Theme 1 - Introduction to Markets and Market Failure Flashcards
1
Q
Ceteris paribus
A
Assumption that other things are being held equal or constant, so nothing else changes
2
Q
Positive statement
A
Statement which is objective and can be tested with factual evidence to be proven or disproven
3
Q
Normative statement
A
Statement which is subjective and based on value judgement
4
Q
Basic problem of economics
A
Wants are infinite but resources are finite, so choices have to be made
5
Q
Opportunity cost
A
The value of the next best alternative forgone
6
Q
Four factors of production
A
- Capital
- Enterprise
- Land
- Labour
7
Q
Capital
A
Refers to all man-made resources that are used to produce goods or services in the future
8
Q
Enterprise
A
Willingness and ability to take the risks of combining the other three factors of production in order to make a product or service
9
Q
Land
A
All natural resources used in production
10
Q
Labour
A
All productive human effort, both physical and mental, paid or unpaid
11
Q
Production possibility frontiers
A
Depicts the maximum productive potential of an economy, using a combination of two goods or services, when resources are fully and efficiently employed
12
Q
Law of diminishing returns
A
As more units of a variable input are added to a fixed input, the additional output (marginal product) gained from each extra unit of input will eventually decrease, assuming all other factors remain constant
13
Q
Capital goods
A
Goods which can be used to produce other goods, such as
machinery
14
Q
Consumer goods
A
Goods which cannot be used to produce other goods, such as
clothing
15
Q
Specialisation
A
Process where individuals, firms or economies focus on producing a narrow range of goods or services
16
Q
Division of labour
A
Process of breaking down production into separate tasks, with different workers specialising in specific tasks
17
Q
Advantages of specialisation
A
- Higher output and potentially higher quality
- More opportunities for economies of scale, so the size of the market increases
- More competition which gives an incentive for firms to lower their costs, which helps to keep prices down
18
Q
Disadvantages of specialisation
A
- Work becomes repetitive, which could lower the motivation of workers, potentially affecting quality and productivity
- Could be more structural unemployment, since skills might not be transferable
- Producing a lot of one type of good through specialisation, could decrease variety for consumers
19
Q
Functions of money
A
- Medium of exchange
- Measure of value (unit of account)
- Store of value
- Method of deferred payment
20
Q
Medium of exchange
A
It can be used to buy and sell goods and services and is
acceptable everywhere
21
Q
Measure of value (unit of account)
A
It provides a means to measure the relative values of different goods and services, and also puts a value on labour
22
Q
Store of value
A
It is able to keep its value and can be kept for a long time
23
Q
Method of deferred payment
A
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, which relies on money storing its value
24
Q
Free market economy
A
When the government leaves markets to their own devices, so the market forces of supply and demand allocate scarce resources
25
Advantages of a free market economy
1. 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
2. The bureaucracy from government intervention is avoided
3. Some economists might argue the freedom gained from having a free economy leads to more personal freedom
26
Disadvantages of a free market economy
1. The free market ignores inequality and tends to benefit those who hold most of the wealth
2. Monopolies could exploit the market by charging higher prices
3. There could be the overconsumption of demerit goods, which have large negative externalities, such as tobacco
4. Public goods are not provided in a free market, such as national defence and merit goods, such as education, are underprovided
27
Command economy
When the government allocates all of the scarce resources in an
economy to where they think there is a greater need
28
Advantage of a command economy
1. It might be easier to coordinate resources in times of crises, such as wars
2. The government can compensate for market failure, by reallocating resources
3. Inequality in society could be reduced, and society might maximise welfare rather than profit
