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ECON > Week 2 > Flashcards

Week 2 Flashcards

1
Q

What’s a price taker?

A

a person or firm with no power to be able to influence the market price
- it has to accept the market price as given
- consumers are price takers also as they have to accept prices as given of goods

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2
Q

what is a perfectly competitive market?

A

where both producers and consumers are too numerous to have any control over prices whatsoever, a situation where everyone is a price taker

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3
Q

what is a free market?

A

one in which there is an absence of government intervention. individual producers and consumers are free to make their own economic decisions

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4
Q

what is a price mechanism?

A

the system in a market economy whereby changes in price in response to changes in demand and supply have the effect of making demand equal to supply

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5
Q

what is equilibrium price?

A

the price where the quantity demanded equals the quantity supplied, the price where there is no shortage or surplus

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6
Q

what happens if consumer decide they want more of a good?

A

demand will exceed supply, the shortage will then cause the price of the good to rise. this acts as an incentive for producers to supply more, at the same time discourage consumers from buying so much. the price will continue to rise until the shortage has been eliminated

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7
Q

what happens when consumers decide they want less of a good?

A

supply will exceed demand, the resulting surplus will cause the price of the good to fall. this will act as a disincentive to producers, who will supply less and will encourage consumers to buy more. the price will continue to fall until the surplus has been eliminated

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8
Q

what is equilibrium?

A

a place of balance, a position from which there is no inherent tendency to move away

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9
Q

what happens when the demand for a good increases in the goods market?

A
  1. demand for good rises
  2. creates a shortage
  3. causes price of the good to rise
  4. eliminates the shortage by choking off some of the demand and encouraging firms to produce more
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10
Q

what happens in the factor market when there’s an increase in factors of production?

A
  1. the increased supply of the good, causes an increase in demand for factors of production ie inputs used in making it
    2.causes a shortage of those inputs
  2. causes their prices to rise
  3. eliminates their shortage by choking off some of the demand and encouraging the suppliers of inputs to supply more
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11
Q

how are goods markets interdependent?

A

a rise in the price of one goof may encourage consumers to buy alternatives, this then drives up price of alternatives which encourage producers to supply more of the alternatives

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12
Q

what is the law of demand?

A

the quantity of a good demanded per period of time will fall as the price rises and rise as the price falls, other things being equal

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13
Q

why do we have a law of demand?

A
  1. people will feel power, they will not be able to afford to buy so much of the good with their money, the purchasing power of their income has fallen -> income effect of a price rise
  2. the price has risen relative to other goods, people will thus switch to alternatives or substitute goods. -> substitution effect of a price rise
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14
Q

what is the income effect?

A

the effect of a change in price on quantity demanded arising from the consumers becoming better or worse off as a result of the price change

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15
Q

what is the substitution effect?

A

the effect of a change in price on quantity demanded arising from the consumer switching to or from alternative products

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16
Q

what is quantity demanded?

A

the amount of a good that a consumer is willing and able to buy at a given price over a given period

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17
Q

what is the demand schedule for an individual?

A

a table showing the different quantities of a good that a person is willing to buy at various prices over a given time period

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18
Q

what is market demand schedule?

A

a table showing the different total quantities of a goof that consumers a willing and able to buy at various prices over a given period of time

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19
Q

what is a demand curve?

A

a graph showing the relationship between the price of a good and the quantity of the good demanded over a given time period. Price is measured on the vertical axis, quantity demanded on the horizontal axis

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20
Q

what factors affect demand apart from price?

A
  • tastes of consumers
    -the number and price of substitute goods
  • number and price of complementary goods
  • income
  • distribution of income
  • expectations of future price changes
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21
Q

what are substitute goods?

A

a pair of goods that are considered by consumers to be alternatives to each other. as the price of one goes up, the demand for the other rises

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22
Q

what are complementary goods?

A

a pair of goods consumed together, if the price of one goes up, demand for both goods fall

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23
Q

what are normal goods?

A

goods whose demand rises as people’s incomes rise

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24
Q

inferior goods?

