Theme 1 (MDF) Flashcards
1
Q
What is the basic economic problem?
A
Unlimited wants vs. limited resources (so resources have to be allocated between competing uses)
2
Q
Why is choice central to the basic economic problem?
A
All economic decisions incur an opportunity cost.
3
Q
Economics is the study of?
A
How society allocates its scarce resources in order to maximise welfare.
4
Q
What is the central purpose of economic activity?
A
Production of goods and services to satisfy the needs and wants of society.
5
Q
What are economic resources?
A
Land, labor, capital, entrepreneurship.
6
Q
Definition of labour?
A
Human resources which contribute to output.
7
Q
What does a PPF show?
A
They allow economists to analyse trade offs by showing the maximum combination of two goods or services that can be produced when a fixed number of resources are efficiently used, at a given level of technology.
8
Q
Why is the PPF bowed out?
A
Increasing opportunity costs and specialization.
9
Q
Would a fall in unemployment shift a PPF?
A
No, it would move closer to the line. (We are not producing at productive capacity.)
10
Q
What is an economic good?
A
A product which requires resources to produce it and therefore has an opportunity cost.
11
Q
What are intermediate goods?
A
Goods used in the production of other goods.
12
Q
Why are experiments in economics hard to conduct?
A
Economists can rarely conduct experiments and partly because it is often hard to isolate the effects of any particular event.
13
Q
What are final goods?
A
Finished goods and services produced for the ultimate user.
14
Q
What are the 3 basic economic questions?
A
- What to produce? 2. How to produce? 3. For whom to produce?
15
Q
What are the 3 economic agents?
A
- Consumers 2. Producers 3. Government
16
Q
What is a buffer stock scheme?
A
A scheme intended to stabilise the price of a commodity by purchasing excess supply in periods when supply is high, and selling commodity reserves when supply is low.
17
Q
What does Ceteris Paribus mean?
A
All other things held constant. When variables that are not mentioned remain constant.
18
Q
Why do economists build models?
A
Impossibility of undertaking a lab experiment. It summarises the relationships among economic variables.
19
Q
To ‘think like an economist,’ decisions should include?
A
Which variables will and will not be studied.
20
Q
Why is supply inelastic in the short run?
A
At least one factor of production is fixed.
21
Q
Factors affecting demand?
A
- Consumer income
- Consumer tastes
- Substitute goods
- Complements
- Expectations
- Population and demographic changes
22
Q
Factors affecting supply?
A
- Production costs
- Technological advancements
- Government policies
- Natural disasters/weather conditions
- Changes in expectations
- Government intervention
- Natural resource availability
23
Q
How could worker productivity be improved?
A
- More training
- Better technology
- Specialisation
- More experience
24
Q
What is the public sector?
A
Government.
25
What is the private sector?
Part of the economy involving the private ownership of businesses.
26
What is opportunity cost?
The loss of the next best alternative forgone.
27
What is a positive statement?
Can be proven or disproven by data.
28
What is a normative statement?
Cannot be tested or validated and may contain a value judgement.
29
Are decisions made by the government normative or positive?
Normative, they make decisions based on their value judgements.
30
What is value neutrality?
The characteristic of being free of personal beliefs and opinions that would influence the course of research.
31
What are free goods?
Goods that are unlimited in supply and which therefore have no opportunity cost.
32
Example of a free good?
Air.
33
What are economic goods?
Goods that are scarce because their use has an opportunity cost. They are created from scarce resources and therefore command a price.
34
When price increases, it causes?
A contraction along the demand curve.
35
This contraction is explained by which two effects?
Substitution effect: prices rise -> consumers retract their demand and find other, cheaper goods.
Income effect: as prices rise, consumers experience a fall in their real incomes so they demand less.
36
When demand increases?
Extension along the price curve.
37
What is demand?
Amount of goods or services that consumers are willing and able to buy at various prices.
38
Factors that may cause a shift in the demand curve?
Advertising, income, fashion and tastes, price of substitute goods, price of complementary goods, demographic changes.
39
Define direct tax?
A tax that must be paid directly to the government by the person on whom it is imposed (ex. property tax).
40
Define indirect tax?
A tax on consumer expenditure.
41
When will the government receive more tax revenue?
When demand is inelastic.
42
What type of goods should the government tax during a boom?
Income elastic goods (normal/luxury).
