Unit 2: How Markets Work Flashcards
What is the main objective of consumers when making economic decisions?
Maximizing utility
What is the main objective of producers when making economic decisions?
Maximising profit
What is meant by effective demand?
** Demand backed up by an ability to pay
i.e not just desiring the product
What are the 5 main determinants of demand?
Price, Income, other goods, brand reputation, tastes and preferences
What does a point on a demand curve show?
How much of a good will be demanded at a price level
What would cause an extension/contraction in the demand curve?
Change in price
What would cause a shift in the demand curve?
Any change in conditions of demand
Give an example of something that would shift the demand curve for potatoes to the right
Potatoes are revealed to be more healthy/prevent disease
demand changes
Give an example of something that would shift the demand curve for potatoes to the left
Potatoes revealed to cause cancer
demand decreases
Define demand
The quantity of a good or service that consumers choose to buy at any possible price in a given period
Define market demand
Total demand in a market for a good, the sum of all individuals’ demand, at each given price.
Define diminishing marginal utility
When an individual gains less additional utility from consuming a product, the more of it is consumed
Define contractions in demand
A movement along a demand curve to the left, showing there is a fall in the quantity demanded caused by an increase in price.
A move
Define extensions in demand
A movement along a demand curve to the right, showing there is an increase in the quantity demanded caused by a decrease in price.
Define the law of demand
there is an inverse relationship between quantity demanded and the price of a good or service, ceteris paribus
Define the demand curve
A graph showing how much of a good will be demanded by consumers at any given price
Define a shift in demand
where the whole demand curve shifts to the right or left
Define a normal good
A good where the quantity demanded increases in response to an increase in income
Define an inferior good and give an example
A good where the quantity demanded decreases in response to an increase in income, e.g Asda smartprice baked beans
Define substitutes
When the demand for one good is likely to rise if the price of the other good rises (directly proportional)
Define complements
if an increase in the price of one good causes the demand for the other good to fall (inverse)
Define derived demand and give an example
When the demand for one good or service comes from the demand for another good or service. e.g cars and steel
Define joint supply and give an example
A good which is the by-product of another good, and so are produced together e.g.beef and leather, wool and sheepskin
Define composite demand and give an example
One good which is demanded for 2 different purposes e.g milk, for yoghurt and butter
Define elasticity
A measure of the sensitivity of one variable to changes in another variable
Define relatively elastic in terms of PED range of values
1 < PED < infinity
Define relatively inelastic in terms of PED range of values
0 < PED < 1
Define unitary elasticity in terms of PED range of values
PED = 1
Define income elasticity of demand in words
A measure of the sensitivity of quantity demanded to a change in consumers incomes
Define luxury good in terms of income elasticity
One for which the income elasticity of demand is positive, and greater than 1, such that as income rises, consumers spend proportionally more on the good
Define a necessity good in terms of income elasticity
A good for which the income elasticity is positive, and less than 1, such that as income rises, consumers spend proportionally less on the good
Define cross-price elasticity of demand (XED)
A measure of the sensitivity of quantity demanded of a good or service to a change in the price of some other good or service
Define supply
The quantity of a good or service that firms choose to sell at any given period
Define a firm
An organisation that brings together factors of production in order to produce output
Define a competitive market
A market in which individual firms cannot influence the price of the good they are selling, because of competition from other firms
Define a supply curve
A graph showing the quantity supplied at any given price
Define a cartel
An agreement between firms in a market on price and output with the intention of maximising their joint profits
Define price elasticity of supply (PES)
A measure of the sensitivity of quantity supplied of a good or service to a change in the price of that good or service
Define market equilibrium
A situation in a market where Qd = Qs
Define comparative static analysis
Examines the effect on equilibrium of a change in the external conditions affecting a market
Define consumer surplus
The value that consumers gain from consuming a good or service over and above the price paid
Define marginal social benefit (MSB)
The additional benefit that society gains from consuming an extra unit of a good
Define producer surplus
The difference between the price received by firms for a good or service and the price at which they would have been prepared to supply that good or service
Define marginal cost
The cost of producing an additional unit of output
Define indirect tax
A tax levied on expenditure on goods and services, where the liability can be passed onto someone else e.g VAT
Define direct tax
a tax charged directly to an individual based on a component of income e.g income tax
Define the incidence of a tax
The way in which the burden of paying a sales tax is divided between buyers and sellers
Define a subsidy
A grant given by the government to producers to encourage production of a good or service.
