Theme 1 Flashcards
Whats are the 4 factors of production? (the inputs available to supply goods and services in an economy)
and what are they?
- Land - the resource that encompasses the natural resources used in production
- Labour - amount of physical, mental and social effort used to produce goods and services
- Capital - the assets - physical tools, plants and equipment
- Enterprise - making the other 3 factors of production into something useful often takes creativity and some risk
Whats the basic economic problem?
resources have to be allocated between competing uses because wants are infinite whilst resources are scarce (infinite wants with finite resources)
what are scarce resources?
resources that are limited in supply so that choices have to be made about their use
What do economists do to simplify reality?
Ceteris paribus - all other things being equal
Whats a normative statement?
Statements which cannot be supported or refuted. Subjective- based on opinions
Whats a positive statement?
A statement which can be supported or refuted by evidence ( proven true or false) Objective( based on facts)
What are the economic agents and what do they want to maximise?
(rational decision-making)
- Consumers wish to maximise utility
- Producers wish to maximise profits
- Government wish to maximise overall level of utility of its citizens
Whats the opportunity cost?
Value of the next best alternative forgone
Whats a renewable source?
Ones that can be replenished
Whats a non-renewable source?
In finite supply and therefore will run out
Whats specialisation?
specialisation is when economic units such as individuals, firms, regions or countries concentrate on specific goods or services.
Whats specialisation by individuals is and who came up with it?
Division of labour - Adam Smith - pins factory - 1 worker if to do all processes himself makes 20 pins but 10 workers together specialising in a variety of tasks could make 48000 pins
How does division of labour come about?
Workers specialise in different tasks - leads to enormous increase in productivity (output per unit of input employed) arises from both increases in labour productivity (output per worker) and capital (output per unit of capital employment)
Why division of labour is productive?
Makes it cost-effective to provide workers with specialist tools
Time is saved as workers are specialised in to those tasks which they are best suited.
What are the 3 sectors of the economy?
Primary - raw materials are extracted and food is grown
Secondary - raw materials are transformed into goods
Tertiary - produces services
Adam Smith say about economic activity?
Less government or control over businesses and consumers will lead to a thriving society.
Derived from the self-interest objectives (consumers and production), operation of price mechanism which leads to optimum resource allocation and therefore best outcome of society
Invisible hand leads to more competitiveness and self interest so consumers get best price to max utility and firms receive best price to max profit.
Whats allocative efficiency?
A state in the economy where production represents the consumers preferences. Where the last unit provides a marginal benefit equal to the marginal cost of producing.
Whats productive efficiency?
Where the economy or economic system cannot produce any more of one good without sacrificing production of another good and without improving the production technology.
What would a fall in price in a demand curve mean?
As the price of the product has fallen, the utility maximising behaviour of consumers would lead to an extension of demand along the demand curve from A to B and Q2 would be demanded.
Whats utility maximisation?
the consumer should buy a good up to the point where the last £ spent on a good provides the same marginal utility (satisfaction) as the last £ spent on every other good.
What does a production possibility frontier show?
Shows the maximum potential output of an economy
A growth in the economy will do what to the PPF and vice versa?
- Shift outwards (quantity of resources available for production increases. e.g. more workers) and inwards if the production potential decreased.
How do you calculate opportunity cost?
.
What is utility?
The satisfaction gained from consuming a good
What is marginal utility?
Is the increase is satisfaction consumers gain from consuming an extra unit of a good
What is diminishing marginal utility?
Occurs when marginal utility gained from consuming a product is less than the marginal utility gained from consuming the previous unit.
What are the assumptions of rational economic decision making?
Consumers aim to maximise utility
Producers aim to maximise profit
The social factors affecting demand?
Social awareness - health risks
Social norms - norms of behaviour
Social pressures - peer pressure
The emotional factors affecting demand?
Emotional arousal - health insurance at times of crisis
Binge drinking and eating at times of personal insecurity
Emotional attachment to products
Whats bonded rationality?
Most consumers do not have sufficient information to make fully-informed judgements when making their decisions.
Complexity of products also makes life difficult
Suggests that consumers opt to satisfied rather than maximise
Rules of thumb and approximates when active in different markets
What are heuristics?
Are mental shortcuts or rules of thumb for decision-making to help people make a quick, satisfactory, but perhaps not perfect, answer to a complex question.
