Unit 7 20 markers Flashcards
assumptions of indifference curves
consumers are rational and always aim to maximise utility
only two goods are considered
the prices of the two goods are constant
the goods perfectly substitute each other
if there is indifference between A and B and between B and C there is also indifference between A and C
consumers have perfect knowledge of the market
what does an indifference curve show
the utility derived from the combinations of two goods available to the consumer
at each point on an indifference curve a consumer is equally satisfied
it has a convex shape due to the law of diminishing marginal utility
an indifference map is just multiple curves on the same axes
what does a budget line show
the combinations of two goods a consumer can buy with a given income and prices
a rise in incomes means a consumer can buy more of both products so consumption rises
the income and substitution effects
the income effect is changes in consumption levels when incomes rise or fall
the substitution effect arises from changes in price when a consumer substitutes spending away from the relatively more expensive goods towards the relatively cheaper cone
the income effect works in the opposite direction to the substitution effect in the case of an inferior good but in the same direction in the case of a normal good
where is maximum satisfaction
where the budget line is a tangent to the indifference curve
assumptions and evaluation of indifference curves
assumes consumers are rational and can calculate and substitute difference combinations and total utilities
fall in price causes rise in demand for both goods so can’t tell what type
hard to apply substitutability to one off invisible purchases
consumer faces many more than two goods
consumer preferences and therefore derived utility may change over time
what is productive efficiency
producing at the lowest cost
allocative efficiency is using scarce resources in a way that produces the highest utility
usually refers to the short run but cna also involve producing at the lowest point on the LRAC curve
in the model of perfect competition a firm will achieve allocative efficiency in the short run
perfect competition
is a market where buyers and sellers are so many than monopoly elements are cleared and all firms are price takers
low barrier to entry and exit
large number of buyers and sellers
buyers and sellers have perfect information
homogenous products
efficiency in perfect competition
every firm is considered allocatively and productively efficient
increased competition reduces price and cost to lowest LRAC where P=MC=AC
evaluation of perfect competition
monopoly may be more efficient since they may be able to use abnormal profits to invest in research and development leading to dynamic efficiency
most consumers have imperfect information and choices are influenced by marketing
may be imperfect information in markets such as for key raw materials
rare for barriers to entry and exit to be costless
may not be able to benefit from economies of scale due to small firms and small market shares existing so prices and therefore productive efficiency may not be as low as possible
less consumer choice
horizontal integration
where 2 firms merge at the same level in the production cycle
if 2 firms merge producing similar goods at the same stage of production is likely to lead to a monopoly
monopoly characteristics
differentiated products
one firm holds the majority of market share
the firm is a price maker
high barriers to entry and exit so abnormal profit can be made in the long run
monopolies evaluation
monopolies can drive smaller firms out of business
may also lead to less choice due to the nature of a monopoly
monopolies have less incentive to be efficient but dynamic efficiency may occur if they use their long run supernormal profit to invest in research and development
may lead to more unemployment if labour begins to be replaced by machinery
merging evaluation
the firm may argue that an increase in size will lead to more opportunities to provide a wider range of goods and services and therefore better choice
merger may lead to dynamic efficiency which allows more long term investment and lower prices
firms may be more able to benefit from economies of scale leading to lower prices also
negative effects of mergers can be mitigated by government intervention and regulations