43
Factors affecting PES?
- Spare capacity
- State of economy
- Availability of FoPs
- Stockpiles and perishability
- Whether the raw materials are scarce
- Length of the production process
44
If you can't stockpile a good, is it elastic or inelastic?
Inelastic.
45
What is ad valorem tax?
Tax levied as a percentage of the value of the good.
46
Why are taxes ineffective when trying to counter inelastic demand?
Because the consumers will continue to consume the goods even if the consumer burden is as large as it can be.
47
What does the whole rectangle represent on a subsidy diagram?
The cost of a subsidy.
48
What is utility maximization?
The proposal that people make decisions by selecting the option that has the greatest utility.
49
What is total utility?
The overall benefit gained from consuming a good.
50
Specific tax: top rectangle, bottom rectangle and total square?
Top: incidence of tax on consumer.
Bottom: producer burden.
Total: tax revenue.
51
On a graph showing the effects of an ad valorem tax, where do we find the price received by producers?
At the point on S below the point where S+tax intersects D.
52
What is allocative efficiency?
Point on the PPF that maximises social welfare.
53
What are demerit goods?
Goods that are considered to be undesirable for consumers and are over-provided by the market, maybe due to the good having negative externalities.
54
What is asymmetric information?
Where consumers and producers have unequal access to information about a good or service in the market.
55
Why is indirect tax seen as regressive?
Because even when people have a high income they pay the same tax as those who have a low income.
56
Definition of information failure?
Information failure occurs when consumers do not have sufficient information to take decisions that will maximise their welfare.
57
What is a stockpile?
Stock of goods held in reserve.
58
How short is the short run and how long is the long run?
Short run: at least one FOP is fixed, long run they are all variable.
59
Formula for savings ratio?
Total Savings/Disposable Income x 100.
60
What is the social optimum?
The price and quantity combination that would exist if there were no externalities.
61
Where is the social optimum?
Where MSB = MSC.
62
Why are merit goods underprovided?
They have a higher private cost than social cost so these externalities are ignored and the good is underproduced.
63
What does it mean to internalise the externality?
An attempt to deal with an externality by bringing an external cost or benefit into the price system through tax.
64
Why does the government impose specific taxes?
- Increases revenue
- Can internalise the externality.
65
In order to internalise the externality, the tax imposed must be equal to?
The external cost at the socially efficient quantity.
66
What is market failure?
When the market fails to allocate society's resources efficiently, instead of producing and consuming goods at the socially optimal level of output.
67
How is the unequal distribution of wealth considered as market failure?
Some economists argue that wealth should be redistributed to benefit society.
68
Advantages and disadvantages of subsidies on goods with positive externalities?
- Internalises the benefit of the good
- Could change consumer preferences
But
- Difficult to put a monetary value on the externalities
- Opportunity cost.
69
How does market failure come about?
The price mechanism has not taken into account all the costs and/or benefits in the production/consumption of the goods/services.
70
What is the social benefit?
Private benefit + external benefit.
71
What is the private benefit?
The benefit received by the consumer of a good or service.
72
What are remittances?
A transfer of money by a foreign worker to an individual in their home country.
73
What is consumer surplus?
The amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it.
74
Factors affecting consumer surplus?
The gradient of the demand curve (more inelastic, more surplus). Changes in the condition of demand (e.g. increase demand will increase the surplus).
75
What is producer surplus?
The difference between the lowest price a firm would be willing to accept for a good or service and the price it actually receives.
76
Different word for producer surplus?
Profit.
77
Factors affecting producer surplus?
The gradient of the supply curve (more inelastic, more surplus). Changes in the conditions of supply.
78
Effect of a subsidy on consumer surplus?
Increases size.
79
Effect of tax on surplus?
Both decrease.
80
Where is consumer surplus on a graph?
Below the demand curve and above the price (the top one).
81
Where is producer surplus on a graph?
The area below the price and above the supply curve (the bottom one).
82
What is oligopolistic competition?
Occurs when only a few firms dominate a market so they have to watch the other firm's actions.
83
What are the 3 parts of the price mechanism?
Rationing - makes sure supply = demand. Incentivising - suppliers can determine whether there is profit to be made. Signalling - it highlights to producers whether they need to increase or decrease their levels of supply.
84
Disadvantages of the price mechanism?
