Semester 1 Flashcards
Define economics…
Economics is a Social Science that
studies the choices that individuals, businesses, governments and entire societies make
as they
cope with scarcity
and
the incentives that influence and reconcile those choices.
Define the 2 areas of economics…
Microeconomics is the study of choices that individuals and businesses make, the way those choices interact in markets, and the influence of governments.
Macroeconomics is the study of the performance of the national and global economies.
What are the 2 big economic questions?
- How do choices end up determining what, how and for whom goods and services get produced?
- When do choices made in the pursuit of self interest also promote the social interest?
Break down big question 1 into what, how and for whom goods and services get produced…
- What is produced e.g. services, production, construction, agriculture.
- How its produced by factors of production e.g. Land, Labour, Capital, Entrepreneurship.
- For whom is who gets the goods and services, depends on the income that factors of production earn… e.g. Land earns rent, labour earns wages, capital earns interest, entrepreneurship earns profit.
Explain big question 2 how the pursuit of self interest promotes social interest…
- Self Interest: choices that you think are best for you.
- Social Interest: choices that are best for society as a whole.
- Social Interest has two dimensions:
Efficiency.
Equity.
Example: globalisation, monopolies.
What are the 6 key ideas of the economic way of thinking ?
6 Key Ideas:
- A choice is a trade-off.
- People make rational choices by comparing benefits and costs.
- A benefit is what you gain.
- A cost is what you give up.
- Most choices are “how-much” decisions made at the margin.
- Choices respond to incentives.
What are positive statements ?
- A statement that can be tested.
Example: Global warming is the result of burning fossil fuels.
What are normative statements ?
- What should be.
Example: We should abolish tuition fees.
How can we distinguish between correlation and causation ?
- Models allow us link cause and effect by focusing on a specific issue.
Application: experiments, statistical analysis.
What is the PPF ?
- The Production Possibilities Frontier (PPF) is the boundary between those combinations of goods and services that can be produced and those that cannot.
- Illustrates scarcity, opportunity cost, (in)efficiencies, trade-offs.
What is production efficiency ?
- When goods and services are produced at lowest cost.
What is production inefficiency ?
- Resources unused or badly used.
- Combination inside PPF.
What is the opportunity cost ?
- Highest valued alternative foregone.
How does a concave shaped PPF impact the opportunity costs ?
From A to B:
- PPF is flat.
- Increase in pizza costs a small amount of cola.
From E to F:
- PPF is steep.
- Increase in pizza costs a large amount of cola.
How do you find the point which is allocatively efficient on the PPF ?
- Produce at lowest cost and is most valued.
- Is allocatively efficient.
- All points on PPF achieve production efficiency.
How can we find the optimal combination on the PPF ?
- Compare Marginal Cost with Marginal Benefit.
- Marginal implies ONE more UNIT of production/consumption.
How does the opportunity cost impact marginal cost ?
- Increasing opportunity cost of a pizza…
- Means increasing marginal cost of a pizza.
Define the marginal benefit…
- The benefit received from consuming one more unit of it.
- Linked to willingness to pay.
- Dependant on preference of organisation/individual.
- Curve is downward sloping
*How can you find the point of allocative efficiency ?
- The point where the marginal cost line overlaps with the marginal benefit.
- Therefore meaning that MC = MB
What is economic growth in relation to PPF ?
The expansion of the PPF and an increase in the standard of living is called economic growth.
What 2 key factors influence economic growth ?
- Technological Change
2. Capital Accumulation
What is the opportunity cost of economic growth ?
- Decreasing current production of consumption goods and services.
Define a market…
- A market is any arrangement that enables buyers and sellers to get information and trade with each other.
7 key points which define a competitive market…
- Many buyers and sellers.
- No entry barriers.
- Suppliers are price takers.
- The market price is low and is equal to marginal cost.
- Profits are zero in the long run.
- Goods are identical.
- Consumers have perfect information.
Define the quantity demanded…
The quantity demanded of a good or service is the amount that consumers plan to buy during a particular time at a particular price.
State the law of demand…
- All else equal, when the price of a good rises, the quantity demanded of the good decreases; and when the price of a good falls, the quantity demanded of the good increases.
What does the law of demand result from ?
Income effect.
Substitution effect.
What can a demand curve also be known as ?
A demand curve is also a willingness-and-ability-to-pay curve.
Willingness to pay measures marginal benefit.
Demand curves can be nonlinear or linear.
5 main determinants of changes in demand…
- Income (normal good and inferior good).
