unit 3 AOS 1 Flashcards
relative scarcity
- the basic economic problem, refers to the idea that peoples needs and wants are unlimited, relative to the limited amount of resources available to satisfy these needs and wants, therefore producers need to make decisions about how to use resources efficiently to maximise consumer satisfaction & LS
resources/ factors of production
the inputs used in the production of g & s
- land: found in the natural environment- rivers, forests, oceans
- labour: the human skill & talent used in production- employees such as mechanic, doctor, teacher
- capital: physical equipment & machinery used in production of other g & s- roads, factories, tools, computers
opportunity cost
the benefits lost when forgoing production in one area, and choosing to allocate scarce resources to their next most productive use
> occurs due to relative scarcity, must make decisions about how to allocate scarce resources in order to maximise society satisfaction
> can be illustrated on the PPF
the three basic economic questions
- what and how much to produce
> type and quantity of each good or service to produce with limited resources available in order to maximise consumer satisfaction - how to produce
> producing in the most most efficient way –> cheapest & most profitable - for whom to produce
> how a nations goods, services & incomes will be shared
economic efficiency
means that resources are used to produce g&s that best satisfy wants, needs & wellbeing
- allocative: resources are allocated to areas of production that maximise satisfaction of society’s wants and needs
- productive/ technical: firms using lowest cost production method. maximise output per unit of input
- dynamic: resources are quickly allocated in response to changing needs & tastes. the speed of change from one point to another
- intertemporal: balance between spending on current consumption vs saving for future consumption, immediate wants vs those of future generations, enviro sustainability
non-price conditions affecting price changes in a market
- if there are more buyers and fewer sellers, price rises
- if there are fewer buyers more sellers, price falls
conditions of a free & perfectly competitive market
strong comp between sellers & between buyers
- consumer sovereignty
> consumers dictate how resources are allocated
- firms have no market power or control over prices
> many firms producing the same product, therefore they are price takers (unable to influence prices)
- ease of entry or exit
> firms can easily reallocate their resources, meaning they can enter or leave a market easily. barriers to entry are limited
- products are homogenous
- resources are mobile
> resources can easily be used from one use to another in response to relative prices and profits
- behaviour is rational and includes profit maximisation
> selling at highest possible price, buying at lowest
- there is perfect knowledge of the market
relative prices & profits
prices: the price of one good or service compared to another
profits: level of profit gained from producing one good or service compared to another
> relative prices give an indication of relative profits and influence how firms allocate their resources
the law of demand
states that the quantity of a particular good or service that buyers are prepared to purchase varies inversely with the change in price
> as price rises, demand falls (contracts) and vice versa
theories explaining the law of demand
- the income effect: when the good or service becomes more expensive, fewer people have the income to afford to buy it, so demand contracts
- the substitution effect: when the good or service becomes more expensive & less affordable, buyers look for cheaper alternatives, so demand contracts
movement along vs shift of the demand curve
- movement: caused only by a change in price, movement from one point to another.
> movement upwards = rise in price
> movement downwards = fall in price - shift: non-price factors cause buyers to purchase more or less of a good or service
> increase in factors= shift outwards to the right
non-price factors affecting the demand curve
cause a shift of the whole curve
- changes in disposable income
- consumer confidence
- changes in demographics & population size
- changes in preferences and tastes
- changes in interest rates on borrowed money
- changes in the price of substitutes
- changes in the price of complementary g & s
the law of supply
states that the quantity of a good or service produced varies directly with the change in price
> as price rises, suppliers are more willing to produce (expansion) and vice versa
theories explaining the law of supply
- the profit motive: a higher selling price in the market, while other factors like production costs remain unchanged, usually means an increase in sales revenue, encouraging firms to expand supply
- consideration of opportunity costs: the opportunity costs of producing another g or s, making it more profitable to reallocate resources away from other uses to increase output, expanding supply
> not in SD
movement along vs shift of supply curve
- movement: only caused by change in price
- shift: due to changes in non-price supply side conditions
> stronger conditions = increase supply
> weaker conditions = decrease supply
effects of changes in supply & demand on equilibrium price & quantity traded
changed in non-price demand and supply conditions cause the lines to shift, resulting in new equilibriums
- increased demand = increase in equilibrium price & quantity & vice versa
- increased supply (shift inwards & right) = decreased equilibrium price & increased equilibrium quantity
- decreased supply (shift outwards & left) = increased equilibrium price & decreased equilibrium quantity
non-price factors affecting the supply curve
shift the supply line to the left or right
- changes in costs of production
- changes in technology & productivity
- changes in climatic conditions
- changes in the number of suppliers
price elasticity of demand
