Theme 1 - Markets and Market Failure [INCOMPLETE - NO GOV INTERVENTION] Flashcards

1
Q

Why do economists develop models

A
  • explain how economy works
  • developed by putting forward model, gathering evidence, accepting/challenging/disregarding model
  • too many variables which can change so assumptions are made
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2
Q

Why do economists make assumptions when developing models

A
  • too many variables which can change
  • allows them to simplify problem
  • ceteris paribus = all other things remaining equal
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3
Q

What is a positive statement

A
  • objective and made without any obvious value judgements
  • can be tested to be proven/disproven
  • expressed in the form of a hypothesis that can be analysed and evaluated
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4
Q

What is a normative statement

A
  • subjective and based on opinion
  • cannot be proven/disproven
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5
Q

What are value judgments

A
  • influence economic decision making and policy
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6
Q

What is the economic problem

A
  • stems from the basic problem of scarcity
  • how to use the available scarce resources to satisfy people’s infinite needs and wants as effectively as possible
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7
Q

What are the questions that economics sets out to investigate

A
  • what to produce
  • how to produce it
  • who to produce it for
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8
Q

What are economic agents and who are they

A
  • groups that participate in the economy
  • producers, consumers and the government
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9
Q

What do the economic agents do

A
  • producers create goods and services
  • consumers buy goods and services made by firms
  • the government sets out the rules that other economic agents must follows, also produces some goods and services like infrastructure and healthcare
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10
Q

What is a renewable resource

A
  • resource of economic value that can be replenished or replaced on a level equal to consumption
  • as long as rate of consumption is less than or equal to rate of replenishment, stock will not decrease
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11
Q

What is a non-renewable resource

A
  • resource of economic value which cannot be readily replaced by natural means on a level equal to consumption
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12
Q

What is opportunity cost

A
  • the value of the next best alternative foregone
  • same resource cannot be used to produce different goods at the same time so decisions have to be made on where to use them
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13
Q

How do the economic agents make decisions for opportunity cost

A
  • consumers choose how to use their limited income based on what gives them the greatest level of satisfaction
  • producers choose what to do with their limited resources and decisions are based on profit
  • the government decides where to spend their limited tax revenue based on what maximises social welfare
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14
Q

What are the factors of production

A
  • capital
  • enterprise
  • land
  • labour
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15
Q

What is capital

A
  • goods used to make other goods and services (machinery)
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16
Q

What is enterprise

A
  • willingness of people in business to take risks to make a profit
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17
Q

What is land

A
  • natural resources which can be used to make goods and services
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18
Q

What is labour

A
  • all the work done by humans in production
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19
Q

What is a possibility production frontier (PPF)

A
  • shows maximum possible combinations of capital and consumer goods that economy can produce with its current resources and technology
  • no indication which combination is best
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20
Q

When is an economy efficient

A
  • economic efficiency is achieved when resources are used for their best use
  • at all points on PPF curve, resources are allocated efficiently
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21
Q

What does a movement on the PPF curve show

A
  • a change in the combination of goods produces
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22
Q

What does a shift on the PPF curve show

A
  • change in productive potential of the economy
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23
Q

What are consumer goods

A
  • goods that are demanded and bought by households and individuals to increase satisfaction
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24
Q

What are capital goods

A
  • goods that are produced in order aid the production of consumer goods
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25
Q

What is specialisation

A
  • production of a limited range of goods by a company/individual/country
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26
Q

What is division of labour

A
  • when labour becomes specialised in a particular part of the production process
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27
Q

What is productivity

A
  • output produced over inputs used
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28
Q

Who is Adam Smith and what did he believe in

A
  • economist who focused on specialisation and division of labour
  • stated how they can increase labour productivity, allowing firms to increase efficiency and lower production costs
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29
Q

What does increased productivity lead to

A
  • higher output and quality
  • higher living standards
  • more efficient use of resources
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30
Q

What are the advantages of specialisation and division of labour in production

A
  • DoL allows labour productivity to be increased so workers are quicker, better and more efficient
  • lead to higher quality of goods and services
  • more cost effective
  • time is not wasted
  • workers only need to be trained to do one specific task, which saves time and money
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31
Q

