Topic 2 - Microeconomics Flashcards
What is a market?
A market is where a buyer and seller come together to carry out an economic transaction
What are the non-price determinants of demand?
- Income
- Price of substitutes
- Price of complementary goods
- Tastes and preferences
- Future price expectations
- Number of consumers
What is price elasticity of demand?
A measure of the sensitivity of quantity demanded to changes in price of a good or service
Formula for PED
(Percentage change in quantity demanded)/(Percentage change in price)
What are the determinants of PED?
- The number and closeness of substitutes
- Necessity of the product (width of definition)
- Proportion of income spent on the good
- Time period considered
What is income elasticity of demand (YED)?
A measure of how the demand for a product changes when income changes
Formula for YED
(Percentage change in quantity demanded)/(Percentage change in income)
What are the non-price determinants of supply?
- Cost of factors of production
- Price of related goods
- Taxes and subsidies
- Expectation of future prices
- Changes in technology
- Weather or natural disasters
What are the determinants of PES?
- How much costs rise as output is increased
- Time period considered (more elastic over time)
- The ability to store stock
What is consumer surplus?
The extra utility gained by consumers from paying a price that is lower than that which they are prepared to pay
What is producer surplus?
The actual earnings that a producer makes from a given quantity of output, over and above the amount the producer would be prepared to accept for that output
What is community surplus?
Producer surplus + consumer surplus - the total benefit to society when a market is in equilibrium
What is indirect tax?
A tax imposed on expenditure on goods and services
Advantages of indirect tax
- Increased government revenue
- Limits consumption of demerit goods
Disadvantages of indirect tax
- Lower consumer disposable income
- Little effect on PED inelastic goods
Indirect Tax diagram
Textbook pg. 110
Who pays what share of indirect tax?
If PED is elastic: producers pay more
If PED is inelastic: consumers pay more
What is a subsidy?
An amount of money paid by the government to a firm, per unit of output
Advantages of a subsidy
- Lowers price of goods (more disposable income)
- Guarantees supply of necessary products
- Improves employment
- Enable competition with foreign producers
Disadvantages of a subsidy
- Government expenditure
- Little effect on PED inelastic goods
- Firms don’t have an incentive to improve efficiency
- Requirement of taxes to fund subsidy
- Foreign producers unable to compete - dumping
What are price ceilings?
Price ceilings are maximum prices set by the government below the equilibrium price for a certain set of goods
Price ceiling diagram
Textbook pg. 120
Subsidy diagram
Texbook pg. 116
Advantages of a price ceiling
- Decreased price (higher disposable incomes)
- Promotes consumption of merit goods
Disadvantages of a price ceiling
- Shortage (Demand > Supply)
- Possible emergence of Black Market
- Unemployment due to reduced revenue
What are price floors?
Minimum prices set by the government above the equilibrium price for a certain set of goods and services
Advantages of price floors
- Raise incomes for producers
- Protects workers
- Reduces consumption of demerit goods
Disadvantages of price floors
- Surplus (Supply > Demand)
- High prices lead to lower disposable incomes
Why do governments intervene in markets?
- More merit goods, less demerit goods
- Promote sustainability
- Promote equity and economic well-being
What is an externality?
An externality occurs when the production or consumption of a good or service has a spillover effect upon a third party
What causes a negative externality of production?
MSC > MPC
What causes a negative externality of consumption?
MPB > MSB
What causes a positive externality of consumption?
MSB > MPB
What causes a positive externality of production?
MPC > MSC
How can a government fix a positive externality of consumption?
- Subsidies
- Public awareness campaigns
- Legislation (vaccines)
How can a government fix a positive externality of production?
- Subsidies
- Direct provision (government becomes producer)
How can a government fix a negative externality of consumption?
- Indirect taxes
- Legislation/regulation
- Education/raising awareness
What are common pool resources?
Natural resources, such as fishing grounds, forests, and pastures, which are non-excludable, but rivalrous. In the absence of management, common pool resources are inevitably downgraded
What is the Tragedy of the Commons?
The cumulative effect of all rational producers acting in their own self-interest, and degrading common pool resources
What is the free-rider problem?
Those who do not change their behavior to account for the Tragedy of the Commons benefit from those who do
How can the Tragedy of the Commons be reduced?
- International Agreements
- Tradeable permits
- Carbon tax
- Legislation
- Subsidies (increase use of renewable, decrease the use of fossil fuel)
- Collective self-governance (working together)
Why must governments provide public goods?
Public goods are non-excludable and non-rivalrous, meaning that private producers have no incentive to provide them. Hence, governments must do it themselves.