measures the responsiveness of the quantity demanded relative to the % change in price
> whether demand contracts a little or a lot due to price changes
- demand is relatively elastic: changes by a larger proportion than the change in price (line is flat)
- demand is of unit elasticity: change is same as price change
- demand is relatively inelastic: changes by a smaller proportion than the change in price (line is steep)
factors affecting PED
- degree of necessity
> necessities are inelastic, whereas luxury items are elastic - availability of substitutes
> items with lots of substitutes are more elastic than unique items - proportion of income
> items representing a higher proportion of income are more elastic than cheaper things - time
> demand is more elastic in the long-term than short, as time gives people a chance to find alternatives or change habits
price elasticity of supply
measures the responsiveness of the quantity supplied to a change in price
- elastic supply: supply changes by a larger proportion than change in price (line is flat)
- inelastic supply: supply changes by a smaller proportion than the change in price (line is steep)
- supply is of unit elasticity: supply changes by same proportion as the change in price
factors affecting PES
- availability of spare capacity
> more elastic if levels of supply can be easily changed by moving resources between industries - production/ time period
> more difficult to expand supply in the short term following a price increase, more elastic long-term - durability of goods
> items that don’t deteriorate (minerals, wheat) are more elastic than those that cannot be stored or deteriorate quickly
significance of price elasticity of demand & supply
- the pricing policies of sellers
> sellers can increase their prices if their products have no substitutes, increasing their profits as demand is inelastic - the raising of government revenue
> govs can put heavy excise tax on products with inelastic demand to raise revenue
role of relative prices in the allocation of resources
- businesses watch changes in relative price & make decisions about how to allocate their resources between competing uses to maximise profits
> rise in relative prices means businesses need to allocate more resources to that area
> fall in relative prices means businesses need to move resources and decrease production in that area
role of free & competitive markets in promoting efficient allocation of resources & LS
- free and competitive markets determine relative prices, which alter relative profits and how businesses allocate their resources.
> ensures resources are allocated efficiently, as firms will reallocate their resources in order to maximise satisfaction of wants and needs in order to maximise their profits - improves LS by satisfying wants and needs
- business expansion = more jobs = more incomes = improved LS
- changes in relative prices affect incomes & purchasing power, impacting LS
types of market failure
occurs when the operation of the price system involving the forces of demand and supply, do not allocate resources efficiently to maximise the general satisfaction of society’s needs and wants.
- public goods
- externalities
- asymmetric information
- common access resources
public goods- type of market failure
goods and services that can be consumed collectively by an individual, without preventing others from accessing them
> eg. defence, police, non-toll roads
> those who do not pay cannot be easily excluded from gaining benefits, making it hard to make profits
these are:
1. non-excludable: nobody can be refused access, leads to the free rider problem, as people can use without paying tax
2. non-rivalrous: one person using it does not prevent another from also using it & gaining benefit, because some people don’t pay, insufficient resources will be allocated
externalities- type of market failure
- extra costs (negative) or benefits (positive) to third parties as a result of production or consumption
- negative externalities lead to misallocation of resources & damage to third parties
- positive externalities lead to underallocation of resources
asymmetric information- type of market failure
when one group in the market (usually sellers) has more knowledge than the others (usually buyers), which means rational choices cannot be made & society wellbeing is reduced
common access resources- type of market failure
environmental natural inputs such as air, minerals, oceans and forests. non-excludable and free, but also rivalrous
> survival of current and future generations is jeopardised when when these are overused (climate change, severe weather events)
government intervention to address market failure
- indirect taxation
> reduce negative externalities by raising the price of particular goods, changing decisions of buyers and sellers. cause them to reallocate resources to other areas of production eg. tax on alcohol - subsidies
> reduce neg by encouraging consumers to change their behaviour & reduce consumption of products that cause negative externalities. eg. subsidies to encourage installation of solar panels
> can also encourage producers to produce g&s with pos externalities - advertising
> reduce asymmetric info & externalities, inform consumers so that they can make more effective choices - direct provision
> directly providing goods and services - regulations
one example of government intervention that unintentionally leads to a decrease in one type of efficiency
paying subsidies to the coal industry
- encourages production, exports & employment
- may unintentionally reduce allocative and intertemporal efficiency by:
> increasing CO2 emissions, accelerating climate change & severe weather events, adding to negative externalities & lowering LS of future generations
> creates a large opportunity cost
> encourages overproduction & consumption of coal, taking resources away from more productive uses that would have greater society satisfaction, undermining allocative
> satisfying immediate wants without taking future gens into account (intertemporal)