What are the disadvantages of specialisation and division of labour in production

A
  • work can become repetitive and boring which leads to poor quality
  • reduction in craftsmanship, leading to more of a standardised production
  • if one area of production is delayed, all other following areas need to be stopped
  • workforce do not have wide industrial training and could suffer from structural unemployment
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32
Q

What are the advantages of specialisation and division of labour in trade

A
  • theory of comparative advantage states countries should specialise in producing goods where they have lowest opportunity cost, so they are relatively best at producing. Helps boost economy
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33
Q

What are the disadvantages of specialisation and division of labour in trade

A
  • countries may become over-dependent on one particular export, if this fails their economy may collapse => primary product dependency
  • other countries specialise in non-renewable resources and these could run out, leading to a huge loss of income
  • high interdependence
  • more competition to cut costs so wages may fall (not necessarily true)
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34
Q

What are the functions of money

A
  • medium of exchange
  • measure of value
  • store of value
  • method of deferred payment
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35
Q

How is medium of exchange a function of money

A
  • allows money to be used to buy and sell goods and services and is acceptable everywhere
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36
Q

How is measure of value a function of money

A
  • can compare value of two goods
  • puts value on labour
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37
Q

How is store of value a function of money

A
  • able to keep its value and can be kept for a long time
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38
Q

How is method for deferred payment a function of money

A
  • money can allow for debts to be created
  • people can therefore pay for things without having money in the present and pay for it later
  • relies on money storing its value
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39
Q

What can lower costs from specialisation and DoL lead to

A
  • increased investment
  • higher wages
  • lower prices
  • greater chance for new and improved products emerging
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40
Q

What are the different types of economies

A
  • free market economy
  • mixed economy
  • command economy
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41
Q

What is the free market economy

A
  • individuals are free to make their own choices and own the factors of production without government interference
  • resources are allocated through price mechanism
  • consumers make decisions based on satisfaction
  • producers makes decisions based on profit
  • no economy is completely free as government has to intervene to an extent
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42
Q

What did Adam Smith think about the free market economy

A
  • believed in this economy and the laissez-faire approach by governments
  • explained how there was an invisible hand in the market which allocated resources to everyone’s advantage
  • believed competition in the market caused lower prices and benefits consumer
  • did also argue state needs to provide some goods/services (laws, property rights, infrastructure)
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43
Q

What did Freidrich Hayek think about the free market economy

A
  • argued state control of economy leads to loss of freedom
  • believed poor in free market countries were better than those in command economies as they had freedom
  • central planning by governments led to what a small minority wanted being forced on the whole society
  • consumers know what they need in their own situation
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44
Q

What are the advantages of a free market economy

A
  • system is automatic due to invisible hand
  • consumers have freedom of choice (consumer sovereignty)
  • high motivation as people know working hard could lead to high potential rewards
  • political freedom
  • as firms are in competition, they will produce at lowest cost, ensuring productive efficiency
  • free market economies have higher growth
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45
Q

What are the disadvantages of a free market economy

A
  • higher levels of inequality
  • lack of merit goods and little control of demerit goods
  • resources could be wasted on unproductive expenses such as advertising
  • if competition disappears then there may be monopolies
  • problem of externalities
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46
Q

What is a command economy

A
  • all factors of production (but labour) is owned by the state and labour is directed by the state
  • everyone is working for a common good
  • resource allocation carried out by government
  • all workers receive save wage and products are standardised
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47
Q

What did Karl Marx think about the command economy

A
  • believed in command economy and criticised capitalism
  • believed capitalist’s profit came from exploiting labour
  • wanted to remove difference between incomes of owners and workers
  • two class system in capitalism (businesses growing by workers getting poorer)
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48
Q

What are the advantages of a command economy

A
  • state provides minimum standard of living, less inequality
  • less wastage of resources as there is no need for competitive services
  • long term planning means industry doesn’t have to keep changing and shifting resources
  • standardised products mean they are produced cost effectively
  • government (who are motivated by wellbeing of country), decide resource allocation
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49
Q

