Theme 1 - Markets, Consumers and Firms Flashcards
What is the basic economic problem?
Resources are finite and needs/wants are infinite, so resources must be used optimally.
Define scarcity
When there is a shortage of resources in relation to the quantity of needs/wants.
Define opportunity cost
The value of the next best alternative foregone.
What 3 things must we consider when producing a good?
- What to produce
- How to produce it
- Who to produce it for
Name a few different business objectives
- Profit maximising
- Sales maximising
- Survival
- Market share maximising
- Customer satisfaction
What is profit satisficing and when might a firm choose to advocate this?
Occurs when a firm earns just enough profits to keep shareholders happy.
Occurs when there is a divorce of ownership and control, whereby managers will make enough profits to keep shareholders happy, whilst still maintaining their own objectives.
Give the equations for:
1. Profit maximising
2. Sales maximising
- Marginal Cost = Marginal Revenue (MC=MR)
- Average Cost = Average Revenue (AC=AR)
What is Corporate Social Responsibility (CSR)?
A form of self-regulation, whereby firms take responsibility for their actions that harm the environment, and aim to maximise social welfare.
Recall an example of Corporate Social Responsibility (CSR)
As global warming and climate change is becoming an increasingly worrying issue across the world, firms could attempt to reduce their carbon footprint by investing in green energy.
Name the different types of stakeholders (economic agents)
- The shareholders
- Employees
- Consumers
- Managers
- Government
- Suppliers
Give a brief description of the principal-agent problem
Describes how the agent - who makes decisions for the principal - acts in their own best interests, linked to the theory of asymmetric information.
Occurs when the owners of the firm sell their shares, thereby partially losing control of its day-to-day operations.
Give a brief description of the theory of Creative Destruction
Proposed by Schumpeter, this is the idea that new entrepreneurs are innovative and grow more productive than old, idle firms who are eventually forced out of the market.
Give one example of Creative Destruction
Technological advancements have led to the creation of DVDs, to the introduction of Blu-Ray, to the expansion of downloadable films, which has now triggered the downfall of DVDs.
What is the main incentive for entrepreneurs?
Taking risks for profit.
How do entrepreneurs make a profit?
By bringing together all 4 factors of production:
- Land
- Labour
- Capital
- Enterprise
Recall two non-financial motives an entrepreneur might have
- Ethical stance and social entrepreneurship.
- Independence and working from home.
Define all 4 factors of production
Land: natural resources such as oil and coal
Labour: human capital
Capital: goods which can be used in the production process
Enterprise: the innovator and risk-taker
What is specialisation?
Each worker completes a specific task in the production process, aimed at improving efficiency and thus the average cost of production.
Give a few benefits and drawbacks of specialisation
✓ Higher output
✓ Opportunities for greater economies of scale
X Work becomes monotonous and demotivating
X Give rise to structural unemployment, as some
skills may not be transferable
Why would higher interest rates be seen as a disadvantage to firms?
Higher interest rates implies getting a loan is more expensive, which raises the cost of production for firms.
It also encourages more saving and less spending on the consumer side, which results in less profits for firms.
What is the relationship between exchange rates and the level of imports/exports?
High exchange rate: Imports cheap, Exports dear -SPICED
Low exchange rate: Imports dear, Exports cheap - WPIDEC
How could a high rate of unemployment benefit firms?
An increase in unemployment mean there is a larger supply of labour, which gives firms bargaining power and the ability to reduce wages, thus lowering overall costs of production.
What could unpredictable inflation imply for firms?
Unpredictable inflation reduces overall business confidence, as it is difficult to anticipate future interest rates, unemployment rates, economic growth, etc. Therefore, firms cut down on their investment and wait for calmer economic conditions.
Define:
1. Effective demand
2. Individual demand
3. Market demand
- The quantity that consumers are willing to buy at the current market price
- The demand of an individual or firm
- The sum of all individual demands in the market
How do prices affect the demand/supply curve?
Prices cause movements along the demand and supply curves.
Prices do not cause shifts in the demand and supply curves.
What does each letter in the PIRATES mnemonic stand for?
Population
Income
Related Goods
Advertising
Tastes and Fashions
Expectations
Seasons
What are the 3 different types of supply?