- The prices of related goods (complements and substitutes).
- Expected future price and income.
- Preferences.
- Population.
*How do the 5 determinants of demand impact the demand curve ?
- Own price changes of a good are reflected as a movement along the demand curve.
- Any other determinant shifts a good’s demand curve.
Define the quantity supplied…
The quantity supplied of a good or service is the amount that producers plan to sell during a given time period at a particular price.
State the law of supply…
- All else equal, the higher the price of a good, the greater is the quantity supplied; and the lower the price of a good, the smaller is the quantity supplied.
Why would supply of a good or service increase ?
- If the price of a good or service rises, supply increases as it is worth incurring the extra costs
- Therefore 𝑀𝐵 >𝑀𝐶.
What is a supply curve also known as ?
A supply curve is also a minimum supply-price/marginal cost curve.
What does the supply curve show ?
Shows the lowest price at which someone is willing to sell an additional unit.
This lowest price is marginal cost, i.e. supply is positive if price is equal to marginal cost.
6 main determinants of supply…
- The prices of productive resources/input costs
- The prices of related goods produced (substitute/complements).
- Expected future prices.
- The number of firms.
- Technological progress.
- State of nature.
*How do the 6 main determinants impact the supply curve ?
- Input prices will change the shape of the curve.
- Decrease/increase in supply will shift curve
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Define market equilibrium…
Equilibrium in a market occurs when the price matches the plans of buyers and sellers.
Define the equilibrium price…
The equilibrium price is the price at which the quantity demanded equals the quantity supplied.
Define the equilibrium quantity..
The equilibrium quantity is the quantity bought and sold at the equilibrium price.
How can we use algebra to determine equilibrium quantity and price ?
Let 𝑃=𝑎−𝑏𝑄_𝑑 represent market demand.
Let 𝑃=𝑐+𝑑𝑄_𝑠 represent market supply.
We can determine equilibrium quantity and price through 𝑄_𝑑=𝑄_𝑠=𝑄^∗.
First, equate prices as 𝑎−𝑏𝑄_𝑑=𝑐+𝑑𝑄_𝑠.
Then substitute into appropriate equation.
Define the price elasticity of demand..
- The price elasticity of demand is a units-free measure of the responsiveness of the quantity demanded of a good to a change in its price, all else equal.
3 determinants of PED…
- The closeness of substitutes.
- The proportion of income spent on the good.
- Time period considered.
How can PED be classified ?
Price elasticity of demand can be defined as follows:
Inelastic Demand: 𝑃𝐸𝐷<1.
Elastic Demand: 𝑃𝐸𝐷>1.
Unit Elastic Demand: 𝑃𝐸𝐷=1.
How is PED calculated ?
𝑃𝐸𝐷 is calculated using the formula:
Percentage change in quantity demanded)/(Percentage change in price
How can calculating PED be important in real life situations?
Several countries, e.g. Denmark and France, have introduced taxes on unhealthy foods.
Taxes means higher prices for consumers.
Impacting the quantity demanded.
How can a business use PED to increase its total revenue?
A good business strategy to increase total revenue is to
offer price discounts or increase the price of a commodity.
To decide which strategy is best a business may look at the PED.
When may it be appropriate for a business to increase or decrease price using PED ?
- If a good is inelastic, increasing the price would increase revenues.
- If a good is elastic, decreasing the price would increase revenues.
What is the cross price elasticity of demand ?
- The cross price elasticity of demand is a measure of the responsiveness of demand for a good to a change in the price of a substitute or a complement, all else equal.
How do we calculate the CPED ?
“Percentage change in quantity demanded “ /”Percentage change in price of substitute/complement “
What is the income elasticity of demand ?
The income elasticity of demand measures how the quantity demanded of a good responds to a change in income, all else equal.
How can the IED be classified ?
Income elasticity of demand can be defined as follows:
Inferior Good: 𝐼𝐸𝐷<1.
Normal Good, Income Elastic: 𝐼𝐸𝐷>1.
Normal Good, Income Inelastic: 0
What is the elasticity of supply (PES) ?
The elasticity of supply measures the responsiveness of the quantity supplied to a change in the price of a good, all else equal.
What are the 2 determinants of the elasticity of supply ?
The determinants of the elasticity of supply are:
- Resource substitution possibilities.
(How easily a good can be reproduced).
- Time frame for supply decisions.
(Comparing immediate, short-run, and long-run responses).
What 5 ways are scarce resources often allocated ?
- Market price.
- Command system.
- Majority rule.