What are the disadvantages of a command economy

A
  • impossible for state to make so many decisions correctly, could lead to over or under supply and a waste of resources
  • decision making is slow as there’s many stages and there could be increased bribery and corruption
  • less motivation and efficiency as everyone receives same wage so people will know working harder does not increase standard of living
  • consumers lose freedom
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50
Q

What is a mixed economy

A
  • compromise economy between free market and command
  • both free market mechanism and government planning process allocate a significant amount of total resources in a country
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51
Q

What is the governments role in a mixed economy

A
  • creating a framework of rules
  • supplements and modifies the price system
  • redistribute income
  • stabilises the economy
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52
Q

How does the government create a framework of rules in a mixed economy

A
  • prevent the abuse of monopolies
  • protect consumers as they pass a large amount of consumer protection laws
  • protect property rights
  • ensure safety standards protecting employers and employees
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53
Q

How does the government supplement and modify the price system in a mixed economy

A
  • produce public and merit foods and limit production of demerit foods
  • government action ensures the consideration of externalities
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54
Q

How does the government redistribute income in a mixed economy

A
  • move income from one group of people to another
  • use taxes to take money from one group and give the money to the poor
  • form of benefits for those out of work or on low incomes
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55
Q

How does the government stabilise the economy in a mixed economy

A
  • attempts to manage level of demand in the economy to prevent extremes of too much or too little demand
  • do this through fiscal and monetary policies
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56
Q

How do consumers make rational decisions

A
  • aim to maximise utility
  • utility is the satisfaction gained from consuming a product
  • rational consumer is called Homo Economicus, who makes decisions by calculating the utility gained from each decisions and chooses the one which gives most satisfaction
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57
Q

How do producers make rational decisions

A
  • aim to maximise profit
  • economic theory assumes firms are run for their owners and shareholders and so aim to maximise profit in order to keep shareholders happy
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58
Q

How do governments make rational decisions

A
  • aim to maximise social welfare
  • voted in by public and work for public so aim to maximise their satisfaction by taking decisions which increase social welfare
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59
Q

Why may consumers not behave rationally

A
  • habitual behaviour / consumer inertia
  • influence of other people’s behaviour
  • consumer weakness at computation
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60
Q

What is demand

A
  • the quantity of a good or service purchased at a given price over a given time period
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61
Q

How do movements on a demand curve look like

A
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62
Q

What is the difference between a shift and movement on the demand curve

A
  • movement is caused by a change in the price of the good
  • shift is caused by a change in any other factor which affects demand
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63
Q

What is a contraction in demand

A
  • quantity demanded falls because of an increase in price
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64
Q

What is an extension in demand

A
  • quantity demanded rises due to a decrease in price
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65
Q

How do shifts on a demand curve look like

A
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66
Q

What are the conditions of demand

A
  • population
  • income
  • related goods
  • advertising
  • taste/fashion
  • expectations
  • seasons
  • legislation
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67
Q

How does population affect demand

A
  • if population rises, demand increases so curve shifts to the right
  • there are more people in the country who would want a good
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68
Q

How does income affect demand

A
  • for most goods, if income increases, demand increases and shifts to right as people can afford to buy more of the product
  • fall in come then demand decreases and shifts to left
  • however, for some goods, increase in income and lead to fall in demand (income elasticity of demand
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69
Q

How do related goods affect demand

A
  • if goods are complements or substitutes of each other then a change in price of another good causes a shift in demand curve
  • substitutes are goods which are alternatives to each other, so if demand for one increases, demand for the other decreases
  • complements are goods which go together so if demand for one increases, demand for the other does as well
  • cross elasticity of demand
70
Q

How does advertising affect demand

A
  • if firm carries out a successful advertising campaign, demand is likely to increase
  • if competitor firm carries out successful advertising campaign, demand for first firm falls
71
Q

How does taste/fashion affect demand

A
  • if something becomes more fashionable, we expect demand to increase
  • if something becomes less fashionable, demand falls
72
Q

