Theme 1 Flashcards
Ceteris paribus
All other things remaining the same
Positive statements
Objective statements which can be tested with factual evidence to be proven or disproven
Ad valorem tax
An indirect tax imposed on a good where the value of the tax is dependent on the value of the good
Asymmetric information
Where one party has more information than the other, leading to market failure
Capital
One of the four factors of production; goods which can be used in the production process
Capital goods
Goods produced in order to aid production of consumer goods in the future
Command economy
All factors of production are allocated by the state, so they decide what, how and for whom to produce goods
Complementary goods
Negative XED; if good B becomes more expensive, demand for good A falls
Consumer goods
Goods bought and demanded by households and individuals
Consumer surplus
The difference between the price the consumer is willing to pay and the price they actually pay
Cross elasticity of demand (XED)
The responsiveness of demand for one good to a change in the price of another good
Demand
The quantity of a good/service that consumers are able and willing to buy at a given price at a given moment in time
Diminishing marginal utility
The extra benefit gained from consumption of a good generally declines as extra units are consumed; explains why the demand curve is downward sloping
Division of labour
When labour becomes specialised during the production process so do a specific task in cooperation with other workers
Economic problem
The problem of scarcity; wants are unlimited by resources are finite so choices have to be made
Efficiency
When resources are allocated optimally, so every consumer benefits and waste is minimised
Enterprise
One of the four factors of production; the willingness and ability to take risks and combine the three other factors of production
Equilibrium price/quantity
Where demand equals supply so there are no more market forces bringing about change to price or quantity sold
Excess demand
When price is set too low so demand is greater than supply
Excess supply
When price is set too high so supply is greater than demand
Externalities
The cost of benefit a third party receives from an economic transaction outside of the market mechanism.
External cost/benefit
The cost/benefit to a third party not involved in the economic activity; the difference between social cost/benefit and private cost/benefit
Free market
An economy where the market mechanism allocates resources so consumers and producers make decision about what is produced, how to produce it and for whom
Free rider principle
People who do not pay for a public good still receive benefits from it so the private sector will under-provide the good as they cannot make a profit
Government failure
When government intervention leads to a net welfare loss in society
Habitual behaviour
A cause of irrational behaviour; when consumers are in the habit of making certain decisions
Incidence of tax
The tax burden on the taxpayer
Income elasticity of demand (YED)
The responsiveness of demand to a change in income
Indirect tax
Taxes on expenditure which increase production costs and lead to a fall in supply
Inferior goods
YED<0; goods which see a fall in demand as income increases
Information gaps
When an economic agent lacks the information needs to make a rational, informed decision
Labour
One of the four factors of production; human capital
Land
One of the four factors of production; natural resources such as oil, coal, wheat, physical space
Luxury goods
YED>1; an increase in incomes causes an even bigger increase in demand
Market failure
When the free market fails to allocate resources to the best interest of society, so there is an inefficient allocation of scarce resources
Market forces
Forces in free markets which act to reduce prices when there is excess supply and increase them when there is excess demand
Minimum price
A floor price which a firm cannot charge below
Mixed economy
Both the free market mechanism and the government allocate resources
Model
A hypothesis which can be proven or tested by evidence; it tends to be mathematical whilst a theory is in words
Negative externalities of production
Where the social costs of producing a good are greater than the private costs of producing the good
Non-excludability
A characteristic of public goods; someone cannot be prevent from using the good
Non-renewable resources
Resources which cannot be readily replenished or replaced at a level equal to consumption; the stock level decreases over time as they are consumed
Non-rivalry
A characteristic of public goods; one person’s use of the good does not prevent someone else from using it
Normal goods
YED>0; demand increases as income increases
Normative statements
Subjective statements based on value judgements and opinions; cannot be proven or disproven
Opportunity cost
The value of the next best alternative forgone
Perfectly price elastic good
PED/PES=Infinity; quantity demanded/supplied falls to 0 when price changes
Perfectly price inelastic good
PED/PES=0; quantity demanded/supplied does not change when price changes
Positive externalities of consumption
Where the social benefits of consuming a good are larger than the private benefits of consuming that good
Positive statements
Objective statements which can be tested with factual evidence to be proven or disproven
Possibility production frontier (PPF)
Depicts the maximum productive potential of an economy, using a combination of two goods or services
Price elasticity of demand
The responsiveness of demand to a change in price
Price elasticity of supply
The responsive of supply to a change in price
Price mechanism
The system of resource allocation based on the free market movement of prices, determined by the demand and supply curves
Private cost/benefit
The cost/benefit to the individual participating in the economic activity