- Some goods objectively shouldn't be produced through the price mechanism (organs).
- There will be missing markets for some goods.
- The price mechanism usually has no moral overlay or beliefs before a government intervenes.
85
What did Smith call the price mechanism?
The invisible hand.
86
Y axis on macroeconomics PPF?
Y - consumer.
87
X axis on macroeconomics PPF?
X - capital.
88
Effect of emigration on PPF?
Inward shift.
89
What is meant by Enterprise/Entrepreneurship?
An entrepreneur combines and organises land, labour and capital to produce a good.
90
What could cause demand for houses to increase?
- Limited supply, would be difficult to increase the supply of houses due to time lags.
- Buying of second homes by the wealthy.
- Migrants buying homes.
91
Formula for accelerator effect?
It=A(Yt-Yt-1).
92
Why do goods become more elastic over time?
Because people find more alternatives.
93
What is a public good?
A good that is both non-rivalrous and non-excludable.
94
What 2 characteristics do public goods have?
- Non-excludable, people cannot be prevented from consuming the good.
- Non-rival, consuming does not reduce the quantity available for the next person.
95
What are quasi-public goods?
Public goods which take on some of the characteristics of private goods.
96
Why would public goods not be produced in a free market?
Suppliers cannot stop consumers from accessing these goods and therefore they will not produce them (free rider problem).
97
Why may the government have to pay for flood defenses?
Individuals may refuse to pay but still use services due to the free-rider problem (if the flood services were provided by private sector) leading to insufficient funds to build flood defences.
98
What is a command economy?
An economy in which production, investment, prices, and incomes are determined centrally by a government.
99
What is a free market?
An economic system in which prices are determined by unrestricted competition between privately owned businesses.
100
Why does inequality occur in the free market?
There is freedom to own resources. Those who own resources are likely to earn more income than those who do not own resources.
101
What are subsidies?
A sum of money granted by the government to assist an industry or business so that the price of a commodity or service may remain low or competitive.
102
What is utility theory?
A theory that allows decision makers to incorporate their risk preference and other factors into the decision-making process.
103
What is unitary demand?
Total revenue will remain the same if price is increased.
104
What is a free market economy?
Prices for goods and services are determined by the open market and consumers.
105
Advantages of a free market?
- Economic efficiency
- Lower prices
- More choice
106
Disadvantages of a free market?
- High consumption of resources
- Environmental destruction
- Some will be out-competed
- Inequality
107
Disadvantages of a free economy?
- What is fair in the free market may not be fair in reality.
- Goods we need in society may not be produced if they cannot generate a profit.
- Monopolies may arise.
- Inequality.
- Market failure prevalent.
108
What is a market economy?
An economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services.
109
Advantages of a command economy?
- Correct market failure
- Less inequality
- Stop monopoly abuse.
110
Example of monopoly abuse?
Turing Pharmaceuticals raised the AIDS pill from $13 to $750 overnight.
111
Disadvantages of a command economy?
- Less efficient as the government is not a profit maximising entity.
- Government may not know what's best due to asymmetric information.
- Choice restriction.
- Destroys incentives.
112
Example of free market economy?
USA, Hong Kong 1960s.
113
Examples of command economy?
Cuba, North Korea 1980s.
114
Examples of mixed economy?
Germany, United Kingdom.
115
Which type of economy did Smith want?
'Laissez-faire' free market, thought that the price mechanism was perfect.
116
Which type of economy did Hayek want?
Mixed economy.
117
Which type of economy did Marx want?
Command economy.
118
Example of command economy failure?
30 million deaths from a famine in China.
119
Why did Marx hate the free market?
He believed it created prosperity for few and poverty for many. Exploited the proletariat / it would break down because owners of business made huge profits at the expense of workers.
120
Advantages of mixed economy?
- Economic efficiency
- Income equality (social welfare programmes)
- Consumer protectionism
- Employment stability
- Provides public goods.
121
Disadvantages of mixed economy?
- Reduced innovation
- Political influence
- Inefficient resource allocation
- Reduced incentives.
122
What is economies of scale?
When the average cost of producing a good or service falls as the quantity produced increases.
123
What does a straight line PPF indicate?
Constant opportunity cost as the two goods use identical factors of production.
124
What is a trade-off (PPF)?
The alternative you face if you decide to do one thing rather than another.
125
What is productive efficiency?
