Theme 1 (Micro) Flashcards
What is ceteris paribus ?
(1.1.1)
Economies as a social science
Everything apart from the factors you are modelling is equal.
What is are positive and normative statements ?
(1.1.2)
Normative and positive statements
Positive Statement - Can be tested against real world evidence.
Normative Statement - Based on value judgemants which are subjective and cant be tested as proof.
What is the economic problem ?
(1.1.3)
Economic problem
Unlimited wants of cosumers.
Limited F.O.P to meet the demand.
Define Opportunity Cost ?
(1.1.3)
Economic Problem
The benefit foregone the next best alternative.
What are the TWE’s of Opportunity Cost ?
(1.1.3)
Economic Problem
Habitual behaviour - Consumers fall into routines.
Agents Face Multiple Options - Agents may not be able to compute all private costs and benefits.
Draw a PPF ?
(1.1.4)
PPF
What are Capital and Consumer Goods ?
(1.1.4)
PPF
Consumer Goods - Output that is consumed by households which derives utility.
Capital Goods - Piece of manufacturing equipment used in production process.
Where on a PPF is Efficient ?
(1.1.4)
PPF
Operating on the line of the PPF is efficient.
Operating within the PPF shows inefficency and a misallocation of resources.
What causes an outward shift in the PPF ?
(1.1.4)
PPF
An increase in the F.O.P will cause an outward shift in PPF.
What causes an inward shift in PPF ?
(1.1.4)
PPF
An inward shift is caused by external causes and represents economic decline.
Example - War / Natural Disaster
Whats Adam Smith’s theory ?
(1.1.5)
Specialisation
Adam Smith wrote about the division of labour.
Whereby splitting the production process - leads to specialisation - leads to Increased productivity / Decrease in waste.
Risks of Division of Labour ?
(1.1.5)
Specialisation
Boredom caused by :
-Repetition
-Lack of social interaction
-Low self worth
How to Compensate Boredom in the Division of Labour ?
(1.1.5)
Specialisation
- Higher Pay, Linked to Output
- Job Rotation (Variance)
- Increase use of capital equipment
What are the Advantages of Specialising in Production ?
(1.1.5)
Specialisation
Increasing output allows for investment into machinery -> Automation is more productive -> More K can increase productivity of labour -> Overcome scarcity and allows for lower prices
Increasing investment into K & R&D -> Increase innovation -> Improve product quality = increase sales and support growth
What are the Disadvantages of Specialising in Production ?
(1.1.5)
Specialisation
High sunk costs = Risk of losses
Supply chain disruption = Production has to stop
Any mistake in production = High cost
What are the 4 functions of money ?
(1.1.5)
Specialisation
- A medium of exchange: It is widely accepted token which can be exchanged for goods and services.
- A measure of value: Prices reflect the value society places on them.
- A store of value: Possible to use for future transactions.
- A method of deffered payment: It can be postponed in the future, expressed as a form of debt
Define Free Market Economy ?
(1.1.6)
Markets
Free market economy: Where there is no government intervention and supply and demand dtermine what is produced through the price mechanism.
What was Adam Smith’s Argument ?
(1.1.6)
Markets
Smith argued that economies function most efficiently and fairly when individuals are allowed to pursue their own interests.
dynamic free markets are the best method to allocate resources through the price mechanism.
What’s the Advantages of a Free Market Economy ?
(1.1.6)
Markets
Allocative Efficiency - Whereby G/S that people demand are produced
Productive Efficiency - Firms cut costs and make efficient use of scarce finite reources.
Risks of Free Market Economy ?
(1.1.6)
Markets
Risk market failure:
- Over-consumption of G/S with high private and external costs.
- Under-consumption of G/S with high private and external benefits.
Risk of absolute poverty is much higher.
High levles of wealth and income inequality.
High risk of monopolies.
What did Marx Believe ?
(1.1.6)
Markets
Owners with objectives of profit will end up exploiting workers wages.
Owners will replace labour with K causing monotonous jobs and unemployment.
Competition will cause firms to go bust leading to monopolies.
Capitalism has weaknesses and flawes and will eventually self-destruct.
What are the Characteristics of a Command Economy ?
(1.1.6)
Markets
- Governments will own some or all goods and services within industries.
