Theme one Flashcards
What is the definition of micro economics
Economics concerned with single factors and the effects of individual decisions - buisnesses
What is macro economics
Economics concerned with large scale or general economic factors, such as interest rates and productivity - government
What is the definition of demand
The quantity of a good or service that consumers are willing and able to buy at a given price in a given time period
What is the law of demand
As price increases, quantity decreases, they have an inversely proportional relationship
What is the opportunity cost
The value of the next best alternative forgone when a choice is made
What is the definition of supply
The quantity of a good/ service producers are willing and able to produce at a given price in a given time period
What is the law of supply
As price increases, quantity increases, they have a directly proportional relationship
What happens when we increase quantity produced and why
The price of the product will increase as increasing price is necessary to maintain profit margins
What can we see from Production possibility curves/ production possibility frontiers
Maximum possible production within given factors of production and various combinations of two goods/ services that can be produced
What are the factors that affect demand?
Population (directly proportional relationship)
Advertising (directly proportional relationship)
Substitutes price (other businesses increasing price will increase demand)
Income
Fashion/ tastes
Interest rates (If interest rates decrease consumers are more likely to buy luxury goods)
Complements price ( printers + printer ink)
What are normal goods
Cars, eating at restaurants
What are inferior goods
Fast food or public transport
What are the factors of production
Capital (machines and tractors, man made)
Enterprise (entrepreneurs, people at the top)
Land
Labour
What does a linear PPF show
Constant opportunity cost
What does a concave PPF show
Increasing opportunity cost
What is productive efficiency
Using all the factors of production to the maximum availability, this can be seen at any point on the curve
What are some ways businesses could increase production of a product
Reallocate factors of production so there is more focus on the desired product
Increase quality/ quantity of factors of production, this will positively affect both goods. They could also do this for just one of the products
What is the term which means all other factors remain unchanged?
Ceteris parabus
What is increasing the price known as?
Contraction of demand
What is decreasing the price known as?
Extension of demand
What is Pareto efficiency?
The idea that no one can be made better off without making someone else worse off
What is productive efficiency?
Using up all the factors of production to their maximum level
What are the factors which affect supply
Productivity (output per worker/ per machine per hour)
Indirect tax (tax on production)
Number of firms (how many of the same business)
Technology
Subsidy (money grant given by the government)
Weather (agricultural businesses)
Cost of production
(oil, raw materials, gas, electricity, rent)
What is the definition of a market?
Any place where buyers meet suppliers to exchange goods or services
What is equilibrium
Where demand and supply are equal
What does it mean if someone says the market is clear
The market is at equilibrium
What is a free market
A market without intervention from the government
How does the price mechanism work if the price is too high?
A signal is sent to producers that the price is too high, this can be seen through empty tables, fully stocked shelves etc. They are given an incentive to lower their prices, the supply and demand are now at a perfect equilibrium.
How does the price mechanism work if the price is too low
A signal is sent to producers, seen by competition between buyers, long queues or huge waiting lists. Producers will raise their price, supply and demand are now at a perfect equilibrium
What are the four functions of the price mechanism
Allocate recourses effectively by creating equilibrium, demand is now at the same level as supply (4)
Rationing excess supply/ demand by encouraging or discouraging consumption, raising the price lowers demand, lowering the price raises demand (3)
Sending a signal to producers that prices are too high/ low (1)
Incentivise to change price and increase profit (2)
What is excess supply?
If supply is greater than demand, the excess is the amount extra that there is
Where can we see equilibrium on a demand/ supply and price graph
At the point where demand and supply are the same
What is consumer surplus?
The difference between the price consumers are willing and able to pay for a product and the price they actually pay
How do we calculate consumer surplus
The area below the demand curve and above the price line
What happens to consumer surplus as price is decreased?
Consumer surplus increases
What is producer surplus?
The difference between the price producers are willing and able to produce a good or service for and the price they actually receive
How do we calculate producer surplus?
The area above the supply curve and below the price line
What happens to producer surplus as the price is increased?
Producer surplus also increases
What is society surplus?
The sum of producer and consumer surplus
What happens to the demand of a good if its compliments price increases?
It decreases
What happens to the demand of a good if the price of its substitute increases?
It will increase as more consumers will be willing to buy it
What is derived demand?
When the demand for a good or service comes from the demand for something else, aeroplanes are derived from the demand for holidays
What is an example of derived demand
Labour is derived from the demand for goods and services
What is composite demand?
The idea that two goods need the same input to make them
What is an example of composite demand?
Cheese and butter both need milk
What will happen to the quantity production of a good if its composites demand increases?
It will decrease
What is joint supply
The idea that the increase of the production of one good will also increase the production of another good due to the second good being a byproduct of the first
What is an example of joint supply
Honey and beeswax
What is the definition of price elasticity of demand (PED)
Measures the responsiveness of quantity demanded given a change in price
What is the equation for PED
%change in quantity/ % change in price
What does it mean if the PED is more than one
Demand is price elastic
What does it mean if the PED is less than one?
