Pack 2: The Demand and Supply Model Flashcards
What is rational decision making?
Economic agents making decisions to maximise their benefit
What is utility maximisation?
Consumers making decisions to gain as much satisfaction as possible
What is profit?
Total revenue minus total cost
What is profit maximisation?
Firms making decisions to ensure largest difference between total revenue and cost
Why might consumers not behave rationally?
~Herding behaviour
~Consumer weakness at computation
~Habitual behaviour
~Nudge theory - can be used to reduce market failure (positive)
What is demand?
The amount of good or services consumers willing to buy at a given price
What is marginal utility?
Change in satisfaction from consuming extra unit of good/service
What is diminishing marginal utility?
Individual gaining less additional utility from consuming more of a product
What is supply?
Amount of goods firms willing to put on the market at a given price
What is market equilibrium?
Price and quantity where demand equals supply
What is the price mechanism?
Free market allocating resources through interaction of demand/supply
What are the 3 functions of the price mechanism?
~Signalling
~Incentives
~Rationing
What is signalling?
Price provides information to consumers + producers to aid rational decision making
What are incentives?
Price in market encourages change in behaviour, consumers to maximise utility, producers to maximise profit
What is rationing?
Price in market determines who can afford the good/service and thus who is provided with it
What are the other functions of the price mechanism?
~Controls entry/exit of firms
~Eliminates surpluses and shortages
What is a consumer surplus?
Difference between what consumers are willing and able to pay for a good compared to what they actually pay
What is a producer surplus?
Difference between the market price which firms receive and the price they are willing and able to supply at
What is indirect taxation?
Charge levied on goods/services by government, increase producer costs, shifts supply to the left
What is specific/unit tax?
Levy set by government on goods/services at a constant amount per item
What is ad valorem tax?
Levy set by government on goods/services as % of a price
What is a subsidy?
Sum of money paid by government to producer to encourage production and reduce price
What are the limitations of subsidies?
~Financial cost
~Opportunity cost
~Efficiency issues