4. The abuse of monopoly power could be prevented
29
Disadvantages of a command economy
1. Governments fail, as do markets, and they may not be fully informed for what to produce
2. They may not necessarily meet consumer preferences
3. It limits democracy and personal freedom
30
Mixed economy
An economy where both the free market mechanism and the government planning process allocate a significant amount of the total resources in the country
31
Rational decision making
When making economic decisions, consumers aim to maximise their utility and firms aim to maximise profits
32
Demand
Quantity of a good or service that a consumer is able and willing to
buy at a given price during a given period of time
33
Conditions of demand
1. Population
2. Income
3. Related goods
4. Advertising
5. Taste/fashion
6. Expectations
7. Seasons
34
Law of diminishing marginal utility
The satisfaction derived from the consumption of an additional unit of a good will decrease as more of a good is consumed
35
Total utility
The satisfaction gained by a customer as a result of their overall consumption of a good
36
Marginal utility
The change in satisfaction resulting from the consumption of the next unit of a good
37
Derived demand
When the demand for one good is linked to the demand for a related good
38
Composite demand
When the good demanded has more than one use, for example milk, assuming there is a fixed supply of milk, an increase in the
demand for cheese will mean that more cheese is supplied, and therefore less butter can be supplied
39
Joint demand
When goods are bought together
40
Price elasticity of demand
The responsiveness of demand to a change in price
41
Formula for price elasticity of demand
% Change in quantity demanded / % Change in price
42
Elastic demand
A good which is very responsive to a change in price, meaning that the change in demand is greater than the change in price and PED>1
43
Inelastic demand
A good which is unresponsive to a change in price, meaning that the change in price is greater than the change in demand and PED<1
44
Unitary elastic demand
A good where quantity demanded changes by exactly the same percentage as price, meaning that PED=1
45
Perfectly elastic demand
A good where a change in price causes quantity demanded to fall to 0, meaning that PED=Infinity
46
Perfectly inelastic demand
A good where a change in price causes zero changes to quantity demanded, meaning that PED=0
47
Factors influencing Price Elasticity of Demand
1. Availability of substitutes
2. Time
3. Necessity
4. Percentage of total expenditure
5. Addictiveness
48
How a change in price affects revenue with a elastic demand curve
A decrease in price leads to an increase in revenue and an increase in price leads to a decrease in revenue
49
How a change in price affects revenue with a inelastic demand curve
A decrease in price leads to a decrease in revenue and an increase in price leads to an increase in revenue
50
Income Elasticity of Demand
The responsiveness of demand to a change in income
51
Formula for Income Elasticity of Demand
% Change in quantity demanded / % Change in income
52
Normal good
A good for which demand increases when income rises and decreases when income falls, meaning YED>0
53
Inferior good
A good for which demand decreases when income rises and increases when income falls, meaning YED<0
54
Luxury good
A type of normal good for which demand increases more than proportionally as income rises, meaning YED>1
55
Cross Elasticity of Demand
The responsiveness of demand for on one product (A) to a change in the price of another product (B)
56
Formula for Cross Elasticity of Demand
% Change in quantity demanded of good A / % Change in price of good B
57
Substitute goods
Goods that can be used in place of each other. When the price of one good increases, the demand for its substitute increases, meaning XED>0
58
Complementary goods
Goods that are consumed together, meaning that when the price of one good increases, the demand for its complement decreases, meaning XED<0
59
Supply
Quantity of a good or service that a producer is able and willing to
supply at a given price during a given period of time
60
Joint supply
When increasing the supply of one good causes an increase or decrease in the supply of another good. For example, producing more lamb will increase the supply of wool.