How do expectations affect demand

A
  • expectations of what might happen in the future can have a big impact on levels of demand
  • if people expect shortage of something or price rises, demand for product increases
  • if people expect price falls in future, demand decreases until price falls
73
Q

How do seasons affect demand

A
  • some products will find their demand affected by the weather
  • hot summers can increase demand for sun cream and a fall in demand for umbrellas
74
Q

How does government legislation affect demand

A
  • government can implement laws which lead to increases in demand for goods
  • demand for car seats increased after the government made it a legal requirement for young children to sit in them
75
Q

What is the law of diminishing marginal utility

A
  • satisfaction derived from consumption of an additional unit of good decreases as more of a good is consumed, ceteris paribus
76
Q

What can the law of diminishing marginal utility help explain

A
  • demand curve sloped downward
  • if more of a good is consumed, less satisfaction is derived from good
  • means consumers less willing to pay high prices at high quantities since they gain less satisfaction
77
Q

Why does the demand curve slope downward

A
  • inverse relationship between price and quantity, which can be explained by law of diminishing marginal utility
78
Q

How do consumers act rationally

A
  • spending money according to what gives them the greatest level of satisfaction or welfare
79
Q

What is price elasticity of demand (PED)

A
  • responsiveness of demand to a change in the price of a good
80
Q

How can price elasticity of demand (PED) be calculated

A

Change in quantity demand / change in price

81
Q

What type of elasticity is present at different numerical values

A
  • 1 = unitary elastic
  • > 1 = relatively elastic
  • <1 = relatively inelastic
  • ∞ = perfectly elastic
  • 0 = perfectly inelastic
82
Q

What factors can influence the price elasticity of demand

A
  • number substitutes
  • time
  • necessity/luxury
  • proportion of income
  • addictivenss
83
Q

How does the number of substitutes affect the price elasticity of demand

A
  • if a product has many substitutes, it will be elastic
  • an increase in price will lead to consumers buying those substitutes instead
  • if product does not have many substitutes, consumers will not have many alternatives so product is inelastic
84
Q

How does time affect the price elasticity of demand

A
  • if consumers have a lot of time, it would be easier to find alternatives so the good is more elastic
  • less time means good is inelastic
85
Q

How does the good being a necessity affect the price elasticity of demand

A
  • if the good is a necessity, it will be inelastic as people will still buy it when prices rise
  • if good is a luxury then it would be elastic as people would only buy when prices are low
86
Q

How does proportion of income spent affect the price elasticity of demand

A
  • if only a small amount of a person’s income is spent on the good, a significant increase would have a small impact on buying that product
  • this would mean the good is inelastic
  • if the good previously already took a large proportion of income, another increase would make it elastic
87
Q

How does addictiveness affect price elasticity of demand

A
  • if a product is addictive, people will buy it even if prices rise, making it inelastic
  • if a product is not addictive, it would be inelastic
88
Q

How is price elasticity of demand significant

A
  • determines effects of imposition of indirect taxes and subsidies
89
Q

Draw the incidence of tax diagrams for elastic demand

A
90
Q

Draw the incidence of tax diagrams for inelastic demand

A
91
Q

How is tax significant for price elasticity of demand

A
  • more elastic lowers incidence of tax on consumer
  • means added tax will only slightly increase price for consumer while supplier covers rest
  • inelastic demand means majority of tax is pushed onto consumers
  • tax would be ineffective at reducing output but government gains higher revenue
92
Q

How are subsidies significant for price elasticity of demand

A
  • elastic demand means consumer sees small fall in price while producer gains extra revenue
  • inelastic demand, more the price falls
  • elastic demand also means large change in output following subsidy, while inelastic means little change
  • therefore subsidies on inelastic goods are ineffective at increasing output
  • they are cheaper for the government to impose since output increases by less so government pays subsidy on less goods
93
Q

Explain the diagram for incidence of tax on elasticity

A
  • first diagram shows inelastic demand and curve is steep
  • tax leads to small fall in output but large increase in price
  • second diagram shows elastic demand as curve is sloping
  • output falls significantly and producer burden is high
  • diagrams also show revenue generated is higher when demand is inelastic
  • shift from S1 to S2 in tax diagram shows raise in cost of production and shifts supply to left
94
Q

