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Microeconomics > Theme 1 Topic 2 > Flashcards

Theme 1 Topic 2 Flashcards

1
Q

What are the 2 underlying assumptions of rational economic decision making?

A
  1. Consumers aim to maximise utility
  2. Firms aim to maximise profits
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2
Q

What is maximisation?

A

When an economic agent tries to obtain the most that they can from the economic activity that they undertake.

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3
Q

What are economic objectives?

A

The use of resources in order to meet the goals of an economic agent over a long period of time.

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4
Q

What are the economic objectives of households? (2)

A
  1. The maximisation of private benefits from consumption.
  2. The maximisation of private benefits from working.
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5
Q

What are private benefits?

A

Accrue to an individual or firm through economic activity.

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6
Q

What are the 4 ways in which firms behave rationally?

A
  1. Profit maximisation
  2. Profit satisficing
  3. Sales maximisation
  4. Growth
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7
Q

What is demand?

A

The quantity that purchasers are willing and able to buy at a given price in each period of time.

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8
Q

What does the law of demand state?

A

Demand varies inversely with price.

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9
Q

What is a complementary good?

A

Products which are used together and are bought alongside another good.

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10
Q

What is a substitute good?

A

A product that can be used in the place of another. This creates competition.

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11
Q

Why is the demand curve downward sloping? (3)

A
  1. Substitution effect
  2. Income effect
  3. Diminishing marginal utility
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12
Q

What is marginal utility?

A

The extra satisfaction (utility) gained from consuming an additional unit of a good/service.

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13
Q

What is a demand curve?

A

Shows what the quantity demanded of a good will be at a given price.

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14
Q

What is a fall in price called on the demand curve?

A

Expansion in demand

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15
Q

What is a rise in price called on the demand curve?

A

Contraction in demand

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16
Q

What is the abbreviation for the influencing factors on demand?

A

F.L.A.T. S.C.I.P.

F= FASHION
L= LEGISLATION
A= ADVERTISING
T= TAX
S= SUBSTITUTE
C= COMPLEMENTARY
I= INCOME
P= POPULATION

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17
Q

If there is an increase in demand which way does the curve shift?

A

To the right

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18
Q

If there is a decrease in demand which way does the curve shift?

A

To the left

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19
Q

What is the price elasticity of demand?

A

PED is a measure of how responsive demand is to a change in price.

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20
Q

What is elastic coefficient?

A

A measure of the response of one variable to changes in another variable.

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21
Q

What is the PED equation?

A

PED = % change in demand / % change in price

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22
Q

What elastic coefficients present inelasticity?

A

Between 0 and 1 (or -1)

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23
Q

What elastic coefficients present elasticity?

A

Between 1 and infinity

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24
Q

What is unitary elasticity?

A

Constant elasticity

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25
Q

What are the 3 determinants of price elasticity of demand?

A
  1. Substitutes
  2. Time
  3. Definition of the market
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26
Q

What is income elasticity of demand?

A

YED is a measure of the responsiveness of demand to a change in income.

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27
Q

What is the formula for YED?

A

YED = % change in quantity demanded / % change in income

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28
Q

How is income inelasticity presented by a YED?

A

-1 < +1 (demand changes at a lower proportion than the increase in income)

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29
Q

How is income elasticity presented by a YED?

A

< -1 or > +1 (demand changes at a higher proportion than the increase in income)

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30
Q

What is a normal good in terms of elasticity of demand?

A

Demand increases when incomes increase. Always have a positive income of elasticity of demand.

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31
Q

What is an inferior good in terms of elasticity of demand?

A

Demand decreases when incomes increase. Always have a negative income of elasticity of demand.

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32
Q

What are the 2 types of normal goods?

A
  1. Necessities (positive YED between 0-1)
  2. Luxuries (positive YED greater than 1)
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33
Q

What does relative inelasticity depend on?

A

It depends on how necessary the product is to the consumer

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34
Q

What are the determinants of income elasticity of demand?

A
  1. Whether the good is necessary or luxury
  2. The level of income of a consumer
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35
Q

What are the 3 abbreviations for price elasticity of demand, income elasticity of demand, and cross elasticity of demand?

A

price elasticity = PED
income elasticity = YED
cross elasticity = XED

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36
Q

How is YED relevant to firms?

A
  1. In terms of standards of living
  2. In terms of the economic cycle
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37
Q

What is cross elasticity of demand?

A

(XED) is a measure of the responsiveness of demand for one good (x) to a change in price of another good (y)

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38
Q

What is the co efficient for cross price inelastic?

A

-1 to 1 (demand for good x changes at a lesser proportion than the change in price of good y)

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39
Q

What is the co efficient for cross price elastic?

A

<-1 or >+1 (demand for good x changes at a greater proportion than the change in price of good y)

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40
Q

What are the 3 determinants of cross elasticity of demand?

