topic 3 Flashcards
Definition: Law of Demand
price and quantity demand have an inverse relationship because of the Law of Marginal Utility
Definition: Law of Diminishing Marginal Utility
utility as you consume more units of a specific G&S decreases therefore only lower prices will entice customers to consume more
Definition: Quantity Demand
the level of demand at a particular price
Describe the theoretical Demand Curve of a normal good
X axis = price / Y axis = quantity demand
negative sloping curve
Describe the movement of the Demand Curve
Movement ALONG the demand curve is due to a change in price (moving up is a contraction as price goes up / down is an expansion as price goes down)
Movement OF the demand curve is due a change in anything BUT price (shifting right is an increase / shifting left is a decrease)
What are the factors affecting market demand?
- population size
- demographic
- distribution of income
- consumer expectations for future prices
Describe the movement of a substitutes’ demand curve?
if income decreases, the DC shifts right
if income increases, the DC shifts left
Describe the movement of a compliment’s demand curve?
if income decreases, the DC shifts left
in income increases, the DC shifts right
Definition: Consumer Surplus
a measure of the utility that people gain from consuming G&S under the price mechanism (surplus of utility firms aim to get rid of using price differentiation)
Definition: Derived demand
the demand for the FOP/factor markets due to the demand for final G&S
Definition: Supply
the quantity of a good or service producers are willing to supply for sale at a particular price at a particular time shown through the supply curve, a graphical representation of the relationship between price and quantity supplied
What is the law of supply?
supply, profit and price have a positive/direct relationship (shown by the positive slope of the supply curve)
What are the factors affecting supply?
- price (of the specific G/S and the price of substitutes and compliments)
- cost of FOP
- technology changes
- producers expectations about the market
- producers preferences
- monopoly vs competition
- seasonal changes
- increase/decrease in productivity
Movement along the supply curve?
contraction/expansion due a change in price
Movement of the supply curve?
increase/decrease due to a change in anything BUT price
Definition: Producer surplus
difference between the price a producer sells the G/S for and its marginal cost (below the price and above the demand curve)
Definition: market equilibrium
where the demand curve and supply curve intercept (demand = supply)
Definition: Price mechanism
process by which decision about selling prices and production quantities are determined supply and demand curve equilibrium
What the roles of price?
Allocating resources so producers recieve max profit
Rationing to remove surplus and shortage
Incentivising producers to take risks and satisfy N/S
Scarcity - solve the problem of scarcity
Equilibrating supply and demand in markets
What are the motives for spending?
- speculatory
- precautionary
- transitionary
Demand decreases ____
price decreases and quantity supplied decreases (surplus)
Demand increases ____
price increases and quantity supplied increases (shortage)
Supply decreases ____
price increases and quantity supplied decreases (shortage)
Supply increases ___
price decreases and quantity supplied increases (surplus)
What does Elasticity of Demand do?
describes the degree of consumer responsiveness to a change in price
What is an inelastic demand curve?
If price rises by x% and quantity demand falls by >x%
Inelastic = (< 1)
Perfectly Inelastic = 0
- many substitutes and is a luxury
- increases consumer surplus
What is an elastic demand curve?
If price rises by x% and quantity demand falls by >x%
Elastic = (> 1)
Perfectly Elastic = infinity
- is a luxury
- decreases consumer surplus
What is a unit elastic demand curve?
If price rises by x% and quantity demand falls by x%
Unit elastic = 1
What is the Total Revenue Method?
- INELASTIC if total revenue moves same to price
- ELASTIC if total revenue moves opposite to price
- UNIT ELASTIC if total revenue is static while price changes
What is the general method?
= % of change in quantity demand / % of change in price
What are private goods?
A good or service that is rival (if someone consumes the good, the availability for others is diminished) and excludable (those who don’t pay for the good don’t consume it)
There is a direct payment from consumer to producer
Has inforcable property rights and sold by firms for profit
What are (pure) public goods?
A good and service that is non rival and non excludable
There is no direct payment
No inforcable property rights and provided by government (e.g national defence)
What are (impure) public goods?
Public goods with privatisation provision that are rival and excludable but not profitable to all
What are Merit goods?
are rival and excludable but not provided by free markets so the government provides or subsides because they have positive externalities (benefits both consumer and society’s members)
e.g opera, libraries
What are Demerit goods?
G&S whose consumption is considered unhealthy because of negative externalities (harms both consumer and society’s members)
What is market failure?
it occurs when the market is at equilibrium but when markets don’t produce desired outcomes meaning equilibrium price or quantity is considered inappropriate. 4 types:
- price too high –> price ceiling
- price too low –> price floor
- quantity too high –> sales tax
- quantity too low –> sales subsidies
What is a price ceiling?
occurs when price is deemed too high at market equilibrium by the government so they implement a price ceiling or max price below normal equilibrium to protect consumers from over pricing
consequences - shortages and black markets
What is a price floor?
occurs when price is deemed too low at market equilibrium by the government so they implement a price floor or min price above normal equilibrium to protect producers from going bankrupt
consequences - surplus, govt has to buy surplus
What is a sales tax?
occurs when the quantity produced of a good (with negative externalities) is deemed too high by gov so they tax the good
supply curve moves left (vertical distance of tax), price increases and demand decreases, cost of production increases and supply decrease
(inelasticity increases, consumer tax portion increases)
What are sales subsidies?
occurs when the quantity produced of a good (with positive externalities) is deemed too low by gov so they subsidise the good
supply curve moves right (vertical distance of subsidy), price decreases and demand increases, cost of production decreases and supply increases
What is market structure?
identifies how a market for goods and services is made from different factors:
- KEY INDICATOR: number and size of firms that make up the industry
- KEY CAUSE: nature of the product (e.g products with less substitutes are more expensive so less companies produce them)
- KEY CAUSE: Freedom of entry and exit from the industry (aka Barriers to Entry).
- IMPACTS: Control over price, factors of production and output.
What is the market structure spectrum?
PERFECT COMPETITION
MONOPOLISTIC COMPETITION
ALIGOPOLY
- 3-4 firms
DUOPOLY
- 2 firms
MONOPOLY
- less competitive
- higher prices
- less innovation
- need to regulate
Characteristics of Perfect Competition
- larger number of firms
- less imperfections
- lower prices (firm has no control over price, are PRICE TAKERS)
- more innovation
- no need to regulate
- products are homogenous (lots of substitutes)
- easy barrier to entery
- e. g closest is agriculture
Characteristics of Monopolistic Competition
- majority with 40-50 firms
- most common
- due to imperfections and product differentiation (advertised by advertising and loyalties) they have some control over price
- barriers to enter relatively easy
Oligopoly
Characteristics of Oligopoly/Duopoly
- few firms (3-4)
- PRICE MAKERS
- potential for collusion (illegal activity where firms work together to decrease supply and increase demand and increase price in an inelastic demand)
- interdependence of firms (similar behaviour)
Characteristics of Pure Monopoly
where one producer dominates the industry. rare because when firms reach 25% market share the ACCC investigates them
- origins (growth of firm EOS, amalgamation - buy out competition, nationalisation by gov, natural monopoly bc of product)
- increased price (eat into consumer surplus)
- less efficient
- less choice
- dead weight loss
