Theme 1 - Introduction To Markets And Market Failure Flashcards
Ceteris Paribus
The assumption that everything else will remain the same
What are economic models?
A simplified description of reality
Economics seeks to…
…meet society’s needs and wants
Reasons for high rent prices (5)
- limited housing supply
- high property prices
- high living costs
- different regions
- housing market instability
Basic economic problem
Unlimited wants but limited resources
The 4 types of markets
Centrally planned
Mixed
Free enterprise
Traditional
The 4 economic agents (and what they aim to achieve)
Government - maximise social welfare
Consumers - maximise their satisfaction
Workers/employees - maximise the benefits of work
Firms/businesses - maximise profit
Definition of utility
The economic term for satisfaction/value
Definition of marginal
Additional
Definition of marginal utility
The change in satisfaction from consuming an extra unit
Definition of total utility
The total satisfaction derived
Definition of demand
The amount of a product people are willing and able to buy at a given point
Demand and price have a … relationship
Inverse
Change in price…
Move along the curve
Change in any other factors (except price)…
Shift graph left/right
Definition of expansion
Lowering of the price leads to an increase in demand
Definition of contraction
Increase of the price leads to a decrease in demand
Main factors that shift the demand curve (6)
- population
- advertising
- income/money
- change in price of complementary goods
- change in price of substitute goods
- trends/fashion
The supply curve is the…
…correlation between the cost of a good/service and the quantity supplied for a given period.
Definition of a normative statement
Subjective statements that are based on an opinion (e.g. I think, it might, you should)
Definition of positive statement
Objective statements that can be tested/measured and are based evidence (e.g. will)
What are the 4 resources?
- Capital
- Enterprise (entrepreneurs)
- Land
- Labour
Definition of opportunity cost
The loss of other alternatives when one alternative is chosen
What does PPF (graph) stand for?
Production Possibility Frontier
What does a PPF show?
The maximum output combination of 2 products
Why is there an opportunity cost in PPF graphs?
Due to a scarcity of resources
Definition of specialisation
When an individual/firm/business concentrates on a product or task
Definition of division of labour
When production is broken down into many separate tasks and one person focuses and repeats one of those tasks
Definition of absolute advantage
Being able to produce more of something than another country (assuming both have the same number of resources/FOP available)
Definition of comparative advantage
Being able to produce something at a much lower opportunity cost than another country
What is the equation for working out comparitive advantage/opportunity cost from a graph?
Factor A / Factor B = opportunity cost of Factor B
What are the functions of money? (4)
- a medium of exchange (between suppliers and customers)
- a measure of value (price tags)
- a store of value (weekly wages)
- a method of settling debts
The demand curve shows the amount of a product that consumers would buy at different…
Prices
The demand curve slopes … because as the price … the more of it people will buy
Downwards / decreases
Definition of taxes
A charge levied by the government to raise revenue (decrease supply)
Definition of subsidies
Any form of government support offered to producers to make products cheaper by offsetting some of their operating costs (increases output)
Surplus is…
Excess supply
Shortage is…
Excess demand
When demand = supply it is called…
Equilibrium
The opposite to equilibrium is…
Disequilibrium
Definition of derived demand
When the demand for a good/service is related to another good/service.
Eg. Increase in demand for cars leads to an increase in demand for fuel
What are the 4 basic types of elasticity?
- price elasticity of demand (PED)
- price elasticity of supply (PES)
- income elasticity of demand (YED)
- cross elasticity of demand (XED)
What is the equation for “Price Elasticity of Demand” (PED)?
(%change in quantity demanded) / (%change in price) = PED
(For PED and PES) What do the values mean? (5)
∞ = perfectly elastic
> 1 = elastic
1 = unit elastic
< 1 = inelastic
0 = perfectly inelastic
A highly inelastic graph would have a … demand line
(Almost) vertical
A highly elastic graph would have a … demand line
(Almost) horizontal
Name 3 economic theorists
Adam Smith (1723-1790) Capitalism / Mixed Economy
Karl Marx (1818-1883) Communism / Centralised Economy
Friedrich Heyak (1899-1992) Free Market / Free Economy
Which theory did Adam Smith develop?