Explain the diagram for incidence of subsidy on elasticity

A
  • demand is inelastic => small rise in output but large fall in price with little producer gain
  • demand is elastic in second => large rise in output but small fall in price
  • show government has to spend more for subsidies on elastic goods
  • shift from S1 to S2 on subsidy diagrams decreases cost of production and shifts supply to the right
95
Q

How is revenue and PED linked

A
  • elastic demand curve => decrease in price leads to increase in revenue, and increase in price leads to decrease in revenue
  • inelastic demand curve => decrease in price leads to decrease in revenue, and increase in price leads to increase in revenue
  • unitary elastic curve => change in price does not affect total revenue
96
Q

What is income elasticity of demand

A
  • YED
  • responsiveness of demand to a change in income
97
Q

How do you work out YED

A

change in quantity demand / change in income

98
Q

What are the different goods in YED

A
  • inferior good => YED<0, rise in income leads to fall in demand for good
  • normal good => YED>0, rise in incomes leads to rise in demand for good
  • luxury good => YED>1, type of normal good
  • goods can be elastic or inelastic
  • inelastic goods tend to be necessities
99
Q

What is the significance of YED

A
  • important for businesses to know how their sales will be affected by changes in income of population
  • if economy is improving and people’s incomes rise, it is vital a business knows whether this increases sales or not
  • may have an impact on type of goods a firm produces
  • during times of prosperity, firms might producer more luxury goods and less inferior goods
100
Q

What is cross elasticity of demand

A
  • XED
  • responsiveness of demand for one product (A) to the change in price of another product (B)
101
Q

How do you work out XED

A

Change in quantity demand of A / change in price of B

102
Q

What are the types of goods in XED

A
  • substitutes => XED>0, increase in price of B will increase demand for A
  • complementary goods => XED<0, increase in price of A will decrease demand for B
  • unrelated goods => XED=0, change in price of B has no impact on A
  • size of integer reprints strength of relationship
103
Q

What is the significance of XED

A
  • firms need to be aware of their competition and those producing complementary goods
  • need to know how price changes by other firms will impact them so they can take appropriate action
104
Q

What is supply

A
  • quantity of a good or service that firms are willing to sell at a given price over a given time period
105
Q

What causes movements in supply

A
  • change in price of good
  • movement down the curve is a contraction => quantity supplied falls due to decrease in price
  • movement up the curve is an extension => quantity supplied rises due to increase in price
106
Q

What causes shifts in supply

A
  • change in any of the factors which affect supply
  • left shift is a decrease in supply => fewer goods supplied at each and every price
  • right shift is an increase in supply => more goods supplied at each and every price
107
Q

What are the conditions of supply

A
  • costs of production
  • price of other goods
  • weather
  • technology
  • goals of supplier
  • government legislation
  • taxes and subsides
  • producer cartels
108
Q

How do costs of production influence supply

A
  • if business has increase in costs but selling price stays same, they make less money
  • they will put up prices in order to avoid making a loss
  • less is thus supplied at each price => curve shifts left
  • if they have decrease in costs, it shifts right
109
Q

How does the price of other goods influence supply

A
  • joint supply is where production of one good automatically causes production of another good
  • increased production of first good increases supply of second good
  • competitive supply is where production of one good prevents supply of another
  • increased production of first good decreases supply of second good
110
Q

How does weather influence supply

A
  • supply of some goods is dependent on weather
  • e.g. if weather is good, more wheat will be produced so curve shifts right
111
Q

How does technology influence supply

A
  • if new technology is introduced, it leads to fall in production costs as there is higher productive efficiency
  • encourages firms to lower prices or produce more for same price, causing right shift
112
Q

How do goals of the supplier influence supply

A
  • if supplier is motivated by helping society and providing a service, they may increase supply even when that doesn’t provide extra profit
113
Q

How does government legislation influence supply

A
  • some legislation automatically increases supply of a good causing right shift
  • however, high levels of regulation may increase costs and decrease supply
114
Q