Any point on the PPF curve.
126
What is inertia?
The inability to act. Some consumers may not act rationally because they cannot/are stuck to their old ways.
127
What is bounded rationality?
Cognitive limitations that constrain one's ability to interpret, process, and act on information.
128
What are the 3 influences on consumer's rational decision making?
- Influence of others
- Importance of habitual behaviour
- Weak consumer computation.
129
What is the influence of others?
- Herd behaviour
- Peer pressure
- Advertising (of celebrities)
- Emotional decisions.
130
What is the importance of habitual behaviour?
- Consumers make so many purchases that they rely on habits to speed up the process.
- Rule of thumb.
- Consume inertia (buying).
131
What are the three influences on consumer's rational decision making?
- influence of others
- importance of habitual behaviour
- weak consumer computation
132
What are the components of the influence of others?
- herd behaviour
- peer pressure
- advertising (of celebrities)
- emotional decisions
133
Why is habitual behaviour important in consumer decision making?
- Consumers make many purchases relying on habits to speed up the process.
- Rule of thumb.
- Consumer inertia develops.
134
What is a rule of thumb?
A practical principle or guideline that can be used as a rough basis for making decisions or solving problems.
135
What is weak consumer computation?
- Too many choices make it harder for consumers to weigh up different benefits.
- Often lack the time or ability to make decisions.
136
What can you apply elasticities to?
- tariffs
- effectiveness of min/max prices
- impact of minimum wage
- devaluation and revaluation
- tradable pollution permits
137
When is PED elastic?
PED is elastic when PED is larger than 1.
138
What is an example of sellers exploiting consumer's rational decision-making?
Chewing gum at the cash register.
## Footnote
Cheaper alternatives are placed high up or low down to make it hard for consumers to compute.
139
When is PED inelastic?
PED is inelastic when PED is smaller than 1.
140
If PED is inelastic, what should you do to increase revenue?
Increase the price.
141
If PED is elastic, what should you do to increase revenue?
Decrease the price.
142
What happens if you raise the price when demand is perfectly elastic?
Total revenue could fall to zero.
143
What is specialisation of labour?
When a worker becomes an expert in a particular profession or in a part of a production process.
144
How does specialisation affect production?
Specialisation raises productivity as one should aim to use the most productive capital to improve at one thing.
145
What does YED > 0 indicate?
Normal good.
146
What does YED > 1 indicate?
Luxury good.
147
What does YED < 0 indicate?
Negative = inferior good.
148
What if the XED is negative?
They are complementary goods.
149
What if the XED is positive?
They are substitute goods.
150
What if the XED number is large?
They have a strong relationship.
151
What if PED is above 1?
The good is elastic.
152
What if PED is lower than 1?
The good has inelastic demand.
153
What if XED is 0?
The goods are unrelated.
154
Why does a firm want to know XED?
To know whether increasing the price of its product will lead to a huge fall in demand.
155
What does YED between 0 and 1 indicate?
Demand is inelastic.
156
What does PED = 0 indicate?
Perfectly inelastic.
157
What does PED = 1 indicate?
Unitary elastic.
158
What does it mean if demand is unitary elastic?
Quantity demanded changes by the same percentage as price.
159
What does PED = infinity indicate?
Perfectly elastic.
160
What is the formula for PED?
% change in quantity demanded / % change in price.
161
What is the formula for PES?
% change in quantity supplied / % change in price.
162
What is the formula for YED?
% change in quantity demanded / % change in income.
163
What is the formula for XED?
% change in quantity demanded for good X / % change in price of good Y.
164
What does XED indicate?
Positive - substitute; negative - complementary.
165
What are goods in joint-supply?
These are two goods where the production of more of one leads to the production of more of the other.
166
What does YED indicate?
+ normal; - inferior.
167
What will PES always be?
Positive.
168
What will PED always be?
Negative.
169
What are the six things that affect PED?
SNAP BT
- necessity
- addiction/habit
- substitutes
- brand loyalty
- proportion of income
- time period
170
What are the determinants of PES?
Time, mobility of factors of production, unused capacity, and ability to store stocks.
171
What does PES > 1 indicate?
Price elastic supply.
172
What does PES = 0 indicate?
Perfectly inelastic supply.
173
What is the law of diminishing marginal returns?
Adding further factors of production may only slightly improve output and can decrease total revenue.