Private goods
Goods that are rivalry and excludable
Producer surplus
The difference between the price the producer is willing to charge and the price they actually charge
Public good
Goods that are non-excludable, non-rivalry, non-rejectable and have zero marginal cost
Rationality
Decision-making that leads to economic agents maximising their utility
Regulation
Laws to address market failure and promote competition between firms
Relatively price elastic good
When PED/PES>1; demand/ supply is relatively responsive to a change in price so a small change in price leads to a large change in quantity demanded/supplied
Relatively price inelastic good
When PED/PES<1; demand/supply is relatively unresponsive to a change in price so a large change in price leads to a large change in quantity demanded/supplied
Renewable resources
Resources which can be replenished, so the stock of resources can be maintained over a period of time
Scarcity
The shortage of resources in relation to the quantity of human wants
Social cost/benefit
The cost/benefit to society as a whole due to the economic activity
Social optimum position
Where social costs equal social benefits; the amount which should be produced/consumed in order to maximise social welfare
Social science
The study of societies and human behaviour
Specialisation
The production of a limited range of goods by a company/country/individual so they aren’t self-sufficient and have to trade with others
Specific tax
A tax imposed on a good where the value of the tax is dependent on the quantity that is bought
State provision
When the government provides public goods or merit goods which are underprovided in the free market
Subsidy
Government payments to a producer to lower their costs of production and encourage them to produce more
Substitutes
Positive XED; if good B becomes more expensive, demand for good A rises
Supply
The ability and willingness to provide a particular good/service at a given price at a given moment in time
Symmetric information
Where buyers and sellers both have access to the same information
Trade pollution permits
Licenses which allow businesses to pollute up to a certain amount. The government controls the number of licenses and so can control the amount of pollution. Businesses are allowed to sell and buy the permits which means there may be incentive to reduce the amount they pollute
Unitary price elastic good
When PED/PES=1; a change in price leads to a change in output by the same proportion
Utility
The satisfaction derived from consuming a good
Weakness at computation
A cause of irrational behaviour; when consumers are bad at making calculations, estimating probabilities and working out future benefits/costs
Advantages for Specialisation
- Higher output and potentially higher quality, since production focusses on what people and businesses are best at. o There could be a greater variety of goods and services produced. o There are more opportunities for economies of scale, so the size of the market increases. o There is more competition and this gives an incentive for firms to lower their costs, which helps to keep prices down.
Disadvantages of specialisation
o Work becomes repetitive, which could lower the motivation of workers, potentially affecting quality and productivity. Workers could become dissatisfied. o There could be more structural unemployment, since skills might not be transferable, especially because workers have focussed on one task for so long. o By producing a lot of one type of good through specialisation, variety could in fact decrease for consumers. o There could be higher worker turnover for firms, which means employees become dissatisfied with their jobs and leave regularly.
Functions of money
o A medium of exchange: without money, transactions were conducted through bartering. Goods and services were traded with other goods and services, but people did not always get exactly what they wanted or needed. The goods and services exchanged were not always of the same value, which also posed a problem. Exchange could only take place if there was a double coincidence of wants, i.e. both parties have to want the good the other party offer. Using money eliminates this problem. o A measure of value (unit of account): Money provides a means to measure the relative values of different goods and services. For example, a piece of jewellery might be considered more valuable than a table because of the relative price, measured by money. Money also puts a value on labour. o A store of value: Money has to hold its value to be used for payment. It can be kept for a long time without expiring. However, the quantity of goods and services that can be bought with money fluctuates slightly with the forces of supply and demand. o A method of deferred payment: Money can allow for debts to be created. People can therefore pay for things without having money in the present, and can pay for it later. This relies on money storing its value.
Free market advantage
o Firms are likely to be efficient because they have to provide goods and services demanded by consumers. They are also likely to lower their average costs and make better use of scarce resources. Therefore, overall output of the economy increases. o The bureaucracy from government intervention is avoided. o Some economists might argue the freedom gained from having a free economy leads to more personal freedom.
Free market disadvantage
o The free market ignores inequality and tends to benefit those who hold most of the wealth. There are no social security payments for those on low incomes.
o There could be monopolies, which could exploit the market by charging higher prices.
o There could be the overconsumption of demerit goods, which have large negative externalities, such as tobacco.
o Public goods are not provided in a free market, such as national defence. Merit goods, such as education, are underprovided.