What do we assume is the main objective of governments?
Improve economic and social welfare of citizens
Name 4 factors affecting demand
Income
taste/preferences/trends
Weather/seasons
Other goods (substitutes, complements)
PED formula
PED = % change in Qd / % change in P
At what values is PED perfectly inelastic and perfectly elastic?
perfectly inelastic: 0
perfectly elastic: minus infinity
Formula for YED (income elasticity of demand)
YED = % change in Qd / % change in Y (income)
XED formula
% change in Qd of good A / % change in P of good B
If a good is price elastic and price falls, what will happen to revenue ceterus paribus?
Increase
If a good is price inelastic and price falls, what will happen to revenue ceterus paribus?
Decrease
Revenue formula, and how to find revenue on a demand curve
Qd x P
Revenue = area under demand curve
Name 4 factors affecting elasticity for consumers
PANT
Proportion of income spent on product, Availability of close substitutes, Necessity of luxury, Time
At what values is YED perfectly elastic/perfectly inelastic (and which goods represent these for elastic)?
Perfectly inelastic: zero
Perfectly elastic: infinity, luxury goods and minus infinity, inferior goods
At what values of XED are subtitutes and complements
Substitutes: greater than 0 to infinity
Complements: less than 0 to negative infinity
What causes a movement in the supply curve?
Change in price
What causes a shift in the supply curve?
Change in conditions of supply
What is the relationship between Qs and price and why?
direct - higher P, higher Qs as there is a greater incentive to produce
Name 5 causes of a shift in the market supply curve
Change in production cost per unit
Advance in production technology
More producers
Better weather (e.g farming)
Taxes (in), subsidies (out), and gov regulations
Define the short-run
At least one factor of production is fixed
Define the long-run
All factors of production are variable
What type of elasticity is supply if you cannot increase at least one factor of production in the short run and why?
Supply must be inelastic as it cannot quickly respond to a change in demand.
PES formula
PES = % change in Qs / % change in P
At what values is PES perfectly inelastic, unitary, and perfectly elastic?
Perfectly inelastic: 0
Unitary: 1
Perfectly elastic: infinity
Name 4 factors affecting PES
TASA
Time, Availability of PRODUCER substitutes, Spare capacity, Availability of stocks (e.g can product be stored - if so then it is elastic as can respond to P change)
Define excess supply, and what will happen to prices
Too much output and not enough supply
Prices go down until they reach equilibrium
Define excess demand, and what will happen to prices
Quantity producers are willing to supply is less than the quantity consumers want to purchase
Prices rise until they reach equilibrium
Name 3 functions of the price mechanism
Rationing (prices ration scarce resources when D > S)
Signalling (Change in P provides information about change in market conditions and change to act on the signal)
Incentives (change in P provides incentive to increase/decrease production)
How is consumer surplus found on a demand curve?
Area below demand curve but above market price
How is producer surplus found on a supply curve?
Area above supply curve but below market price
Define producer surplus
Difference between price a producer would have accepted and the price the producer received
How does a price increase affect consumer / producer surplus?
Consumer: surplus decreases
Producer: Surplus increase
How do indirect taxes affect the supply curve?
Shifts left as they cause an increase in supply cost.
Name the 2 types of indirect tax, define, and give an example for each
Ad valorem tax: based on value of product e.g VAT
Specific tax: set amount per unit of product e.g excise duty
How do ad-valorem taxes affect the supply curve, and why?
Skewed shift inwards - as P increases, willingness to supply decreases as cost has increased per unit of output
How are consumers and producers benefitted by subsidies?
Consumers: lower price
Producers: cost of supply is cheaper
What effect does a subsidy have on the equilibrium price if there is inelastic demand?
Larger (than if it were elastic)
What effect does a subsidy have on the equilibrium quantity if there is elastic demand?
Larger (than if it were inelastic)
Name 4 ways of assessing the effectiveness of a subsidy
Meeting aims
Changing productivity
Cost of subsidy compared to benefit
Correcting market failure
Name 2 ways consumers act irrationally
Influenced by behaviour of others
Emotional factors
Name 3 ways consumers don’t act perfectly rationally
Abiding to social norms
Habits
Availability bias (attaching an emotional connection to an event)
Name 3 reasons why consumers cannot act perfectly rationally
Lack of available information
Limits on time for decision making
Computational weakness