174
What is diminishing marginal utility?
Decreasing satisfaction or usefulness as additional units of a product are acquired.
175
How is diminishing marginal utility shown by the demand curve?
Consumers gain less marginal utility per additional unit, leading to an inverse relationship between price and quantity demanded.
176
What is marginal utility?
Satisfaction or usefulness obtained from acquiring one more unit of a product.
177
Who believed in the division of labour?
Adam Smith.
178
What book did Adam Smith discuss the division of labour?
The Wealth of Nations (1776).
179
What is division of labour?
The breaking down of the production process into small parts with each worker allocated to a specific task.
180
What are three pros of dividing labour?
- Each worker is arranged by their expertise, maximising productivity.
- Workers only need to be trained in one sector, lowering training costs.
- Less time wasted switching from task A to task B.
181
What are three cons of dividing labour?
- Specialised workers may struggle to find employment if their job collapses.
- Boredom can increase absenteeism.
- Over-specialisation can deplete natural resources.
182
What are three pros of specialisation?
- Increase in productivity due to use of specialist equipment.
- Economies of scale reduce long-run average costs.
- Helps firms save on training costs.
183
What are four cons of specialisation?
- Boredom can lead to lower productivity.
- Workers struggle when unemployed due to lack of other skills.
- Can increase recruitment costs and absenteeism.
- Mass-produced goods can reduce consumer variety.
184
What are the advantages of division of labour and specialisation on trade?
It can result in economic growth, more choice, and lower prices.
185
What are the disadvantages of division of labour and specialisation on trade?
- Overdependence on imported goods.
- Imports may exceed the value of exports.
- Non-competitive goods can harm the economy.
186
What are three factors that limit the effectiveness of the division of labour?
- Size of market.
- Type of product.
- Transport costs.
187
What is staff turnover?
The rate at which employees leave a company and are replaced.
188
What are the four functions of money?
1. Medium of exchange
2. Unit of account
3. Store of value
4. Standard of deferred payment
189
What is a medium of exchange?
Anything that is used to determine value during the exchange of goods and services.
190
What is a standard of deferred payment?
Money must be acceptable to make purchases today that will be paid in the future.
191
What is a unit of account?
A means for comparing the values of goods and services.
192
What is a store of value?
An item that people can use to transfer purchasing power from the present to the future.
193
What is consumer sovereignty?
The power of consumers to decide what gets produced.
194
Why is there income inequality in a free market?
There is freedom to own resources; those who own resources are more likely to earn more income.
195
What are the four characteristics of a free market?
- Private ownership of resources.
- Price determined by competition between firms.
- Prices determined by supply and demand.
- Profit motive.
196
What are the four characteristics of a command economy?
- No profit motive.
- No competition.
- State-owned resources.
- Goods are allocated by the state.
197
What are the four characteristics of a mixed economy?
- Private ownership.
- State ownership.
- Government intervention.
- Market-based pricing.
198
Why does the government provide healthcare if it is not a public good?
Because it creates positive externalities.
199
Why can the free market not provide public goods?
Because of the free rider problem.
200
What is the free rider problem?
A free-rider is someone who consumes a good without paying for it because it is non-excludable.
## Footnote
e.g., free Wi-Fi or street lighting.
201
What are the four factors of production?
Land, labor, capital, entrepreneurship.
202
How can you shift the PPF?
Increase the quality and quantity of the factors of production.
203
What is an example of improving the quality of factors of production?
Improve the education and training of workers.
204
What is an example of improving the quantity of factors of production?
Looser immigration policies.
205
What does an increase in the production of capital goods on a PPF indicate?
Lower living standards.
206
What are factors causing an outward shift in the PPF?
- Discovery of new natural resources.
- Advances in technology.
- Improvements in education and training.
- Immigration.
207
What are factors causing an inward shift in the PPF?
- Deep recessions.
- Natural disasters.
- Depletion of natural resources.
208
Why may a deep recession lead to an inward shift of the PPF?
Deep recessions can lead to reduced investment in research and development, slowing technological progress.
209
What is labour hysteresis?
When labor loses their skills/productivity after a deep recession.
210
What are tradable pollution permits?
Companies are offered permits as rewards for not polluting and can trade these permits for money.
211
What are the downsides of tradable pollution permits?
- Companies may exploit legal loopholes.
- It is not global, allowing relocation to bypass permits.