A

goods whose demand falls as peoples income rise

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25
Q

what causes the demand curve to shift right?

A

if the determinant causes demand to increase, (even if theres no change in price)

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26
Q

what causes the demand curve to shift left?

A

if a change in a determinant other than price causes demand to fall, the curve shifts to the left

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27
Q

how do you distinguish between shifts and movements along the demand curve?

A
  • a shift in demand is referred to as a change in demand
  • a movement along the demand curve as a result of a change in price is referred as change in the quantity demanded
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28
Q

what is price elasticity of demand?

A

a measure of the responsiveness of quantity demanded to a change in price. the proportionate change in quantity demanded divided by the proportionate change in price

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29
Q

how do you measure the price elasticity of demand?

A

proportion or % change in quantity demanded divided by the proportionate or % change in price

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30
Q

why is elasticity measured in % or proportionate?

A
  • it allows comparison of changes of two things measured differently
  • only sensible way of deciding how big a change in price or quantity is
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31
Q

what shape is the demand curve?

A

it is downward sloping
- if price increases +, the quantity demanded will fall -
- if price falls -, the quantity demanded will increase +

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32
Q

what is elastic?

A

if demand is (price) elastic, then any change in price will cause the quantity demanded to change proportionately more. ignoring the negative sign, it will have a value greater than 1.

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33
Q

what is inelastic?

A

if demand is (price) inelastic, then any change in price will cause the quantity demanded to change proportionately smaller amount. ignoring the negative sign, it will have a value less than 1.

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34
Q

what is unit elasticity?

A

when the price elasticity of demand in unity, this is where demand changes by the same proportion as the price. price elasticity is equal to 1.

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35
Q

what is total sales revenue (TR)?

A

the amount a firm earns from its sales of a product at a particular price. TR = P x Q where p is price and q is quantity.
- its gross revenue, revenue before an tax or costs

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36
Q

what happens to the Total revenue when demand is elastic?

A
  • when price rises, the quantity demanded falls more, therefore TR falls
  • when price falls, the quantity demanded rises more, therefore TR rises
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37
Q

what happens to sales revenue when demand is inelastic?

A
  • when price rises, the quantity demanded falls less, TR rises
  • when price falls, the quantity demanded rises less, TR falls
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38
Q

what is totally inelastic demand?

A

its shown as vertical straight line, no matter what happens to price, the quantity demanded remains the same

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39
Q

what is infinitely elastic demand?

A

shown by a horizontal straight lines, at any price above p1 demand is zero. but at p2 or any price below demand is ‘infinitely’ bigger

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40
Q

what is unit elastic demand?

A

this is where price and quantity change in exactly the same proportion. any rise in price will be offset by a fall in quantity leaving TR unchanged

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41
Q

what is income elasticity of demand? how do you measure it?

A

the responsiveness of demand to a change in consumer incomes,
- proportionate or % change in demand divided by the proportionate or % change in income

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42
Q

what is cross elasticity of demand?

A

the responsiveness of demand for one good to a change in the price of another.
- proportionate or % change in demand for good A divided by proportionate of % change in price of good B

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43
Q

what does price elasticity of demand allow us to do?

A

enables us to predict how much the demand curve for the first product will shift when the price of the second product changes.

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44
Q

what is the major determinant of cross elasticity of demand?

A

closeness of the substitute or complement. the closer it is, the bigger will be the effect on the first good of a change in the price of the substitute or complement and so the greater will the cross elasticity be (pos or neg)

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45
Q

what is price elasticity of supply? how is this measured?

A

the responsiveness of quantity supplied to a change in price, the proportionate change in quantity supplied divided by the proportionate change in price
- proportionate or % change in quantity supplied divided by proportionate or % change in price

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46
Q

what are the determinants of price elasticity of supply?

