Unit 2 - The price system and the microeconomy Flashcards
Define effective demand
An individual’s desire for a product backed up with the ability to pay for it
What is the law of demand?
- When price increases, QD falls
- When price decreases, QD rises
What is the law of supply?
- When price rises for goods, producers will supply more
- When prices fall, quantity supplied by producers fall
Define normal good
When an individual’s income increases, their demand also increases and vice versa
Define inferior good
When an individual’s income increases, their demand for a good will fall and vice versa.
E.g: Goods that are considered as less desirable/low quality (cheap foods like ramen or frozen foods)
What are the determinants of demand?
- Income
- Price of other goods/substitute goods
- Tastes/preferences
- Expectation of future prices
- Distribution of population, size, gender, age
- Distribution of income
What are the determinants of supply?
- Cost of production
- Availability of resources
- Climate
- Technology
- Government regulation
- Taxes and subsidies
- Price of other goods producer could supply
What causes a shift in the demand curve?
- The demand curve shifts to the right when individuals are able to purchase more
- The demand curve shifts to the left when individuals are able to purchase less
Causes of shift in demand curve to the right
- Rise in income for normal good
- Fall in income for inferior good
- Rise in price of substitute
- Fall in price of complement
- Taste changes in favor of product
- Expectations of future prices rise
- Increase in population
- More even distribution of income
Causes of shift in demand curve to the left
- Fall in income for normal good
- Rise in income for inferior good
- Fall in price of substitute
- Rise in price of complement
- Taste changes away from product
- Expectations of future prices fall
- Decrease in population
- Less even distribution of income
Causes for supply curve shifting to the right
- Low COP
- More available resources
- Better climate conditions
- Improved tech
- Changes in govt regulations in reducing cost or increasing supply
- Fall in tax, increase subsidy
- Reduction in price of alternative products firm could produce
Causes for supply curve shifting to the left
- High COP
- Less available resources
- Worse climate conditions
- Setbacks in tech
- Changes in govt regulations where cost increases or it’s difficult to supply
- Increase in tax, no subsidy given
- Increase in price of alternative products firm could produce
What happens when there is a MOVEMENT along the demand curve?
- Contraction: movement UP demand curve
- Expansion: movement DOWN demand curve
- An increase in demand means a fall in price and increase in QD (expansion)
- A fall in demand means a rise in price and decrease in QD (contraction)
What happens when there is a MOVEMENT along the supply curve?
- An increase in supply means a rise in price and rise in QD (expansion)
- A decrease in supply means a fall in price and fall in QD (contraction)
Define elasticity?
It’s the responsiveness of demand or supply to a change in one of its determinants
Define PED, YED, and XED
PED = Measures the responsiveness of a change in QD of a product to a change in its price
YED = Measures the responsiveness of a change in QD of a product to a change in consumer’s income
XED = Measures the responsiveness of change in QD of one product to a change in price of another product
Define elastic demand
The percentage change in QD is more responsive than the percentage change in price
Define inelastic demand
The percentage change in QD is less responsive to the percentage change in price
Describe the meanings of values for PED
- PED = 0 (Perfectly inelastic demand) –> A change in P doesn’t change the QD
- PED < 1 (Inelastic demand) –> A % change in QD is less responsive to a % change in P
- PED = 1 (Unitary elasticity of demand) –> The % change in QD is equal to the % change in P
- PED > 1 (Elastic demand) –> A % change in QD is more responsive to a change in P
- PED = ∞ (Perfectly elastic demand) –> A small change in P brings about an infinite change in QD
Describe the meanings of values for YED
- YED < 1 (income inelastic) –> A % change in QD is less responsive to a % change in income
- YED > 1 (income elastic) –> A % change in QD is more responsive than a % change in income
- YED = 1 (unitary income elasticity) –> A % change in QD is equal to a % change in income
- YED = 0 (Zero income elasticity) –> A change in income doesn’t change the QD
- YED < 0 (Negative income elasticity of demand) –> Change in income leads to a change in QD in the opposite direction
Describe the relationship between substitutes and complements
- Products with a positive XED are substitutes
- Products with a negative XED are complements
Define positive XED and give example
- A change in P of one good leads to a change in QD of another in the SAME DIRECTION
- Eg: Rise in P of tea = Fall in QD of tea = Rise in QD of coffee
Define negative XED and give example
- A change in P of one good leads to a change in QD of another in the OPPOSITE DIRECTION
- Eg: Rise in P of cars = Fall in QD of cars = Fall in QD of fuel
Describe elastic demand
- PED > 1
- Eg: Luxury products
- Higher PED = more elastic demand is for product
- Elastic demand is higher at higher prices than low
- Elastic demand curve diagram is a flat demand slope
Describe inelastic demand
- PED < 1
- Eg: Products that are necessities (medicine, rice)
- The lower the PED = The more price inelastic the product will be
- Inelastic demand diagram has a steep demand curve
What are the factors affecting demand?