- Lottery.
- First-come, first-served.
How are demand curves linked to a customers willingness to pay ?
A demand curve is a marginal benefit curve; it is based on one’s willingness to pay.
What is the individual demand ?
The relationship between the price of a good and the quantity demanded by one person is called individual demand.
What is the market demand ?
The relationship between the price of a good and the quantity demanded by all buyers in the market is called market demand.
How can we create a market demand curve ?
The market demand curve is the horizontal sum of the individual demand curves.
What is the consumer surplus ?
Consumer surplus is the extra benefit received from a good over the actual amount paid for it.
How is the consumer surplus measured ?
It is measured by the area under the demand curve and above the price paid, up to the quantity bought.
What is the individual supply ?
The relationship between the price of a good and the quantity supplied by one producer is called individual supply.
What is the market supply ?
The relationship between the price of a good and the quantity supplied by all producers in the market is called market supply.
How can we create a market supply curve ?
The market supply curve is the horizontal sum of the individual supply curves.
What is the producer surplus ?
Producer surplus is the amount received from the sale of a good or service over the cost of producing it.
How can we measure the producer surplus ?
It is measured by the area below the market price and above the supply curve, summed over the quantity sold.
Why do we calculate consumer surplus and producer surplus ?
To get an objective definition of social welfare:
“Social Welfare = Consumer Surplus + Producer Surplus”
Consumer surplus and producer surplus can be applied to evaluate the effects of government policy on social welfare.
What is a market failure and how is it caused ?
We call a situation in which a market delivers an inefficient outcome one of market failure.
It occurs due to overproduction or underproduction (market disequilibrium).
What are 5 sources of market failure ?
Sources of market failure: Price and quantity regulations. Taxes and subsidies. Externalities. Public goods. Monopoly.
What is a deadweight loss ?
A deadweight loss is the loss in total surplus for a given quantity produced.
How can ideas about equity be divided into 2 groups ?
- It’s not fair if the result isn’t fair.
Utilitarianism.
Big Trade-Off.
Making Poorest Well Off. - It’s not fair if the rules aren’t fair.
Symmetry Principle.
Fair Rules and Efficiency.
What is a price ceiling ?
A price ceiling is a government regulation of the maximum price that may be legally charged.
What do the effects of a price ceiling depend on ?
The effects of a price ceiling depend crucially on whether the ceiling is binding or not binding.
What does it mean if a price ceiling is binding ?
If the price ceiling is set below the equilibrium price, it has powerful effects: it is binding.
What does it mean if a price ceiling is not binding ?
If the price ceiling is set above the equilibrium price, it has no effect: it is not binding.
What is a price ceiling called in the market for rental housing ?
This is called a rent ceiling; the most extreme form of rent control.
What can a binding rent ceiling cause ?
- A shortage (underproduction)
- Creates Black Markets.
- Lottery, queues, and discrimination.
- Increased search activity: the time spent looking for someone with whom to do business is called search activity.
What are the implications of a binding rent ceiling ?
- A rent ceiling leads to an inefficient use of resources.
- The quantity of rental housing is less than the efficient quantity, so a Deadweight Loss (DWL) arises.
What is a price floor ?
A price floor is a regulation that makes it illegal to trade at a price lower than a specified level.
What is it when a price floor is applied to labour markets ?
When a price floor is applied to labour markets it is called a minimum wage.
When is a price floor binding or not binding ?
If a price floor is set below the equilibrium price, it has no effects: it is not binding.
If a price floor is set above the equilibrium price, it has an effect: it is binding.
How can a minimum wage have a negative impact ?
A minimum wage leads to an inefficient use of resources.
The quantity of labour employed is less than the efficient quantity and there is a DWL.
What are primary methods of government intervention?
Primary methods of intervention are:
Price supports.
Quantity regulations (Quotas).
Subsidies.
When may government interventions be needed ?
Agricultural output and price are particularly susceptible to bad weather conditions.
To help farmers avoid low prices and low incomes, governments intervene in the market for agricultural products.
What is a price support ?
A price support is the government guaranteed minimum price of a good.
What is tax incidence ?
Tax incidence is the division of the burden of a tax between the buyer and the seller.
What does the tax incidence depend on ?
- The tax incidence depends on the elasticities of demand and supply.
- The more inelastic the demand, the larger is the burden of the tax on buyers.
- The more elastic the demand, the larger is the burden of tax on sellers.
What is the relationship between elasticity of supply and tax incidence ?
The more elastic the supply curve the greater is the burden of tax on buyers, and vice-versa.