Demand is price inelastic
What does it mean if PED is 0?
Demand is perfectly inelastic
What does it mean if PED is infinity?
Demand is perfectly price elastic
What does it mean if PED is 1?
Demand is unit price elastic
What is price inelasticity mean?
Quantity changes by proportionally less than price
What does price elasticity mean?
Quantity changes by proportionally more than price
How do we draw price inelasticity?
Vertical line
How do we draw price elasticity?
Horizontal line
Price is elastic if there are
Substitutes (more of)
Percentage of income (more of)
Luxury (more) necessity (less)
Addictive (inelastic)
Time period (inelastic in the short term, becomes more elastic)
What is division of labour?
Dividing the production of a product into smaller tasks and allocating labour to each task
What are the advantages of specialisation of labour
- Increased efficiency as workers become more efficient in their small area
- Less time/ money spent on training
- More specialist tools can be made
- Less time moving tools/ moving between jobs so more time efficient
5.
What are the four functions of money?
- Method of exchange- of goods and services
- Store of value - workers can earn their wages and store them for later
- Measure of value - money helps us to understand how much things are worth
- Measure of deferred payment - banks can loan people money and add interest so that when the money is payed back it still has the same value
What is an economy with no money known as?
A barter economy
What is a positive statement
A factual statement
What is a normative statement?
A value judgement
What are constraints?
Limits to what we can afford to consume
How do we calculate total revenue?
Price of a product x quantity sold
What is total revenue?
Total income
What happens to revenue if the price is elastic
If we increase the price, revenue will decrease
If we decrease the price, revenue will increase
What happens to revenue if the price is inelastic?
If we increase the price, revenue will increase
If we decrease the price, revenue will decrease
What is PES?
Price elasticity of supply
What does PES measure?
The responsiveness of quantity supplied given a change in price
How to calculate PES?
Change in quantity supplied/ change in price
What type of number is PES?
Positive
How do we show that supply is price elastic?
Horizontal line
How do we show that supply is price inelastic?
Vertical line
What are the factors affecting PES?
Production lag - the longer it is the more inelastic price is
Stocks - the more you have the more elastic
Spare capacity- more is more elastic
Substitutability of factors of production- how quickly you can switch to producing more of a different good
Time - inelastic to elastic
What is XED?
Measures the responsiveness of quantity demanded of a good/ service given a change in the price of another
How do you calculate XED?
% change in quantity demanded of good A/ % change in price of good B
What does it mean if XED is positive?
Goods are substitutes
What does it mean if XED is negative?
Goods are compliments
What does it mean if XED is more than one?
Demand is price elastic (strongly related)
What does it mean if XED is less than one?
Demand is price inelastic ( weakly related)
What does it mean if XED is 0?
Demand is perfectly price inelastic ( no relationship)
How do we draw XED> 1
Horizontal line
How do we draw XED<1?
Vertical line
What does YED measure?
The responsiveness of quantity demanded given a change in income
How do we calculate YED?
YED = % change in quantity demanded/ % change in income
What does it mean if the YED is positive?
It is a normal good
What does it mean if the YED is negative?
It is an inferior good
What does it mean if YED is more than one?
Demand is price elastic and the good is a normal luxury
What does it mean if YED is less than one?
Demand is inelastic normal necessity
What is PED useful for?
Useful for pricing decisions to increase total revenue, if price is elastic and they know it is going to fall in the near future, they need to increase employment, output and stocks
What is the use of PES?
Find ways to make supply price elastic by increasing the effectiveness of the PSSST factors
Why is XED useful?
Pricing decisions- if there are two compliment goods for example printers and printer ink, reduce the price of printers so people buy one, they will need printer ink so increase the price of that and make more profit
Substitutes - cut the price of your substitute, if they cut their price follow their lead. Compete on non price factors to make yours and your substitutes good less similar- avoid price wars. Be prepared to increase output if substitutes raises price, have less output if substitute lowers price
Why is YED useful?
Useful for planning for recessions and booms e.g if producing a normal good and there is a boom increase price, employment, output and stocks
What are the limitations of using price elasticity to make decisions?
These figures are only estimates based off data collected through surveys
Some businesses base these figures off data based off competitors and past data which is assuming cetris parabus which is inaccurate
PED varies along the demand curve
What are the uses of indirect tax?
Raise government revenue
Solve the market Chris is of goods such as cigerettes/ alcohol/ fuel ( reduce the consumption of goods which do harm to society)
What is direct tax?
Tax on income that can’t be transferred such as income tax or national insurance
What is indirect tax?
Tax on income that increases cost of production but can be transferred to consumers via higher prices
What is a specific tax?