- Joint supply
- Composite supply
- Competitive supply
Recall 3 reasons why the supply curve is upward sloping
- If price increases, it’s more profitable for firms to supply the good
- High prices encourage new firms to enter the market
- Larger output increases costs, which are passed onto
consumers in the form of higher prices
What does each letter in the PINTSWC mnemonic stand for?
Productivity
Indirect Taxes
Number of Firms
Technology
Subsidies
Weather
Costs of Production
How will the exchange rates affect the level of supply?
A decrease in the exchange rate boosts the costs of imports (raw materials), which increase the cost of production for firms, thus shifting the supply curve to the left.
Define the market equilibrium price
This is the price where supply meets demand, and has no tendency to change (P1Q1).
What are the cons of using the supply and demand model to explain real-world problems?
X They only show certain markets
X Assume price increases means firms will supply more
X Assume perfect information
X Assume perfectly competitive markets
What phrase describes the mechanism that determines market price?
The ‘invisible hand of the market’
What are the 3 different functions of the price mechanism?
- Rationing
- Incentive
- Signalling
What is the difference between a mass market and niche market?
A mass market is the largest group of consumers for a product.
A niche market is a smaller market, focused on a specific product.
Why are niche markets generally better at allocating resource?
As niche markets target the consumers directly, rather than generally, they are closer to the consumer and therefore have a better idea of who needs what goods.
Describe the difference between primary and secondary research
Primary research is carried out directly (e.g. surveys), whereas secondary research is carried out via a third-party (e.g. governments).
Evaluate the use of primary research over secondary research
Primary research is expensive but produces more specific findings than secondary research, which may not be as useful.
Define market research
The collection of data in order to learn about the needs and wants of consumers.
What is a disadvantage to using samples to analyse the market?
The sample used may be biased, and therefore give invalid results.
What is market segmentation?
This is when the market is divided into categories of consumers based on their characteristics, needs, etc.
How could market segmentation benefit firms?
By categorising consumers based on their needs/wants, firms can better target their goods to fulfill these specific needs.
How does a market map work?
It illustrates all the positions a product can take based upon two dimensions which are significant for consumers.
It then identifies which existing products meet which consumer needs, thus identifying gaps for new market participants to fill.
Give examples of dimensions used in market mapping
High vs. low price
High vs. low volume
Heavy vs. light
Good vs. lesser quality
When does a firm have a competitive advantage over other market participants?
This occurs when the firm in questions produces better products than its competitors in the same market.
How can a firm gain a competitive advantage?
It can use price, quality, cost or a niche market to give itself a unique features that makes it stand out from its competitors in the same market.
What is product differentiation?
The act of distinguishing one product from another.
How can value be added to products and services?
Value can be added to a product using a brand, quality, good service, unique features and convenience for the customer.
How do firms in a perfectly competitive market determine the prices of their goods and services?
Firms must take the equilibrium price of the market, where supply = demand.
These types are firms are price-takers.
Describe the difference between stable markets and dynamic markets
A stable market rarely changes the prices of goods, whereas dynamic market prices are constantly changing.
How do banks encourage/discourage saving and investing?
They manipulate interest rates, so high interest rates encourage savings and discourage investing.
What is a bank’s main source of profit, and how do they earn this?
A bank’s main source of profit is interest rates, which they earn through loaning consumers money.
What is the role of a central bank?
To manipulate interest rates, the exchange rate and the money supply.
Recall the names of the central banks in:
1. The European Union
2. England
3. The United States
- European Central Bank (ECB)
- Bank of England (BoE)
- The Federal Reserve (The Fed)
Name the rate that central banks control, which determines overall interest rates
The base rate.
What is a mortgage?
A mortgage is a loan taken out to buy a house, whereby the house is used as collateral in the event of default.
What is the Monetary Policy Committee (MPC) and what do they do?
A group of nine members, independent of the government, who meet frequently to discuss future interest rate changes.
Define risk
The probability of damage, loss or injury occurring.
When do banks face risk?
They face risks when they lend money, as there is the possibility of that debt not being repaid.
Recall the difference between limited and unlimited liability
In the event of insolvency, unlimited liability leaves the owner of the firm at risk of their own assets being repossessed to meet their financial obligations, whereas limited liability results in the owner only having to pay back what they invested in the firm.
Name the 3 different types of credit
- Loans
- Overdraft
- Trade credit
What is trade credit?
This is a loan to a firm given by its suppliers, so the goods can be bought immediately and paid for at a later date.