- Production is decided by government agencies, who decide most socially efficient G/S to produce.
- Government may set prices or give consumers rations directly.
What are the Advantages of a Command Economy ?
(1.1.6)
Markets
- Low inequality and focus on social welfare
- Prevent abuse of monopoly power
-Prevents mass unemployment
Hayeks Disadvantages of Command Economies ?
(1.1.6)
Markets
Hayek - criticised command economies as he claimed the government couldnt process all the information needed to distribute goods efficiently
Government intervention would distort the price mechanism and lead to an inefficient allocation of resources
Disadvantages of Command Economy ?
(1.1.6)
Markets
- Price controls lead to shortages and surpluses
- Inefficient firms are protected and keep going, therefore firms cant respond to consumer preferences efficiently
- Creates a climate where government can extend control into peoples lives
What is a Mixed Economy ?
(1.1.6)
Markets
Mixed Economy - Where markets allocate resources, but governments interveen to different extents to ensure a minimum standard of living snd to correct other market failures
How do consumers aim to maximise utility ?
(1.2.1)
Rational decision making
You will continue to consume as long as the marginal private benefit is greater than the marginal private cost
What is consumer weakness at computation ?
(1.2.1)
Rational decision making
Information can be hard or complex to understand
If consumers are not aware of the full private benefit or full private cost and the alternatives
The choice they make may not lead to the highest level of utility
How does the influence of others effect peoples behaviours ?
(1.2.1)
Rational decision making
This is referred to as herding behaviour
As people consciously or unconsciously follow what others are doing - the market as a whole can display irrationality
Humans have a desire to not be left out - this can encourage market sentiment
What is habitual behaviour ?
(1.2.1)
Rational decision making
Def : A ridgid pattern of behaviour followed by an individual
Because of this consumers may stick to previous choice even though its now irrational
What are the TWE’s of Irrational Behaviour ?
(1.2.1)
Rational decision making
- The private benefit of consumption is subjective
- The risks of irrational behaviour increase when the private benefit and cost are hard to calculate
Define Demand ?
(1.2.2)
Demand
Def : quantity of a good or service that consumers are willing and able to buy at different prices during a certain time
Factors that Shift a Demand Curve ?
(1.2.2)
Demand
Population - Influeneces amount of possible consumers
Advertising - Increase awareness and perception of quality
Substitutes - Change in price or quality of competition effects opportunity cost
Income - Influenece ability to consume G/S
Fashion - Social trends cause high levels of utility for short time period
Interest Rate - Determines cost of borrowing, therefore sales of big ticket items
Complementary G/S - Where a products use is linked to another
PASIFIC
What is diminishing marginal utility and how does it influence demand ?
(1.2.2)
Demand
Marginal utility is the additional utility, or amount of satisfaction, gained from each additional unit of consumption
Marginal utility will usually decrease with each additional increase in the consumption of a good
What is Price Elasticity of Demand ?
(1.2.3)
P.E.D
The responsivness of quanitity demanded to a change in price
Elastic = Change is more than proportional
Inelastic = Change is less than proportional
What is the formula for PED ?
(1.2.3)
P.E.D
%Δ in QD
%Δ in P
Draw an elastic demand curve ?
(1.2.3)
P.E.D
What is meant by perfectly price elastic demand ?
(1.2.3)
P.E.D
An increase in price will see demand fall to zero
Draw an inelastic demand curve ?
(1.2.3)
P.E.D
What is meant by perfectly inelastic demand ?
(1.2.3)
P.E.D
If there is a change in price there will be no change in demand
What factors influence PED ?
(1.2.3)
P.E.D
- Availability of substitutes
- Addictiveness of the G/S
- Price of product as % of income
- Time period that product is needed (Emergency = High Price)
TWE’s of PED ?
(1.2.3)
P.E.D
PED is an estimated average and therefore can be incorrect
Types of PED with corresponding numbers ?
(1.2.3)
P.E.D
Perfectly Inelastic = 0
Relatively Inelastic = 0 to -1
Unitary = -1
Relatively Elastic = -1 to infinity
Perfectly Elastic = infinity
Define Unitary elasticity ?