- Big firms can afford permits and continue to pollute.
212
What are the benefits of tradable pollution permits?
- Incentivises firms to switch to eco-friendly production.
- Firms can reinvest money from permits to grow their business.
- Government can tax permits to increase revenue.
- Firms maintain competitiveness.
213
What is the effect of reducing the number of tradable pollution permits?
- Increased price.
- Decrease in negative externalities.
214
Why may tradable pollution permits be less effective than a tax?
With a tax, firms know their costs and can plan for investment; with permits, costs are dictated by the price mechanism.
215
What is welfare loss?
The excess of social costs over social benefits for a given output.
216
What is social benefit?
Private benefit + external benefit.
217
What is social cost?
Private cost + external cost.
218
What is external benefit?
Social benefits - private benefits.
219
What is the definition of private cost?
A cost paid by the consumer or the producer.
220
What are negative production externalities?
Negative - right, social optimum on higher axis.
221
What are positive consumption externalities?
Positive - left social optimum on higher axis.
222
What is the y-axis for externalities?
Costs / benefits.
223
What are direct taxes?
Income tax or corporation tax.
224
What are reasons the market may fail?
- Externalities.
- Non-provision of public goods.
- Information gaps.
- Monopoly.
- Moral hazard.
- Immobility of labor.
- Speculation and market bubbles.
225
What is social demand?
Demand for a good/service that reflects both private and external benefits of its consumption.
226
What are demerit goods?
Goods that have negative externalities and are often overconsumed.
227
What are merit goods?
Goods that are underproduced by the market without government intervention, e.g., schooling, healthcare.
228
What is the definition of externalities?
Effects on a third party as a result of an economic transaction/activity.
229
Are private benefits and costs inside or outside the price mechanism?
Inside.
230
Are externalities inside or outside the price mechanism?
Outside.
231
What are the two goods that are free at the point of consumption?
- Public goods.
- Merit goods.
232
What is intervention buying?
The government buys the excess supply.
233
What problems may arise from intervention buying?
Opportunity cost, expenses of storing goods, taxpayers' money, higher prices for consumers, potential underground markets.
234
What is government failure?
When government intervention leads to a more inefficient allocation of resources and a net welfare loss.
235
Who found that increased education leads to less crime?
Moretti (2001).
236
Why does the government sometimes use taxpayers' money for projects rather than subsidising private firms?
Positive externalities resulting from people using railways rather than roads; risk/imperfect information if the project is undertaken by the private sector.
237
What are the disadvantages of subsidies?
1. Opportunity cost - loss of government spending in other areas.
2. Encourage inefficiency - firms become complacent.
3. Difficult to estimate subsidy.
4. Distorts competition and leads to government failure.
238
What is welfare loss?
Refers to a loss of a portion of social surplus that arises when MSB doesn't equal MSC.
239
What government intervention can there be on the free market not supplying state education?
- Minimum price.
- Subsidy.
- Information campaigns.
- Provide state schools.
240
Does government supply vary depending on price or profit?
No.
241
How does the government solve the market failure of underproduction of healthcare?
NHS.
242
What are the downsides of the NHS and state education?
- NHS may have long wait times.
- Education may suffer due to larger class sizes.
243
How can the government solve the overconsumption of the NHS?
- Increase tax, increase supply.
- Make people pay.
244
What are the pros of charging for healthcare?
- Rations demand.
- Eases pressure on NHS.
245
What are the advantages of minimum price?
- Producers know in advance the price they will receive.
- Allows producers to plan investment and output.
- Discourages consumption of demerit goods.
- Prevents exploitation of high prices by monopolies.
246
What are the disadvantages of minimum price?
- Surpluses each year if price is too high.
- Involves cost of storage paid by taxpayers.
- Encourages overproduction leading to misallocation of resources.
247
What is the Principle-Agent Problem?
When the agent (worker or manager) doesn't act in the best interest of the principal (owner).
248
What does 'consumer sovereignty' mean?
Consumers have the power to decide through their actions what goods and services are produced.
249
What is welfare loss if there are positive externalities?
It is on the left.
250
What is welfare loss if there are negative externalities?
It is on the right.
251
What are the advantages of regulation?
- Sends a strong signal to the market to resolve market failure.
- Easy to implement and flexible.
- Historically successful in decreasing market failure.