How do taxes and subsidies influence supply

A
  • tax decreases supply
  • subsidy increases supply
115
Q

How do producer cartels influence supply

A
  • some firms or countries come together in order to decrease supply and therefore increase price of their good to increase profit
116
Q

What is price elasticity of supply

A
  • PES
  • responsiveness of supply give a change in price of goods
117
Q

How do you work out PES

A

Change in quantity supplied / change in price

118
Q

What are values for PES

A
  • unitary elastic => PES=1
  • relatively elastic => PES>1
  • relatively inelastic => PES<1
  • perfectly elastic => PES=infinity
  • perfectly inelastic => PES=0
119
Q

What are factors affecting PES

A
  • time
  • stocks/finished goods
  • spare capacity
  • perishability
120
Q

How does time affect PES

A
  • impact on amount of good that can be supplied at any price
  • in short term, firm could sell more products but still be restricted by FoPs meaning it still is relatively inelastic
  • in long term, they can increase factors therefore supply is elastic
  • long the period of time the supplier has to make a change and increase production, more elastic it is
121
Q

How do stocks/finished goods influence PES

A
  • if business has stockpile, then when prices go up, they can use excess supply from stockpile meaning it is elastic
122
Q

How does spare capacity influence supply

A
  • if business not utilising all FoPs, and there is an increase in price, they can increase FoPs and minimise spare capacity, making it elastic
123
Q

How does perishability influence PES

A
  • more perishable the good is, the less elastic it is
124
Q

What is price determination

A
  • equilibrium point refers to point where there are no more forces thar bring about changing prices
  • price equilibrium is where supply = demand (market clearing point)
125
Q

What is excess demand

A
  • if price set below equilibrium, then there is excess demand
  • as a result, there is a shortage in market
  • firms can charge higher prices, causing extension in supply and a contraction in demand
126
Q

What is excess supply

A
  • if price set higher than equilibrium, there will be excess supply
  • firms will have unsold goods and encourage them to sell excess goods on sale, causing prices to fall and supply to contract and demand to extend
127
Q

What is the price mechanism

A
  • in free market, prices determined by price mechanism
  • determines how much is bought and sold
  • Adam Smith => invisible hand
128
Q

What are the functions of the price mechanism

A
  • rationing
  • signalling
  • incentive
129
Q

What is the rationing function of the price mechanism

A
  • price system is a way of rationing goods
  • when price increases, some people cannot afford to buy good and some may not have desire
  • limited resources can be rationed and allocated to people who can afford them and value them
130
Q

What is the signalling function of the price mechanism

A
  • price mechanism acts as a signal where resources should be used
  • when prices rise, producers move resources into manufacture of that product
  • change in price indicates to suppliers and consumers that market conditions have changes so they should change quantity bought and sold
131
Q

What is the incentive function of the price mechanism

A
  • acts as inventive for people to work hard
  • buyers realise with more money they can buy more goods
  • suppliers realise with more produced, they can make more money
  • low prices act as incentive for consumers to buy more of a good and high prices incentivise more selling for suppliers
132
Q

Explain the price mechanism in the context of a local market

A
  • coronavirus pandemic disrupted supply chains across planet
  • many countries blocked imports to prevent spread
  • if we take example of British supermarkets, less imports from other countries means there are fewer goods on supermarket shelves
  • as demand for food is high but supply is low, price of food raises to ration excess demand so only consumers who value food buy them
133
Q

Explain the price mechanism in the context of a national market

A
  • price of housing differs across the UK => high in south and low in north
  • London is not only the capital but also second largest financial centre in the world
  • population of London is relatively high compared to rest of UK so house prices rise through rationing
  • house prices also incentivise firms to allocate resources to production of more houses, as there is profit to be made
134
Q

Explain the price mechanism in the context of a global market

A
  • in 1973, OPEC proclaimed an oil embargo due to geopolitical factors regarding America and the Middle East
  • sent price of oil at record breaking levels across the planet, as oil was an invaluable resource to countries
  • shows rationing function as disequilibrium of supply and demand meant high prices deterred consumers who didn’t value oil highly, which left market open only to those consumers who did
135
Q

