keynes viewed as central to maintaining economic stability.
Role of Government in Mitigating Issues
- Keynes believed that government intervention could help address the inequalities and instabilities arising from specialisation.
- Through public investment, redistribution policies, and demand management, governments could balance the benefits of specialisation with the need for stable and inclusive economic growth.
- This would ensure that the productivity gains from specialisation contribute to overall economic welfare without exacerbating inequality or cyclical unemployment.