- Easy to understand.
252
What are the disadvantages of regulation?
- Can be expensive to maintain.
- May lead to further inefficiencies.
- Can encourage illegal activity.
- May have time lags.
- Requires employment for regulation.
253
When does the government fail with its intervention?
- Information gaps.
- Administration and enforcement costs.
- Impact on incentives.
254
Why would there be an underconsumption of education in the free market?
People would be unable to afford it.
255
What are the disadvantages of regulation?
1. Can be expensive to maintain
2. May lead to further inefficiencies
3. Can encourage illegal activity
4. May be time lags
5. People have to be employed to regulate these policies
256
When does the government fail with its intervention?
1. Information gaps
2. Administration, enforcement costs
3. Impact on incentives, people may do the bad thing until they are actually told off
257
Why would there be an under consumption of education in the free market?
People would be unable to afford it and may think that it is not worth it due to the opportunity cost of getting a job.
258
What government interventions may solve under consumption of education?
1. Minimum price
2. Subsidising private schools
3. Information campaigns
4. Provision of state schools (most effective)
259
Why is the supply of public goods inelastic?
Because supply does not vary depending on price and profit.
260
What is government intervention?
Government intervention is where the government steps in to correct market failure and improve the allocation of resources.
261
What are the 8 types of government intervention?
1. Minimum price
2. Maximum price
3. Subsidies
4. Indirect taxes
5. Provision of public goods
6. Tradeable pollution permits
7. Regulation
8. Provision of information
262
What are the advantages of provision of public goods?
1. May reduce inequality
2. Could result in an increase in consumption of merit goods
## Footnote
However, they may have negative production externalities.
263
How does a maximum price lead to a further misallocation of resources in the housing market?
Tenants lost incentive to look after their houses and to rent them out, resulting in less houses being available and the conditions of houses worsening.
264
How does a minimum price lead to market failure in the European food market?
They increased minimum price to help farmers, leading to a surplus and farmers had to dispose of their food, harming surrounding areas and rivers, and overusing their soil.
265
How can information failure lead to market failure through government projects?
Government may make assumptions and predictions on the costs of their projects, but these estimates may be very far off, wasting billions in the process.
266
What is an indirect tax?
A tax on consumer expenditure.
267
What is VAT?
VAT is a percentage of the price of a product.
268
What is the difference between VAT and indirect tax?
If the price of a good increases, the revenue from a specific tax stays the same, but the revenue on VAT taxed goods increases because it is a percentage.
269
What is VAT in the UK?
20%.
270
How do indirect taxes lead to greater social efficiency?
By resulting in an allocation where MSC = MPC.
271
What are the advantages of indirect taxes?
1. Internalises the externality
2. Polluters and consumers will pay
3. Increases tax revenue
4. Can also incentivise a reduction in pollution
272
What are the disadvantages of indirect taxes?
1. Difficult to measure the level of pollution
2. Higher prices for consumers
3. May force firms out of business leading to negative costs for the whole economy
4. Inelastic goods will not see consumption fall
5. Development of illegal markets
6. Regressive taxation
273
What are the advantages of a subsidy?
1. Reduction in costs of production to allow suppliers to reduce the price
2. Incentive to increase consumption
3. May help reduce inequality
274
What are the disadvantages of a subsidy?
1. Costs to taxpayer
2. Ineffective in increasing consumption if demand is inelastic
3. Difficulty of setting an appropriate subsidy due to quantifying the external benefit
275
Why do governments use maximum prices?
To control price ceilings to allow some consumers to purchase goods that were previously unobtainable.
## Footnote
Example: Cyprus introducing a maximum price on milk.
276
What are the advantages of maximum price?
1. Enables low income households to afford goods
2. Can help with inflationary problems
3. Can prevent exploitation by monopolies to consumers
277
What are the disadvantages of maximum price?
1. Encourages black markets
2. If the government subsidises firms to continue production, it costs money to taxpayers
3. Producers may leave the market and use their resources to make more profitable goods
278
How do minimum and maximum prices cause market failure?
They distort the price mechanism.
279
How do maximum prices in the housing market lead to government failure?
1. Lack of housing
2. Deterioration of building properties
3. Black market could be used (unintended consequences)
280
How do government interventions distort the market?
If some firms get subsidies and other firms don't.
281
Why may a government set a minimum price?