Behaviour
.
What is demand?
Demand is the quantity of goods and services that will be bought at any given price over a period of time.
When does a market exist?
Whenever there are buyers and sellers of a particular good. Buyers demand goods from the market whilst sellers supply goods to the market.
What does the demand curve show?
Effective demand. It shows how much would be bought at any given price and not how much buyers would like to buy if they had unlimited resources.
What will an increase in income do to a normal good (demand curve)? Conditions of demand
Cause a shift to the right of demand curve.
What will the price of other goods be known as?
Condition of demand - complement and substitutes
Other factors of conditions of demand?
- Income
- Price of other goods
- Changes in population
- Changes in fashion
- Changes in legislation
- Advertising
What is consumer surplus?
The difference between the value to buyers and what they actually pay. Is a measure of the welfare that people gain from consuming goods and services.
Indicated by the area under the demand curve and above the market price.
Indirect factors that would increase rail travel?
If oil price increased, less people would be less likely to travel by car and therefore increasing sales of rail travel (shift right)
What is PED?
Measure of the change in the quantity demanded or purchased of a product in relation to its price change.
PED zero means?
PED 0-1 means?
PED 1 means?
PED >1 means?
PED infinity means?
Perfectly inelastic - quantity demanded does not change at all as price change - revenue increases as price increases
Inelastic - unresponsive to a change in price - revenue increases as price increases (PERFECT no Q change)
Unit elasticity - responsive to a change in price (according to same percentage as the change in price) - no change
Elastic - highly responsive to a change in price - revenue decreases as price rises (PERFECT no P change)
Perfectly elastic - there is one price at which consumers are prepared to pay. - no change
The equation for PED?
dP/P
What is YED?
income elasticity of demand is the responsiveness of the quantity demanded for a good to a change in consumer income
What is XED?
A measure of the responsiveness of demand for one good, x to a change in price of another good, y
XED formula?
% change in quantity demanded by good x
/
% change in price of good y
XED Coefficients?
Cross price inelastic?
Cross price elastic?
Substitutes and complements?
- -1+1 demand for good x changes at a greater proportion than the change in price of good Y
Complements are negative (demand curve down trend)
Substitutes are positive (demand curve up trend)
Whats a normal good?
Most goods are normal goods (YED)
- if the price of a normal good or service increases demand for that good or service will decrease and vice versa
However as incomes of consumers increases, demand for normal goods will increase (rightwards shift)
Whats an inferior good?
is one where demand decreases as incomes increase
- have negative income elasticities (YED)
Whats a substitute good?
If the XED > 0 (i.e. it is positive), then the two goods are substitutes. This means one could replace the other, such as tea and coffee:you could drink tea OR coffee. The two goods ‘substitute’ each other; as the demand for one rises, the demand for the other falls.
Whats a complement good?
If XED < 0 (i.e. it is negative), then the two goods are complements. This means a good would be bought in conjunction with the other, such as milk AND coffee, or mint sauce AND lamb. The two goods ‘complement’ each other; as the demand for one rises, the demand for the other also rises.
Whats price elasticity of supply?
Is the degree to which the effective desire for something changes as its price changes. The responsiveness to supply to a change in price.
Formula for PES?
% change in quantity supplied
/
% change in price
What does an outward shift of supply suggest?
More can be supplied at each price level and there being a decrease in the cost per unit produced. (Vice versa)
Whats does a luxury good have (YED)?
income elasticity >1
What does a necessity have (YED)?
income elasticity >0 and <1
Whats market equilibrium?
A situation where for a particular good supply = demand. When the market is in equilibrium, there is no tendency for prices to change. We say the market-clearing price has been achieved.
Factors affecting PES?
- Spare production capacity - if spare capacity - can increase output without a rise in costs and supply will be more elastic in response to a change in demand
- Stocks of finished products and components - if they are at a high level - then can respond to a change in demand - supply will be elastic - perishable goods are often harder / more expensive to store
- Availability of producer substitutes / factor mobility - these are goods which producers can easily produce as alternatives. If capital and labour are mobile then elasticity is likely to be high
- Time period - supply is more price elastic the longer the time that a firm is allowed to adjust its productive levels.
What is PED determined by?