A tax per unit
How do we draw a specific tax on a graph?
Can be drawn as a parallel line to the original tax - supply curve shifts upwards
What is AD valorem??
Tax as a % of price
How do we draw ad valorem tax on a graph?
The supply curve will pivot
How do we work out government revenue from a specific tax diagram?
Go to the new equilibrium
Work out the vertical difference between the two supply curves
Multiply by the quantity sold at this point
How to work out consumer burden?
Quantity of new equilibrium X the point from the original price to where it matches equilibrium in quantity
How to calculate producer burden?
Original price to where it matches equilibrium in quantity down to the same point on the original supply curve X quantity sold
How to calculate producer revenue after indirect tax?
Go down from the new equilibrium to the same point on the original supply curve, the price X quantity of this product is the new producer revenue
Dead weight loss?
The triangle of original equilibrium, new equilibrium, and the same point on the original supply curve from the new equilibrium
What is the burden for consumers if demand is price elastic?
Lower
What is the producer burden if demand is price elastic?
Higher
What is the government revenue if demand is price elastic after indirect tax
Lower
What is the consumer burden if demand is price inelastic?
Higher
What is the producer burden if demand is price inelastic?
Lower
What is the government revenue if demand is price inelastic?
Higher
What happens if demand is perfectly price elastic after an indirect tax?
Producers take the entire burden and gov rev is at the lowest
What happens if demand is perfectly price inelastic after indirect tax
Consumers take the entire burden and government revenue is at the highest
What is the consumer burden when supply is price elastic after indirect tax
Higher
What is the producer burden when supply is elastic?
Lower
What is the consumer burden when supply is price inelastic after indirect tax
Lower
What is the producer burden when supply is price inelastic?
Higher
Who takes all the burden when supply is perfectly price elastic?
Consumer
Who takes all the burden when supply is perfectly inelastic?
Producer
What is a subsidy?
Money grant given to firms by the government to reduce costs in production aims encourage an increase in demand
What are the uses of a subsidy?
Solve market failures by making goods such as vaccinations, public transport and education ( things that benefit society as a whole)
Increase affordability of necessities
What does subsidy do to the supply curve?
Shifts it downwards
What does subsidy do to price/ quantity
Decreases price and increases quantity
How do you work out the cost of subsidy to the government?
Go to the new equilibrium, find the difference between the two supply curves at this point, multiply by the quantity sold at this point
How do we work out producer revenue after subsidy?
Go to the new equilibrium and find the same point on the original supply curve X the quantity sold at this point
How to work out dead weight loss of a subsidy?
Triangle of old equilibrium, new equilibrium, go to new equilibrium up to the same point on the original supply curve
How to calculate consumer savings with a subsidy?
Quantity at old equilibrium X go to price of new equilibrium, go across until it meets quantity of old equilibrium
What is a price floor?
Minimum price enacted by the government, usually set above the equilibrium market price
Benefits of a price floor?
Protect producers from price volatility ( could save them from poverty/going out of business)
Solve market failures by discouraging consumption of demerit goods
Costs of a price floor?
Take a higher % of income from the poor than they do from the rich
Taxes and opportunity cost, could society benefit more from lower taxes/ money spent elsewhere from intervention buying
Risk of black markets forming
What happens to supply and demand given a price floor
Contraction of demand
Extension of supply
What is intervention buying?
Government buying excess supply created by price floor back off producers
What is producer revenue with intervention buying after a price floor?
QS X P(min)
What is producer revenue without intervention buying after a price floor?
P(min) X QD
What is the cost to the government of intervention buying?
QS-QD X P(min)
What is the dead weight loss of intervention buying?
Triangle of original equilibrium, new demand X P (min) and QD on supply curve
What is a price ceiling?
A fixed price enacted by the government and usually set below the equilibrium market price
Benefit of price ceiling?
Increase affordability of necessity goods
What happens to demand and supply given a price ceiling?
Contraction of supply
Extension of demand
Costs of a price ceiling?
Creates excess demand - could lead to long waiting lists of black markets forming
Producer revenue lost -some may leave the market
What is the dead weight loss given a price ceiling?
Triangle of equilibrium, QS X P (max), same quantity of original demand curve
What are private costs and what are they abbreviated to?
MPC and they are the producers costs of production
What is a marginal private cost?
The cost of producing one more unit
What are external costs?
Any impact on third parties e.g environment as a result of production
How do we calculate social cost?
Private costs + external costs
What is the supply curve equal to?
Private costs + external costs however in an allocatively efficient market, we assume there are no external costs
What is an individual benefit and what does it abbreviate to?
MPB and it is the benefit the consumer gets from consuming a product
What is marginal individual benefit?
The increased benefit consumers get per extra unit consumed
How do we calculate social benefits?
Individual benefits + external costs/ benefits as a result of consumption
What is the demand curve equal to?