A
  1. the amount that costs rise as output rises.
    - the less the additional costs of producing additional output, the more firms will be encouraged to produce for a given price rise, the more elastic supply will be
    - supply is less likely to be elastic if firms have plenty of spare capacity, if they can get extra supplies of materials
  2. immediate time period - firms will be unable to increase supply immediately
  3. short run - if a slightly longer time period is allowed to elapse, some inputs can be increased (materials) while other are fixed (machinery), supply can increase somewhat
  4. long run - there will be sufficient time for all inputs to be increased and for new firms to enter the industry, supply is then likely to be highly elastic
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47
Q

why does elasticity vary with the time period?

A

producers and consumers take time to respond to a change in price, the longer the time period, the bigger the response, and the greater the elasticity of supply and demand

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48
Q

what is speculation?

A

this is where people make buying or selling decisions based on their anticipations of future plans

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49
Q

what is self-fulfilling speculation?

A

the actions of speculators tend to cause the very effect that they had anticipated

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50
Q

What is stabilising speculation?

A

where the actions of speculators tend to reduce price fluctuations

51
Q

what is destabilising speculation?

A

where the actions of the speculators tend to make price movements larger

52
Q

what is risk?

A

this is when an outcome may or may not occur, but where its probability of occurring is unknown

53
Q

what is uncertanity?

A

when an outcome may or may not occur, and where its probability of occurring isnt known

54
Q

what are future of forward markets?

A

a market in which contacts are made to buy or sell at some future date at a price agreed today

55
Q

what is future price?

A

a price agreed today at which an item (eg commodities) will be exchanged at some set date in the future

56
Q

what is spot price?

A

the current market price

57
Q

what is one way to reduce risks?

A

hold stocks
- if the price of a firms product falls unexpectedly, it can build up on stocks rather than release its product to the market
- if the price later rises, it can then release stocks to the market

58
Q

what is total utility?

A

the total satisfaction a consumer gets from the consumption of all the units of a good consumed within a given time period

59
Q

what is marginal utility?

A

the extra satisfaction gained from consuming one extra unit of a good within a given time period. in money terms, is it when you are willing to pay for one more unit of the good

60
Q

what is the principle of diminishing marginal utility?

A

as more units of a good are consumed, additional units will provide less additional satisfaction then previous units

61
Q

what is consumer surplus? how is it measured?

A

the excess of what a person would have been prepared to pay for a good ie (the utility measured in money terms) over what the person actually pays.
- total consumer surplus equals total utility minus total expenditure

62
Q

what is marginal consumer surplus? how is it measured?

A

the excess of utility from the consumption of one more unit of a good (MU) over the price paid, its the difference between the maximum amount that you are willing to pay for one more unit of a good (MU) and what you are actually charged (P)
- MCS = MU - P where MU is marginal utility and P is price

63
Q

what is total consumer surplus (TCS)? how is it measured?

A

its the sum of all the marginal consumer surpluses you have obtained from all the units of a good you have consumed. its the difference between the total utility from all the units and your expenditure on them.
- TCS = TU - TE
where TE is total expenditure on a good (P x Q), this is a similar concept to TR (total revenue). they are both defined as P x Q, but in total expenditure, Q is the quantity purchased by the consumers whereas in total revenue, Q is the quantity sold by the firm

64
Q

what is rational consumer behaviour?

A
65
Q

what is an individual’s demand curve?

A

its the same as their marginal utility curve for that good, measured in terms of money,
- as long as individuals seek to maximise consumer surplus and hence consumer where P = MU, their demand curve will be along the same line as their marginal utility

66
Q

what would the market demand curve look like?

A

it will simple be the horizontal sum of all the individual’ demand curves and hence MU curves,
- total consumer surplus is the sum of the consumer surplus of each individual consumer

67
Q

how would market demand and consumer surplus look on a graph?

A

the price elasticity of demand at any given price, will reflect the rate at which MU diminished. if there are close substitutes for a good, its likely to have an elastic demand, and its MU will diminish slowly as consumption increases
- this is due to the increased consumption of the product will be accompanied by decreased consumption of alternative products.
- since total consumption of this product plus the alternatives has increased only slightly, marginal utility will fall only slowly

68
Q

how do shifts in the demand relate to marginal utility?