Recall the pros and cons of overdrafts
✓ The interest is only paid on the money borrowed
X The interest rates are very high
X The amount you can borrow is limited
Recall 4 examples of sources of credit
- Banks
- Venture capital
- Share capital
- Leasing
What is Venture Capital?
When a specialist firm provides funding in return for a share of the company.
What is a major benefit of using personal savings to finance ventures?
✓ There is no interest paid, because the money is yours.
Define retained profit
Money left after taxes and other fees have been deducted.
In what scenario would it be wise for a firm to sell its assets to finance operations?
When the assets in question are no longer used or obsolete.
Where is collaborative funding usually conducted?
On the internet
Why would it be more expensive for small firms to access credit than larger firms?
It takes time for small firms to build a strong credit history, and so they must pay higher interest rates than larger firms with good credit histories.
What do private costs determine about the good produced?
- How much of the good should be produced.
- The market price of the good.
What is the equation for the total social cost?
Social Cost = Private Costs + External Costs
How would you calculate the external costs from a graph?
This is the vertical distance between the Marginal Social Cost (MSC) line and the Margin Private Cost (MPC) line.
Do the MPC and MSC lines move parallel to each other?
No, both lines diverge from each other as external costs increase disproportionately to output.
Define externality
A cost or benefit to a third-party member outside the market transaction.
Where on a graph is the socially optimal point in a market?
Where MSC=MSB
What is market failure?
Market failure occurs when the free market fails to allocate resources to the socially optimal level of output.
Describe the difference between public and private goods
Public goods: Non-excludable & non-rival
Private goods: Excludable & rival
Why are public goods underprovided in a free market?
People who do not pay for the good receive the same benefits from it compared to the ones who do pay. Therefore it is underprovided by the private sector as there
is no potential for profit.
Recall the link between market failure and perfect information
Rarely do both parties of a market transaction have perfect information and so there is usually a misallocation of resources, hence market failure.
Why do governments often intervene in free market?
Governments usually intervene to correct market failure.
Recall 3 examples of government intervention
- Regulation
- Indirect taxes
- Subsidies
Name the 2 different types of indirect taxes
- Ad valorem tax
- Specific tax
How do indirect taxes reduce the quantity of demerit goods consumed?
Firms that have to pay the taxes pass them onto consumers in the form of higher prices, thus reducing the quantity demanded.
Define subsidy
A payment from the government to firms in order to lower their costs of production and encourage them to produce more.
Would the government subsidise alcohol products or education, and why?
Education, because this is a merit good and so subsidising it would encourage learning and improve the quality of the labour force.
Which way would a subsidy shift the supply curve?
To the right (as it reduces the cost of production, which encourages firms to produce more).
How could a subsidy potentially become a source of government failure?
It could distort price signals by distorting the free market mechanism.
Give an example of unintended consequences when implementing government policies
The policy could be expensive to implement
Give the equation for total revenue?
TR = Price x Quantity sold
What is the equation for average revenue?
AR = TR/Quantity sold
What is the definition of marginal revenue?
The extra revenue earned by producing one extra unit of output
How do you calculate marginal revenue?
By taking the differences of total revenue between different levels of output
What are the 2 different types of costs?
Fixed costs
Variable costs
Give examples of fixed costs
Rent, mortgage payments, salaries
Give examples of variable costs
Cost of Sales, Wages, Utilities
What is the equation for percentage change?
(Final value - Starting value) / Starting value
Define contribution
The total profit made by selling each product
Give the equation for contribution
Contribution = Selling price - Variable costs
Why does the contribution equation exclude fixed costs?
Because fixed costs don’t vary with output
What is the margin of safety?
The difference between actual level of output and the break-even level of output, which indicates how much sales can fall before a firm starts making a loss
How does profit act as a signal in markets?
High profit margins incentivize new firms to enter the market, and vice versa
How does price act as a signal in markets?
It signals where resources are needed most in a market
What is the comprehensive statement of income
This shows the revenues and expenses of a firm which gives an overview of their financial position
How will a change in expenditures affect net profit?
It reduces net profit as expenditures as they are cash outflows
Give 3 ways that a firm measures profitability
- Gross profit margin
- Operational profit margin
- Net profit margin
Define operational profit margin
This is the profit earned from the core business operations
What is a comprehensive statement of income used for?
To identify where a firm are spending more than they can afford
