Week 1: The Market Mechanism Flashcards
What is a market?
A place where parties can come together to exchange goods and services usually for money (can be either physical or virtual
3 roles of prices
- Send signals
- Rations resources
- Provides incentives
Sends signals - role of prices
Prices send messages to economic agents to help to make economic decisions I.e a price increase/decrease indicates scarcity/abundance
Rations resources - role of prices
I.e higher prices reduce demand which allows goods to be distributed to those willing to play
Provides incentives - role of prices
Higher prices = higher profits = producers increase production
What is demand?
Is the quantity of a good that buyers wish to continue to purchase at each conceivable price
Characteristics of demand curves (4)
- Refer to a single product or good
- It doesn’t represent one singular quantity
- It represents the different qualities that all buyers would purchase at each conceivable price, ceteris paribus (means ‘holding everything else equal’)
- Demand curves represent the relationship between price and demand
Example of an individual demand curve
- This is derived from tastes of an individual
- There is a negative relationship between price and quantity demanded
What is a market demand curve?
Is the horizontal summation of the indivual demand curves
Characteristics of market demand curves
• Market demand is obtained by adding the individual demands
What is demand determined by?
What three factors shift the demand schedule?
- Income (y)
- Price change if another good (good z)
- Tastes and preferences
How does income (y) shift the demand schedule? (2)
- For normal goods as income increases the quantity demand also increases
- For inferior goods as income increases the quantity demanded decreases
How does the price changing of another good (good z) shift the demand schedule? (2)
- Complementary goods such as cars and petrol - if car prices go down demand for petrol will increase
- For substitute goods such as tea and coffee - if tea prices go up there is likely to be a greater demand for coffee
What is the factor which causes a movement along the demand schedule?
A change in the price of the good
What is the difference between ‘moving along’ and a ‘shift’ of a demand schedule?
A shift is called “a change in demand” where as moving along is called “a change in the quantity demand”
Example of a moving along curve
What is supply?
Is the quantity of a good that producers are willing to produce at each conceivable price
Characteristics of supply (3)
- Supply refers to a single product/good
- It doesn’t represent one singular quantity but represents all that producers would sell at every possible price
- The relationship between price and quantity supplied can be represented as a supply curve
Characteristics of a supply curve (2)
- Supply curve is upward sloping
- There is a positive relationship between price and quantity supplied
What factors affect the supply curve? (4)
- Technology
- Input prices (e.g wages and raw material costs)
- Government regulations (e.g taxes)
- The price of the good
What factors SHIFT the supply schedule? (3)
- Technology - technology increases so quantity supplied increases
- Changes in input prices - decreases then quantity supplied increases
- Goverment regulations e.g subsidy
What factor cause a MOVING ALONG the supply curve?
A change in the price of the good
What is the shift of a supply curve known as?
A change in supply
What is the movement along a supply curve known as?
A change in quantity supplied
What is market equilibrium? (2)
- Is the point on a supply and demand graph where the two points intersect
- P1 = the market clearing price which is the price where whatever is produced at that price is also consumed at that price
Market disequilibrium graph when there is excess supply (2)
- If the price were at P2 there would be excess supply which can be quantified by doing Q3 - Q2
- Therefore to sell excess stock the supplier must reduce the price
Market disequilibrium graph when there is excess demand (3)
- If price were at P2, there would be excess demand which can be quantified by Q3 - Q2
- At P2, consumers want to demand more (Q3) than producers wish to supply (Q2)
- Suppliers respond by increasing the price until equilibrium is reached again
What is assumed with ceteris paribus?
It’s assumed that nothing else is changing
Impact of decreasing income on the market mechanism (4)
- A decrease in income leads to a decrease in demand therefore demand shift to the left from D1 to D2
- Equilibrium then moves from point A to point
- Price decreases from P1 to P2
- Quantity demanded decreases from Q1 to Q2
What is a price floor? (2)
- Is when the price is artificially held above the equilibrium price so the price is not allowed to drop below this level
- Governemnts may do this because they feel the market clearing price is too low
Examples of price floors (2)
- Minimum wage (exploited workers)
- Minimum price on alcohol (public health)
Price floor diagram (alcohol example) (2)
- Minimum price creates a market disequilibrium
- Qs - Qd is what’s not being consumed
What is a price ceiling? (aka max price) (2)
- Is when price is artificially held below the equilibrium price so the price is not allowed to rise above this level
- Government may do this as they feel the market clearing price is too high
Example of a price ceiling
Rent control - in order to have affordable living
Example of a price ceiling diagram (rent example) (2)
- Qd > Qs there is excess demand
- Qd - Qs = People who have no home
Lionel Robbins (1932) economics definition
Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses
Alfred Marshall’s economics definition (2)
- A study of mankind in the ordinary business of life
- It examines that part of an individual and social action i which is most closely connected with the attainment, and with the use of material requisites of well being
When is a good/service scarce?
If it has an oppurinity cost
What is an opportunity cost? (3)
- Is the true cost of a choice and the value of the next best alternative foregone where a choice needs to be made between severally mutually exclusive alternatives given limited resources
- Expresses the basic relationship between scarcity and choice
- Costs and benefits are weighed up of the choice and the alternatives choices
What does a production possibility frontier (PPF) show?
It shows the maximum possible output combinations of two goods or services an economy can achieve when all resources (land, labour & capital) are fully and efficiently employed
Characteristics of a production possibility frontier (PPF) (4)
- A, B and C are efficient output combinations lying on the PPF
- D and E are inefficient combinations - not all resources fully utilised
- F is an output combination that is not yet attainable
- Oppurtunity cost of service output in terms of manufacturing output increases as we move down the PPF
Different allocation systems (3)
- The command economy e,g North Korea, former USSR
- The free market economy e.g USA prior to the 1930
- The mixed economies e.g most modern economies
What is the difference between positive and normative economics?
- Positive economics has objective explanation
- Normative economics has prescriptions based on value judgement
Example of positive economics
A tax being imposed on cigarettes therefore increasing cigarette prices
Example of normative economics
A tax should be imposed on tobacco to improve public health
What is microeconomics?
Is the branch of economics that markets behaviour of indivual consumers and firms in an attempt to understand the decision making process of firms and households
What is macroeconomics?
Is the field of economics that studies the behaviour of the aggregate economy