A

eg how would the marginal utility of and so the demand for margarine be affected by a rise in the price of butter?
- the higher the price of butter would cause less butter to be consumed. this would increase the marginal utility of margarine, since people are using less butter their desire for margarine is higher. the MU curve and so demand curve shifts to the right

69
Q

how does the change in consumption of one good affect marginal utility?

A

a change in the consumption of one good will affect the marginal utility of the substitute and complementary goods. it will also affect the amount of income left over to be spent on other goods.

70
Q

what is consumer durable?

A

a consumer good that lasts a period of time, during which the consumer can continue gaining utility from it eg a car, tablet, phone

71
Q

what is expected value?

A

the average value of a variable after many repetitions, ie the sum of the value of a variable on each occasion divided by the number of occasions

72
Q

what are the three categories of attitude towards risk?

A
  1. risk neutral - people will always choose the option with the highest expected value
  2. risk averse - people will never choose a gamble if it has the same expected value as the pay-off from not taking a gamble
  3. risk loving - people will always choose the gamble if it had the same expected value as the pay-off from not taking the gamble
73
Q

what is certainty equivalent?

A

the guaranteed amount of money that an individual would view as equally desirable as the expected value of a gamble. if a person is risk averse, the certainty equivalent is less than the one expected value

74
Q

what is risk premium?

A

the expected value of a gamble minus a persons certainty equivalent

75
Q

what is diminishing marginal utility of income?

A

where each additional pound earned yields less additional utility than the previous pound

76
Q

what is spreading risks (for an insurance company)?

A

the more policies an insurance company issues and the more independent the risks of claims from these policies are, the more predictable will be the number of claims

77
Q

what is the law of large number?

A

the larger the number of events of a particular type, the more predictable will be their average expected outcome

78
Q

what is independent risks?

A

where two risky events are unconnected. the occurrence of one will not affect the likelihood of the occurrence of the other

79
Q

what is diversification?

A

a business growth strategy in which a business expands into new markets outside of its current interests

80
Q

what is adverse selection in the insurance market?

A

where customers with the least desirable characteristic from the sellers point of view are more likely to purchase an insurance policy at a price based on the average risk of all the potential customers

81
Q

what is moral hazard?

A

where one party to a transaction has an incentive to behave in a way that reduces the pay off to the other party. the temptation to take more risks when you know that someone else will cover the risks if you get into difficulties. in the case of banks taking risks, the ‘someone else’ may be another bank

82
Q

what is the problem of moral hazard?

A
  • Once a person has a permanent contract of employment they might not work as hard as the employer anticipated.
  • If someone else is willing to pay your debts (e.g. your payments), you are likely to take less care with your spending. A similar type of argument has been used for not cancelling the debts of poor countries.
  • If a bank knows that it will be bailed out by the government, i.e. it is too big to fail, it may undertake more risky lending strategies.
  • If you hire a car, you may be rough with the clutch or gears, knowing that you will not bear the cost of the extra wear and tear of the car.
  • When working in teams, some people may slack, knowing that more diligent members of the team will cover for them (giving them a ‘free ride’).
83
Q

how to tackle moral hazard?

A
  • an uniformed party to devote more resources to monitoring the actions and behaviour of the informed party
  • change the terms of the deal so that the party with the unobservable actions has an incentive to behave in ways that are in the interests of the uniformed party
84
Q

what is characteristics (or attributes) theory?

A

the theory that demonstrates how consumer choice between different varieties of a product depends on the characteristics of these variables, along with prices of the different varieties, the consumer’s budget and the consumer’s tastes

85
Q

what is the budget constraint?

A

the amount that a consumer buys of a brand will depend in part on the consumer’s budget and on the price of the product.
- a change in budget and a change in price affect the movements along the ray (check pg 104)

86
Q

what is the efficiency frontier?

A

a line showing the maximum attainable combinations of two characteristics for a given budget. these characteristics can be obtained by consuming one or a mixture of two brands or varieties of a product

87
Q

what is the indifference curve?