Individual benefits (MPB) + external costs however we assume there are none of these in an allocatively efficient market
How do we know we have achieved allocative efficiency?
Maximisation of society surplus
Maximisation of net social benefit
Where resources perfectly follow consumer demand
What is maximisation of net social benefit?
Not having any excess supply or demand
What is private optimum?
MPC=MPB
What is social optimum?
MSC=MSB
What are public goods?
A service that is provided without producer benefit to all members of society
What is the free rider problem?
People who benefit from public goods either not paying for them or not paying enough
What are common access resources?
Recourses which are not owned by anyone, do not have a price and are available for anyone to use
What is market failure?
When the free market fails to allocate resources at the socially optimum level of output
What are the causes of market failure (6)
Positive/ negative externalities being ignored by producers and consumers as producers are profit maximisers and consumers are utility maximisers both are acting out of their own self interest
Information failure around merit/ demerit goods
Free rider problem around public goods
Overproduction of common access recourses
Income inequality- at what point does it become unfair?
Monopoly power- barriers to entry for other firms, the firm at the top has the power to charge unfairly high prices
Factor immobility- supply unable to increase given an increase in demand
What is a negative externality?
Costs on a third party as a result of the actions of a separate agent
Examples of negative externalities as a result of production?
Air pollution, recourses depletion, resource degradation, deforestation
What is resource degradation
If recourses are dumped and this causes further damage for example in the sea
What is resource deprecation?
Using up resources to the extent that there is none left for future generations
How do social costs affect equilibrium?
If production then supply curve shifts upwards, if consumption then demand curve shifts down, markets will continue at original equilibrium so true allocative efficiency is not reached
What is the result of social costs not being taken into account?
Over production + over consumption
Supply: price too low
Demand: price too high
Mis allocation of recourses
Examples of negative externalities in consumption
Second hand smoking, cost to NHS+ police for overconsumption of alcohol, lost productivity to employers
What is a third party?
Am economic agent not involved in the transaction
How to calculate welfare loss of negative externalities of production?
Market equilibrium, up to same quantity on new supply curve and new equilibrium
What are positive externalities?
Benefits to third parties as a result of the actions of a separate agent
Examples of positive externalities in consumption?
Vaccines (less chance of others getting ill)
Education (higher income can pay more tax benefit society)
Gyms + healthy food ( higher productivity at work)
How do positive externalities in consumption affect allocative efficiency?
Demand shifts outwards but markets continue to operate at private optimum
How do we calculate dead weight loss of positive externalities of consumption?
Old equilibrium, same point on original demand curve, new equilibrium
What are the problems with ignoring positive externalities?
Under production/ consumption and mis allocation of recourses, price is too high
Examples of positive externalities in production?
In work training- other companies can poach higher skilled workers
New technology can be copied - no R&D costs (research and development)
What happens to supply if positive externalities of production are considered?
Supply curve shifts down
How to calculate the dead weight loss of positive externalities of production
Old equilibrium, down to same point on original supply curve, new equilibrium
What are the effects of not considering positive externalities
Under production/ consumption
Misallocation of recourses
Allocative efficiency is not achieved
Definition of merit goods?
Goods which are deemed to be more beneficial to society than people realise
What is information failure?
Consumers not having the correct information about goods due to the information not being present at all, information not being clear, or consumers choosing to ignore information
What is asymmetric information?
One party in a transaction having more information than another party
Reasons for incorrect consumption of merit/ demerit goods?
Information failure and asymmetric information
What are demerit goods?
Goods which are more harmful to society than people realise
What are public goods?
Goods which are non excludable and non rivalry
What is non excludable?
No price can be charged for the good
What is non rivalry?
The quantity of the good doesn’t diminish under consumption
Why may a good be non excludable?
The benefits of consuming a good cannot be confined to the individual who has paid
No efficient way of charging
Issues with public goods?
Causes free rider problem- means there is no private motive to supply (missing market)
What is a quasi public good?
Sometimes shows characteristics of public goods, sometimes private
What is a club good?
Rival but non excludable
What is a common resource?
Non excludable but rival, natural recourses over which no private ownership has been established
What is the tragedy of the commons?
Private producers acting out of self interest and using up so much that it leads to a depletion of these recourses
Examples of common recourses?
Anything in the sea or forests
Why might private producers keep taking common recourses even when they can see depletion is happening
Profit motive
If one producer stops and all others continue, only the one who stops loses out, unlikely to do this
What is the tragedy of the commons an example of?
A negative externality of production
What is government failure?
When the costs of intervention outweigh the benefits
What is the result of government failure?
Worsening of the allocation of scarce resources- harming social welfare
What are the four causes of government failure?
Information failure, costs of intervention, unintended consequences, regulatory capture
Describe information failure?
