trial unit 1 Flashcards
Scarcity vs shortages
Scarcity: OC arises as there are insufficient resources to supply consumers (or firms or governments) with everything they want, forcing them to make choices. This is called an OC
(scarcity is the basic economic problem)
Shortages:insufficient resources to supply consumers with what they demand at a particular time. (i.e.) what they are willing and able to pay. A shortage can be controlled through price movements. Shortage isn’t universal, more regional.
Temporary and controlled through price movements
3 reasons why the demand curve slopes downwards(need definitions)
The Diminishing Marginal Utility Effect – as consumers increase consumption of a good or service they experience the law of diminishing marginal utility. As their satisfaction falls after each marginal unit they are prepared to pay less to consume more.
The Substitution Effect – as the price rises then the marginal utility per £ of the last unit consumed falls. A rational consumer would therefore switch consumption to a substitute product that offered greater utility at a cheaper price i.e. one which they view as better value for money.
The Income Effect – as the price rises then a person’s real income (i.e. their buying power) falls so they are no longer able to buy the same quantity. Demand for the product then falls.
Explain 3 reasons why the demand curve for some goods slopes upwards from left to right
Giffen/essential goods (ID) as low income consumers may cancel consumption of other goods and use their income to buy more of these essential goods (EXP) (1)
Veblen/ostentatious goods (ID) as some consumers will demand more as they wish to demonstrate their wealth (EXP) (1)
speculative demand (ID) results in consumers buying more of a good as they think it will be worth more in the future (EXP) (1)
subsidies
subsidies are payments made to producers from the government in order to make the product cheaper to produce or cheaper to consume
For example, farmers are given subsidies in order to support their incomes and make the production of agricultural goods more profitable (otherwise farming communities may go into further decline with further job losses). This increases supply.
Determinants of PED
If the good has a number of close substitutes demand for it will be more elastic. (1 mark) This is because consumers will be more likely to switch to another good when the price goes up.(1 development mark) eg branded toothpaste etc. (1 development mark)
If the good is a necessity, demand will be less elastic. (1 mark) e.g. bread or milk. (1 development mark)
If a small proportion of income is spent on the product demand will be relatively inelastic (1 mark) This is because changes in price are less likely to be noticed. (1 development mark) eg crisps.
(1 development mark)
If the goods are purchased frequently demand for it will be more inelastic.
How the price mechanism helps to allocate scarce resources:
Rationing – prices serve to ration scarce resources when demand outstrips supplyWhenever resources are particularly scarce, demand exceeds supply and prices are driven up. The effect of this is to discourage demand and conserve resources. The greater the scarcity, the higher the price and the more the resource is conserved.
(individuals)
Signalling – prices adjust to demonstrate where resources are required, and where they are not (i.e. high price smart phone versus lower priced tablets) (firms)
Price changes send contrasting messages to consumers and producers about whether to enter or leave a market.
Rising prices give a signal to consumers to reduce demand and they give a signal to potential producers to enter a market.
Conversely, falling prices give a positive message to consumers to buy while sending a negative signal to producers to leave a market.
For example, a rise in the market price of’ smartphones sends a signal to potential manufacturers to enter this market, and perhaps leave another one.
Incentives – when the price of a product rises, quantity supplied increased (i.e. if oil prices increases, supply will increase) (firms)
An incentive is something that motivates a producer or consumer to follow a course of action or to change behaviour.
Higher prices provide an incentive to existing producers to supply more because they provide the possibility of more revenue and increased profits.
The incentive function of a price rise is associated with an extension of supply along the existing supply curve.
The free market mechanism
No role for the government
All scarce resources are owned by private individuals
Scarce resources are allocated based upon the rationing, signalling and incentive functions only
Consumers aim to maximise utility and producers aim to maximise profit
The market mechanism is ‘guided by an invisible hand’
Benefits of the free market mechanism
Buyers are free to purchase any commodity which they like and in whatever amounts.
Allocative efficiency – producing what people want and the price people prepared to pay
The seller of a good or its producer can also produce whichever product they want to and also increase the capacity of any individual commodity depending upon the forces of the market.
