Theme 1: Introduction to Markets and Market Failure Flashcards
Ad valorem tax
An indirect tax imposed on a good where the value of a tax is dependent on the value of a good
Asymmetric information
When one party has more information than the other, leading to market failure
Ceteris Paribus
All other things remain constant
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 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 (A) to a change in price of another good (B)
%Change in QD of A / %Change in P of B
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 is specialised during the production process
Economic problem
The problem of scarcity; wants are unlimited but resources are finite
Efficiency
When resources are allocated optimally, so every consumer benefits and waste is minimised
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 or benefit a third party receives from an economic transaction outside of the market mechanism
External cost/benefit: (2)
- 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 decisions about what is produced, how to produce and for whom
Free rider principle (2)
- People who do not pay for a public good but still receive benefits from it
- 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 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
%change in QD / %change in Y
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 rises
Information gap
When an economic agent lacks the information needed to make a rational, informed decision
Information provision
When the government intervenes to provide information to correct market failure
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
Maximum price
A ceiling price which a firm cannot charge above
Minimum price
A floor price which a firm cannot charge below
Mixed economy
Both the free market mechanism and the government allocate resources
Negative externalities of production
Where the social costs of producing a good are greater than the private costs of producing the good
Non-excludable
A characteristic of public goods; someone cannot be prevented 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 statement
Subjective statements based on value judgements and opinions; cannot be proven or disproven
Opportunity cost
The value of the next best alternative forgone
Positive statement
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, when resources are fully and efficiently employed
Price elasticity of demand (PED):
The responsiveness of demand to a change in price
% change in QD / % change in P
Price elasticity of supply (PES)
The responsiveness of supply to a change in price
% change in QS / % change in P
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 rivalrous and excludable
Producer surplus
The difference between the price the producer is willing to charge and the price they actually charge
Public goods
Goods that are non-excludable and non-rivalry
Rationality
Decision-making that leads to economic agents maximising their utility
Regulation
Laws to address market failure and promote competition between firms
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
Specialisation
The process of an organisation concentrating its labour and resources on a certain type of production to be more efficient and create a comparative advantage for an economy.
Specific tax
A tax imposed on a good where the value of a tax is dependent on the quantity that is bought
State provision of goods
Through taxation, 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
Symmetric information
Where buyers and sellers both have access to the same information
Tradable pollution permits
Licences which allow businesses to pollute up to a certain amount. The government controls the number of licences 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
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