To ensure that producers receive a certain price for their product as consumers have to pay.
## Footnote
Example: Scotland in order to tackle over-consumption of alcohol.
282
What 3 sectors does the government set a minimum price on?
1. Commodities
2. Consumer goods
3. Labour market
283
What are the advantages of minimum price?
1. Producers know in advance what price they will receive
2. Producers can plan future investment and output
3. Stops consumption of demerit goods
284
What is the disadvantage of minimum price?
Surpluses each year if minimum price is too high.
285
What happens if the maximum price is below the equilibrium price?
It can create a shortage of supply as consumers demand more at the lower price, but producers are not willing to supply as much due to lower profit margins.
286
What happens if the minimum price is below the equilibrium price?
It has no effect on the market.
287
What if minimum wage is above the equilibrium (wage) price?
There will be an excess supply of labour.
288
What are examples of the government providing information?
Providing information on health risks associated with smoking / food traffic light labels.
289
Why is providing information sometimes ineffective?
There is a cost to providing this information and there is no guarantee that the people will follow it.
290
When are bans from the government effective? When are they used?
If the good is harmful; they are used when MSC > MPC.
291
Why are bans ineffective?
Encourages black markets and illegal activity.
292
What are the 4 causes of government failure?
1. Distortion of price signals
2. Unintended consequences
3. Excessive administrative costs
4. Information gaps
293
What is distortion of price signals?
The actions of government which distort the operation of the price mechanism and misallocates resources.
294
What are unintended consequences?
When policies have effects that were not anticipated or contrary to the intended objectives.
295
What are excessive administrative costs?
The social benefits of a policy might not be worth the financial cost of administering the policy.
296
What are information gaps in government?
Government may not have all the right information, leading to a further misallocation of resources.
297
What are the 4 markets where there is government failure?
1. Indirect taxes
2. Agricultural stabilisation schemes
3. Housing market
4. Environmental policies
298
What is an example of government failure in the wind turbine market?
£9.3 million granted to wind turbines to slow down their production as the network was unable to cope with the amount of electricity.
299
Is nuclear energy renewable?
No, it uses uranium, a finite non-fossil fuel source, mined from below the earth.
300
What is an example of a positive production externality?
Redevelopment of brown field sites, e.g., converting it into a playground or a shopping center, may create a local multiplier effect.
301
What is an example of a negative consumption externality?
Smoking.
302
What is a good with mixed externalities?
Plastic; prevents food waste but is bad for the environment.
303
Why are externalities hard to quantify?
1. Some are subjective
2. Some do not have well-defined markets or prices
3. Some are not immediately apparent, e.g., mental health or air pollution.
304
How many Londoners die early every year due to air pollution?
284 (Guardian, 2023).
305
What is the tragedy of the commons?
A situation where a commonly available resource is abused without anybody feeling a responsibility to protect it as they only regard the short-run.
306
What are the determinants of supply?
1. Resource prices
2. Technology
3. Taxes and subsidies
4. Prices of other goods
5. Price expectation
6. Number of sellers in the market
307
What are the determinants of price elasticity of demand?
Substitutes, percentage of income, luxury, addictive, time (SPLAT).
308
What are the determinants of price elasticity of supply?
1. Time
2. Stocks
3. Working
4. Ease of entry
5. Availability of factors of production
6. Availability of substitutes
309
What is the elasticity of short run?
Less elastic.
310
What is the elasticity of long run?
More elastic.
311
Why does PES become more elastic in the long run?
All factors of production are variable.
312
What are the 3 E's to use in evaluation?
1. Effective
2. Efficient
3. Equitable
313
What is excess of supply called?
Surplus/glut.
314
What is excess of demand called?
Shortage.
315
Why do companies want to know the YED?
Firms use elasticities to set prices and predict revenue changes.
316
Why does government want to know elasticities?
Government uses elasticities to make taxation and subsidy decisions.
317
What is the market mechanism/invisible hand?
Prices allocate scarce resources among competing consumers.
318
What did Hayek promote instead of government spending?
Private investment.
319
What is an advantage of a free market economy compared to a command economy?
Competitive markets responsive to consumers.
320
What is the definition of productivity?
Output per unit of input.
321
What is a factor of production?
An input used in the production of a good or service.
322
Does an increase in unemployment shift the PPF inwards?
No, it just moves to a point inside the PPF.