Politicians are not always experts. Most externalities are very difficult to value, therefore the policy could be too strict or too loose
Describe intervention costs?
Admin + enforcement of the policy itself, for example intervention buying, opportunity cost + fairness to the taxpayer has to be considered
Describe regulatory capture
If the regulator is trying to control monopoly power, the CEO may influence the regulator and they may end up helping the firm instead of the society
Describe unintended consequences
Black markets may arise
Impact on low income families (e.g taxes and minimum prices increase price)
Impact on firms (may become too reliant on subsidies)
Indirect tax or minimum wage (price floor) may cause unemployment
How can an indirect tax help to solve market failure?
Increases cost of production (also increases price)
Internalises externality
Solves overconsumption/ production
Gains allocative efficiency + gov rev
How do we show an indirect tax correcting market failure in production?
Draw an arrow from the MPC curve to the MSC curve
How do we show an indirect tax correcting market failure in consumption?
Draw a second supply curve shifted upwards
The point where it meets the original demand curve should be the same quantity as Qstar
Why is price inelastic demand a problem when using indirect tax to solve market faliure?
If there is no change in quantity, the size of the externality stays the same or does not change much, the tax is ineffective, one reason for this could be addiction
Why is regression a problem when using indirect tax to solve market failure?
Takes a higher % of income of the poor than it does of the rich, causes inequity which most view as unethical
Why is it a problem that using indirect tax to solve market failure causes black markets?
Quality of product is likely to be lower- externalities grow
Black markets need policing, enforcement cost
Government revenue is lost
What is the cause of over/ under taxing when using indirect tax to solve market failure and why is this a problem?
Information gap, externalities are difficult to measure
Undertaxing is ineffective
Overtaxing is unfair to the poor, may cause firms to leave the business, leads to the rising of black markets
How to we show subsidy correcting market failure in production?
An arrow from MPC to MSC
How do we show a subsidy correcting market failure in consumption?
Shift the supply curve downwards, the point where it meets MPC should be parallel with Q*
How does a subsidy help to solve market failure?
Lowers production costs
Lowers price
Increases quantity
Solves underproduction and consumption
Allocative efficiency and welfare are gained
Why is cost an issue when using subsidy to correct market faliure?
Opportunity cost
Fairness to tax payer
Debt/ interest on debt if the money has been borrowed
Why is inelastic demand an issue when using subsidy to correct market faliure?
If demand is inelastic e.g public transport the size of the externality will not change very much and Q* is not reached
Why are over and under subsidising an issue when using subsidy to correct market faliure?
Under- externality is not fixed and Q* is not reached
Over- cost argument grows even more
Caused by the information gap- externalities are hard to measure
What could the firms do with a subsidy that would be an issue and not correct market faliure, why is this an issue?
Use it to cover debt, CEO could keep it for themself, pay their staff higher salaries
Price does not change, demand does not change, ineffective use of money
What is regulation?
A law enacted by the government that must be followed by economic agents to encourage a change in behaviour
What type of approach is regulation?
Command and control approach
Types of commands in regulation
Limit- e.g age limits or time limits for when you can purchase alcohol
Compulsory- e.g compulsory graphic advertising on cigarette packaging
Innovative regulation e.g pay extra for a plastic bottle and get the money back when you bring it back
Cap- e.g pollution caps
Bans- e.g public smoking bans
Types of control in regulation
Enforcement
Punishment e.g fine
Why is cost a problem with government regulation
Cost of administration + cost of enforcement
Opportunity cost
Fairness to taxpayer
Interest on debt if the money is borrowed
How is equity a problem in government regulation?
Fairness to firms- some firms may struggle more than others to reduce carbon emissions particularly older firms
How are black markets + unintended consequences a problem in government regulation?
Black markets- policing costs, gov rev is lost, welfare loss to consumers as product is likely to be of lower quality
Producers may find a way to cheat the regulation
How is setting the wrong strictness of regulation a problem?
Too lax- problem is not solved
Too strict- too burdening to producers as it discourages demand, firms may move to another country or shut which causes unemployment
How do tradable pollution permits work?
Government sets cap at Q* ( this assumes governments can perfectly measure the negative externality of pollution)
The total amount allowed by the country is divided up between firms, and handed out, this is known as as a permit (one permit is 1000 tonnes)
Firms now have a choice: invest in green technology or buy up spare permits
Why is it better for firms to invest in green technology over buying spare permits?
Firms can profit by selling spare permits
Firms will not be affected when the price of permits increases
Why are tradable permits for pollution effective?
Internalise the externality
Allocative efficiency is reached
Describe the price quantity graph of tradable pollution permits?
Demand is normal
Supply is perfectly inelastic (amount of permits will never change)
Why may price of a permit increase?
Demand may increase
Government may tighten cap
Why is enforcement an issue with tradable pollution permits?
