Theme 1 - Introduction to Markets and Market Failure (1.2 - How Markets Work) Flashcards
Describe the Neo-Classical theory [1]
Ref - 1.2.1 - Rational Decision Making
The assumption that all economic agents will act rationally to maximise their benefits or utility. [1]
What is meant by consumer utility? [1]
Ref - 1.2.1 - Rational Decision Making
The satisfaction derived from consuming specific goods. [1]
Which 4 groups of economic agents can the theory of maximisation be applied to? [4]
Ref - 1.2.1 - Rational Decision Making
Consumers [1]
Firms [1]
Workers [1]
Governments [1]
Describe 2 examples in which economic agents agree with the theory of Maximisation [4]
Ref - 1.2.1 - Rational Decision Making
Consumers are assumed to maximise their consumer utility [1], so they must compare the utility gained from consuming a unit to it’s opportunity cost. [1]
Workers are assumed to maximise their welfare at work [1], so they must consider factors such as pay and job security. [1]
What is meant by “the margin”? [1]
Ref - 1.2.1 - Rational Decision Making
A decision made by an economic agent is made in isolation, without other influencing factors. [1]
Define demand [1]
Ref - 1.2.2 - Demand
Quantity of G+S that consumers are able and willing to pay at a given price. [1]
Explain 2 conditions of demand which changes the level of demand [4]
Ref - 1.2.2 - Demand
Income - A rise in income will lead to a rise in demand [1] as consumers have more disposable income to use to buy G+S. [1]
Demand for complements - As demand for one good rises (e.g. washing machines) [1], demand for another good will rise (e.g. washing powder) [1]
State the Law of Diminishing Marginal Utility. [1]
Ref - 1.2.2 - Demand
The utility gained from consuming a specific good falls the greater the number consumed [1]
Describe how the Law of Diminishing Marginal Utility works in real life [2]
Ref - 1.2.2 - Demand
The more avaliable a good, the less marginal utility is provides [1], as consumers are likely to have consumed the same good already [1]. (e.g. chocolate)
Explain how other consumer’s behaviours may influence consumer behaviour [3]
Ref - 1.2.10 - Alternative Views of Consumer Behavior
Consumer may adhere to social normalities in order to “fit in” [1], therefore they are more likely to act irrationally in consumption [1], which can cause herding behaviour over time, as more consumers want to “fit in” [1]
Explain how habitual behaviour can influence consumer behaviour [3]
Ref - 1.2.10 - Alternative Views of Consumer Behavior
Many consumer may be addicted to substances such as alcohol [1], therefore they may act irrationally and buy more alcohol instead [1], therefore alcohol is price inelastic. [1]
State and define the 3 other types of demand. [3]
Ref - 1.2.2 - Demand
Joint Demand - An increase in demand for one good, rises demand for another good. [1]
Competitive Demand - When demand increases for one good, demand decreases for another. [1]
Derived demand - Goods demanded only for production of other goods. [1]
State what is meant by supply. [1]
Ref - 1.2.4 - Supply
The amount of goods firms are willing and able to sell at a given price. [1]
Explain 2 reasons why the supply curve may shift. [4]
Ref - 1.2.4 - Supply
Higher costs of production decrease supply, [1] as there is less incentive to supply in a market with low profits. [1]
Better technology can improve productivity by improving capital [1], therefore reduce production costs and increase supply. [1]
State and describe the 2 types of supply. [2]
Ref - 1.2.4 - Supply
Joint supply - When supply of one good increases, supply of another good also increases. [1]
Competitive supply - When P of (X) increases, so supply of good (Y) falls, so firms switch to producing good (X) [1]
Describe how excess supply is reached in an economy. [2]
Ref - 1.2.6 - Price Determination
When the price level is above equilibrium [1]
So consumers are deincentivised to consume, so excess supply is formed. [1]
Describe how excess supply is eliminated [2]
Ref - 1.2.6 - Price Determination
Prices would need to contract [1] making products cheaper which raises demand, until a new equilibrium is reached. [1]
Describe how excess demand is reached in an economy. [2]
Ref - 1.2.6 - Price Determination
Price would be below equilibrium [1].
