Theme 1: How do Markets Work Flashcards
When making economic decisions, consumers aim to maximise their …….. and firms aim to maximise ……..
Utility and Profits
Consumer Utility
total satisfaction received from consuming a good or service
Two ways to make a decision are?
Intuition and Rational
Limitations of rational decision making?
Takes longer despite possibly being fairer.
What are the assumptions of the bounded rationality model?
1- The first satisfactory alternative is selected. 2- The decision maker recognises they perceive the world as simple. 3- The decision maker recognises the need to be comfortable without considering every alternative. 4- Decisions could be made by heuristics.
Heuristics
Mental shortcuts or “rules of thumb” that often lead to a solution (but not always).
Factors that shift the demand curve are?
Population Income Related goods Advertising Tastes and Fashions Expectations Seasons
Derived demand
Demand for one good is linked to the demand for a related good.
Composite demand
When the good demanded has more than one use so assuming supply stays the same an increase in one good leads to a decrease in supply of another.
Joint demand
When goods are bought together.
diminishing marginal utility
Decreasing satisfaction or usefulness as additional units of a product are acquired
equation for price elasticity of demand
% change in quantity demanded / % change in price
unitary elastic
describes demand whose elasticity is exactly equal to 1
inelastic demand
A situation in which an increase or a decrease in price will not significantly affect demand for the product
elastic demand
A situation in which consumer demand is sensitive to changes in price
perfectly inelastic
quantity does not respond at all to changes in price (E=0)
perfectly elastic
demand which falls to zero when price changes
Factors effecting PED
Necessity Substitutes Addictiveness Proportion of income Durability Peak and off peak
If a firm sells a good with an inelastic demand, they are likely to put most of the tax burden on ……………
consumer
If a firm sells a good with an elastic demand, they are likely to put most of the tax burden on ……………
themselves (the firm)
Equation for income elasticity of demand
% change in quantity demanded / % change in income
Luxury goods have a PED of YED ……
> 1 as income increases this causes an even bigger increase in demand/
Normal goods have a PED of YED ……
> 0 as demand increases as income increases
Inferior goods have a PED of YED ……
<0 as they see a fall in demand as income rises.
Equation for cross elasticity of demand
% change in quantity demanded of good X / % change in price of good Y
Complementary goods have a ………. XED
negative
Substitute goods have a ………. XED
Positive
Unrelated goods have a ………. XED
0
Factors that cause a shift in the supply curve
Productivity Indirect taxes Number of firms Technology Subsidies Weather Costs of production
equation for price elasticity of supply
% change in quantity supplied / % change in price
Factors effecting PES
the number of producers, spare capacity, ease of switching, ease of storage, length of production period, time period of training, factor mobility, and how costs react.
What are the 3 main functions the price mechanism uses to allocate resources
Rationing Incentive Signalling
Consumer surplus
The difference between what a firm is willing to pay and the price they actually pay.
Producer surplus
The difference between the price the producer is willing to charge and the price they actually charge.
Economic welfare
The total benefit society receives from an economic transaction.
How is economic welfare calculated
The area of producer surplus and consumer surplus added together.
Two types of indirect taxes
specific tax and ad valorem tax
Consumer subsidies affect demand and do/do not shift the ………. curve.
do not supply
Producer subsidies lower the cost of production and do/do not shift the ………… curve.
do supply
What are the 3 reasons why a consumer might not act rationally?
1- The influence of other peoples behaviour. 2- The importance of habitual behaviour. 3- Consumer weakness at computation.
