Theme 1: Introduction to Markets and Market Failure Flashcards
What is a Maximum Price?
A legally-imposed maximum price in a market that suppliers cannot exceed.
What is a Minimum Price?
Minimum prices or price floors are the minimum legally allowed prices for a good set by the government.
What is a Pollution Permit?
A Pollution Permit allows the owner to pollute up to a specific amount of pollution and the government controls how many permits there are so limits the maximum amount of pollution.
Why does the government provide public goods?
Public Goods are non-excludable and non-rivalry and so the free rider problem says they will be under-provided by the free market.
Why does the government provide information?
To allow people to make informed decisions. They may also force companies to provide information.
What is Government Failure?
When government intervention leads to a new/deeper market failure.
What are Unintended Consequences?
When a government intervention causes effects which the government did not intend to happen.
What is Ceteris Paribus?
All sciences make assumptions when developing models and theories, and this allows them to simplify the problem. Economists use the term ‘ceteris paribus’ meaning all other things remaining equal
What is a Positive Statement?
A positive statement is a statement which is objective and made without any obvious value judgements or emotions. They can be tested to be proven or disproven
What is a Normative Statement?
A normative statement is one which is subjective and based on opinion, so cannot be proven or disproven. It often includes words such as ought, maybe, unwise or should
What is Value Judgement?
A statement about how good or bad you think something is, based on personal opinion rather than facts
What is the problem of Scarcity?
The basic problem of economics is that of scarcity . People have finite needs, but infinite wants. Although wants are infinite, resources are finite and limited.
What are Renewable Resources?
A renewable resource is resource of economic value that can be replenished or replaced on a level equal to consumption. As long as the rate of consumption is less than or equal to the
rate of replenishment, the stock will not decrease.
- For example, oxygen, solar power and fish are renewable.
What are Non-Renewable Resources?
A non-renewable resource is a resource of economic value that cannot be readily replaced by natural means on a level equal to consumption. This includes fossil fuels such as coal, oil and gas.
What is Opportunity Cost?
The cost of the next best alternative foregone.
What are the 4 Factors of Production?
- Land - All natural resources used in production e.g. raw materials, land or minerals.
- Labour - All productive human effort, both physical and mental, paid and unpaid.
- Capital - All man-made aid to manufacture.
- Enterprise - The willingness and ability to take the risks of combining the other 3 factors in order to make a product or service.
What are Production Possibility Frontiers?
The PFF shows the maximum possible combinations of capital and consumer goods that the economy can produce with its current resources and technology.
- A movement along the curve indicates a change in the combination of goods produced.
- A shift of the curve indicates a change in the productive potential of the economy.
What are Consumer Goods?
Consumer goods are goods that are demanded and bought by households and individuals.
What are Capital Goods?
Capital goods are goods that are produced in order to aid the production of consumer goods in the future.
What is Specialisation?
Specialization refers to the concentration of individuals, firms, or nations on producing a limited range of goods or services.
What is the Division of Labour?
The division of labour is a form of specialization where tasks are divided among workers.
What economist stated specialisation and the division of labour allowed firms to increase labour productivity, efficiency and lower their costs of production?
Adam Smith
What are the 4 functions of money?
- A medium of exchange: It can be used to buy and sell goods and services and is acceptable everywhere.
- A measure of value: It can compare the value of two goods, such as a table and a skirt. It is also able to put a value on labour.
- A store of value: It is able to keep its value and can be kept for a long time
- A method for deferred payment: 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. This relies on money storing its value.
What is a Free Market Economy?
In a free market economy, individuals are free to make their own choices and own the factors of production without government interference. Resources are allocated through the price mechanism.
- Laissez faire approach from the government.
What economist believed in the Free Market Economy?
Adam Smith
What did Friedrick Hayek believe?
Friedrich Hayek (1899-1992) argued that state control of the economy leads to the loss of freedom. He believed that the poor in free market (or freer market) countries were better off than those in command economies because at least they had personal freedom.
What is a Command Economy?
In a command (planned) economy, all factors of production, except labour, is owned by the state and labour is directed by the state. There is no private property and everyone is assumed to be selfless, working for a common good. Resource allocation is carried out by the government, rather than the price mechanism.
What did Karl Marx believe?
Karl Marx (1818-1883) believed in the command economy and criticised capitalism. Marx believed that capitalist’s profit came from exploiting labour as they underpaid workers for the value that they actually created. He wanted remove the difference between the incomes of owners and workers and believed that capitalism would collapse leading to communism.
What is a Mixed Economy?
Both types of economies have benefits but also major problems so most economies have tried to move towards some form of compromise economy , called a mixed economy. This is an economy where both the free market mechanism and the government planning process allocate a significant amount of the total resources in the country.
What is the government’s role in a Mixed Economy?
- Creating a framework of rules: Regulation and consumer protection.
- Supplements and modifies the price system: They produce public and merit goods, such as emergency services and transport, and limit the production of demerit goods.