Low income countries may not be able to afford this
Where there is an enforcement cost we must always consider opportunity cost
What are the unintended consequences of tradable pollution permits if the externality cannot be perfectly measured?
If the cap is too strict:
Some firms may close, which causes unemployment
Some firms may move to other countries, which causes carbon leakage and doesn’t solve the problem
Firms may pass on costs to consumers through higher prices, allocative efficiency and consumer welfare are lost
If the cap is too lax:
The problem is not fixed
Why is lack of international corporation a problem with tradable pollution permits?
China and USA, the two biggest pollutants, have not joined the agreement, is it effective?
Many developing countries will not join as they want the opportunity for economic growth, this is bad because these countries are some of the biggest polluters
What is state provision?
Direct provision of goods and services by the government for free at the point of consumption
What are examples of state provision?
Healthcare and education
How does state provision work?
Government provides the socially optimum quantity of recourses( healthcare and education) this assumes that the government can perfectly measure externality
It is now free at point of consumption
Underproduction/ consumption is solved
Allocative efficiency is reached
Describe the price quantity graph for state provision
Supply is perfectly inelastic
Demand is normal
When is state provision needed?
When a good would be under consumed and underproduced in the free market
When there is inequity over a good
Why is excess demand an issue with state provision?
Medical- long waiting list of people who have to live in pain- who deserves to be treated first is normative
Education- may be larger class sizes- people pay in non monatory ways
Why is inefficiency of state organisations an issue with state provision?
No profit motive= organisations may be unproductive, this is very wasteful
Why is cost an issue with state provision?
Opportunity cost
Fairness to taxpayer
Debt if money is borrowed
Why is imperfect information an issue with state provision?
Externalities are difficult to measure, may be an over or under allocation of these goods
How will (theoretically) a price floor help to resolve market failure?
Contract demand - discourage consumption-quantity will fall
Externality is internalised
Welfare is maximised as socially optimum level is reached
Why would price inelastic demand be a problem when using a price floor to resolve market failure?
There will be no contraction of demand therefore Q* will not be reached
Why does a price floor lead to regression?
Higher prices burden the poor more than the rich, increases income inequality ( regression)
What are the problems with black markets being created when using a price floor to solve market failure?
Monitoring cost- opportunity cost
Consumer welfare is lost as this product is likely to be of a lower quality
Gov rev is decreased, due to legal businesses making less money to pay to the government
What are the problems with difficulty setting the price floor at the right level in solving market failure?
Externality’s are difficult to measure, governments are very unlikely to have perfect information, therefore it is unlikely the price floor will be set at Q*
If it is too high, it will burden producers too much, they may leave the country, or close down, which would cause unemployment
If it is too low then Q* is not reached
How does a price ceiling (theoretically) solve market failure?
Extension of demand of essentials, equity is increased, e.g rent controls
Why is excess demand a problem when using a price ceiling to resolve market failure?
Leads to a shortage and people going without essentials e.g accommodation
Why re black markets a problem when using a price ceiling to resolve market failure?
Monitoring costs- opportunity cost.
Consumer welfare is lost as this product is likely to be of a lower quality than a similar product sold in a legal market
Gov rev is lost as legal businesses are making less profit and are therefore paying less tax
Why is decreased quality of good/ service an issue when using price ceilings to resolve market failure?
Landlords/ producers have no profit motive, therefore will not try to improve their product
Landlords may “cheat” for example by charging for a key or to rent furniture, therefore the real price of rent would not change
Why is setting the right level of price ceiling a problem when trying to resolve market failure?
Externalities are difficult to measure, especially as governments usually have imperfect information
If the price ceiling is too low, there will be massive amounts of excess demand
Too high: equity not reached
What are the costs involved with using a price ceiling to resolve market failure?
Enforcement cost- opportunity cost
Government may have to subsidies landlords/ bus companies for a price ceiling- opportunity cost and fairness to taxpayer have to be considered
What is information provision?
Government funded information provision/ advertising/ education in order to encourage or discourage consumption of certain goods
What are some examples of information provision?
School curriculum, TV, newspapers, billboards, magazines, news, radio
After information provision for a merit good, what would happen to the demand curve?
It shifts upwards
After information provision for a demerit good, what happens to the demand curve?
It shifts downwards
What is the purpose of information provision?
Consumers now have more information about the goods they are consuming, so will now have a better understanding of the utility they will gain (mpb)
This will shift the demand curve in the desired direction
Allocative efficiency is now reached
This is a market friendly, less paternalistic technique
Why is cost an issue with information provision?
Administration cost- opportunity cost
If the money is international debt then this will have to be payed back with interest
Why is the fact that there is no success guarantee an issue when using information provision to correct market failure?
Lots of cost involved which could be money wasted- inefficient allocation of resources
Consumers may continue to act irrationally, as they may of understand the information or choose to ignore it- consumer weakness at computation
What kind of technique is information provision?
