Theme 1 (textbook) Flashcards
Define ceteris paribus
All other things being equal
What is a positive statement
A statement that is about facts and is testable
What is a normative statement
A statement that involves a value judgement about what ought to be
Define scarcity
A situation that arises when people have unlimited wants in the face of limited resources
Define free goods
Goods such as the earth’s atmosphere that are not normally regarded as being scarce
Define economic goods
Goods that are scarce
Define opportunity cost
The value of the next-best alternative forgone
Who are the 3 key economic agents
Consumers
Producers
Government
What are the 4 factors of production
Land
Labour
Capital
Enterprise
What are the rewards for each factor of production
Land - rent
Labour - wages
Capital - interest
Enterprise - profit
What is the difference between renewable and non-renewable resources
Renewable - natural resources that can be replenished
Non renewable - natural resources that once used cannot be replenished
Give 2 examples of renewable resources and non-renewable resources
Renewable - forests that can be replanted, solar energy
Non-renewable - coal, oil
What is a production possibility frontier
A curve showing the maximum combinations of goods and services that can be produced in a given period
Define a trade-off
A situation in which the choice of one alternative requires the sacrifice of another
Define capital goods and give 2 examples
Goods used for the production process
Machinery or factory builidings
Define consumer goods
Goods produced for present use
Define economic growth
An expansion in the productive capacity of the economy
Define GDP
A measure of the economic activity carried out in an economy over a period
Define division of labour
A process whereby production is broken down into a sequence of stages
Workers are assigned to a particular stage
Define specialisation
The process of focusing production on a specific task or area
Advantages of division of labour
Increase in productivity
Decrease in cost of production
Overall output increased
Disadvantages of division of labour
Workers find task tedious and become bored and careless
Increase in staff turnover
Team of workers become inflexible (if a worker is ill it is difficult to find cover)
5 functions of money
Medium of exchange
Unit of account
Store of value
Measure of value
Method of deferred payment
Define a free market economy
An economy in which market forces are allowed to guide the allocation of resources
Define a command economy
An economy in which decisions on resource allocation are made by the state
Define a mixed economy
An economy in which resources are allocated partly through price signals and partly by intervention by the state
Define rational consumers
Consumers maximising utility
Define rational producers
Aiming to maximise profits
Define profit
The total revenue a firm receives from selling its product minus the total cost of producing it
Define demand
The quantity of a good or service that consumers are willing and able to buy at any given price in a given period of time
Define diminishing marginal utility
The situation where an individual gains less additional utility from consuming a product, the more it is consumed
Define the law of demand
There is an inverse relationship between quantity demanded and the price of a good or service
Why is the demand curve downward sloping
There is an inverse relationship between price and quantity demand
What factors influence demand
Price of the good
Price of other goods
Income
Consumer preferences
Movements along vs. Shifts in the demand curve
Movement - change in price
Shift - non-price factors
Define normal good and give an example
Where the quantity demanded increases in response to an increase in consumer income
Holidays abroad
Define inferior good and give an example
Where the quantity demanded decreases in response to an increase in consumer income
Public transport
Define a substitute good
Demand for one good increases if the price for the other good rises
Define a complement good
An increase in price for one good causes the demand for another good to fall
Define PED and give the formula
Measures the sensitivity of quantity demanded to a change in the price of a good or service
% change in QD / % change in price
Define price elastic
When a change in price leads to a more than proportionate change in demand
1 <PED< infinity
Define price inelastic
When a change in price leads to a less than proportionate change in demand
0 <PED< 1
Define unitary elastic
Elasticity = -1
Why may firms be interested to know their price elasticity of demand
It shows how a change in price will affect their total revenue
PED = 0
Demand is perfectly inelastic
PED is between 0 and -1
Demand is price inelastic
PED = -1
Demand is unit price elastic
PED is between -1 and infinity
Demand is price elastic
PED = infinity
Demand is perfectly elastic
4 factors influencing PED
Availability of substitutes
Wether an individual regards the good as a necessity or as a luxury item
% of income the good or service takes up
Time period
What is the elasticity of demand like in the long run
Elastic
Define income elasticity of demand and give the formula
Measures the sensitivity of quantity demanded to a change in consumer income
% change in Quantity demanded / % change in consumer income
Define normal good
As income rises, consumers spend proportionally less on the good
0 <YED< 1
Define luxury good
As income rises, consumers spend proportionally more on the good
1 <YED
Define cross elasticity of demand and give the formula
Measures the sensitivity of quantity demanded of a good or service to a change in price of another good or service
% change in QD of good X / % change in price of good Y
XED is negative
Complement good
XED is positive
Substitute good
Define supply
The quantity of a good or service that producers are willing and able to sell at any given price in a given period of time
4 factors that influence supply
Productions costs
Technology of production
Taxes and subsidies
Number of firms operating in the market
Movements along vs. Shifts in the supply curve
Movement - change in market price
Shift - non-price factors
Define price elasticity of supply
A measure of the sensitivity of quantity supplied of a good or service to change in the price
PES= % change in QS / % change in price
Price elastic supply
Where the PES>1
Define excess supply
A situation in which the quantity that firms are willing and able to supply exceeds the quantity that consumers wish to demand at the going price
What causes excess supply
Price is set at a level that exceeds the value that most consumers place on a good/service, so they will not buy it