61
Conditions of supply
1. Costs of production
2. Price of other goods
3. Weather
4. Technology
5. Goals of the supplier
6. Government legislation
7. Taxes and subsidies
8. Producer cartels
62
Price Elasticity of Supply
The responsiveness of a change in supply to a change in price
63
Formula for Price Elasticity of Supply
% Change in quantity supplied / % Change in price
64
Elastic supply
A good which is very responsive to a change in price, meaning that the change in SUPPLY is greater than the change in price and PES>1
65
Inelastic supply
A good which is unresponsive to a change in price, meaning that the change in price is greater than the change in supply and PES<1
66
Unitary elastic supply
A good where quantity supplied changes by exactly the same percentage as price, meaning that PES=1
67
Perfectly elastic supply
A good where a change in price causes quantity supplied to fall to 0, meaning that PES=Infinity
68
Perfectly inelastic supply
A good where a change in price causes zero changes to quantity supplied, meaning that PES=0
69
Factors influencing Price Elasticity of Supply
1. Time
2. Level of stocks
3. Working below full capacity
4. Availability of factors of production
5. Ease of entry into the market
6. Availability of substitutes
70
Price mechanism
Process by which market forces of supply and demand determine the allocation of resources, production, and distribution of goods and services in a market economy
71
Functions of the price mechanism
1. Rationing
2. Signalling
3. Incentive
72
Rationing function
When goods and services are scarce, prices rise to reduce excess demand and ensure that resources are allocated efficiently
73
Signalling function
When prices rise or fall to signal whether firms should increase or decrease production and whether consumers should buy more or less of a good
74
Incentive function
When changes in price create incentives for producers and consumers to change their behavior, so for producers higher prices incentivise firms to increase supply because of higher profits whereas for consumers higher prices discourage demand
75
Consumer surplus
The difference between the price the consumer is willing and able to pay and the price they actually pay
76
Producer surplus
The difference between the price the producer is willing to charge and the price they actually charge
77
Economic welfare
The overall well-being and standard of living of individuals, households, and society as a whole. It includes material wealth (income, consumption) and non-material factors (health, education, environment).
78
Indirect taxes
A tax imposed on goods and services rather than directly on income or wealth. It is paid by producers but passed on to consumers through higher prices
79
Types of indirect taxes
1. Ad valorem taxes
2. Specific taxes
80
Ad valorem taxes
An indirect tax that is charged as a percentage of the price of a good or service rather than as a fixed amount per unit
81
Specific taxes
An indirect tax that is charged as a fixed amount per unit of a good or service, regardless of its price
82
Subsidy
Financial support provided by the government to reduce production costs or lower the price of goods and services
83
Incidence of tax
How the burden of a tax is shared between consumers and producers. It depends on the price elasticity of demand and supply
84
Rational decision making
An economic principle where individuals, firms, and governments make choices that maximise their utility, profit or overall benefit, based on available information
85
Alternative views of consumer behaviour
1. Influences of other people
2. Influence of habitual behaviour
3. Consumer weakness at computation
86
Types of market failure
1. Externalities
2. Under-provision of public goods
3. Information gaps
87
Externality
The cost or benefit a third party receives from an economic transaction outside of the market mechanism. This leads to the over or under-production of goods, meaning resources aren’t allocated efficiently
88
Public goods
Goods that are non-rivalrous and non-excludable goods or services, meaning they are underprovided by the private sector due to the free-rider problem
89
Free-rider problem
When individuals benefit from a good or service without paying for it, leading to under-provision or market failure in a free market
90
Information gaps
When buyers and sellers do not have access to complete or accurate information, leading to imperfect decision-making and potential market failure
91
Private costs
The costs to the individual participating in the economic
activity, with the supply curve representing private costs
92
Private benefits
The benefits to the individual participating in the economic
activity, with the demand curve representing private benefits
93
Social costs
The costs of the activity to society as a whole
94
Social benefits
The benefits of the activity to society as a whole
95
External costs
The costs to a third party not involved in the economic activity
96
External benefits
The benefits to a third party not involved in the economic
activity
97
Merit good
A good with external benefits, where the benefit to society is greater than the benefit to the individual, these tend to be underprovided and under consumed in a free market
98
Demerit good
A good with external costs, where the cost to society is greater than the cost to the individual, these tend to be over provided and over consumed in a free market
99
Negative externalities of production
When social costs are greater than private costs
100
Positive externalities of consumption
When social benefits are greater than social costs
101
Government intervention for negative externalities
1. Indirect taxes and subsidies
2. Tradable pollution permits
3. Provision of the good
4. Provision of information
5. Regulation
102
Symmetric information
Where buyers and sellers have potential access to the same information, this is perfect information