- Substitutes - if no substitutes - price inelastic
- Time - in s/r products are likely to be more price inelastic as consumers find it difficult to change their shopping habits - in l/r products are likely to be more price elastic as consumers adjust to changing market conditions
- Definition of the market - some markets have no close substitutes. e.g cigarettes
What will happen to XED if a product has close substitutes?
A small rise in price of X causes large rise in demand for Y.
What will happen to XED if a product has weak substitutes?
A large rise in price of S leads to a small increase in demand for T.
What will happen to XED if a product has close complements?
A small fall in price of A causes a large rise in demand for B.
What will happen to XED if a product has weak complements?
A large drop in price of E causes only small rise in demand for F.
What does it mean if supply is elastic?
Producers can increase their output without a rise in cost or a time delay
What does it mean if supply is inelastic?
Firms find it hard to change their production in given time period.
PES: PES>1 PES<1 PES=0 PES=infinity
PES>1= then supply is price elastic PES<1= then supply is price inelastic PES=0= supply is perfectly inelastic PES=infinity= supply is perfectly elastic following a change in demand
Whats the basic law of supply?
Is that as the price of a product rises, so businesses expand supply to the market.
What does an upward supply curve assume?
Firms are motivated to produce by profit
The cost of producing a unit increases as output increases (rising marginal cost)
(The willingness of a firm…)
Causes of shifts in the supply curve?
- Changes in the unit costs of production - lower outward as can produce more for less
- A fall (depreciation) in the exchange rate - causes an increase in prices of imported components and raw materials
- Advances in production technologies - outward
- The entry of new producers - into the market - outward
- Favourable weather conditions - outward
- Taxes, subsidies and government regulations
What does equilibrium mean?
What is the term used when to say they are out of balance?
Means a state of equality or balance between market demand and market supply.
Disequilibrium
What is allocative efficiency?
Occurs where customer satisfaction is maximised in the production of goods and services
- At this point quantity supplied will equal quantity demanded
P=MC
What is productive efficiency?
occurs where no additional (or maximum) output can be produced from the the factor inputs available at the lowest possible average or unit cost
Economic efficiency?
Occurs when we have allocative and productive efficiency at the same time.
What does a price above the equilibrium price incentivise and disincentivize?
Producers and disincentivize consumers. Producers see opportunity as they can sell more, however leads to excess supply as consumers buy less.
What is the incentive function?
When changes in price encourages buyers and sellers to change the quantity they buy and sell. A rise in price encourages buyers to purchase less and steers to produce more; and vice versa.
What is the rationing function?
When changes in price lead to more or less being produced, so increasing or limiting the quantity demanded by buyers.
What is the signalling function?
When changes in price give information to buyers and sellers which influence their decisions to buy and sell.
What does the price mechanism describe?
Describes the means by which millions of decisions taken by consumers and businesses interact to determine the allocation of scarce resources between competing uses. - the signalling function will allow prices to demonstrate where resources are in required or where they are not.
marginal…
.
Whats an indirect tax?
A tax on the sale of goods and services which causes the supply curve to shift left because it raises costs of production. (VAT, Carbon Tax, Fuel and Tobacco)
Whats an advalorem tax?
A percentage tax e.g. on sale price
Causes a pivot shift of the supply curve
Specific unit tax?
A set tax per unit.
Causes a parallel shift of supply curve.
How do you identity total value of tax revenue?
.
What is the incidence (or burden) of tax?
The amount that the consumer (or producer) will pay for the tax.
Whats a subsidy?
A subsidy is a financial incentive to produce or consume a given product.
EVAL: (indirect taxes)
Whats a progressive tax?
Whats a regressive tax?
Whats a proportional tax?
What are some other issues
A tax that takes a higher proportion of income as income rises
A tax that takes a higher proportion of income as income rises
A tax that takes the same proportion of income regardless of the level of income
Setting the ‘right’ tax rate is extremely unlikely as its virtually impossible to measure the value of externalities and therefore virtually impossible to set the ‘right’ rate of tax.
PED and Cost of collection
What are the 6 words associated with market failure?
- Information gaps
- Positive externalities
- Labour immobility
- Public goods
- Natural monopoly
- Subsidies
What is market failure?
When the free market fails to allocate scarce resources at the socially optimum level of output
What happens as demand (PED) is inelastic to consumer surplus?