What is consumer surplus

A
  • difference between price consumer is willing to pay and price they actually pay, set by price mechanism
136
Q

What is producer surplus

A
  • difference between the price the supplier is willing to produce their product at and the price they actually produce at, set by the price mechanism
137
Q

What do consumer and producer surpluses show

A
  • economic gain from buying and selling of the good
  • consumer surplus shows welfare gained by consumers
  • total satisfaction consumers receive is total area under demand curve
  • producer surplus shows economic gain from selling
138
Q

How does elasticity affect producer and consumer surplus

A
  • perfectly elastic demand means there is no consumer surplus
  • perfectly inelastic demand means that consumer surplus is infinite
  • the more inelastic demand is, the higher consumer surplus likely to be
  • when supply is perfectly elastic, producer surplus is 0
  • when supply is perfectly inelastic, producer surplus is infinite
139
Q

How do changes in supply and demand affect producer and consumer surplus

A
  • decrease in demand/supply leads to decrease in both producer and consumer surplus
  • increase in demand/supply leads to increase in both producer and consumer surplus
140
Q

What is an indirect tax

A
  • tax on expenditure
  • person who is ultimately charged tax is not the person responsible for paying sum to government
  • business is required to pay tax but customer is charged instead
141
Q

What are the types of indirect taxes

A
  • ad valorem tax
  • specific tax
142
Q

What is an ad valorem tax

A
  • tax increases in proportion to value of good
  • tax is a percentage of cost for the good
143
Q

What is a specific tax

A
  • amount is added to price
  • constant, parallel
144
Q

Explain the impact of a tax

A
  • causes inward supply shift as it increases cost of production
  • leads to rise in prices and fall in output (diagram)
  • consumers suffer higher tax burden from high prices
  • producers suffer higher tax burden from high costs
  • government gains tax revenue => producer + consumer burden
145
Q

What is the incidence of tax

A
  • tax burden on the taxpayer
  • if PED is perfectly elastic / PES is perfectly inelastic, supplier pays all the tax
  • if PED is perfectly inelastic / PES is perfectly elastic, tax passed onto consumer
  • more elastic the demand is / less elastic the supply is, the lower the incidence of tax on the consumer, meaning suppler pays more
  • ceteris paribus, more inelastic demand => higher tax revenue for government as demand does not see fall
146
Q

What is a subsidy

A
  • grant given by government
  • payment to encourage production/consumption of a good or service
147
Q

Explain the subsidy diagram

A
  • subsidy increases supply as cost of production falls
  • therefore rise in output and fall in prices
  • total area shows government spending
148
Q

Explain the synoptic point for taxes and subsidies

A
  • both can have macroeconomic effects
  • e.g. subsidies can be used to encourage exports or protect domestic industries
  • indirect taxes can be regressive
  • both have implications on government budget
149
Q

Explain the synoptic point for producer and consumer surplus

A
  • macroeconomic policies can be assessed by considering their effect on producer and consumer surplus
  • e.g. use of tariffs leads to loss of consumer surplus
150
Q

What are reasons preventing consumers from acting rationally

A
  • influence of others
  • habitual behaviour / consumer inertia
  • weakness at computation
  • lack of knowledge
151
Q

What is market failure

A
  • occurs when market fails to allocate scarce resources efficiently
  • causes loss in social welfare
152
Q

What are the types of market failure

A
  • externalities
  • under provision of public goods
  • information gaps
153
Q

What are externalities

A
  • cost/benefit received by a third party from an economic transaction outside of the market mechanism
  • leads to over/under production of goods => resources aren’t allocated efficiently
154
Q

What is under provision of public goods

A
  • public goods are non rivalry and non excludable
  • means they are under provided by the private sector due to free rider problem
  • market is unable to ensure enough of these goods are provided
155
Q

What are information gaps

A
  • information gaps exist when either the buyer or seller does not have access to the information needed for them to make a fully-informed decision
156
Q