Definition of a firm…
A firm is an institution that hires factors of production and organises them to produce and sell goods and services.
What are the 3 types of firms ?
Proprietorship
Partnership
Company
What is a proprietorship ?
a firm with a single owner who has unlimited liability.
What is a partnership ?
a firm with two or more owners who have unlimited liability.
What is a company ?
owned by one or more shareholders with limited liability.
What is the opportunity cost of production ?
Total costs
What does the opportunity cost of production for a firm consist of ?
Explicit costs: cost of resources bought from the market.
Implicit costs: cost of resources owned by the firm.
What are 3 examples of explicit opportunity costs ?
Materials
Wages
Marketing
What are 3 examples of implicit opportunity costs ?
Time (next best income forgone)
Machinery/Equipment
Land/Building/Office-Space
How are explicit and implicit opportunity costs normally measured ?
Implicit: Typically Measured as Financial Flows
Explicit: Typically Unmeasured (no physical payment)
What is economic depreciation ?
Measures the fall in the market value of a firm’s capital over time.
What is foregone interest ?
the funds used by the factory to buy physical capital (machinery, equipment) that could instead have been invested in bonds from which the owner would have earned interest.
What is the difference between economic and accounting profit ?
Economic Profit: total costs include both explicit and implicit costs.
Accounting Profit: total costs only include explicit costs.
What is the difference between economic and normal profit ?
The return that an entrepreneur can expect to receive on average is called normal profit.
Normal profit is part of the firm’s total costs, so economic profit is profit over and above normal profit.
How can firms decisions to achieve profit maximisation be categorised ?
These decisions can be characterised into time-frames:
short run / long run
What is a short run decision ?
at least one input - usually physical capital/plant size - is fixed.
What is a long run decision ?
all inputs including plant size are variable.
How can a firm increase output in short run ?
To increase output in the short run, a firm must increase the amount of variable input (e.g. labour) employed.
What 3 concepts describe relationship between output and the quantity of labour employed ?
Total product.
Marginal product: (Δ𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑑𝑢𝑐𝑡)/(Δ𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐼𝑛𝑝𝑢𝑡) = (Δ𝑂𝑢𝑡𝑝𝑢𝑡 (𝑄))/(Δ𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑊𝑜𝑟𝑘𝑒𝑟𝑠 (𝐿)) (denoted as Δ𝑄/Δ𝐿 where Δ→ Change in).
Average product: = (𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑑𝑢𝑐𝑡)/(𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐼𝑛𝑝𝑢𝑡)=(𝑇𝑜𝑡𝑎𝑙 𝑂𝑢𝑡𝑝𝑢𝑡)/(𝑁𝑜. 𝑜𝑓 𝑤𝑜𝑟𝑘𝑒𝑟𝑠)=𝑜𝑢𝑡𝑝𝑢𝑡 𝑝𝑒𝑟 𝑤𝑜𝑟𝑘𝑒𝑟 ( 𝑑𝑒𝑛𝑜𝑡𝑒𝑑 𝑎𝑠 𝑄/𝐿).
What pattern do almost all production processes in the short run show ?
Increasing Returns.
Diminishing Returns.
What is the law of diminishing returns ?
as a firm uses more of a variable input with a given quantity of fixed inputs, the marginal product of the variable input eventually diminishes.
What does a marginal product short run curve show ?
SRMP Curve shows:
Increasing marginal returns initially.
Diminishing marginal returns eventually.
How does the marginal product curve relate to the average product curve in the short run ?
When MP curve lies above the AP curve: AP is increasing.
When MP curve lies below the AP curve: AP is decreasing.
What ways do we normally measure short run production costs ?
We generally measure cost as: Total Fixed Costs (𝑇𝐹𝐶): rent. Also includes opportunity costs. Total Variable Costs (𝑇𝑉𝐶): raw materials, wages. Total Costs (𝑇𝐶=𝑇𝐹𝐶+𝑇𝑉𝐶)
How is short run average cost broken down?
Average cost is broken into:
Average Fixed Cost: 𝐴𝐹𝐶=𝑇𝐹𝐶/𝑄
Average Variable Cost: 𝐴𝑉𝐶=𝑇𝑉𝐶/𝑄
Average (Total) Cost: 𝐴𝐶=𝑇𝐶/𝑄; 𝐴𝐶=𝐴𝐹𝐶+𝐴𝑉𝐶
How is short run marginal cost calculated ?