The invisible hand theory:
- Self Interest
- Circular Flow of Income
- Risk & Reward
- Trade leaves us all better off
- Wealth is created through productive labor, and that self-interest motivates people to put their resources to the best use.
Which theory did Karl Marx develop?
Marxism
- Capitalists control the capital.
- The capitalists are motivated by profit so pay poor wages which affects spending.
- Marx believed sharing the wealth was a better idea.
Which theory did Friedrich Hayek develop?
- Only Buyers & Sellers understand the market.
- The government might try to help.
- But any policy unintentionally makes things worse.
- Better off leaving the market alone.
- Believes the only place for government is passing essential laws (Like Health and Safety), collecting general taxes (Like VAT).
- Then letting the market take care of itself!
Definition of elastic
A product is considered to be elastic if the quantity demand of the product changes more than proportionally when it’s price increases or decreases
Definition of inelastic
When the price of a good/service changes, consumers’ buying habits stay about the same
Determinants of Elasticity of Demand (SPLAT)
- Substitutes (no. and closeness)
- Percentage of increase
- Luxury / necessity
- Addictive / habit-forming
- Time period
What is the equation for Price Elasticity of Supply (PES)?
(%change in quantity supplied) / (%change in price) = PES
Determinants of Elasticity of Supply? (PEPS T)
- Pace of technological advancement
- Ease of switching between products in production
- spare Production capacity (CELL)
- spare Storage capacity
- Time period for production adjustment
What is the equation for Income Elasticity of Demand?
(%change in quantity demanded) / (%change in income) = YED
(For YED and CE) What do the values mean? (6)
> 1 = elastic
< 1 = inelastic
1 = luxury
< 1 = necessity
Negative - inferior good (and a substitute good)
Positive - normal (and a complimentary good)
Definition of recession
2 consecutive periods of negative growth (6 months)
Definition of cross elasticity
The responsiveness of demand of one good to changes in the price of a related good - either a substitute or a complementary good/service
What is the equation for Cross Elasticity of Demand?
(%change in quantity demanded of good A) / (%change in price of good B) = XED
What does a negative symbol in front of the XED value mean?
Substitute (positive relationship)
What does a positive symbol in front of the XED value mean?
Complementary (inverse relationship)
The higher the the value of XED…
…the stronger the relationship
Definition of market failure
When the market fails to allocate resources effectively
Definition of negative externalities
When a 3rd party is negatively effected by a market transaction
What do the following stand for?
- MPC
- MPB
- MSC
- MSB
MPC - marginal private cost
MPB - marginal private benefit
MSC - marginal social cost
MSB - marginal social benefit
What does the triangle show in a negative externalities graph?
The negative externalities (the extra cost to society)
Which line is added in a negative externalities graph (and direction)?
Marginal Social Cost (MSC) - bottom left to top right
Definition of positive externalities
When a 3rd party is positively effected by a market transaction
Which line is added in a positive externalities graph (and direction)?
Marginal Social Benefit (MSB) - top left to bottom right
Definition of Price Mechanism
The interaction of buyers and sellers in free markets to enable goods, services and resources to be allocated by prices
What are the functions of the price mechanism (3)?
- rationing function
- signalling function
- incentive function
What is the rationing function?
Resources are scarce —> demand exceeds supply + price goes up
The greater the scarcity, the higher the price and the more the resource is rationed
What is the signalling function?
Higher prices —> signals to consumers to reduce consumption + signals to firms to produce more
Falling prices —> signals to consumers to enter a market + signals to producers to leave a market
What is the incentive function?
Higher prices —> incentive for consumers to consume less + incentive for producers to produce more
Falling prices —> incentive for consumers to consume more + incentive for producers to produce less
Definition of rational decision making
(The assumption that) people aim to maximise their own welfare
Reasons why humans are irrational decision makers (10)
- incomplete information
- limited capacity to calculate all costs and benefits - limited computation
- influenced by social networks
- often act reciprocally rather than self interests
- lack self control and seek immediate satisfaction
- loss averse
- make different choices in cold/emotional states
- often fall back on simple rules of thumb when choosing
- satisfice rather than maximise
- have a strong default to maintain the status quo
Complete market failure is…
When there is no supply of products
Partial market failure is…
When the market functions but produces the wrong quantity of a product or the wrong price
What are public goods?