What are the different types of externalities

A
  • private costs/benefits => costs/benefits to individual participating in economic activity
  • social costs/benefits => costs/benefits of the activity to society as a whole
  • external costs/benefits => costs/benefits to third party not involved in economic activity, difference between private and social costs/benefits
157
Q

What is a merit good

A
  • good with external benefits
  • benefit to society is greater than the benefit to the individual
  • goods tend to be underprovided by free market
158
Q

What is a demerit good

A
  • good with external costs
  • cost to society is greater than cost to individual
  • over provided by free market
159
Q

What do externality diagrams look at

A
  • marginal costs and benefits
  • extra cost/benefit of producing/consuming one extra unit of the good
  • e.g. MPB is extra satisfaction gained from individual consuming one more of a good and the MSB is extra gain to society from consumption of one more good
160
Q

Draw and explain a negative production externality diagram

A
  • negative externalities of production occur when social costs are higher than private costs
  • market left to operate freely will ignore external costs
  • produces where MPB=MPC at market equilibrium
  • at Q1, society costs are higher than benefits, resulting in welfare loss => AB
  • economy should produce at social optimum position of MSB=MSC
  • difference between MSC and MPC increase as output grows, as external costs grow the more people do it
161
Q

Draw and explain a positive consumption externality diagram

A
  • positive externalities of consumption occur when SBs are higher than SCs
  • market left to its own devices and will produces at MPB=MPC, and will not consider benefits to society
  • if market considers all benefits, it would produce at MSB=MSC
  • failure of market to consider external benefits led to misallocation of resources so there is underproduction
  • leads to welfare loss => AB
  • difference between MPB and MSB grows since external benefits grow from consumption
162
Q

How can size of externalities be calculated

A
  • difficult to work out size of externality
  • tends to be placed on value judgements => difficult to monetise external costs
  • many externalities involved with information gaps => people are unaware of the full implications of their decisions
163
Q

How can government intervention reduce externalities

A
  • indirect taxes and subsides => taxes can be put on goods with negative and subsides on positive
  • tradable pollution permits => allow firms to produce certain amount of pollution
  • provision of the good => high SBs so government may provide through taxation
  • provision of information => helps people make informed decisions
  • regulation => limit consumption, e.g. ban advertising
164
Q

What are public goods

A
  • missing from free market but offers benefits to society
  • non rivalry => one person’s use of the good does not stop someone else from using it
  • non excludable => cannot stop someone from accessing good and someone cannot chose not to access the good
165
Q

What are quasi public goods

A
  • quasi public goods / non pure public goods
  • goods which aren’t perfectly non rivalry and non excludable but aren’t perfectly rival or excludable
  • e.g. roads which are semi excludable as there could be tolls and semi rivalry as people don’t use up roads but congestion causes problems during rush hour
166
Q

What is the free rider problem

A
  • says you cannot charge an individual a price for the provision of a non excludable good as someone else will gain benefit from it without paying anything
  • free rider is someone who receives benefits without paying for it
  • private sector producers do not provide public goods as they cannot be sure of making profits, due to non excludability of public goods
  • therefore if provision of public goods was left to market mechanism, market would fail
167
Q

What are the different type of information

A
  • symmetric information => buyers and sellers have potential access to same information => perfect information
  • however many decisions are based on imperfect information so economic agents are unable to make informed decisions
  • asymmetric information => one party has superior knowledge compared to another
  • usually seller has more information than buyer => can take advantage and charger more
168
Q

How do information gaps lead to market failure

A
  • misallocation of resources
  • people do not buy things that maximise their welfare
  • means that consumer demand or producer supply for a good may be too high or low
  • price and quantity are thus not in social optimum position
  • economic agents are unable to make rational decisions
169
Q

What can influence information gaps

A
  • advertising leads to information gaps
  • designed to change attitudes of consumers to encourage them to buy good
  • may cause them to think benefits are greater than they actually are
  • increases in technology reduces information gaps as people can get more information
170
Q

What are examples of information gaps

A
  • drugs => users do not see long term problems
  • pensions => young people do not see long term benefits
  • financial services => suppliers have more information than consumers so abuse customers for their own benefit