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Economics > Unit 2: Microeconomics > Flashcards

Unit 2: Microeconomics Flashcards

1
Q

Demand

A

The quantity of a good or service that consumers are willing and able to purchase at a given price

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2
Q

Theory of demand

A

States that price of good increase = quantity demand decrease, and vice-versa

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3
Q

Ceteris paribus

A

All other things being equal (assumption in theory of demand/supply)

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4
Q

Economic theory assumptions

A

Consumers want to maximize utility (satisfaction gained from consumption) and are rational

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5
Q

Marginal utility

A

The additional satisfaction a consumer gains from consuming one additional unit of a good

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6
Q

Law of diminishing marginal utility

A

Marginal utility declines as more of good is consumed, hence price consumer is willing to pay for additional unit decreases, and hence there is an inverse relationship between quantity demanded and price

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7
Q

Why price increase = quantity demanded decrease

A

Income effect and substitution effect

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8
Q

Income effect

A

Price increase means consumers can afford less

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9
Q

Substitution effect

A

Price increase causes some consumers to switch to alternative good/service

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10
Q

Leftward movement along supply/demand curve

A

Contraction

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11
Q

Rightward movement along supply/demand curve

A

Expansion

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12
Q

Non-price determinants of demand

A
  • substitute goods (actions of competitors)
  • publicity
  • demographic changes
  • global events
  • speculation
  • marketing
  • seasonality
  • government policy
  • trends/tastes
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13
Q

Price elasticity of demand (PED)

A

Measures responsiveness of quantity demanded to a price change

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14
Q

Price elastic demand

A

Price change leads to a proportionally greater change in quantity demanded (flatter demand curve, PED > 1)

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15
Q

Price inelastic demand

A

Price change leads to a proportionally smaller change in quantity demanded (steeper demand curve, PED < 1)

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16
Q

Unit elastic demand

A

Quantity demanded changes in proportion to price (PED = 1)

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17
Q

Determinants of PED

A
  • number and closeness of substitutes
  • necessity of good
  • proportion of income spent on good
  • brand loyalty
  • time period under consideration (demand more elastic in long run)
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18
Q

Calculating PED

A

%∆Qd / %∆P

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19
Q

Percentage change

A

difference / original value (x 100)

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20
Q

Interpreting PED

A

Always negative and written as such, but negative ignored to interpret value

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21
Q

Revenue

A

Money earned by a business from selling good/service (price x quantity)

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22
Q

Revenue for price elastic good/service

A

Price decrease = higher revenue

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23
Q

Revenue for price inelastic good/service

A

Price increase = higher revenue

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24
Q

Primary commodities PED

A

More inelastic (due to higher necessity, less substitutes)

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25
Q

Manufactured goods PED

A

More elastic (due to lower necessity, more substitutes)

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26
Q

Supply

A

The quantity of a good or service that producers are willing and able to produce/sell at a given price

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27
Q

Theory of supply

A

States that price of good increase = quantity supplied increase, and vice-versa

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28
Q

Why price increase = quantity supplied increase

A

Incentive of higher revenue/profits (incentivizes producers to enter market)

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29
Q

Non-price determinants of supply

A
  • changes in costs of factors of production
  • random shocks (e.g. natural disasters, weather, conflict)
  • government intervention (e.g. taxes, subsidies)
  • profitability of producing alternative products
  • technological changes (can reduce costs of production)
  • joint supply (production process yields multiple outputs)
  • number of firms in market
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30
Q

Price elasticity of supply (PES)

A

Measures responsiveness of quantity supplied to a price change

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31
Q

Price elastic supply

A

Price change leads to a proportionally greater change in quantity supplied (flatter supply curve, PES > 1)

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32
Q

Price inelastic supply

A

Price change leads to a proportionally smaller change in quantity supplied (steeper supply curve, PES < 1)

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33
Q

Unit elastic supply

A

Quantity supplied changes in proportion to price (PES = 1)

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34
Q

Fully inelastic supply

A

Quantity supplied not at all responsive to price change (vertical supply curve, PES = 0)

