Unit 1 - Markets in Action Flashcards
The fine art of Shayan Khaksar.
What is the economic problem?
The economic problem is there are scarce resources in relation to unlimited wants.
What are the 4 factors of production?
Land, labour, capital and enterprise.
How can specialization address the problem of scarcity?
Specialisation can be used to address the problem of scarcity in the sense; as regions specialise, more output can be produced, meeting more wants. Surpluses can be traded (creating dependency).
What is opportunity cost?
Opportunity cost is the cost of the next best alternative forgone
What is the PPC?
The PPC/PPF/PTC shows the maximum combination of 2 goods (given current resources, current technology and assuming that all resources are fully utilised). As you produce more of one good, the opportunity cost is the other good. Convex shape. Economic growth will shift curve outwards.
Competitive market
A competitive market is a market that operates through the laws of supply & demand.
Consumer surplus
The difference between the price that customers are willing to pay, & the price that they actually pay.
Producer surplus
The difference between the price that suppliers are willing to sell at, & the price actually charged.
What are the factors affecting demand?
Price,
Price of substitutes & compliments,
Income,
Advertising,
Tastes/trends,
Addictiveness
What do movements on the supply curve represent?
Movement up the curve [expansion of supply] means a higher price, movement down the curve [contraction of supply] means lower price.
What factors affect supply?
Changes in cost
Legislation
Price elasticity of demand (PED)
How responsive demand is to a change in price.
%ΔQD/%ΔP
Price elasticity of supply (PES)
How responsive supply is to a change in price.
%ΔQS/%ΔP
Income elasticity of demand (YED)
How responsive demand is to a change in income.
%ΔQD/%ΔY
Cross elasticity of demand (XED)
How responsive demand for one product is to a change in price of another.
%ΔQD of GOOD A/%ΔP of GOOD B
Cross elasticity of demand is positive for…
Substitutes
Cross elasticity of demand is negative for…
Compliments
What factors affect PED?
Addictiveness,
Proportion of real/disposable income,
Availability of substitutes
Business relevance of elasticity
Set a price, ways to increase revenue (inelastic – lower price and vice versa), luxury/normal good/inferior good (-YED)/necessity, as income rises demand for normal goods increase, set pricing structures (bundling), however only estimates (inaccurate data leads to inaccurate elasticity co-efficient)
Market equilibrium
Market equilibrium occurs where demand meets supply
Market failure
Market failure occurs when the price mechanism fails to allocate resources efficiently all the time.
Free market forces fail to produce the products that people want, in the quantities they desire and at prices that reflect consumer satisfaction.
Externalities
Costs/benefits imposed upon a third party who aren’t directly involved in a decision making process.
Internalising the externality
Making the externality part of the price.
Eg. Externalising the externality of petrol.. tax the good (to the level of welfare loss), this will successfully internalise the externality.
Social costs/benefits
The total cost/benefit arising from a particular decision.
Private costs/benefits
The costs/benefits that accrue to an individual/firm
External costs/benefits
Social costs/benefits exceed private costs/benefits.
Costs/benefits upon the third party.
Information failure
Lack of how good/bad a product or service is for you, hence insufficient demand will be registered in the free market. Demand is below optimum level – the market has failed.
When information is lacking, missacurate, unprocessable and out of date leading to consumers and producers making decisions that do not maximise welfare.
Merit good
Positive externalities.
People do not perceive the full benefits. Under-consumed. Eg. Education.
Demerit good
Negative externalities.
People do not perceive the full costs. Over-consumed. Eg. Cigs.
Public good
Non-excludable (cannot stop being provided to everyone). Non-rival (if one person consumes it, it doesn’t stop other people). Eg. Streetlighting.
Quasi-public good
Kind of public, but not fully. Eg. Beach – can get crowded (rival).
+/- Externalities
- Divergence between private/social costs/benefits
- Not reflected in price
- Over/under produced and consumed
- External costs = neg. externality & vice versa
Merit/demerit goods
- Due to a lack of information
- People do not perceive full costs/benefits
- Over/under produced and consumed
Why do governments intervene?
To achieve economic efficiency & to achieve a fair or equitable distribution of resources in the economy.
Method of Intervention 1
Indirect taxation
Taxing firms who produce demerit goods. De-merit goods are overproduced (imperfect information) so production needs to decrease to social optimum.
Advantages of indirect taxation
- Deter demand as price increases
- Firms are forced to reduce supply, solving over-production
- Costs of production are raised, shifting the supply curve
- Reduces firm’s profit margin – stop producing the good if it gets too low?
- Allocative efficiency
- Internalises the externality & thus correct the misallocation of resources
Disadvantages of indirect taxation
- In order to prevent government failure, the tax must equal external cost
- Tax can be inflationary and reduce real GDP
- Restricts economics growth – unemployment
- Inelastic demand products can increase price to pass the cost onto customers (polluter doesn’t pay)
- Relocate abroad (tax-less)
- Taxes on necessities may be regressive
Method of Intervention 2 - Subsidies
Subsidising production of merit goods. Payment to producers to decrease their costs & increase output.
Advantages of subsidies
- Control inflation rates
- Boost living standards of some groups
- Encourage consumption of merit goods with positive externalities
- Increase social benefits
- Improve under-consumption of merit goods to create allocative efficiency
- Boost employment of LT unemployed
Disadvantages of subsidies
- Opportunity cost of dishing out money to groups
- Which groups should receive the subsidy? – fairness + equity
- Alternatives – income support through tax system
- People may not benefit from subsidy – yield no satisfaction
Advantages of regulation (method of intervention 3)
- Restrict amount of –ext produced
- Fine companies – lots of money
Disadvantages of regulation (method of intervention 3)
- Not always enforceable
- Need evidence to prove breaking of law
Advantages of polluter permits (method of intervention 4)
- Tradable between firms
- Encourages less pollution if firms have an incentive to make money
- Limits amount of neg ext (pollution)
Disadvantages of polluter permits (method of intervention 4)
- Monopoly can buy them all out
- Encourage businesses to travel elsewhere
Advantages of state provision of public goods (method of intervention 5)
- Ensures provision
- Meets demand
Disadvantages of state provision of public goods (method of intervention 5)
- Expensive for govt
- No profit motive; not as efficient
Advantages of provision of information (method of intervention 6)
- Corret level of demand would be registered
Disadvantages of provision of information
• Must ensure information is correct/suitable/cheap or free
Define allocative efficiency
Allocative efficiency is achieved when the value consumers place on a good or service (reflected in the price they are willing to pay) equals the cost of the resources used up in production.
Condition required is that price = marginal cost. When this condition is satisfied, total economic welfare is maximised. When you get goods that have negative externalities, the market price is not reflective of the true social costs. So if allocative efficiency was truly achieved, the price of the goods with negative externalities would be the private costs + the social costs (ie the damage caused to a third party, e.g. the environment). Things are being produced that people want.
Define economies of scale
When costs fall in the long run due to an increased scale of operation. Examples included; bulk buying materials, division of labour, technological advancements
Define pareto efficiency
Where it is not possible to make someone in society better off without making someone else worse off
Define productive efficiency
Where production is at the possible cost. Using the least amount of scarce resources to produce a product.
