Unit 3, Area of Study 1 - Microeconomics Flashcards
Opportunity Cost
The value of the next best alternative that is foregone whenever a choice or decision is made.
- Examples:*
- You have $50 in your pocket, you decide to go out for dinner with some friends, instead of buying a new shirt for summer = opportunity cost is the new shirt*
- Free pizza is being offered on Enderly lawn, however there is a long queue, what is the opportunity cost of consuming a piece of pizza? = opportunity cost is the time spent in line.*
Relative scarcity
(basic economic problem)
Refers to the basic economic problem where resources are limited in supply relative to the unlimited wants and needs of individuals, businesses, and governments.
How does relative scarcity lead to an opportunity cost?
Relative scarcity leads to opportunity cost because, in a world of limited resources and unlimited wants, choices must be made about how to best allocate our scarce resources. When a decision is made to use resources to satisfy a need or want, the next best alternative foregone represents the opportunity cost.
Demand
Demand is the willingness and ability of consumers to buy.
Law of demand
As the price increases, the quantity consumers are wiling and/or able to demand decreases
As the price decreases, the quantity consumers are wiling and/or able to demand increases
Income effect
A reduced consumption of a good or service whose price has increased that is due to the reduction in the consumers purchasing power or an increase in consumption of a good or service whose price has decreased that is due to the increase in the consumers purchasing power.
This factor contributes to / influences consumer willingness and/or ability to consume, and helps explaining why the demand curve slops downwards.
Subsitution Effect
Refers to the way consumers react to changes in the prices of goods by substituting one good for another. When the price of a good increases, consumers will seek out an alternate product to consume in place of the good in focus. When the price of a good decreases, then consumers are likely to consumer more of this good in place of alternates.
This is a key component of the law of demand, which states that as the price of a good or service decreases, the quantity demanded increases, and as the price increases, the quantity demanded decreases.
Microeconomic demand side non-price factors
Factors that cause the whole demand curve to shift left or right.
- Changes in Disposable income (Disposable Income)
- The price of substitutes – a substitute is a good or service that can be consumed in place of another, for example, a hot chocolate is an substitute as a hot drink for hot tea.
- The price of complements – are goods and services that are usually consumed together, for example, cereal and milk.
- Preferences and tastes. - refer to the individual desires, likes, and choices of consumers that influence their demand for goods and services.
- Interest rates - cost of borrowing and the incentive to save.
- Population demographics - refer to the statistical characteristics of a population (i.e. population growth and demographic change)
- Consumer confidence (sentiment) = level of optimism or pessimism in the future state the economy and their own job security
Supply
Supply is influenced by the willingness and ability of suppliers to supply.
Law of supply
As the price increases, the quantity that suppliers are willing and/or able to supply increases.
As the price decreases, the quantity that suppliers are willing and/or able to supply decreases.
Profit Motive (influences the law of supply)
As the price of a product rises, producers have a greater incentive to increase production because they can potentially earn higher profits.
In addition, it attracts new suppliers into the market through the operation of relative prices.
Microeconomic supply side non-price factors
Factors that cause the whole supply curve to shift left or right.
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Changes in cost of production Refers to the costs incurred by a business/producer in the process of producing goods or services.
These can include:
Labour costs in the form of wages or salaries
Costs of raw materials
Costs of equipment used in the production process
Costs of land and premises required to produce
Can include indirect taxes, for example, a carbon tax - number of suppliers - literally how many producers/suppliers produce the good or service in the market.
- Technology = e.g. NBN or AI
- Productivity = the level of outputs that are produced from given level of inputs
- Climatic Conditions (for example, positive climatic conditions can lead to increase yields for farmers, increasing the production of goods such as wheat.
7 step response for explaining / describing a market adjusting to a new equilibrium
- Explain the situation in your own words
- Supply or demand
- Increase or Decrease
- Shift the curve left or right
- If price were to remain at P1 temporary shortage (demand exceeds supply) or surplus (supply exceeds demand) forms.