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35
Q

Determinants of PES

A
  • mobility of factors of production (how quickly can production change in response to price)
  • storage of product (how long can it be stored)
  • time period under consideration (longer time under consideration = supply more price elastic, as factors of production are fixed in short term but can be changed in long run)
36
Q

Calculating PES

A

%∆Qs / %∆P

37
Q

Market

A

Interaction of consumers (demand) and sellers/producers (supply)

38
Q

Point where supply = demand

A

Equilibrium (or market clearing price)

39
Q

Functions of prices in a market

A
  • Signalling function (determine how resources should be allocated)
  • Rationing function (reduce demand for scarce resource)
  • Incentive function (change behaviour of consumers/producers)
40
Q

Price mechanism

A
  1. Demand/supply curve shifts due to non-price determinant
  2. Disequilibrium at original price due to excess demand/supply signals to producers to increase/decrease prices
  3. Expansion/contraction along demand curve due to price change rationing demand/incentivizing buying—more/less people willing and able to buy due to income effect
  4. Expansion/contraction along supply curve due to price change incentivizing/disincentivizing production—more/less suppliers willing and able to supply due to increased/decreased profits
  5. New equilibrium price/quantity forms and market clears at P1 Q1
41
Q

Consumer surplus

A

Difference between what a consumer is willing to pay for a good and the price they actually pay (top half of left sector)

42
Q

Producer surplus

A

Difference between the price a firm would be willing to receive for a good and the actual price they receive (bottom half of left sector)

43
Q

Consumer + producer surplus

A

Community (social) surplus

44
Q

Community surplus maximized at market equilibrium

A

Allocative efficiency / optimal allocation of resources

45
Q

Stakeholder

A

Individual/group/organization that can affect or be affected by economic activity

46
Q

Stakeholder diagram (impact of price mechanism on buyers/sellers)

A

[see image]

47
Q

Primary commodity

A

Unprocessed raw material of agricultural or mineral origin

48
Q

Price gouging

A

Practice of increasing the prices of goods, service, or commodities to a level much higher than is considered reasonable after a demand or supply shock

49
Q

Reasons not to price gouge

A
  • bad publicity
  • might cause government to intervene and cap prices
  • legal issues
  • higher prices incentivize more producers to enter market
50
Q

Price ceilings (maximum prices)

A

When the government/market regulator sets a maximum price which prevents producers/suppliers raising the price above it

51
Q

Price ceilings diagram

A

[see image]

52
Q

Impacts of price ceiling

A
  • market disequilibrium due to excess demand
  • can lead to black market activity where shortage causes more consumers to be willing and able to purchase at a higher price
53
Q

How to resolve disequilibrium due to price ceiling

A
  • government/regulator can resolve disequilibrium by subsidising production of good by amount needed to cover shortage
  • introducing a rationing system (as in WWII)
54
Q

Government expenditure on subsidising production of good to resolve excess demand after maximum price

A

Pmax X (Qd – Qs)

55
Q

Impact on stakeholders and welfare (price ceiling)

A
  • producer revenue decreases (increases, if PED is elastic and government subsidises shortage)
  • producer surplus decreases
  • consumer surplus increases (if PED is elastic OR government subsidises shortage) / decreases if PED is inelastic
  • deadweight welfare loss
56
Q

Arguments for price ceilings

A
  • protect consumers from rising prices of essential goods/services
57
Q

Arguments against price ceilings

A
  • create disequilibrium in market
  • costs of subsidies require government spending which either requires increased taxes, government borrowing, or incurs an opportunity cost in reducing spending elsewhere
  • black market activity – promotes illicit activity, violence, and heavier tax burden on law-abiding citizen (as black market is not taxed)
  • inefficiency – create deadweight welfare loss due to reduced community surplus
58
Q

Price floors (minimum prices)

A

When the government sets a minimum price to prevent producers/suppliers from reducing the price below it