(1.2.3)
P.E.D
This is when a change in demand is directly proportional to a change in price
Why is PED useful to government ?
(1.2.3)
P.E.D
The government will seek to reduce consumption of G/S with high private cost or negative externalities
If such products are inelastic the government will need to add a high priced tax to promote change
Opposite for G/S with high private benefit and positive externalities
Define cross elasticity of demand (XED) ?
(1.2.3)
X.E.D
Define substitute goods ?
(1.2.3)
X.E.D
As the price of one good increases the demand of another will increase
Subsitutes = positive number
Define Complementary goods ?
(1.2.3)
X.E.D
As the price for good Y increases the demand for good x falls
Complementary = negative number
What would an XED of 0 mean ?
(1.2.3)
X.E.D
The goods are independant of eachother and therfore dont affect one another
Define income elasticity of demand (YED) ?
(1.2.3)
Y.E.D
What is a inferior good ?
(1.2.3)
Y.E.D
A good whose demand drops when people’s incomes rise
Inferior = Negative number = <0
What is a normal good ?
(1.2.3)
Y.E.D
A good whose demand increases with an increase in income
Normal = Positive numbers
Normal inelastic = 0-1
Luxury = 1 to inifinity
What is a luxury good ?
(1.2.3)
Y.E.D
YED of over 1 = luxury item
What is another term for a luxury good?
(1.2.3)
Y.E.D
Elastic Normal Good - 1 to Infinity
What is supply?
(1.2.4)
Supply Theory
Supply refers to the amount that producers are willing and able to sell at any given price in a given period of time.
2 reasons why supply curves are upward sloping?
(1.2.4)
Supply Theory
- The supply curve is upward sloping to show that the suppliers increase their supply of a good when the price increases
- The law of supply shows supplier’s behavior who moves the supply of a good in the same direction as the change in the price of a good when other factors are constant.
Illustrate an extension in supply / what would cause it
(1.2.4)
Supply Theory
Increase in :
Productivity
Indirect Tax
Number of firms
Tech
Subsidy
Weather
Costs
Illustrate a contraction in supply / what would cause it
(1.2.4)
Supply Theory
Decrease In:
PINTSWC Factors
What does PINTSWC stand for
(1.2.4)
Supply Theory
Productivity
Indirect Tax
Number of Firms
Tech
Subsidy
Weather
Costs
What is the definition of PES & The formula
(1.2.5)
PES Theory
the responsiveness of quantity supplied to a change in price.
PES=
% change in Quantity Supplied
% change in Price
Factors that influence PES
(1.2.5)
PES Theory
- Complexity to make
- Time Frame
- Scarcity of raw materials
What are the number ranges that determine the elasticity of PES
(1.2.5)
PES Theory
Answer between 0 & 1 = inelastic PES (less than proportional)
Answer greater than 1 = elastic PES (more than proportional)
What is meant by perfectly elastic, perfectly inelastic & unitary PES
(1.2.5)
PES Theory
Perfectly inelastic = no change in supply at any price
Perfectly elastic = Price fell by any amount, supply falls by 100%
Unitary = answer = 1, directly proportional
Elastic & Inelastic supply curve :
(1.2.5)
PES Theory
Perfectly Elastic Supply Curve
(1.2.5)
PES Theory
What is the economic term for Long Run
(1.2.5)
PES Theory
All FOP are variable
What is the economic term for Short Run
(1.2.5)
PES Theory
at least one FOP is fixed
Perfectly Inelastic Supply Curve
(1.2.5)
PES Theory
What is the equilibrium?
(1.2.6)
Price Determination
Equilibrium is where supply and demand meet
Illustrate equilibrium price and quantity of a product
(1.2.6)
Price Determination
What is a Surplus & What is a Shortage?
(1.2.6)
Price Determination
Shortage = not enough of a G/S to meet demand
Surplus = demand is below the amount that is being produced
Draw a shortage and explain how they are resolved ?
(1.2.6)
Price determination
Shortages are resolved by increasing the price to meet the new high demand
Draw a suplus and explain how it is resolved ?
(1.2.6)
Price Determination
Surpluses are resolved b reducing price to meet the low demand
Explain the signalling function for demand and supply ?