A
  1. Substitute goods
  2. Complementary goods
  3. No relationship
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41
Q

How do firms try to change the XED of their products?

A
  1. substitute : firms will try to differentiate their products from competitors
  2. complementary : firms will produce a range of complements to accompany their main products
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42
Q

How does price elasticity influence government tax and subsidies?

A

If demand for a good is price elastic there will be a decrease in demand if a tax is imposed, and a large increase if there is a subsidy

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43
Q

How does price inelasticity influence government tax and subsidies?

A

If demand for a good is price inelastic, there will be little change if a tax is imposed. Government revenue will increase. A subsidy on these goods would see little change in demand but a large fall in price and consumers would benefit.

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44
Q

What is supply?

A

The amount of a good that producers are willing and able to sell at any given price.

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45
Q

What are the 6 factors that influence supply?

A
  1. Price of the good
  2. Changing costs of production
  3. New Technology
  4. Price of other goods and services
  5. Government policy (tax, subsidy)
  6. Other factors (expectations)
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46
Q

Which factor causes movement along the curve (no shift)

A

Price of the good

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47
Q

Which factors cause a shift along the supply curve?

A
  1. Changing costs of production
  2. New Technology
  3. Government policy (tax, subsidy)
  4. Other factors (expectations, weather)
  5. Number of firms (more firms, more supply)
  6. Productivity (more productive, more supply)
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48
Q

What relationship do price and supply have?

A

A positive relationship

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49
Q

If supply increases, which way does the curve shift?

A

To the right

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50
Q

If supply decreases, which way does the curve shift?

A

To the left.

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51
Q

What is a specific tax?

A

It is a set amount per unit.

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52
Q

How does the supply curve shift for a specific tax?

A

A parallel shift

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53
Q

What is an ad valorem tax?

A

It is a percentage of the price of the good. As the price of the good increases, the tax set increases.

54
Q

How does the supply curve shift for an ad valorem tax?

A

Shifts upwards whilst also tilting.

55
Q

what is price elasticity of supply / PES ?

A

A measure of the responsiveness of supply to a change in price.

56
Q

What is the PES formula ?

A

PES = % change in quantity supplied / % change in price

57
Q

How is something perfectly inelastic in terms of PES ?

A

If price was to change, the quantity supplied would not be affected. The firm would supply the same amount at any given price.

58
Q

How is something relatively price inelastic in terms of PES ?

A

If price was to change, the quantity supplied would change by a lesser amount. This may be difficult if the incentive to increase supply is not great enough for firms.

59
Q

How is something perfectly elastic in terms of PES ?

A

If price was to stay the same or increase, the quantity supplied would be infinite. If price was to decrease, the quantity supplied would fall to 0.

60
Q

How is something relatively price elastic in terms of PES ?

A

If the price was to change, the quantity supplied would change by a greater amount. The incentive to increase supply has become greater.

61
Q

What are the 3 determinants of PES ?

A
  1. Price : if prices are higher, firms are more profitable as the contribution per unit is higher
  2. Time : short run : price inelastic long run : price elastic
  3. Substitutes : if it is easy for a firm to change production of its products, then PES is likely to be very price elastic. The higher the PES, the easier it is to switch
62
Q

What XED coefficient does a substitue good have?

A

+ (closer substitutes have a higher xed)

63
Q

What XED coefficient does a complementary good have?

A
  • (close complements have a higher xed)
64
Q

What is market equilibrium ?

A

When demand equals supply

65
Q

What is the market clearing price ?

A

When all the products are sold at the price set by the market equilibrium. Any change in demand or supply will lead to a new equilibrium price.

66
Q

How is market equilibrium shown graphically ?

A

At P, demand is equal to supply. All products are sold and no products are left over since the market has been cleared. All of supply has an equal demand.

67
Q

How is excess supply shown graphically ?

A

When price rises to P1. Buyers are demanding less (Q1) at a higher price but firms want to supply more (Q2) at this price. This would cause too much supply (Q1-Q2) in the market). To solve this, firms would need to lower prices to get rid of excess products.

68
Q

How is excess demand shown graphically ?

A

Prices fall to P2. Buyers would demand more (Q2) at the lower price but firms want to supply less (Q1) at this price. This would lead to too much demand (Q2-Q1) in the market. To improve profitability, firms can raise prices to reduce excess demand.

69
Q

How are market forces shown graphically ?

A

They push price towards market equilibrium. Too much supply leads to lower prices, too much demand leads to higher prices. When demand equals supply, we have a market equilibrium price.

70
Q

What is disequilibrium ?

A

An imbalance in the quantity demanded and the quantity supplied of a product.

71
Q

How is a shift in demand shown on a demand-supply curve ?

