Theme 1: Introduction to markets and market failure Flashcards
Normative statement
Subjective and value based
Positive statement
Objective and fact based
Opportunity cost
The cost of any choice in terms of the next best alternative foregone
Capital good
Any good used to increase future levels of production
Consumer good
Satisfies the wants and needs of the consumer directly
4 functions of money
- Medium of exchange
- Store of value
- Unit of account - allows the value of something to be expressed in an understandable way so that it can be compared
- Standard of deferred payment
Pros and cons of free market economy
\+ ensures competition \+ consumers' demand determines pricing - market failure - inequality - economic instability
Pros and cons of command economy
+ considers the effect of externalities and looks to achieve the common good
+ greater equality (in theory)
- lack of competition, efficiency and incentive
Price elasticity of demand
percentage change in quantity demanded divided by percentage change in price
Income elasticity of demand
percentage change in quantity demanded divided by percentage change in income
Cross elasticity of demand
percentage change in quantity demanded of X divided by percentage change in price of Y
Inferior good
Demand for the good declines as income increases e.g. staple goods
Normal good
Demand increases when income increases
Luxury good
A good that is not necessary for living but may be desired amongst those with higher incomes.
3 factors affecting demand elasticity
Availability of substitutes, necessity, time (may be able to afford a good in the short run, but buying it everyday in the long run is unaffordable)
XED of substitutes
The closer the substitute, the more elastic the XED
Complementary goods XED
The closer the complementary good, the more elastic the XED
Unrelated goods XED
0
PES
Percentage change in quantity supplied divided by the percentage change in price
Factors that affect elasticity of supply (4)
Spare production capacity, stocks of finished products and components, the ease and cost of factor substitution/mobility, time period and production speed
Short run
At least one input is fixed and the quantities of other inputs can be varied.
Long run
A period of time in which the quantities of all inputs can be varied
3 functions of price
- Rationing - when there is a shortage of a product, price will rise and deter some consumers from buying the product.
- Incentive - through their choices, consumers send information to producers about the changing nature of their needs and wants.
- Signalling - adjust to demonstrate where resources are required/not.
Producer surplus
The difference between what producers are willing and able to supply a good for and the price they actually receive.
What two shifts of S and D lead to increases in producer surplus
Increase in S, increase in D
Consumer surplus
Difference between the total amount that consumers are willing and able to pay for a good or service and the total amount that they actually pay
What is the relationship between PED and consumer surplus
When demand is perfectly elastic, consumer surplus is zero because the price that people pay matches exactly what they are willing to pay
What will be the effect of increases in S/D on consumer surplus
Increase in S, fall in consumer surplus, increase in demand increase in consumer surplus
Social cost/benefit
Private cost/benefit + externality
Private cost
The cost paid for a good by the consumer or firm
Externality
Effects on a third party arising from the consumption/production of a good or service for which no appropriate compensation is paid.
3 aspects of a public good
- Non-excludability - the benefits from pure public goods cannot be confined to those solely who have paid for it (free rider problem)
- Non-rivalrous - consumption by one consumer does not restrict the consumption of others, MC=0
- Non-rejectable - cannot be rejected by individuals
Asymmetric information
Where one party in an economic transaction possesses greater material knowledge than the other party.
