Theme 1 Flashcards
What is meant by rational decision making?
Making choices to maximise utility from buying and consuming goods and services
What are the assumptions of rational decision making?
Consumers aim to maximise utility
Firms aim to maximise profits
Define the term demand
The quantity of a product that consumers are willing and able to buy at a given price in each time
Explain the demand curve
Shows the relationship between the price of an item and quantity demanded over a period
Explain the difference between a movement along the demand curve and a shift in the demand curve
Movement along the demand curve is caused by a change in price
A shift in the demand curve is caused by a change in one or more factors other than price
Define price elasticity of demand
Measures the responsiveness of quantity demanded for a product after a change in price
The formula to calculate PED is
% change in QD / % change in P
What does it mean if PED = 0
Demand is perfectly inelastic and demand does not change when the price changes
What does it mean if PED is between 0 and -1
Demand is price inelastic
What does it mean if PED = -1
Demand is unit price elastic
What does it mean if PED > 1
Demand is perfectly elastic
Quantity demanded will fall to 0 if price rises
3 factors that are likely to make products have price inelastic demand
Lack of substitutes or competition
Addict goods
A small percentage of income
3 factors that are likely to make products have price elastic demand
Abundance of available substitutes
Luxury good
Large proportion of income
Define income elasticity of demand
Measures the relationship between a change in demand following a change in the real income of consumers
The formula to calculate YED is
% change in demand / % change in income
What does it mean if YED < 0
Inferior good
Demand falls as income rises
What does it mean if YED is between 0 and 1
Normal necessity
Rise in demand is less than proportionate to income
Demand is income inelastic
What does it mean if YED > 1
Luxury goods and services
Demand rises more than proportionate to a change in income
Demand is income elastic
3 products likely to be inferior
Own label discounters
Public transport
Economy class travel
3 products likely to be normal
Electronics
Clothing
High end restaurants
Define Cross elasticity of demand
Measures the responsiveness of demand for good x following a change in the price of good y
The formula to calculate XED is
% change in demand for good x / % change in the price of good y
What does it mean if XED < 0
Complement good
An increase in the price for good x will lead to a decrease in demand for good y
What does it mean if XED > 0
Substitute good
An increase in the price of good x will lead to a rise in demand for its substitute
Define the term supply
The quantity of a good or service producers are willing to supply at a given price
Define the supply curve
Shows a relationship between market price and how much a firm is willing and able to sell
Explain the difference between a movement along the supply curve and a shift in the supply curve
A movement is due to a change in price
A shift is due to any other factor excluding price
4 factors that would cause a shift in the supply curve
Changes in production costs
Changes in technology
Government taxes or subsidies
Changes in climate (agricultural industries)
price inelastic supply curve and a price elastic supply curve
Inelastic - Supply curve is flatter
Elastic - Supply curve is steeper
Define price elasticity of supply
Measures the relationship between change in quantity supplied and a change in price
Formula to calculate PES
% change in QS of X / % change in price of X
What does it mean if PES > 1
Supply is price elastic
What does it mean if PES < 1
Supply is price inelastic
What does it mean if PES = 0
Supply is perfectly inelastic
3 factors that are likely to make products have price inelastic supply
Lack of spare capacity
Low level of stock of raw materials and finished products
Short term
3 factors that are likely to make products have price elastic supply
Spare capacity
Plentiful level of stock of raw materials and finished products
Long term
How does excess demand occur
When Quantity demanded exceeds available supply
How does excess supply occur
When supply is greater than demand and there are unsold goods in the market
Define price mechanism
The means by which decisions of consumers and businesses interact to determine the allocation of resources
Explain the price mechanism function of Rationing
Prices ration scarce resources when demand outweighs supply
Leaving only those willing and able to pay to buy
Explain the price mechanism function of signalling
Prices adjust to demonstrate where resources are required
They rise and fall to reflect scarcities and surpluses
Explain the price mechanism function of incentives
Through choices consumers send information to producers about their changing nature of needs and wants
Disadvantages of the use of the price mechanism to allocate resources
May be inequality in income and wealth
In a free market there is an under-provision of public goods which require government intervention
Difference between positive and normative sta
Positive statements can be tested by referring to evidence
Normative are subjective statements
Define externalities
spill-over effects from production or consumption for which no appropriate compensation is paid to third parties
What is market failure
Occurs whenever a market leads to a misallocation of resources.
Define Negative externalities
Costs to 3rd parties as a result of the actions of producers
Define Positive externalities
Third parties benefit from the spill-over effects of production/consumption
Give 3 examples of activities and the associated negative externality
Factories producing air pollution
Industrial waste
Noise pollution
Give 2 examples of activities and the associated positive externality
Health services eg. NHS
Nursery provision eg. Early years education
Define consumer surplus
The difference between the price consumers are willing and able to pay for a good/service and how much they actually pay
Define producer surplus
The difference between the price producers are willing and able to supply a good/service for and the price they actually receive
Define indirect tax
Tax imposed by government that increased supply costs for producers
2 examples of indirect taxes
VAT
Plastic bag charge
Distinguish between ad valorem and specific indirect tax
Ad valorem - % tax
Specific - set amount per unit
Define public goods
Beneficial to society but are not provided by private firms
Non excludable and Non rivalrous
Examples of public goods
Police services
Public service broadcasting
Parks
Explain the concept of free-rider problem
Individuals benefitting from a public good without contributing to the cost of the good
Because public goods are non excludable
Subsidies
This is an amount given by the government to encourage production or consumption of a good that generates positive externalities
Non rivalrous
One persons consumption does not affect the consumption of someone else
Non excludable
One person cannot be excluded from consuming the good
Government failure
Government intervened in a market and does not achieve the objectives they set out to achieve
Define regulation
Intervention to tackle market failure by direct action to command and control behaviour
Define traceable pollution permit
Controlling pollution based on a market for permits that allow firms to pollute up to a limit
Advantages of a tradable pollution permit
Firms will have an incentive not to pollute
Overall level of pollution can be controlled by government
Disadvantages of a tradable pollution permit
Must be sanctions in place for firms who pollute beyond permitted level
Firms who can afford to buy permits can pollute as much as they want