Command economy advantage
o It might be easier to coordinate resources in times of crises, such as wars. o The government can compensate for market failure, by reallocating resources. They might ensure everyone can access basic necessities. o Inequality in society could be reduced, and society might maximise welfare rather than profit. o The abuse of monopoly power could be prevented.
Command economy advantage
o It might be easier to coordinate resources in times of crises, such as wars. o The government can compensate for market failure, by reallocating resources. They might ensure everyone can access basic necessities. o Inequality in society could be reduced, and society might maximise welfare rather than profit. o The abuse of monopoly power could be prevented.
Command economy disadvantage
o Governments fail, as do markets, and they may not be fully informed for what to produce. o They may not necessarily meet consumer preferences. o It limits democracy and personal freedom.
Factors affecting demand
P- Population. The larger the population, the higher the demand. Changing the structure of the population also affects demand, such as the distribution of different age groups. o I- Income. If consumers have more disposable income, they are able to afford more goods, so demand increases. o R- Related goods. Related goods are substitutes or complements. A substitute can replace another good, such as two different brands of TV. If the price of the substitute falls, the quantity demanded of the original good will fall because consumers will switch to the cheaper option. A complement goes with another good, such as strawberries and cream. If the price of strawberries increases, the demand for cream will fall because fewer people will be buying strawberries, and hence fewer people will be buying cream. o A- Advertising. This will increase consumer loyalty to the good and increase demand. o T- Tastes and fashions. The demand curve will also shift if consumer tastes change. For example, the demand for physical books might fall, if consumers start preferring to read e-books. o E- Expectations. This is of future price changes. If speculators expect the price of shares in a company to increase in the future, demand is likely to increase in the present. o S- Seasons. Demand changes according to the season. For example, in the summer, the demand for ice cream and sun lotions increases.
Factors influencing PED
Necessity Substitutes Addiction income Durability Peak/off-peak Time
Burden of tax graph
Subsidies graph
Factors Shifting supply
o P- Productivity. Higher productivity causes an outward shift in supply, because average costs for the firm fall. o I- Indirect taxes. Inward shift in supply.
N- Number of firms. The more firms there are, the larger the supply.
T- Technology. More advanced technology causes an outward shift in supply.
S- Subsidies. Subsidies cause an outward shift in supply.
W- Weather. This is particularly for agricultural produce. Favourable conditions will increase supply.
C- Costs of production. If costs of production fall, the firm can afford to supply more. If costs rise, such as with higher wages, there will be an inward shift in supply.
Factors influencing PES
1) time scale
2) spare capacity
3) level of stocks
4) barriers to enter the market
Functions of price mech
Rationing
When there are scarce resources, price increases due to the excess of demand. The increase in price discourages demand and consequently rations resources. For example, plane tickets might rise as seats are sold, because spaces are running out. This is a disincentive to some consumers to purchase the tickets, which rations the tickets.
Incentive
This encourages a change in behaviour of a consumer or producer. For example, a high price would encourage firms to supply more to the market, because it is more profitable to do so.
Signalling
The price acts as a signal to consumers and new firms entering the market. The price changes show where resources are needed in the market. A high price signals firms to enter the market because it is profitable. However, this encourages consumers to reduce demand and therefore leave the market. This shifts the demand and supply curves.
Government policies to intervene
Indirect taxes: to reduce the quantity of demerit goods consumed. This increases the price of the good. If the tax is equal to the external cost of each unit, then the supply curve becomes MSC rather than MPC, so the free market equilibrium becomes the socially optimum equilibrium. This internalises the externality. In other words, the polluter pays for the damage.
Subsidies: encourage the consumption of merit goods. This includes the full social benefit in the market price of the good.
Regulation: to enforce less consumption of a good. For example, the minimum school leaving age. If there was a compulsory recycling scheme, it would be difficult to police and there could be high administrative costs. Bans could be enforced for harmful goods, although they can still be consumed on the black market. Bans are only useful where MSC > MPB (the MSC curve is above MPB).
Provide the good directly: The government could provide public goods which are underprovided in the free market, such as with education.
Provide information: so there is no information failure, and consumers and firms can make informed economic decisions. Property rights: this encourages innovation because entrepreneurs can create new ideas, which are protected, and earn profit.
Personal carbon allowances: They could be tradeable, so firms and consumers can pollute up to a certain amount, and trade what they do not use.
Max and min prices
Government failure
Disortion of price signals
unintended consequences
excessive administrative costs
Information gaps
Evaulation
time - long run, short run
Opportunity cost/ costs in general
Governemnt failure
Extend of effectiveness