(1.2.7)
Price mechanism
Demand:
When prices increase this signals a G/S is valued by consumers
Supply:
When prices increase this signals that FOP is becoming scarce
Explain the incentive for firms to produce a G/S ?
(1.2.7)
Price mechanism
Firms want to produce high priced G/S in seek of profit maximising
This means exisiting firms may increase output or new firms will enter the market
(Demand)
Explain the rationing function for G/S ?
(1.2.7)
Price mechanism
Some consumers will not be able to afford higher price or not believe G/S is worth higher price
(Supply)
What are the TWE of the price mechanism ?
(1.2.7)
Price mechanism
- If a G/S is to complex to make
- Monopolies have the power to choose qty sold or price set
- Government intervention
Define consumer surplus and producer surplus ?
(1.2.8)
Consumer Surplus & Producer Surplus
CS - The difference between the amount consumers are willing to pay and the price they pay
PS - The difference between the amount producers are willing to sell for and the price they actually receive
Illustrate consumer surplus and producer surplus on a graph ?
(1.2.8)
Consumer Surplus & Producer Surplus
What is a tax ?
(1.2.9)
Tax & Subsidy
A compulsory contribution to state revenue, levied by the government
What is the difference between direct and indirect tax ?
(1.2.9)
Tax & Subsidy
Direct tax is tax placed on an individual whereby money goes straight to the government Ex. Income tax
Indirect tax is a tax placed on G/S that consumers buy whereby money will first go to a third party than the government Ex. VAT
What are the two types of indirect tax ?
(1.2.9)
Tax & Subsidy
Specific - adds a fixed set amount
Ad-valorem - adds a varying amount
Name 3 reasons why the government might want to tax a product ?
(1.2.9)
Tax & Subsidy
- Discouragement of production of harmful goods
- To control inflation
- To raise revenue
Draw a specific tax ?
(1.2.9)
Tax & Subsidy
Draw an ad-valorem tax ?
(1.2.9)
Tax & Subsidy
Why do taxes result in deadweight loss ?
(1.2.9)
Tax & Subsidy
Deadweight loss is the loss of something good economically that occurs because of the tax imposed
Taxes cause this because prevent people from buying a product that costs more than it would before the tax was applied
What is a subsidy ?
(1.2.9)
Tax & Subsidy
Government financial support
Draw a subsidy diagram ?
(1.2.9)
Tax & Subsidy
Why do subsidy’s create dead-weight loss ?
(1.2.9)
Tax & Subsidy
Because total surplus in a market is lower than in a free market, which creates economic inefficiency
What is market failure ?
(1.3.1)
Market Failure
When the price mechanism leads to an insufficient allocation of resources
How do externalities lead to market failure ?
(1.3.1)
Market Failure
Negative externalities = over-consumption of goods with a large private and social cost
Positive externalities = under-consumption of goods with a large private and social benefit
Caused by information failure
What is a public good ?
(1.3.1)
Market Failure
A good that is non-excludable and non-rivalrous
How does the under provision of public goods cause market failure ?
(1.3.1)
Market Failure
Firms are profit maximising and will not produce public goods as they present no profit incentive
Some goods have a high private and external cost if they do not exist
If the government feels the good/service is in society’s best interest they will pay for the good/service to be put in place
How do informtion gaps lead to market failure ?
(1.3.1)
Market Failure
when consumers are unaware of the full private benefit or cost of a good/service the decision made on the good/service is likely to be inneficient
What is an external benefit and external cost ?
(1.3.2)
Externalities Theory
External benefit = When a 3rd party is impacted by the comsumption (social benefit > private benefit)
External cost = When a 3rd party is impacted by the consumption/prodcution (social cost > private cost)
What is a social benefit and social cost ?
(1.3.2)
Externalities Theory
Social benefit = private benefit + external benefit
Social cost = private cost + external cost
Draw a negative externalities diagram ?
(1.3.2)
Externalities Theory
Draw a positive externalities diagram ?
(1.3.2)
Externalities Theory
What are the 2 characteristics of a public good ?
(1.3.3)
Public Goods
Non-excludable
Non-rivalrous
If a good does not have both or only one it is a private good
What does non-excludable and non-rivalrous mean ?