Long run not short run, this means that results may not show very quickly
What are property rights for market failure?
Giving a private producer the right to own part of a common access resource
How does giving property rights of common access resources help to solve market failure?
The producer will have no incentive to exploit the recourse as this will lead to resource depletion which will affect future profits
Negative externalitity internalised
Supply will now be at Q*
Why is difficultly with effective distribution an issue when using property rights for common access resources to solve market failure?
The air/ sea cannot be divided up
Why is cost an issue when using property rights for common access recourses to resolve market failure?
Enforcement cost (opportunity cost) if this cannot be afforded them there will be mass trespassing
Why is inequity an issue when using property rights for common access recourses to resolve market failure?
If two parties both desire ownership of the same common access recourse, only one can be granted this. The party with ownership rights can sell access to the other, however this will burden the consumers financially. Who deserves ownership rights more is normative
Describe the ownership of different economies?
Private- everything is privately owned
Command- everything is publicly owned
Mixed- There is a mixture of privately and publicly owned goods and services
Describe the motives of different economies?
Private-profit motive MPC
Command: welfare maximisation MSC
Mixed: Goods/ services which are privately owned will have a profit maximisation motive and those which are publicly owned wil have a welfare maximisation motive
Describe the freedom of choice in different economies?
High in a private economy
Low in a command economy
Medium in a mixed economy
Describe the competition in different economies?
Higher in private economies
Lower in command economies
Medium in mixed economies
Describe the extent of the role of the government in different economies?
Private- extremely low
Command - extremely high
Mixed- in the middle
Describe the variety and quality of different goods and services in different markets?
Market- high
Command- low
Mixed- in the middle
Describe the response to demand in different economies?
Private- quick
Command- slow
Mixed- medium
Describe the efficiency of different types of markets?
Market economies- allocative efficiency is reached as wants and needs of consumers are being met, however Q* is not reached as externalities will not be accounted for
Command economies- lower efficiency as there is no profit motive therefore no incentive to cut costs, this means there is a higher probability of wasteful production. However, these economies are less likely to suffer from market failure
Mixed economies- total efficiency is maximised
Describe the shortages/ surpluses created by different types of markets?
Market economies- non existent
Command economies- yes due to lack of price mechanism and imperfect information
Mixed economies- there will be some within the privately owned parts of these economies but none within the publicly owned parts
Describe how merit goods are allocated in different types of economies
Private economies- merit goods will be under provided
Command economies- merit goods will be provided at socially optimum rate
Mixed economies- there is likely to be government intervention
How are demerit goods allocated in different types of economies?
Will be over provided in a market economy
Will be provided at socially optimum rate in a command economy
In a mixed economy there is likely to be government intervention
Describe the allocation of public goods in different types of markets
In a market economy there is likely to be missing markets
In a command economy they will be provided at the socially optimum rate
In a mixed economy there is likely to be government intervention
Describe the income distribution in different types of markets
Most economists argue that the distribution of income in a private economy is too unequal and is unfair
In a command economy it is usually more even
In a mixed economy there is progressive tax (using income tax which is primarily taken from the rich and using it to help the poor) and welfare state (ways of people having an income without working for example benefits or state pensions)
Describe the extent of negative externalities in different economies
Market economies- overproduction of goods and services which generate negative externalities
In command economies all externalities will be accounted for so production and consumption will be at the socially optimum level
In mixed economies there is likely to be government intervention
Describe the likelihood of monopoly’s in different markets
Likely to exist in market economies
Impossible to exist in command economies
In a mixed economy there is likely to be some government intervention
What are different types of markets like in the real world?
Pure market economies don’t exist in the real world, however some economies which are mainly market based include the USA and Singapore
Pure command economies also don’t exist, however some economies which are mostly command are North Korea and Cuba
The majority of economies are mixed economies
Why is it good that the free market creates allocative efficiency?
There will never be a long run disequilibrium
Why is it good that free markets encourage competition?
More choices, higher quality of goods and services, firms will strive to produce efficiently in order to enter competitive prices, consumer welfare is high
What is the risk of government failure in a free market?
Non existent
Why is it positive that consumer have more choice in a free market?
More individual liberty and freedom, higher consumer welfare is
What is dynamic efficiency and why is it positive that this exists in the free market?
Profits made going back into the firm in order to improve it, for example more in work training or improving capital
This will increase the quality and quantity of goods and services produced
As quantity is at its maximum, jobs in this industry will also be maximised, meaning people have the ability to earn higher incomes
This will mean they have more purchasing power, which will lead to economic growth
What are the failures and why is risk of market failure a negative of free markets?