A

An increase in demand causes the curve to shift upwards and to the right from D to D1. This causes price to rise to P1 and quantity demanded for Q1. A new market equilibrium is reached. The shift in demand has caused movement along the supply curve.

72
Q

How is a shift in supply shown on a demand-supply curve ?

A

An increase in supply causes a shift downwards and to the right from S to S1. This causes price to fall to P1 and quantity supplied to rise to Q1. A new market equilibrium is reached. The shift in supply has led to a movement along the demand curve.

73
Q

If there is an increase/decrease in supply and demand, how is this shown on a demand-supply curve ?

A

Only the S1+D1 and S+D points will intersect.

74
Q

What are economic incentives ?

A

They provide reasons for economic agents to provide goods/services. These include incentives, signalling, rationing. They are based off of price mechanism.

75
Q

What is price mechanism ?

A

The method by which goods and services are achieved.

76
Q

Why does the rationing function occur ?

A

Due to an increase in demand or reduced supply of a product that will lead to higher prices being set.

77
Q

Why does the signalling function occur ?

A

Due to changing prices which give a signal to producers and consumers as to whether to leave or enter a market.

78
Q

Why does the incentive function occur ?

A

Due to a consumer or producer being motivated to a course of action.

79
Q

How does the rationing function work ?

A

Excess demand leads to a rise in price of that good (because of scarcity of the product). This leads to rationing of the product since it’s use is restricted. There will be movement along the demand curve, showing a decrease in demand and an increase in price.

80
Q

How does the incentive function work ?

A

Higher prices act as a motivator for firms to increase the supply of a good (because of contribution per unit). As prices increase, revenue and profits also increase. There will be movement along the supply curve showing an increase in supply and an increase in price.

81
Q

How does the signalling function work ?

A

An increase in price gives an indicator to producers that they should supply more.
An increase in price gives an indicator to consumers that they should decrease demand.
A decrease in price will give an indicator to producers that they should decrease supply.
A decrease in price will give an indication to consumers that they should increase demand.
All of these signals lead to a shift in either the supply or demand curve.

82
Q

What is contribution per unit ?

A

The differences between the selling price and variable cost.

83
Q

What is allocative efficiency ?

A

Where consumer satisfaction is maximised in the production of goods and services. Supply equals demand.

84
Q

What is predictive efficiency ?

A

Where no additional (or maximum) output can be produced from the factor inputs available at the lowest possible average cost.

85
Q

What is economic efficiency ?

A

The maximum amount of goods are made at their minimum cost whilst maximising their benefit to society. Both allocative and productive efficiency occur at the same time.

86
Q

Why is allocative efficiency hard to identify ?

A

We need to match consumer preferences to producer output. (Match supply and demand)

87
Q

What does allocative efficiency take into account ?

A

The desire of consumers.

88
Q

Why don’t markets always operate at the market clearing price ? (2)

A
  1. Excess supply
  2. Excess demand
89
Q

What happens if firms are not willing to pay a higher price for goods and firms reduce supply (in terms of allocating resources) ?

A

Leads to reallocation of the firm’s resource to another use.

90
Q

What happens if firms are not willing to pay a higher price for goods and firms reduce supply (in terms of allocating resources) ?

A

Leads to reallocation of the firm’s resource to another use.

91
Q

What is taxation ?

A

The medium through which governments finance their spending and control the economy. It is a charge imposed on a good/individual/firm.

92
Q

What is an indirect tax ?

A

A tax on a good/service.

93
Q

What is a direct tax ?

A

A tax on an individual or organisation.

94
Q

What is the incidence of tax ?

A

The amount that the consumer/producer will pay for the tax.

95
Q

What is a subsidy ?

A

A financial incentive to produce or consume a given product.

96
Q

How is government revenue from tax calculated ?

A

Consumer tax area + producer tax area

97
Q

What effect does the imposition of an indirect tax have on supply and demand ?

A

This leads to an increase in the cost of supply for a firm, so there is a shift in the supply curve to the LEFT. Quantity supplied will decrease. This also causes price to increase. The incidence of the tax paid for by the producer and consumer will be shown on the graph.

98
Q

What happens if an indirect tax is imposed with a demand that is price inelastic ?

A

The incidence of the tax will be greater for the consumer because demand won’t get greatly affected by a change in price.

99
Q

What happens if an indirect tax is imposed with a demand that is price elastic ?

A

The incidence of the tax will be greater for the producer because they don’t want to lose demand, so they will bear the extra costs.

100
Q

What happens if an indirect tax is imposed with a supply that is price inelastic ?

A

The incidence of tax will be greater for the producer.

101
Q

What happens if an indirect tax is imposed with a supply that is price elastic ?

A

The incidence of tax will be greater for the consumer.

102
Q

How is government expenditure on a subsidy calculated ?

A

Gain to consumer area + gain to producer area

103
Q

What effect does the imposition of a subsidy have on supply and demand ?