Producers are free to undertake the risks and rewards (profits) associated with increases in production.
Drawbacks of the free market mechanism
Over consumption of demerit goods(drugs, cigarettes, alcohol) if consumers have a preference for these goods, then they will be provided given that they are profitable to produce.
Social cost ignored. Private firms ignore negative externalities(air, water and noise pollution, road conditions.)
Wastage of resources as consumers may get what they want but not what is good for them.
Barriers to entry
Capital costs are fixed, one-time expenses incurred on the purchase of land, buildings, construction, and equipment used in the production of goods or in the rendering of services. In other words, it is the total cost needed to bring a project to a commercially operable status.
Sunk costs A sunk cost refers to a cost that has already occurred and has no potential for recovery in the future. For example, your rent, marketing campaign expenses or money spent on new equipment can be considered sunk costs. A sunk cost can also be referred to as a past cost
Economies of scale
in microeconomics, economies of scale are the cost advantages that enterprises obtain due to their scale of operation, with cost per unit of output decreasing with increasing scale
Legal barriers
Barriers to entry are the legal, technological, or market forces that discourage or prevent potential competitors from entering a market. … One is natural monopoly, where the barriers to entry are something other than legal prohibition. The other is legal monopoly, where laws prohibit (or severely limit) competition.
Limit pricing
A limit price is a price, or pricing strategy, where products are sold by a supplier at a price low enough to make it unprofitable for other players to enter the market. It is used by monopolists to discourage entry into a market, and is illegal in many countries
Perfect competition
The product that is sold is homogeneous - e.g. each product sold by each firm is identical and are perfect substitutes. There is no differentiation so customers can buy the same product everywhere
Freedom of entry and exit - firms should be able to establish themselves quickly and easily with no costs to exit the industry i.e. no barriers to exit/entry
A large number of small buyers & sellers – therefore no one firm can have any influence on price over another and each firm acts independently – each firm is a price-taker i.e. they charge the market equilibrium price
Perfect information – both buyers and sellers must clearly know about market prices, product quality and cost conditions. Consumers can easily switch between competing firms.
Monopoly definition
A situation in which a single company owns all or nearly all of the market for a given type of product or service
A monopolist has the power to determine either:
The price at which he will sell his product
The quantity at which he wishes to sell
The monopolist cannot determine both
The monopolists power depends upon:
- the availability of close substitutes
The power to restrict new firms entering the market
Government intervention
Tax goods/services which have negative externalities e.g. cigarettes (i.e. make to polluter pay) to reduce demand for them
Subsidies can be provided by the government to increase supply of certain goods which would be unprofitable without government intervention. These are heavily used in the agriculture sector which helps farmers make profit.
Set quotas to limit over production that causing pollution or shortages
Ban certain activities e.g. smoking in bars and restaurants (command and control, techniques
Provides goods deemed necessary to the wellbeing of society such as public/merit goods.
Advertising (government warning of effects of tobacco on the people’s health)
Monopolies exist when one firm dominates a market. The government intervenes through the competition and market authority to control monopolies to ensure that prices are controlled by consumers.
Consequences to government intervention
Using taxation to increase price could result in some businesses passing on the higher costs to consumers. Some forms of taxation can be regressive. This may have inflationary consequences. Some businesses may also have to make workers redundant to compensate for higher costs elsewhere. We lose international competitiveness.
Using subsidies to reduce prices could lead to higher taxes from consumers to pay for this system.
Consumers get no say in what gets subsidised.
Using maximum prices can result in excess demand. If the excess demand is not met by existing producers then it could result in a black market for the product. Low prices can make a business unprofitable. Using minimum prices can result in excess supply which could lead to wasted resources as producers try to exploit the situation.
Explain the law of diminishing marginal returns.
as output increases the efficiency of production falls (ID) causing higher average costs (EXP) (1). If marginal costs are higher than average costs, then average cost is being pulled up (DEV) (1)
this occurs in the short run only (ID) when one factor of production is fixed (for example, capital) (EXP) (1)
as a variable factor is increased (for example, labour) (ID) eventually productivity starts to fall (EXP) (1). This is because the fixed factor is being ‘overworked’ (DEV) (1)
