Theme 1.2 Flashcards
What do consumers aim to maximise when making economic decisions?
Utility
What do firms aim to maximise when making economic decisions?
Profits
Define utility in the context of economics.
The total satisfaction received from consuming a good or service.
What is the first step in the rational decision-making process?
Identify the problem
List the steps in the rational decision-making process.
- Identify the problem
- Find and identify the decision criteria
- Weigh the criteria
- Generate alternatives
- Evaluate alternative options
- Choose the best alternative
- Carry out the decision
- Evaluate the decision
True or False: Intuition in decision-making relies on facts.
False
What is demand?
The quantity of a good or service that consumers are able and willing to buy at a given price during a given period of time.
How does demand generally vary with price?
The lower the price, the more demand increases.
What mnemonic can be used to remember the factors that shift the demand curve?
PIRATES
What does the ‘P’ in PIRATES stand for?
Population
What does the ‘I’ in PIRATES stand for?
Income
What are substitutes in the context of related goods?
Goods that can replace another good.
What are complements in the context of related goods?
Goods that are consumed together.
What is derived demand?
When the demand for one good is linked to the demand for a related good.
What is composite demand?
When the good demanded has more than one use.
What is joint demand?
When goods are bought together.
What does the law of diminishing marginal utility state?
As an extra unit of the good is consumed, the marginal utility falls.
Define Price Elasticity of Demand (PED).
The responsiveness of a change in demand to a change in price.
What indicates a price elastic good?
PED > 1
What indicates a price inelastic good?
PED < 1
What is a unitary elastic good?
PED = 1
What is a perfectly inelastic good?
PED = 0
What is a perfectly elastic good?
PED = infinity
List the factors influencing Price Elasticity of Demand (PED).
- Necessity
- Substitutes
- Addictiveness or habitual consumption
- Proportion of income spent on the good
- Durability of the good
- Peak and off-peak demand
What is the tax burden on consumers for inelastic goods?
Most of the tax burden falls on consumers.
What is a subsidy?
A payment from the government to firms to encourage production and lower average costs.
What is total revenue (TR)?
Total revenue is equal to average price times quantity sold (TR = P x Q).
What happens to total revenue if a firm raises the price of an inelastic good?
Total revenue increases.
What happens to total revenue if a firm raises the price of an elastic good?
Total revenue decreases.
Define Income Elasticity of Demand (YED).
The responsiveness of a change in demand to a change in income.
What are inferior goods?
Goods that see a fall in demand as income increases (YED < 0).
What are normal goods?
Goods for which demand increases as income increases (YED > 0).
What are luxury goods?
Goods for which an increase in income causes an even bigger increase in demand (YED > 1).
Define Cross Elasticity of Demand (XED).
The responsiveness of a change in demand of one good to a change in price of another good.
What is the XED for complementary goods?
Negative XED
What is the XED for substitute goods?
Positive XED
Define supply in economics.
The quantity of a good or service that a producer is able and willing to supply at a given price during a given period of time.
What is the shape of supply curves?
Upward sloping
List the factors that shift the supply curve using the mnemonic PINTSWC.
- Productivity
- Indirect taxes
- Number of firms
- Technology
- Subsidies
- Weather
- Costs of production
What is joint supply?
When increasing the supply of one good causes an increase or decrease in the supply of another good.
Define Price Elasticity of Supply (PES).
The responsiveness of a change in supply to a change in price.
What indicates an elastic supply?
PES > 1
What indicates an inelastic supply?
PES < 1
What is a perfectly inelastic supply?
PES = 0
What is a perfectly elastic supply?
PES = infinity
List the factors influencing Price Elasticity of Supply (PES).
- Time scale
- Spare capacity
- Level of stocks
- How substitutable factors are
- Barriers to entry to the market
What is the price mechanism?
The process that determines the market price and allocates resources in a free market economy.
List the three main functions of the price mechanism.
- Rationing
- Incentive
- Signalling
Define consumer surplus.
The difference between the price the consumer is willing and able to pay and the price they actually pay.
How does the law of diminishing marginal utility affect consumer surplus?
Consumer surplus generally declines with extra units consumed.
Define producer surplus.
The difference between the price the producer is willing to charge and the price they actually charge.
What is economic welfare?
The total benefit society receives from an economic transaction.
What are indirect taxes?
Taxes imposed by the government that increase production costs.
What is the difference between the price the producer is willing to charge and the price they actually charge?
It is the private benefit gained by the producer that covers their costs, measured by profit.
This area is always below the market price and above the supply curve.
What is Economic Welfare?
The total benefit society receives from an economic transaction, calculated by the area of producer surplus and consumer surplus added together.
The sum of consumer surplus and producer surplus is known as community surplus.
What are Indirect Taxes?
Taxes imposed by the government that increase production costs for producers, leading to less supply and higher market prices.
This results in a contraction of demand.
What are Ad valorem taxes?
Taxes that are percentages of the unit price, such as VAT, which adds 20% of the unit price.
This is the main indirect tax in the UK.
What are Specific taxes?
Taxes that are a set amount per unit, such as the 58p per litre fuel duty on unleaded petrol.
If demand is more elastic (PED>1), who bears the incidence of the tax?
The supplier.
If demand is more inelastic (PED<1), who bears the incidence of the tax?
The consumer.
What is a subsidy?
A payment from the government to a producer to lower their costs of production and encourage increased production.
What are some effects of subsidies?
Subsidies can:
* Increase output and lower prices for consumers
* Increase employment rates
* Reduce inequality in society
* Help control inflation
* Boost demand during economic decline
* Encourage consumption of merit goods
* Increase long run aggregate supply if aimed at capital projects
* Cause government failure if inefficient
* Have opportunity costs
* Be funded by taxpayers, who may not benefit directly
* Have a large effect on equilibrium price if demand is price inelastic.
What does it mean for consumers to act rationally?
Making a decision that results in the most optimal level of utility or benefit.
Who is Homo Economicus?
The rational consumer who is a utility maximiser and makes rational decisions.
What influence does other people’s behaviour have on consumers?
It creates a bias within the consumer and encourages them to act against their own best interests due to social pressure.
How does habitual behaviour affect consumer decisions?
It reduces decision-making time and creates a barrier to considering alternatives, leading to irrational actions.
What is consumer weakness at computation?
The inability to exercise self-control in decision-making, often leading to procrastination and irrational choices.
What does the law of diminishing marginal utility suggest?
Every extra unit consumed provides a smaller benefit to the consumer.