A

This leads to a decrease in the cost of supply for a firm. The supply curve will shift to the RIGHT because the quantity supplied will increase. Prices will decrease. The subsidy is shared between the consumer and the producer.

104
Q

What is consumer surplus ?

A

The difference between the price a consumer is willing to pay for a product and the price that they actually pay.

105
Q

How is consumer surplus affected if prices decrease ?

A

Quantity demanded will increase, and consumer surplus will increase. The total consumer surplus will be the 2 areas combined on the demand curve.

106
Q

How is consumer surplus affected in prices increase ?

A

Quantity demanded will decrease, and consumer surplus will decrease. The total consumer surplus will be the smaller area (triangle) below the demand curve.

107
Q

When do you draw consumer surplus, and when do you draw producer surplus ?

A

Consumer : demand curve
Producer : supply curve

108
Q

What is producer surplus ?

A

The difference between the price a producer is willing to supply a product at and the price actually received for the product.

109
Q

How is producer surplus affected if prices increase ?

A

Supply will increase, and producer surplus will increase. The total producer surplus area will be A+B (both triangles combined) above the supply curve .

110
Q

How is producer surplus affected if prices decrease ?

A

Supply will decrease. Producer surplus will decrease. The total producer surplus will be the smaller area/triangle above the supply curve.

111
Q

How is both consumer and producer surplus shown on a supply/demand curve diagram ?

A

Consumer surplus is above, producer surplus on the bottom at the market equilibrium point.

112
Q

How does changes in demand affect consumer surplus ?

A

If demand decreases, consumer surplus decreases. Consumer surplus falls from the bigger triangle to the smaller triangle on the demand curve.

113
Q

How does changes in supply affect producer surplus ?

A

If supply decreases, producer surplus decreases. Producer surplus falls from the bigger triangle to the smaller triangle.

114
Q

What is behavioural economics ?

A

It looks at the psychological reasons behind why people make decisions.

115
Q

What is bounded rationality ?

A

It suggests that when people make decisions, they are limited by the information available to them, their intellectual limitations, the time available to make decisions.

116
Q

What are the 3 limitations for bounded rationality ?

A
  1. The information available to them
  2. Their intellectual limitations
  3. The time available to make decisions
117
Q

What is a social norm ?

A

The rules of behaviour that are considered acceptable within a social group. People who don’t follow the social norms aren’t accepted within the group. This may mean that consumption of a good leads to marginal disutility.

118
Q

What is nudge theory ?

A

An attempt to manipulate social norms through positive reinforcement in a non-coercive manner.

119
Q

What is habitual behaviour ?

A

When people follow the same routines, repeating actions on a regular basis. Some behaviour can be healthy and some can be bad for an individual. Maintaining the status quo means that economic agents may suffer from loss aversion, making decisions based on avoiding loss rather than achieving gain.

120
Q

What is computation ?

A

The ability to make correct decisions based on the information available to them.

121
Q

What is heuristic ?

A

A simple rule that individuals use to make a judgement when undertaking decision-making. They normally focus on one aspect of a problem rather than looking at all the information available. So decision making is flawed.

122
Q

Who named the 3 heuristics that can lead to irrational behaviour by individuals ?

A

Tversky and Kahneman

123
Q

What are the 3 heuristics that lead to irrational behaviour by individuals ?

A
  1. Availability
  2. Representativeness
  3. Anchoring and adjustment
124
Q

What is availability (heuristic) ?

A

Making judgements based on events we can remember rather than the information at hand.

125
Q

What is representativeness (heuristic) ?

A

Categorising based on past information rather than on the information at hand.

126
Q

What is Anchoring and adjustment (heuristic) ?

A

Using an arbitrary starting number to estimate a different number. The starting number is the anchor and we tend to adjust an answer to be close to the anchor.

127
Q

What is the abbreviation for the factors that cause a shift in the supply curve ?

A

P= productivity
I= indirect taxes
N= number of firms
T=technology
S= subsidies
W= weather / expectations
C= changing costs of production

128
Q

In what ways can firms make supply more price elastic ?

A

P : production lag
S : stocks
S : spare capacity
S : substitutes
T : time

129
Q

In what ways can firms make supply more price elastic ?

A

P : production lag
S : stocks
S : spare capacity
S : substitutes
T : time

130
Q

What are problems with elasticities ? (3)

A
  1. Elasticity figures are only estimates (surveys, past data)
  2. We are assuming ceteris paribus (other factors)
  3. PED varies along the demand curve (they can’t keep changing prices and expect the same amount each time)
131
Q

What is the abbreviation for complementary and substitute goods in terms of XED ?

A

Party = positive
Season = substitute
Near = negative
Christmas = complementary

132
Q

What is productivity of labour ?

A

output per worker per time period

Microeconomics (4 decks)

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