So too many consumers would demand the cheaper goods, so excess demand is created. [1]
Describe how excess demand is eliminated [2]
Ref - 1.2.6 - Price Determination
Prices would need to expand [1] allowing demand to fall slowly, until equilibrium is reached. [1]
What is meant by the price mechanism? [1]
Ref - 1.2.7 - Price Mechanism
Free markets allocating resources through interaction of demand and supply. [1]
State the 3 functions of the price mechanism. [3] (HINT - SIR)
Ref - 1.2.7 - Price Mechanism
Signalling [1]
Incentive [1]
Rationing [1]
Describe the signalling function in a price mechanism. [1]
Ref - 1.2.7 - Price Mechanism
The prices provide info to consumers/firms to aid rational decision making. [1]
Describe the incentive function in a price mechanism. [1]
Ref - 1.2.7 - Price Mechanism
Prices incentivise changing of behaviour of consumers+firms, to max welfare/profit [1]
Describe the rationing function in a price mechanism. [1]
Ref - 1.2.7 - Price Mechanism
The price determines who can afford the good, therefore who is supplied the good. [1]
State 2 other functions of the price mechanism. [2]
Ref - 1.2.7 - Price Mechanism
Entry and exit of firms. [1]
Eliminating excess demand and supply. [1]
Describe the function of the price mechanism in the entry and exit of firms. [3]
Ref - 1.2.7 - Price Mechanism
If demand of a good increases, [1] this signals to a producer that that market is more profitable, [1] incentivising producers to expand supply to that market to maximise profits. [1]
What is consumer surplus? [1]
Ref - 1.2.8 - Consumer and Producer Surplus
What consumers are willing to pay for a good, and what they actually pay. [1]
What is producer surplus? [1]
Ref - 1.2.8 - Consumer and Producer Surplus
What firms are willing and able to supply, and the profits they receive. [1]
How is consumer and producer surplus represented on a diagram? [2]
Ref - 1.2.8 - Consumer and Producer Surplus
At equilibrium, consumer surplus is above the price level [1], and producer surplus is below the price level. [1]
What is indirect taxation? [1]
Ref - 1.2.9 - Indirect Taxation and Subsidies
Taxes on good and services. [1]
What are the 2 types of indirect tax? [2]
Ref - 1.2.9 - Indirect Taxation and Subsidies
Unit tax [1]
Ad Valorem tax [1]
What is Ad Valorem tax? [1]
Give an example of Ad Valorem tax? [1]
Ref - 1.2.9 - Indirect Taxation and Subsidies
A tax on a good/service set as a % of a price. [1] (e.g. VAT) [1]
What is unit tax? [1]
Ref - 1.2.9 - Indirect Taxation and Subsidies
A tax on a good/service which is set at a constant rate per item. [1]
On a S+D diagram, where a tax has been added (S+tax), state where government revenue is found. [1]
Ref - 1.2.9 - Indirect taxation and subsidies
Box [abce] [1]
Reference - https://www.youtube.com/watch?v=uKemzVqloYg
On a S+D diagram, where a tax has been added (S+tax), state where tax per unit is found. [1]
Ref - 1.2.9 - Indirect taxation and subsidies
Difference between S+tax and S [1]
Reference - https://www.youtube.com/watch?v=uKemzVqloYg
On a S+D diagram, where a tax has been added (S+tax), state where consumer and producer incidence is found. [2]
Ref - 1.2.9 - Indirect taxation and subsidies
Consumer incidence - Difference in price [1]
Producer incidence - (Goverment revenue area - Consumer burden area) [1]
Reference - https://www.youtube.com/watch?v=uKemzVqloYg
What is a subsidy? [2]
Ref - 1.2.9 - Indirect Taxation and Subsidies
Money from the government to a producer, [1] to encourage production and reduce price. [1]
On a diagram, show where the subsidy applied per unit is found. [1]
1.2.9 - Indirect tax and subsidies
Difference between S(1) and S(1) + Tax [1]
Ref - https://www.youtube.com/watch?v=41p5WFd-y5A
On a diagram, show where the government cost and producer revenue is found. [2]
1.2.9 - Indirect tax and subsidies
Box P(2)BCD [1]
Ref - https://www.youtube.com/watch?v=41p5WFd-y5A
On a diagram, show where the consumer savings are found [1]
1.2.9 - Indirect tax and subsidies
Difference between P(1) and P(2) [1]
Ref - https://www.youtube.com/watch?v=41p5WFd-y5A
Explain one reason why providing subsidies to firms can have a negative impact on a market. [3]
Ref - 1.2.9 - Indirect Taxation and Subsidies
The firm receiving a subsidy may become complacent as a result. [1] This could cause a loss in production and efficiency [1], therefore reducing supply to the economy. [1]
What is the concept of elasticity? [2]
Ref - 1.2.3 - Price Elasticity of Demand
Elasticity measures the extent to which demand or supply will react to a change in the price level [1] or demand for other goods (XED) [1]
How do you calculate percentage change? [1]
Ref - 1.2.3 - Price Elasticity of Demand