Define excess demand
A situation in which the quantity that consumers wish to demand at the going price exceeds the quantity that firms are willing and able to supply
What causes excess demand
Consumers want to buy more of the good/service at the lower price which firms are not willing and able to supply at
Define market equilibrium
When the price is such that the quantity demanded by consumers is equal to the quantity supplied by firms
5 factors that change the market equilibrium
(1 movement, 4 shifts)
Movements along the demand and supply curve:
Price adjustments
Shift in the demand and supply curves:
Change in consumer preferences
Change in price of substitute
Improvement in technology
Increase in labour costs
Define consumer surplus
The value that consumers gain from consuming a good or service over and above the price paid
Define marginal social benefit (MSB)
The additional benefit society gains from consuming an extra unit of good
What will a price increase do to consumer surplus
Reduce overall size of consumer surplus
Affect the welfare that society receives from consuming the good
Define producer surplus
The difference between the price received by firms for a good/service and the price at which they would have been prepared to supply at
How will an increase in demand affect the size of consumer surplus
Demand increases = extension in supply
Both consumers and producers now receive a higher surplus
Define price mechanism
Resource allocation is influenced through rationing, incentives and signalling
Define price signal
The price of a good carries information to producers or consumers that guides the market towards equilibrium and assists resource allocation
Define marginal cost
The cost of producing an additional unit of output
What is the incentive function
Through choices consumers send information to producers about their changing nature of wants and needs
What is the rationing function
When there is a shortage of a product, price will rise and deter some consumers from buying the product
What is the signalling function
Changes in price provides information to both producers and consumers about changes in market conditions
Define indirect tax
A tax levied on expenditure on goods or services
E.g VAT
Paid by seller so affects supply curve
Define specific tax
A sales tax that is set at a constant amount per unit of sales
Define incidence of a tax
The burden of paying a sales tax is divided between buyers and sellers
Define ad valorem tax
A sales tax is set at a percentage of the price
What factor determines the incidence of the tax
Price elasticity of demand
If demand is perfectly inelastic, sellers can pass whole burden of tax on to buyers through an increase in price equal to the value of the tax
How is the supply curve affected by an ad valorem tax
Supply curve steepens
Define subsidy
A grant given by the government to producers to encourage production of a good or service
Define habitual behaviour
Consumers persist in acting in a particular way even when conditions have changed
Define herding
People take decisions based on actions of others
Define market failure
The market equilibrium does not lead to socially optimal allocation of resources
Define externality
A cost or benefit that is external to a market transaction, and is thus not reflected in market prices
How does a subsidy create an opportunity cost
The economic and social case should be judged carefully on the grounds of efficiency and fairness
How does an externality lead to market failure
The costs firms face and price they set
Do not fully reflect actual costs and benefits of production and consumption of that good
Price does not = ‘true’ marginal cost
How do information gaps lead to market failure
Consumers may not fully perceive benefits costs/benefits of consuming a good/service
Cannot truly determine their willingness to consume
Leads to over/under consumption of harmful/beneficial goods/services
Examples of information gaps leading to market failure
Benefits of education not fully perceived
Harmfulness of smoking tobacco not fully perceived
Define private cost
Cost incurred by a producer/consumer as part of a good’s production or consumption
Define external cost
Cost caused by production or consumption
Borne by 3rd party
Not reflected in market prices
Define marginal social cost (MSC)
Cost to society of producing an extra unit of a good
What is represented/similar to the demand curve on an externality diagram
Marginal social benefit (MSB)
Which two curve’s are upward sloping on an externality diagram
Marginal social cost (MSC)
Marginal private cost (MPC)
How is global warming/climate change a negative production externality
Developed countries with transport and industry produce lot’s of pollution
Poorer countries suffer consequences too
E.g Bangladesh prone to severe flooding every year
Application example for correction of externality caused by global warming/climate change
In 1997
Almost every country agreed to cut greenhouse gas emissions by 6%
By 2010
Give an example of a positive consumption externality and explain
Education
Skilled workers can cooperate with each other
Improves productivity
Society gains social benefit
Define net welfare loss
Excess of social cost over social benefits for a given output
Define net welfare gain
Excess of social benefits over social costs for a given output
Define non-excludable
It is not possible to provide a product for one person without allowing others to consume it
Define non-rivalrous
One person’s consumption does not prevent others from consuming it
Define public good
A good that is non-excludable and non-rivalrous
Define free-rider problem
When an individual cannot be excluded from consumption so has no incentive to pay for its provision
Define symmetric information
All participants in a market have the same information about market conditions
Define asymmetric information
Some participants in a market have better information than others about market conditions
Define moral hazard
A person who has taken out insurance is prone to taking more risk
Define regulation
Intervention to tackle market failure by direct action to command and control behaviour
Define tradable pollution permit
Controlling pollution based on a market for permits that allow firms to pollute up to a limit
Advantages of a tradable pollution permit
Firms will have an incentive not to pollute
Overall level of pollution can be controlled by government
Disadvantages of a tradable pollution permit
Must be sanctions in place for firms who pollute beyond permitted level
Firms who can afford to buy permits can pollute as much as they want