103
Asymmetric information
When one party has superior knowledge compared to another. Usually, the seller has more information than the buyer and this means they can take advantage of the other party’s lack of knowledge, by charging them a higher price
104
Market failure
When the free market fails to allocate resources efficiently, leading to overconsumption, under consumption or misallocation of resources. This results in a loss of economic and social welfare
105
Advantages of using indirect taxation to solve a negative externality
1. Internalises the externality, so market now produces at social equilibrium position and social welfare is maximised
2. Raises government revenue, which could be used to solve the externality other ways such as through education
106
Disadvantages of using indirect taxation to solve a negative externality
1. Difficult to know the size of the externality, so it is difficult to target the tax
2. Could be conflict between the government goal of raising revenue and solving the externality
3. Could create black markets
107
Advantages of using subsidies to solve a positive externality
1. Society reaches the social optimum output and welfare is maximised
2. Can encourage enterprise, bringing about equality and encouraging exports
108
Disadvantages of using subsidies to solve a positive externality
1. Government will have to spend a large amount of money, creating a high opportunity cost
2. Difficult to target as size of externality is unknown
3. Can cause producers to become inefficient
109
Minimum price
A government-imposed lower limit on the price of a good or service. It is set above the equilibrium price to ensure producers receive a fair income or to discourage the consumption of harmful goods, set on goods with negative externalities
110
Maximum price
A government-imposed upper limit on the price of a good or service. It is set below the equilibrium price to make essential goods or services more affordable for consumers, set on goods with positive externalities
111
Advantages of using minimum and maximum prices
1. Can be set where Marginal Social Benefit=Marginal Social Cost, allowing for some consideration of externalities to help increase social welfare
2. A maximum price will ensure that goods are affordable, whilst a minimum price will ensure producers get a fair price, both of these are able to reduce poverty and increase equality
112
Disadvantages of using minimum and maximum prices
1. Distortion of the price signals can cause excess demand or supply
2. Difficult for the government to know where to set the prices
3. Both can lead to creation of black markets
113
Buffer stock scheme
A government or industry intervention that aims to stabilize the price of a commodity (e.g., wheat, rice, or oil) by buying surplus stock when prices are low and selling stock when prices are high. This helps to reduce price fluctuations and protect both producers and consumers
114
Tradeable pollution permits
A market-based approach to reducing pollution by giving firms permits (allowances) to emit a certain amount of pollution. Firms that reduce emissions can sell their excess permits, while firms that exceed their limit must buy additional permits or face penalties
115
Advantages of using tradeable pollution permits
1. Since government caps number of permits its guaranteed that pollution will be reduced, maximising social welfare
2. Government can raise revenue be selling permits and fining firms who exceed their pollution limit
3. Encourages companies to invest and use green technology
116
Disadvantages of using tradeable pollution permits
1. Can be expensive to monitor and police
2. Will raise costs for businesses, which will likely be passed onto consumers through higher prices
3. May be difficult to know how many permits the government should allow
117
Advantages of state provision of public goods
1. Corrects market failure by providing important goods, improving social welfare
2. Can help bring about equality, ensuring everyone has access to basic goods
3. Will be benefits of the good itself, such as by providing healthcare the government can ensure the workforce is healthy which can improve economic growth
118
Disadvantages of state provision of public goods
1. Expensive and represents high opportunity cost
2. Since market is not involved, government may produce wrong combinations of goods
3. Government may be inefficient at production since have no incentive to cut costs
4. Government officials may suffer from corruption and conflicting objectives
119
Advantages of provision of information
1. Helps consumers act rationally, allowing the market to work properly
2. Best used alongside other policies, such as can help make demand more elastic in the long run helping indirect taxes becoming more efficient at reducing output
120
Disadvantages of provision of information
1. Can be expensive and create an opportunity cost
2. Governments may lack all the information, making it difficult to inform consumers
3. Consumers may not listen to the information due to irrational behaviour
121
Advantages of using regulation
1. Can ensure consideration of externalities, preventing exploitation of consumers and keep consumers fully informed helping overcome market failure
122
Disadvantages of using regulation
1. Laws may be expensive, creating an opportunity cost
2. Government can suffer from regulatory capture
3. Firms may pass on costs to the consumer through higher prices
4. Excessive regulation may reduce competition and efficiency by increasing bureaucracy and reducing innovation
123
Government failure
When government intervention leads to a deeper market failure, resulting in a net welfare loss
124
Examples of a government failure
1. Distortion of price signals
2. Unintended consequences
3. Excessive administrative costs
4. Information gaps