Examples of missing markets/market failure
Market failure leads to…
Government intervention
What is another name for ‘public goods’?
‘Collective consumption goods’
What are the 3 features of ‘public goods’?
- non-excludability - the benefits derived from pure public goods cannot be confined solely to those who have paid for it
- non-rival - consumption by one consumer doesn’t restrict consumption by other consumers
- non-rejectable - cannot be rejected by people
What is the ‘free-rider’ problem?
Public goods are non-excludable so it is hard to charge everyone for using them.
The government pays for the public good with taxation so everyone is charged.
Definition of maximum pricing
When a price is set which the market will not be allowed to go above
What are some sectors that the government like because of their positive externalities (4)?
- rental market
- elderly care
- health/dental care
- education market
The maximum price has to be set… the current market price.
…below…
Definition of minimum pricing
When a price is set which the market is not allowed to go below
The minimum price has to be set… the current market price.
…above…
What are some products which if minimum priced, society would benefit (4)?
- sugar
- energy drinks
- cigarettes/vapes
- alcohol
Definition of flat tax
A tax on firms, that imposes the same tax rate on all individuals, regardless of their income levels (but can be passed on to costomers through higher prices)
Examples of industries which would benefit from flat tax (6)?
- cigarettes/vapes
- sugar
- fuel
- gambling
- fast food
- alcohol/energy drinks
Definition of ad valorem (unit tax)
a tax that is based on the value of a product or service (% tax)
Main example of ad valorem tax
VAT
In a flat tax graph, the supply line… and the demand line…
…shifts to the left…
…doesn’t move…
In an ad valorem graph, the supply line… and the demand line…
…tilts to be more vertical…
…doesn’t move…
Definition of a quasi-public good
A near-public good i.e. it has many but not all the characteristics of a public good
Examples of quasi-public goods (3)
- beaches
- parks
- swimming pools
Definition of merit good
Goods/services that the government feels people will under-consume and ought to be subsidised or provided free at the point of use so that consumption doesn’t depend primarily on the ability to pay for the good/service
Reasons why education is seen as a merit good (7)
- more efficient/productive workforce
- government can collect more tax
- people can have a higher choice of jobs and opportunities
- people can earn higher income
- the prices of goods decrease due to increased supply
- occupational mobility
- reduces unemployment
Definition of demerit goods
‘Bad for you’ goods
Market fails to take into account the negative externalities of consumption because the social costs exceeds the private costs
Examples of demerit goods (3)
- drugs
- alcohol
- cigarettes/vapes
Definition of asymmetric information
Type of market failure in which one party has more information than the other party.
They use this to exploit the other party.
… information is needed for markets to work
Symmetric…
Examples of asymmetric information (5)
- car sales/car insurance
- doctors/dentists
- landlords
- mortgages
- traders in financial/stock markets
What is carbon trading?
A system of limiting carbon emissions through granting firms permits to emit a certain amount of carbon
What are the advantages to a firm of producing less carbon than the government has permitted them to?
The firm can buy and sell these permits on the open market
They can then use this money to invest in their business
Reasons why young people have such high car insurance payments (6)
- less experience
- more often have accidents
- drive at peak times
- learning to drive
- live in bigger cities (London)
- type of car they drive
Factors that may increase the price of someone’s insurance (5)
- postcode (London/area of high levels of crime)
- lack of experience
- young age
- car’s mileage and type of car
- previous convictions/behaviour
What is the black box scheme?
A type of car insurance which sees a small device fitted out-of-sight in your car and it measures how well you drive in order to reward safe drivers with discounted insurance.
What is ‘consumer surplus’?
The difference between the total amount that consumers are willing to pay and the total amount they actually have to pay.
What is ‘producer surplus’?
The difference between the price the producer is willing to accept and the actual amount they receive.
What is the combined consumer surplus and producer surplus called?
Welfare gain to society
In a consumer surplus and producer surplus diagram, which triangle is which?
The top one - consumer surplus
The bottom one - producer surplus
What does consumer/producer surplus diagrams tell us?
How much a good/service benefits society and how much the welfare gain is