(New value - Original value) / (Original value) x 100 [1]
What are the 4 types of elasticity? [4]
Ref - 1.2.3 - Price Elasticity of Demand
Price elasticity of demand [1] (PED)
Price elasticity of supply [1] (PES)
Income elasticity of demand [1] (YED)
Cross elasticity of demand [1] (XED)
Define PED [1]
Ref - 1.2.3 - Price Elasticity of Demand
The responsiveness of demand to changes in the price level. [1]
What is the formula used to calculate PED? [1]
Ref - 1.2.3 - Price Elasticity of Demand
% Change in quantity demanded / % Change in price level [1]
State the value of PED which represents a price elastic and price inelastic demand. [2]
Ref - 1.2.3 - Price Elasticity of Demand
Price elastic - Less than -1 [1]
Price inelastic - Between 0 and -1 [1]
State the 3 other types of price elasticity of demand, and state the values at which they occur. [3]
Ref - 1.2.3 - Price Elasticity of Demand
Perfectly Price Inelastic - (PED = 0) [1]
Perfectly Price Elastic - (PED = ∞) [1]
Unitary Elastic - (PED = -1) [1]
State and explain 2 factors which influence PED [6]
Ref - 1.2.3 - Price Elasticity of Demand
Number of substitutes [1]. The more available substitutes, the more elastic a good/service is, [1] as consumers can buy substitute goods if another goods prices rise. [1]
Addiction. [1] People who are addicted to substances will continue to buy the substance even if prices rise, [1] therefore the substance becomes more price inelastic. [1]
State the shape of the graph of a price elastic and price inelastic good. [2]
Ref - 1.2.3 - Price Elasticity of Demand
Price elastic - Shallow curve [1]
Price inelastic - Steep curve [1]
How can businesses utilize PED to maximise profits? [2]
Ref - 1.2.3 - Price Elasticity of Demand
When demand is elastic, lowering prices increases revenue [1]. When demand is inelastic, increasing prices will increase revenue [1].
Define YED [1]
Ref - 1.2.3 - Income Elasticity of Demand
The responsiveness of demand to a change in real income [1]
What is the formula used to calculate YED? [1]
Ref - 1.2.3 - Income Elasticity of Demand
% Change in Demand / % Change in Real Income [1]
State the 3 types of goods used to interpret YED, and state the values at which they occur. [3]
Ref - 1.2.3 - Income Elasticity of Demand
Normal Goods - YED is Positive [1]
Inferior Goods - YED is Negative [1]
Luxury Goods - YED is above +1 [1]
State the values at which a good is income elastic and income inelastic [2]
Ref - 1.2.3 - Income Elasticity of Demand
Income Elastic - YED is above +1 or below -1 [1]
Income Inelastic - YED is between +1 and -1 [1]
State and explain 2 factors which may influence YED [4]
Ref - 1.2.3 - Income Elasticity of Demand
Type of good/service. [1] YED can change if the good is inferior or luxury. [1]
Inflation [1] - An increase in inflation can reduce the real value of workers incomes. [1]
How can a business use YED to maximise revenue? [1]
Ref - 1.2.3 - Income Elasticity of Demand
Businesses can use YED of certain goods to plan their production levels. [1]
Define XED [1]
Ref - 1.2.3 - Cross Elasticity of Demand
The responsiveness or demand of good X to a change in the price level of Good Y [1]
What is the formula used to calculate XED? [1]
Ref - 1.2.3 - Cross Elasticity of Demand
% Change in Demand (Good X) / % Change in Price (Good Y) [1]
State the 3 types of goods used when interpreting XED figures, and state the values at which they occur. [3]
Ref - 1.2.3 - Cross Elasticity of Demand
Substitute Good - XED is Positive [1]
Complementary Good - XED is Negative [1]
Unrelated Good - XED = 0
How can a business used XED to maximise revenue? [3]
Ref - 1.2.3 - Cross Elasticity of Demand
Businesses can determine the demand for a certain good, [1] therefore estimate revenue[1], which can help make production decisions to respond to change in demand. [1]
Define PES [2]
Ref - 1.2.5 - Price Elasticity of Supply
The responsiveness of quantity supplied of a good [1] to changes in price. [1]
What is the formula used to calculate PES? [2]
Ref - 1.2.5 - Price Elasticity of Supply
% Change in Quantity Supplied [1] / % Change in Price. [1]
State the values at which PES is price inelastic and price elastic. [2]
Ref - 1.2.5 - Price Elasticity of Supply
Price Inelastic - (0-1) [1]
Price Elastic - (>1) [1]
Explain 2 factors which influence PES [6]
Ref - 1.2.5 - Price Elasticity of Supply
If a good is perishable, such as fresh vegetables, it cannot be stockpiled. [1] It is harder for supply to respond to a change in price, [1] so price is more inelastic. [1]
If entry of firms into a market is easier, such as low start up costs [1], this means that there are more firms to supply more goods in reponse to price change, [1] so supply is more elastic. [1]
