Supply and Demand Flashcards
Why is the supply curve upward sloping?
When the price of a good increases, there is an incentive for suppliers to produce more of the good and sell it at a higher price
What is economics?
Economics is the study of how people interact with each other and with their natural environment in producing their livelihoods, and how this changes over time
What is positive economics?
It explains how the economy works without any recourse to personal value judgement
What is normative economics?
It explains how the economy ought to work and therefore involves an ethical or moral judgement
Why is the demand curve downward sloping? (3 reasons)
Diminishing marginal utility, income effect, substitution effect
What is diminishing marginal utility?
The more one consumes, the less extra satisfaction we feel for each additional unit. Hence one is only willing to consume the next unit if it’s price is lower than the previous (downward sloping demand)
What is the income effect?
How a change in demand for a good is affected by a change in real disposable income. If prices rise, disposable income decreases, therefore demand will decrease as a result of lower disposable income
What is the substitution effect?
How a change in price of a good affects demand compared to others. An increase in the price of a good will encourage consumers to buy different goods, assuming the same level of income.
What happens to supply, demand and prices when there is an increase in DEMAND for a good?
The demand curve will shift to the right (demand is higher at each possible price), prices will rise as a result of the shift, so there will be an increase in the quantity supplied, which is a movement along the supply curve (not a shift).
What happens to supply, demand and prices when there is an increase in SUPPLY for a good?
Supply shifts downwards, prices will decrease (as there will be excess supply), there is a movement along the demand curve to a new equilibrium with a lower price and higher quantity demanded
What is consumer surplus?
Difference between the price consumers are willing to pay and the price they actually pay
What is producer surplus?
Difference between the price sellers are willing to sell for and the price they actually receive
Define own price elasticity of demand (PED)
PED measures the responsiveness of the quantity demand of a good to a change in its own price
What sign does PED have? Give examples of elastic (>1) and inelastic (<1) goods?
Negative - represents negative relationship between price and demand
Elastic - normal/luxury goods e.g. package holidays
Inelastic - necessities e.g. wheat
Is demand more elastic or inelastic in the long-run? Why?
Elastic - consumers have had time to process the price change and adjust their expenditures accordingly
What is the relationship between PED and marginal revenue?
When demand is elastic, MR is positive
When demand is inelastic MR is negative
When MR=0, demand is unitary elastic
What happens to total revenue when the price of a good is reduced that has an elastic PED?
Total revenue will increase - total revenue from new sales will be greater than the fall in existing sales
What happens to total revenue when the price of a good is reduced that has an inelastic PED?
Total revenue will fall - total revenue from new sales would be less than the fall in existing revenue
What happens to total revenue when the price of a good is reduced that is unitary elastic?
No change - increase in revenue from new sales will exactly offset the drop in revenue from existing sales
What is the formula for own price elasticity of demand?
% change in quantity demand of good X / % change in price of good X
Define cross price elasticity of demand (XED)
XED measures the responsiveness of the quantity demand of good X to a change in the price of good Y
What is the formula for cross price elasticity of demand?
% change in quantity demand of good X / % change in price of good Y
Interpret the signs of cross price elasticity of demand?
Positive = substitutes e.g. rail vs bus
Negative = complements e.g. tennis racket and tennis balls
Define income elasticity of demand (YED)
YED measures the responsiveness of quantity demanded to a change in income
What is the formula for YED?
% change in quantity demanded of good X / % change in consumer income
What are the size/sign of YED for:
1) inferior goods
2) normal goods
3) luxury goods?
1) inferior = negative, less than 0
2) normal = positive, greater than 0
3) luxury = positive, greater than 1