- Market forces put pressure on upward/downward pressure on price to adjust to new equilibrium (including whether there is an expansion or contraction along the curve)
- Overall impact on price & quantity.
Price elasticity of demand
The price elasticity of demand (PED) refers to the responsiveness of total quantity demanded** of a product to a **change in the price of that product.
Elastic = high price elasticity of demand
Inelastic = low price elasticity of demand (curve looks like an “I”)
Factors that influence the price elasticity of demand
- The degree of necessity - refers to how necessary the good or service is essential for survival or daily life a good that is necessary for survival or daily life must be purchased so the quantity purchased will not change a lot no matter what the change in price (PED is inelastic), if the good or service is not essential, then quantity can change a lot (PED Is elastic)
- Availability of substitutes - refers to the number of products available that can be consumed in place of the product (substitutes) a lot of substitutes means consumers can easily change the quantity they demand (PED is elastic), however, if there are not a lot of substitutes they cannot (PED is inelastic)
- Proportion of Income refers to the percentage of a consumers income required to purchase the product if it is a large proportion or percentage then consumers will change quantity demanded a lot (PED is elastic) and if it is a small proportion or percentage the change is likely to be small. (PED is inelastic)
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Time
refers to the amount of time that passes and how this can impact on PED. PED is often inelastic in the short term as consumers have limited flexibility to change their spending habits, however, is demand can become more elastic in the longer term due to greater flexibility.
Price elasticity of supply
Refers to the responsiveness of total quantity supplied of a product to a change in the price of that product.
Factors affecting Price elasticity of supply
- Spare capacity - refers to the level at which a producer’s productive resources (natural, labour and capital) are being under-utilised* If all resources are not being fully utilised, then a producer can respond quickly by increasing production levels (PES is elastic), however, if resources are already being fully utilised, they cannot (PES is inelastic)*
- Production period - how long does it take to produce the good or service if the production period is short then the producer can respond quickly and increase production (PES is elastic), however, if production period is long then the producer cannot response quickly (PES is inelastic)
- Durability of goods - how long can the good be stored if the product is durable and can be stored, then a producer can respond quickly as they will have an inventory to draw on, e.g., tinned peaches (PES is elastic), however, if the product is not durable and cannot be stored, then a producer cannot respond quickly as they will not have an inventory to draw on (PES is inelastic)
Relative prices
Scenario: Prices increase in Market A relative to Market B this:
- Price Mechanism describes how the forces of demand and supply influence prices of goods and services and in turn relative prices, the price of one good relative or compared to another,
- An increase in relative prices send price signals to producers that a shortage has formed in the market.
- producers investigate to determine the reason
- If the increase is the result of a increase in demand = profit making opportunity due to unmet consumer demand
- Producers will reallocate resources into Market A to meet the increase in consumer demand (upholding consumer sovereignty) and maximise profits.
Free and Perfectly competitive markets
(4 pre-conditions)
Conditions required:
- Consumer sovereignty exists - Consumer sovereignty is the ability of the consumer in a competitive market economy to direct or allocate resources
- Large number of buyers and sellers and none have market power to influence price = all are price takers.
- Products sold are homogenous meaning they are identical and easily substitutable.
- Ease of exit and entry (i.e. low set up costs, regulations etc)
- Buyers and sellers operate with full information
- Resources are mobile
Allocative efficiency
The most efficient allocation of resources occurs when living standards and welfare are maximised and it is not possible to further increasing living standards by changing the way resources are allocated.
Productive / Technical efficiency
When it is not possible to increase output without increasing inputs (resources). Achieving productive or technical efficiency means maximising the output from a given level of inputs.
Inter-temporal efficiency
How well resources are allocated over different time periods so the living standards of current generations are not jeopardising future generations living standards.
Dynamic efficiency
How quickly an economy can reallocate resources to achieve allocative efficiency, entails firms being adaptive and creative in response to changing economic circumstances.
Market failure
When an unregulated market is unable to allocate resources efficiently or where resources are allocated in such a way that national living standards or welfare are not maximised. It will result in an over-allocation of resources to the production (or consumption) of some goods and services and/or an under-allocation to others.