Monopoly power may mean high barriers to entry for other firms
There may be imperfect information which could lead to irrational decisions from consumers as they do not understand the true utility the good or service is providing them
There would be missing markets of public goods
Externalities are ignored, meaning it is unlikely that production and consumption will be at socially optimum level
Why is inequity an issue in free markets?
Some consumers may be excluded from consuming necessary goods and services
Why is excessive profiteering an issue in the free market?
Firms may cut wages, costs for health and safety or costs for things which are beneficial to society
Why is creative destruction an issue in the free market?
If there was monopoly power for one good, and another good was introduced which consumers believed would provide them more utility, consumers are likely to switch meaning the original firm may close
Why is price volatility in the free market an issue?
If prices are too high, there is an extreme burden on consumers
If prices are too low, there is an extreme burden on producers
What is specialisation (countries)
The concentration of production on a narrow range of goods and services
What is the advantage of maximisation of output after specialisation?
Countries will only produce what they are most efficient at, which will mean they will make more revenue when trading with other countries. This will lead to global economic growth
What are some other advantages of specialisation?
Wider variety of goods and services
The problem of scarcity is overcome which leads to greater allocative efficiency
Costs of production are lower as workers are more specialised
What are the disadvantages of specialisation?
A change in fashion or trends could lead to firms shutting down
National interdependence is required- if there are international relations issues the entire system will fail
Finite resources- if a business only produces petrol and oil runs out, then this firm will shut down.
De-industrialisation - if a foreign firm becomes more efficient at production, then the original, less efficient firm will shut down
What is division of labour?
Breaking down the production process into separate tasks upon specialisation
What are the advantages of division of labour?
Workers are highly productive- this saves time which lowers the cost of production. This means that the profit ability for the firm is high, which can be passed onto consumers through lower prices.
Specialist capital for workers can be created.
There are lower prices, higher quality and quantity of goods and more choices, which means that consumer welfare is maximised
What are the disadvantages of specialisation of labour?
Demotivating of workers- over time productivity may decrease, which may lead to high staff turnover- this may increase training costs and be inefficient in the long run
Risk of structural unemployment long term for workers if they are only qualified to do one thing and it gets replaced by capital
Goods become highly standardised, uniqueness which many consumers love is lost
What is a primary commodity?
Output from the primary sector, whose activities supply unprocessed raw materials
Why is PED inelastic for primary commodities?
They are necessities an there is often a lack of good substitutes
Why is PES inelastic for primary commodities?
Large production lag
Hard to store- low stock
Why are there regular changes in the demand curve of primary commodities?
If there is global economic growth there will be an increase in demand. If there is a slow down in economic growth there will be a reduction in demand for primary commodities
Why are there regular shifts in the supply curve for primary commodities?
Changes in weather affects production of agricultural goods
What happens if demand of primary commodities increases?
Producer revenue will increase, could lead to greater dynamic efficiency, the business has higher profitability potential and producer living standards increases
What happens if prices of primary commodities fall
Revenue falls drastically, living standards and profit ability also fall, in developing countries this leads to absolute poverty
If many producers leave the market, there could be supply concerns
Government revenue and export revenue both decrease, this could worsen poverty particularly in developing countries
Investment will decrease as producers won’t spend on capital
How does an economist create a theory (demand theory)
Observe consumer behaviour
Form hypothesis on how consumers spend
Make predictions from their hypothesis
Use evidence to test predictions
What happens if evidence does not support a prediction?
It is rejected
What happens if evidence does support the hypothesis?
It becomes a theory, and there are more tests to strengthen the theory
What is a vebling good?
Designer brand which the consumption will increase for given higher prices
What is gilling good theory?
When prices increase consumers will buy more as they will switch their income from other gods and services
What is economics?
A positive subject and a social science
What is the difference between the gradient and the elasticity along the demand curve?
Gradient stays the same but elasticity varies
Why are gradient and elasticity different?
Gradient is a basic number whereas elasticity is based on percentage change
Describe elasticity along the demand curve
The top half is always elastic whereas the bottom half is inelastic
Order: perfectly elastic, elastic, unitary elastic, inelastic, perfectly inelastic
What elasticity should firms have in order to maximise revenue?
Unitary price elasticity
Describe the revenue quantity graph
An N shaped curve
Water scarcity in India- case study example
Caused by ground and surface water drying up, also due to population growth (increase in demand) drought (decrease in supply) and poor monitoring of water resources. This has led to a significant price increase, which burdens families and farmers. There is huge concern for the future as both ground and surface water are running out. Farmers are having to dig deeper and deeper to access water which is extremely expensive
Markets in action- demand shift to the left
Peloton bikes- reports of dangerous design faults and a return to office work
Non-essential tech goods such as smart speakers- inflation has reduced the purchasing power of consumers, reduce the willingness and ability to buy
Printed newspapers- online news papers are cheaper and in trend, most people are switching to these
Student housing- rising cost of university has led to many students to live at home with their parents while studying