Marginal Cost: (i.e. the change in 𝑇𝐶 per one unit change in 𝑄): 𝑀𝐶 =∆𝑇𝐶/∆𝑄
What do the short run average cost curves look like on a graph if cost against output ?
𝐴𝐹𝐶 curve is downward sloping.
Spreading FC over output.
𝐴𝑉𝐶 curve is U-shaped.
Diminishing returns to output.
Because 𝐴𝑇𝐶 = 𝐴𝐹𝐶 + 𝐴𝑉𝐶, 𝐴𝑇𝐶 curve is also U-shaped.
What are the shapes of a firms cost curves determined by ?
- Technology
- Eventually diminishing returns.
What shape is the short run marginal cost curve and how does it relate to the average total cost curve ?
𝑀𝐶 curve is also U-shaped.
𝑀𝐶 < 𝐴𝑇𝐶 when 𝐴𝑇𝐶 is decreasing
𝑀𝐶 > 𝐴𝑇𝐶 when 𝐴𝑇𝐶 is increasing
At the minimum 𝐴𝑇𝐶: 𝑀𝐶=𝐴𝑇𝐶
How does the marginal cost curve relate to the marginal product curve ?
𝑀𝐶 is at its minimum at the same output level at which 𝑀𝑃 is at its maximum.
When 𝑀𝑃 is increasing (decreasing), 𝑀𝐶 is decreasing (increasing).
How does the average cost curve relate to the average product curve ?
𝐴𝑉𝐶 is at its minimum at the same output level at which 𝐴𝑃 is at its maximum.
When 𝐴𝑃 is increasing (decreasing), 𝐴𝑉𝐶 is decreasing (increasing).
What is the long run cost ?
The long-run is the time span when all inputs are variable.
A firm can vary both labour and capital.
Since inputs can be varied, all the firm’s costs are also variable in the long-run.
What is the long run average cost curve ?
The LRAC curve is a planning curve.
Tells the firm the option that minimises the average cost of producing a given output range.
Why are there increasing returns to economies of scale with the long run average cost curve ?
- Specialisation and the division of labour.
- Indivisibilities of inputs.
Some inputs are more suited to large scale production. - Multi-stage production.
Using a single factory across all stages of production. - Purchasing, financial, and marketing economies.
Bulk purchases lower average costs.
Why are there diminishing returns to economies of scale with the long run average cost curve ?
- Coordination problems.
Managing firms becomes complex as they grow. - Mass production can also lead to disruption.
As the production process becomes more complex, small delays can be magnified. - Labour may become unionised and more powerful increasing wages.
- Workers may be more alienated in large firms or alienated by repetitive work tasks.
4 ways to classify a market by degree of competition…
Number of firms/market concentration.
Freedom of entry to industry.
Nature of the product (differentiation).
Nature of the demand curve (elasticity; pricing power).
4 basic market structures…
Perfect Competition.
Monopolistic Competition.
Oligopoly.
Monopoly.
What is perfect competition ?
Perfect Competition is a market in which:
- Many firms sell identical products to many buyers.
- There are no restrictions to entry into the market.
- Established firms have no advantages over new ones.
- Sellers and buyers are well informed about prices.
When does perfect competition arise ?
Perfect Competition arises so long as the MES for production is small relative to market demand.
What is a firms marginal revenue?
A firm’s marginal revenue is the change in total revenue (∆𝑇𝑅) that results from a one-unit increase in the quantity sold.
What is the marginal revenue in a perfectly competitive market ?
MR = Price
What does a short run industry supply curve show ?
The short-run industry supply curve shows the quantity supplied by the industry at each price when the plant size of each firm and the number of firms in the industry is constant.
It is the sum of the supply curve for each firm in the industry.
What is the short run supply curve for a firm ?
A firm’s supply curve is a marginal cost curve for all values of price equal to or greater than the minimum average variable cost.
What 2 important short run decisions do firms face ?
What output to produce in order to maximise economic profit?
In the case of an economic loss, should the firm temporarily shut-down?
How do firms determine the output that maximises economic profit ?
To determine the output that maximises economic profits we perform Marginal Analysis.
What is marginal analysis ?
- Compare the 𝑀𝐶 of producing one more unit with the 𝑀𝑅 from selling that unit
How is marginal analysis carried out ?
Use the 𝑀𝑅=𝑀𝐶 rule to find the profit maximising output.
Use 𝑃 and 𝐴𝑇𝐶 curves to measure amount of maximum economic profit.
What are the 3 profit maximisation scenarios ?
Break even
Economic profit
Economic loss