There is greater consumer surplus because there are some buyers willing to pay a very high price to continue to consumer that product.
What is producer surplus?
Producer surplus is the difference between the price producers receive for the good and the marginal cost of producing H.
Indicated in the area above the supply curve and below the current market price.
Whats a positive production externality?
Arise when social costs of production are lower than private costs of production. SMC>PMC (supply)
Whats a negative production externality?
When the private marginal cost (PMC) is greater than the social marginal cost (SMC)
Whats a positive consumption externality?
When social benefits are greater than private benefits MSB>MPB (demand)
Whats a negative consumption externality?
When social benefits are lower than private benefits. MSB
What is the MPC (marginal private cost)?
The costs to those who are directly involved in the market
What is the MEC (marginal external cost)?
The costs to third parties as a result of the markets existence
What is the MSC (marginal social cost)?
The sum of private costs and external costs
What is the socially optimum equilibrium?
The equilibrium that would be achieved if the market outcome reflects the effect of externalities.
Whats a carbon tax?
A carbon tax on the consumption or production of goods and services, which cause carbon emissions. It is a policy designed to make the polluter pay for externalities caused.
Whats an information failure?
not directly in exam
Market failure where consumers or producers either don’t have symmetric information or have assymmetric information?
Whats symmetric information?
not directly in exam
Is when all the relevant information is known by both parties.
Whats asymmetric information?
not directly in exam
Occurs when some parties in a transaction have more information regarding the product than others.
Whats a public good?
The two characteristics..?
(not directly in exam)
Where its use by an individual does not stop others from using it whilst its consumption does not reduce the amount available for consumption by others.
They are non rival goods
- where consumption for the good does not reduce the amount available for consumption by others.
Non excludible goods
- Where, once provided, it is impossible to stop other individuals from using them
Whats government failure?
Occurs when an intervention leads to an even less efficient allocation of resources than with the market failure alone
Whats a merit good?
those goods and services that the government feels that people will under-consume, and which ought to be subsided or provided free at the point of use so that consumption does not depend primarily on the ability to pay for the good or service.
Whats a demerit good?
Goods that are thought to be ‘bad’ for you.
Why is economics considered a social science?
Economics is regarded as a social science because it uses scientific methods to build theories that can help explain the behaviour of individuals, groups and organisations. Economics attempts to explain economic behaviour, which arises when scarce resources are exchanged.
The 7 factors affecting demand?
- Price
- Income of consumers
- Price of substitutes
- Price of complements
- Advertising
- Seasonal
- Changes in taste/fashion
Whats a luxury good? (YED)
A luxury good is a normal good with a positive YED that is greater than 1 (income elasticity >1) This means that as incomes increase the consumer will spend a proportionally higher amount -on that good.
YED = 0.5
Normal good but as this YED is positive but less than 1 this good is termed a necessity good.
What is excess demand?
When the quantity customers want to buy exceeds the quantity firms are able to supply. This is resolved when firms increase prices to reduce the excess demand. This encourages supply and discourages demand until the excess is removed.
What is excess supply?
When the quantity firms supply is greater than the quantity customers want to buy. This is resolved when firms reduce prices to sell off excess supply. Lower prices discourage supply and encourage demand until the excess is removed.
How do you overcome an externality?
Government intervention…
Tax - reduce consumption of negative externality
Subsidy - increase consumption of positive externality
Regulation - e.g. pollution
Nudges and behavioural economics - government could place incentives and make it easier to choose less costly costly environmental choices.
How indirect taxes can fix market failure?
i.
ii.
iii.
i.
i. Tax increases the costs of production of firms
- externality explanation
ii. Firms internalise the externalities
- diagram contextualised
iii. Overconsumption/production is reduced
i. Allocative efficiency and government revenue increase
- used to fund long-term solution
Whats a pollution permit and used as short-term for long-term trend…
- Pollution permits involve giving firms a legal right to pollute a certain amount e.g. 100 units of Carbon Dioxide per year.
- If the firm produces less pollution it can sell its pollution permits to other firms.
- However, if it produces more pollution it has to buy permits from other firms or the government.
- Incentitives
Whats a maximum price?
A maximum price occurs when a government sets a legal limit on the price of a good or service – with the aim of reducing prices below the market equilibrium price.