- Time
- Longer time period = more elastic
- Less time period = more inelastic - The number of substitutes
- More substitutes = more price elastic
- Less substitutes = more price inelastic - Degree of necessity
- More essential = more inelastic
- Less essential = more elastic - Durability and perishability
- More durable = elastic
- More perishable = inelastic - Proportion of income taken by the product
- High proportion of income = elastic
- Low proportion of income = inelastic
What are the major factors determining YED?
- If a product is a luxury or necessity
- How broadly or narrowly a product is defined
(broader = more inelastic, narrower = more elastic) - assuming that the only variable affecting demand that is changing is household income and all other determinants are held constant
What are the major factors determining XED?
- The closeness of the relationship between complements and substitutes
- Higher the value of the XED coefficient = Greater the effect of a change in price of complements/substitutes have on demand for product
- Value of XED coefficient can also be 0
(Means that products are independent or unrelated with each other, e.g.: strawberries and coal) - assuming that the only variable affecting demand that is changing is:
–> household income
–> substitutes and complements
–> all other determinants of demand are held constant
Define indirect tax
A tax on expenditure that’s imposed on the producer but can be passed onto the consumer through an increase in price
- Ad valorem tax
- Specific tax
Define ad valorem tax
A tax (according to value) that’s a percentage tax which is based on the value of an item
Define specific tax
A fixed amount of tax placed on a particular good
Define price elasticity of supply
It’s the responsiveness of the quantity supplied of a product to a change in its price
Explain the meaning values of PES
- Perfectly inelastic = 0
- A change in price leads QS being unchanged - Price inelastic = PES < 1
- A % change in QS leads to a less proportionate or less responsive % change in price - Price elastic = PES > 1
- A % change in QS is more proportionate or more responsive to a % change in price - Unitary elasticity = 1
- A % change in QS leads to an equal % change in price - Perfectly elastic = ∞
- A small change in QS leads to an infinite change in price
What are the factors and impact affecting PES?
- Time
- longer time period = more elastic - Availability of resources
- greater resources and less specialized = more elastic - Spare capacity
- more spare capacity = more elastic - Stocks
- more stocks available = more elastic - Number of firms in market
- more firms in market = elastic - Possibility of switching FOP between uses
- if factors can easily be switched between uses = more elastic
What are the time periods considered for PES and explain?
- Immediate/market period
- QS is completely fixed and supply is perfectly inelastic - Short period
- where one or more FOP are fixed
- supply can only be increased when making greater use of the variable factors
- elasticity of supply can increase but may still be inelastic - Long period
- all FOP are variable
- producer can increase QS by increasing scale of production
- supply is relatively inelastic
Define impact of tax
It’s where the initial burden of paying the tax falls
Define incidence of tax
It’s where the final burden of paying the tax falls
Define direct tax
These are taxes that are paid by individuals or organizations directly to a tax authority or government
Define income tax
Tax that is levied on a worker’s weekly or monthly pay/income
Define equilibrium price
- There is no tendency for change in the market price
- QD = QS
Define market equilibrium
- Price for where there will be no tendency for change based on the existing conditions of demand and supply
- Demand = supply (equilibrium)
Define market disequilibrium
- Demand does NOT equal supply
- Tendency for price to change
- If price increases, demand is greater than supply
- If price falls, supply is greater than demand
Define joint/complementary demand
Where two goods are normally demanded together (cars and fuel)
Define alternative demand
Where two goods are considered alternatives for one another (butter and margarine)
Define derived demand
When the demand for a good or service arises as a result for the demand of another good or service, eg: like labor being demanded so that the demand for clothing products can be met
Define composite demand
When a product is demanded for more than one purpose
Define joint supply
The production of one good brings an increase in supply of another good
Define competitive supply
An increase in supply for one product brings about a decrease in supply for another product
Define signaling, rationing, and incentive function
Signaling = This indicates shortages and surpluses in the market
Rationing = The allocation of scarce resources among competing individuals/groups
Incentive = Encourages producers to supply more/less of a good/service
Define consumer surplus
The difference between the price the consumer is willing to pay, and the actual price paid
Define producer surplus
The difference between the minimum price the supplier is willing to accept for a good and the price actually received
