Questions Flashcards
Why does the demand curve slope downwards?
- Theory of decreasing marginal utility
- Substitution effect
- Income effects
(Page 4)
Determinants of Demand (6)
- Price of a good
- Income (normal, inferior good)
- Price of related goods (substitutes, complements)
- Taste, preference
- Demographic changes (population, n of consumers)
- Future price expectations
Why does the supply curve shift upwards?
- Law of diminishing marginal returns
- Profit
(Page 5)
Determinants of Supply (7)
- Price (movements)
- Change in price of FOPS
- Price of related goods (competitive supply, joint supply)
- Future price expectations
- Indirect tax/subsidies
- Changes in tech
- N of firms
What are the types of economic systems?
- Free market
- Planned/controlled economy
- Mixed economy
Basic economic problem
- What to make
- How to make
- For whom to make
3 functions of price
- Rationing
- Signaling
- Incentive
Problems of planned economy
- Untrue output targets
Gvt sets output targets w/o considering actual demand, overproduction -> surplus -> waste - Lack of incentives
Wage isn’t based on quantity/quality-> low labor productivity - Right to employment
Too many workers - No profits leads to resource waste
Quotas, no fear of bankruptcy or competitiveness, no incentive to minimise COPs - Low prices
Excess demand
Problems of transitional economy
ALL SUDDEN
1. GDP decrease
Firms not prepared to transition -> low productivity
2. Inflation increase
Sudden foreign investment influx and increased competitiveness of new industries leads to rise in prices
3. Increase in U/E
State owned enterprises close, workers can’t find work in private sectors
4. Exchange rate depreciates
Influx of foreign investment pressures currency, ER falls
5. Falling income / more poverty
What is Rational consumer choice composed of
- Consumer rationality
- Perfect information
- Utility maximisation
What is consumer rationality composed of
- Completeness assumption
- Transitivity assumption
- Non satiation assumption
Limitations of rational consumer behaviour
Bias
1. Rule of thumb
2. Framing
3. Anchoring
4. Availability
Alternatives to rational consumer behaviour
- Bounded rationality
- Bounded self control
- Bounded selflessness
- Imperfect information
Types of choice architecture choices
- Default choice
- Restricted choice
- Mandated choice
Goals of firms
- Sales revenue optimisation
MR=0 - Satisficing
- Strategy of firms to achieve satisfactory outcome, not best
- Focusing on research/development to maximise profit rather than hiring more workers to perfect customer service - Corporate social responsibility
- Firms engaging in socially beneficial activities
- Environmentally sound activities, human rights advocation - Market share
- % of total sales in a market earned by a firm - Growth maximisation
- Become an Economy of Scale (cost/unit of output decreases when production levels increase)
- Gain market power
- Influence price
- Diversify production
Determinants of PED
- Availability and closeness of substitutes
- Necessity vs luxury
- Proportion of income spent on a good
- Time
- Over time, consumers may adjust consumption patterns in response to price changes; change habits, adapt to substitutes
PED cases
Elastic PED>1
Inelastic PED<1
Perfectly elastic PED= Infinity (horizontal)
Perfectly inelastic PED = 0 (vertical)
Unit elastic PED=1
What does it mean when YED is positive/negative
+ Luxury or necessity
- Inferior good
Applications of YED
- When under recession, businesses should increase production of inferior goods, viceversa for necessities and luxury goods
- If total income grows by 3% and YED is elastic, demand for goods will rise more than 3%, opposite for normal goods
- Primary sector (agriculture, fishing, forestry, extractions) +YED<1
Manufacturing/service sector +YED>1
As an economy grows primary sector output will shrink, M and S sector output will grow
Cases of YED
Elastic YED>1
Inelastic YED<1
Unit elastic YED=1
Inferior good YED<0
PES determinants
- Time
In SR, PES is lower because resources are fixed in SR - Mobility of FOPs
Being able to easily move FOPS between different uses - Spare capacity of firms
Release good into market when prices rise - Rate at which costs increase
If firms can produce more w/o significant additional costs they are PES elastic - Storability
Applications of PES
Primary commodities are more inelastic than manufactured goods because they are more time-staking to produce and harder to store (tomatoes), Hence, they have a price volatility meaning larger revenue fluctuations and unstable revenue for producers as they struggle to align demand and supply due to these variables
Types of government intervention
Max price (ceiling)
Min price (floor)
Taxation
Subsidy
Why does the Gvt intervene?
- Earn revenue for gvt
- Provide support for firms
- Support low income HH
- Influence levels of firm production
- Influence level of consumption (more merit goods, less demerit)
- Correct market failure
- Promote equity
What are the problems of a max price
- Creates a shortage
- Prices will fall -> people buy more than they need and resale on black market
- Price falls signaling to firms to decrease production, worsening shortage
- Firms gain less revenue
- Non price rationing may occur
Waiting in line, coupon distribution, favouritism
How to fix a maximum price led surplus
- Subsidizing fims
lowering COPs which increase supply at the opportunity cost of taking gvt budget away from other sectors - Offering some alternatives (substitutes)
Demand may redivert to substitutes lowering Qd, but finding substitutes is costly and takes time, GS opportunity cost again
Advantages and disadvantages of a price floor
+ Can protect low income workers
+ Higher prices means higher revenue
- Surplus caused by price floor can bring price down again
- Price increases and some low income consumers may not be able to buy the good longer
- Allocation inefficiency
How do you clear a price floor led surplus?
Buying off the excess goods
+ Minimum price remains in place and loss of excess supply is reduced
- Money used to buy surplus decreases other GS and may lead to taxation
Consequences of buying out a surplus
- Gvt spending opportunity costs and possible taxes
- Consumers pay more, so consumer surplus decreases
- Produces sell at a higher price and quantity and are protected by low cost competition
- More employment, higher incomes
- Foreign consumers who buy off surplus are better of as they buy goods for cheaper than home country
- Global misallocation of resources as high cost firms produce more whilst low cost firms produce less
Implications of minimum wage imposition
- Structural unemployment and labor market rigidities
- Illegal workers working below minimum wage
- Labour resources are misallocated because wages usually act as a signalling price for labor, but with a min price this signalling function is distorted leading to a decrease in hiring
Do excise taxes decrease allocative efficiency
Depends
If without the excise tax, the market is already at equilibrium then yes it will
Consequences of indirect tax with no externalities
- Consumers pay a higher price, Qd falls
- Produces receive lower price, Qs falls and revenue falls
- Gvt receives tax revenue
- Workers produce lower output, more unemployment
- Underallocation of resources leads to society being worse off
Why grant a subsidy?
- Encourage more production
- Encourage more consumption through lower prices
- Can make merit goods and necessities affordable to low income consumers
- Can increase revenue/income
- Can support growth of particular industries
- Can encourage exports
- Improves resource allocation by correcting positive externalities