- Redistributes income: They move income from one group of people to another, from the rich to the poor. They use tax, such as income tax, to take money away from one group then give the money to the poor.
- Stabilises the economy: The government will attempt to manage the level of demand in the economy to prevent extremes of too much or too little demand. They do this through fiscal and monetary policy.
What are the 3 main assumptions of rational economic decision making?
- Consumers aim to maximise utility.
2.Firms aim to maximise profit (Profit Motive).
- Governments aim to maximise social welfare.
What are some factors that could cause the demand curve to shift?
- Population
- Income
- Related Goods
- Advertising
- Taste / fashion
- Seasons
- Expectations
What is Diminishing Marginal Utility?
The Law of Diminishing Marginal Utility states that the satisfaction derived from the consumption of an additional unit of a good will decrease as more of a good is consumed.
What is the formula for Price Elasticity of Demand (PED)?
% change in quantity demanded / % change in price
What is the PED value for unitary elastic PED?
PED = 1
What is the PED value for relatively elastic PED?
PED > 1
What is the PED value for relatively inelastic PED?
PED < 1
What is the PED value for perfectly elastic PED?
PED = infinity
What is the PED value for perfectly inelastic PED?
PED = 0
What are factors influencing PED?
- Availability of substitutes
- Time
- Necessity
- Addictive
- % of income
What is the formula for Income Elasticity of Demand (YED)?
% change in quantity demanded / % change in income
What is the YED value for an inferior good?
YED < 0
What is the YED value for a normal good?
YED > 0
What is the YED value for a luxury good?
YED > 1
What is the formula for Cross Elasticity of Demand (XED)?
% change in quantity demanded of A / % change in price of B
What is the XED value for substitute goods?
XED > 0
What is the XED for complementary goods?
XED < 0
What is the XED value for unrelated goods?
XED = 0
What are some of the factors influencing supply?
- Costs of Production
- Price of other goods
- Weather
-Technology
- Legislation
- Taxes and subsidies
- Producer cartels
What is the formula for Price Elasticity of Supply (PES)?
% change in quantity supplied / % change in price
What is the PES values for unitary elastic PES?
PES = 1
What is the PES value for relatively elastic PES?
PES > 1
What is the PES value for relatively inelastic PES?
PES < 1
What is the PES value for perfectly elastic PES?
PES = infinity
What is the PES value for perfectly inelastic PES?
PES = 0
What are some of the factors affecting PES?
- Time
- Stocks
- Working below full capacity
- Availability of factors of production
- Availability of substitutes
What is Consumer Surplus?
The difference between the price the consumer is willing to pay and the price they actually pay.
What is Producer Surplus
The difference between the price the supplier is willing to produce their product at and the price they actually produce at.
What is an Indirect Tax?
A tax on expenditure where the person is ultimately charged the tax is not the person responsible for paying the sum to the government. E.g. VAT.
What is the Incidence of Tax?
The tax burden on the taxpayer.
What are the 3 main types of Market Failure?
- Externalities
- Under-provision of public goods
- Information Gaps
What is an Externality?
An externality is the cost or benefit a third party receives from an
economic transaction outside of the market mechanism. In other words, it is the spillover effect of the production or consumption of a good or service.
What is Under-Provision of public goods?
Public goods are non-rivalry and non-excludable, meaning they are underprovided by the private sector due to the free-rider problem. The market is unable to ensure enough of these goods are provided.
-One of the best examples of a public good is streetlights
What are Information Gaps?
Economic agents do not always make rational decisions and so resources are not allocated to maximise welfare. For example, consumers do not know the quality of second hand products, such as cars, and pension schemes are complex so it is difficult to know which one is best.
What is Homo Economicus?
The term Homo economicus is the portrayal of humans as agents who are consistently rational and narrowly self-interested, and who pursue their subjectively defined ends optimally.
What are Public Goods?
Non-rivalrous and non-excludable
What are Private Costs/Benefits?
Private costs/benefits are the costs/benefits to the individual participating in the economic activity. The demand curve represents private benefits and the supply curve represents
private costs.
What are Social Costs/Benefits?
Social costs/benefits are the costs/benefits of the activity to society as a whole.
What are external Costs/Benefits?
External costs/benefits are the costs/benefits to a third party not involved in the economic activity. They are the difference between private costs/benefits and social costs/benefits.
What are the parts of STRIPS?
Subsidise
Tax
Regulate
Inform
Pollution Permits
State Control
What is the Free-Rider Problem?
This says that you cannot charge an individual a price for the provision of a non-excludable good because someone else will gain the benefit from it without paying anything. A free rider is someone who receives the benefits without paying for it.
What is Symmetric Information?
Symmetric information occurs where buyers and sellers have potential access to the same information; this is perfect information.
What is Asymmetric Information?
Asymmetric information is when one party has superior knowledge compared to another.