59
Q

Price floors in agriculture

A
  • common for governments of developed economies to set floor price for agricultural commodities
  • want to protect food supply (in order to be self-sufficient in case of war/sanctions/natural disasters)
  • agricultural commodities’s prices are unstable (thus revenues are inconsistent, yet costs tend to be stable)
60
Q

Price floors diagram

A

[see image]

61
Q

Government expenditure on buying excess supply in order to maintain a guaranteed minimum price

A

Pmin X (Qs – Qd)

62
Q

Government maintaining guaranteed minimum price

A
  • buying excess supply is effective for non-perishable goods
  • they can be stored (additional costs) and released during shortage
  • profitable if prices are higher when goods are released
63
Q

Impact on stakeholders and welfare (price floor)

A

if government does not buy up excess supply

  • producer revenue decreases
  • producer surplus increases (decreases if PED elastic)
  • consumer surplus decreases
  • deadweight welfare loss
64
Q

Arguments for price floors

A
  • incentivize suppliers of essential goods to stay in market by guaranteeing producer revenues
  • discourage overconsumption of demerit goods
65
Q

Arguments against price floors

A
  • create disequilibrium in market
  • costs for government of buying up excess supply to maintain guaranteed minimum price either require increased taxes, government borrowing, or incur an opportunity cost in reducing spending elsewhere
  • unintended consequences (consumers buying from abroad, reducing money entering local economy)
  • inefficiency – create deadweight welfare loss due to reduced community surplus
66
Q

Demerit good

A

Good/service that consumption of which is unhealthy, degrading, or socially undesirable

67
Q

Indirect tax

A

A tax on expenditure, paid by seller who may pass the tax on to consumers in form of higher prices

68
Q

Two types of indirect taxes

A
  1. Specific tax – where tax is levied as a fixed amount (e.g. excise duties put on demerit goods)
  2. Ad-valorem tax – where tax is levied as percentage of selling price (e.g. value-added tax (VAT) on most goods/services in UK)
69
Q

Specific tax diagram

A

[see image]

70
Q

Ad-valorem tax diagram

A

[see image]

71
Q

Impact on stakeholders and welfare (indirect tax)

A
  • government tax revenue
  • producer revenue decreases
  • producer surplus decreases
  • consumer surplus decreases
  • deadweight welfare loss
72
Q

Evaluation of indirect taxes

A
  • elasticity of good (less effective when PED inelastic)
  • unintended consequences (e.g. black market—neither decreases consumption nor raises tax revenue)
  • setting right tax level difficult
  • inefficient allocation of resources (deadweight welfare loss)
73
Q

Production subsidy

A

An amount of money paid by the government to a producer per unit of output

74
Q

Production subsidy impact

A

Lowers cost of production for producers allowing for increased output of good

75
Q

Reasons for production subsidy

A
  • lower price of essential goods
  • guarantee food supply within country
  • make domestic producers more competitive in international markets
76
Q

Production subsidy diagram

A

[see image]

77
Q

Impact on stakeholders and welfare (production subsidy)

A
  • government expenditure
  • producer revenue increases
  • producer surplus increases
  • consumer surplus increases
  • deadweight welfare loss
78
Q

Evaluation of subsidies

A
  • government incurs opportunity cost
  • inefficient allocation of resources (expenditure > community surplus increase)
  • dumping
79
Q

Dumping

A

Selling below costs of production of over-subsidized/over-produced agricultural products (HICs to LEDCs)—predatory pricing hurts farming industry of LEDC

80
Q

Consumption subsidy

A

An amount of money paid by the government to a consumer to encourage them to purchase a good/service

81
Q

Consumption subsidy

A

[see image]

82
Q

Consumer incidence (indirect tax)

A

Seller raises price to cover part of tax

83
Q

Producer incidence (indirect tax)

A

Seller pays part of tax by accepting less revenue

84
Q

Consumer/producer incidence diagram (indirect tax)

A

[see image]

85
Q

Consumer incidence (subsidy)

A
86
Q

Producer incidence (subsidy)

A
87
Q

Consumer/producer incidence diagram (subsidy)

A

[see image]

Economics (5 decks)

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