(1.3.3)
Public Goods
Non-excludable - Once a good is provided it is impossible to stop people from using it
Non-rivalrous - The consumption of a good by one person will not prevent anothers ability to consume the good
What is the free rider problem ?
(1.3.3)
Public Goods
Where consumers will benefit from a product without paying for it
What is a quasi public good ?
(1.3.3)
Public Goods
A good that is semi-non-rival and semi-non-excludable
Argues that some public goods may not be pure
Technology has found ways to privatize goods ex - toll roads
What is asymmetric information ?
(1.3.4)
Information Gaps
When one economic agents know more than another or information is incomplete/imperfect
Why does asymmetric information lead to market failure ?
(1.3.4)
Information Gaps
Over consmuption of G/S with high preivate cost = irrational and insufficient allocation of resources
What is maximum pricing ?
(1.4.1)
Maximum Pricing
Where a firm is not allowed to charge above the set price cap
has to be set underneath ‘e’
Give 2 reasons why a government would set a maximum pricing ?
(1.4.1)
Maximum Pricing
The G/S is considered an essential item
Monopolies are abusing there power
Draw a maximum pricing diagram ?
(1.4.1)
Maximum Pricing
Give 2 disadvantages of maximum pricing ?
(1.4.1)
Maximum Pricing
Leads to a shortage = No profit incentive to produce G/S = innefficient
Leads to lack of investment into a market = couls result in black market trade
Give 2 advantages of Maximum Pricing ?
(1.4.1)
Maximum Pricing
Maximum pricing is very reactive to a problem
Makes markets more competitive = if monopolies are abusing power
What is a minimum price ?
(1.4.1)
Minimum Pricing
legally-imposed price floors
Why do governments set minimum pricing ?
(1.4.1)
Minimum Pricing
To stop consumption of goods with high private cost
Draw a minimum price diagram ?
(1.4.1)
Minimum Pricing
What are the disadvantages of minimum pricing ?
(1.4.1)
Minimum Pricing
Harms low income groups the most
Creates a black market
Increasing the rate of tax is better = polluter pays principle
What is a pollution permit ?
(1.4.1)
Tradeable Pollution Permits
The government decides desired level of pollution and then releases permits
Draw a pollution permits diagram ?
(1.4.1)
Tradeable Pollution Permits
How do pollution permits reduce negative externalities ?
(1.4.1)
Tradeable Pollution Permits
Restricts supply = (MPB=MSC)
What are the advantages of pollution permits ?
(1.4.1)
Tradeable Pollution Permits
- Gradual reductions in permits = reduce CO2
- Potentially global solution
- Will lead to firms increasing productive efficiency so they can increase their profit margins
What are the TWE’s of pollution permits ?
(1.4.1)
Tradeable Pollution Permits
- Difficult to know how many permits to provide
- Difficult to measure pollution levels
How are state provisions funded ?
(1.4.1)
State Provision of G/S
Tax revenue
Why do the government provide G/S ?
(1.4.1)
State Provision of G/S
When left to the market G/S are underconsumed due to the free rider problem
Leads to MF whereby MSB doesnt equal MSC
What are the TWE’s of state provision ?
(1.4.1)
State Provision of G/S
- MF can occur through inefficent allocation of resources
- Higher tax rates for all = to fund projects
- Information failure from government can limit the effectivness
How does regulation effect the market for G/S with negative externalities ?
(1.4.1)
Regulation
What are the advantages of regulation ?
(1.4.1)
Regulation
- Often simple to understand
- Can eliminate whole markets
- It is fairer than taxes
What are the disadvantages of regulation ?
(1.4.1)
Regulation
- Risk of government failure
of tax receipts - Could lead to black markets
What are the advantages of tax
(1.4.1)
Tax
- Polluter pays principle
- Tax revenue
- Promotes innovation to avoid tax
What are the disadvantages of tax ?
(1.4.1)
Tax
- Lower income groups pay higher percentage of wealth
- Consumers may seek substitute G/S = Black market
3.
What is government failure ?
(1.4.2)
Government Failure
Government intervention to correct market failure leads to a more innneficient allocation of resources
What are the types of government failure ?
(1.4.2)
Government Failure
- Distortion of price mechanism
- Unintended consequences
- Excessive administrative cost
- Information gaps