A

a line showing all those combinations of two characteristics of a good between which a consumer is indifferent,
- shows the combination of two goods in various quantities that provide equal satisfaction (utility) to a consumer
- used in Lancasters characteristic model

88
Q

what is a indifference map?

A

a diagram showing a whole set of indifference curves. the further away a particular curve is from the origin, the higher the level of utility it represents

89
Q

what is diminishing marginal rate of substitution of characterisitcs?

A

the more a consumer goes of characteristic A and the less of characteristic B, the less and less of B the consumer will be willing to give up to get an extra unit of A

90
Q

what is the optimum combination of characteristics?

A

where the efficiency frontier is tangential to (ie just touches) the highest indifference curve. the rational consumer will purchase at this point

91
Q

how are changes in characteristics represented on a graph?

A
  • a change in a product’s price or a change in the consumers budget, is represented by a movement along the product’s ray
  • a change in the mix of characteristics of a product is represented by a swing in the ray ie a change in its slope
  • a change in consumer tastes is represented by a shift in the indifference curve, they will become steeper if tastes shift towards the characteristic measures on the horizontal axis
92
Q

what are the advantages and disadvantages of characteristic theory?

A

ADV:
- gives useful insights into the process of consumer choice
- can help firms analyse the implications of changing their or their rivals’ product specifications, changes in consumer tastes and changes in their or their rivals’ prices

DISADV:
- some characteristics are difficult or impossible to measure
- only 2 characteristics can be measured on a single 2d diagram
- in practice, the position of indifference curves is difficult to identify

93
Q

what is bounded rationality?

A

when consumers have limited abilities to find and process the relevant information required to make the best decisions ie purchase the goods that generate the most consumer surplus

94
Q

what are heuristics?

A

a mental shortcut or rule of thumb that people use when trying to make complicated choices. they reduce the computational and or research efforts required but sometimes lead to systematic errors

95
Q

what are reference dependent preferences?

A

where people value or code outcomes as either gains or losses in relation to reference point

96
Q

what is loss aversion?

A

where a loss is disliked far more than the pleasure associated from an equivalent sized gain. this dislike of losers is far greater than that predicted by standard economic theory

97
Q

what is endowment effect or (disvestiture aversion)

A

the hypothesis that people ascribe more value to things when they own them than when they are merely considering purchasing or acquiring them - when the reference point is one of ownership rather than non-ownership

98
Q

what is framing?

A

consumption decisions are influenced by the way that costs and benefits are presented

99
Q

what is time consistency?

A

where a person’s preferences remain the same over time. if they plan to do something in the future, such as change energy supplier, they do so when the time arrives

100
Q

what is present bias?

A

where the relative weight people place on immediate costs and benefits versus those that occur in the future is far greater than predicted by standard economic theory. this leads to time inconsistent behaviour

101
Q

what is altruism? in econ

A

positively valuing the pay-offs to others

102
Q

what is envy in econ?

A

negatively valuing the pay-offs to others

103
Q

what is reciprocity in econ?

A

where people’s preferences on the kind or unkind behaviour of others

104
Q

what is traditional economics based on?

A

the premise that consumers act rationally, weighing up the costs and benefits of the choices open to them

105
Q

what is behaviourial economics?

A

acknowledges that real world decisions dont always appear rational, it seeks to understand and explain what economic agents actually do

106
Q

what are the types of heuristics?

A
  • avoid making decisions altogether when faced with too much choice
  • copying and limiting the actions of others
  • basing decisions on easily available info
  • believing that past outcomes have an impact on the current situation
107
Q

what is choice overload?

A

when people are faced with too much choice, this discourages them from buying

108
Q

what does irrational behaviour come from?

A

the choice of reference point for decision making
- this used by people to judge an outcome as a gain or a loss can be be influenced by factors such as their expectations, comparisons with others and adjusting slowly to new info

109
Q

what do people who are loss averse do?

A

they may value things more highly when they own them than when they are considering buying them (the endownment effect) or when the costs or benefits are immediate
- this reference dependent loss aversion may result in people giving additional weight to loss than would occur simply from diminishing marginal utility of income

110
Q

what do the choices that people make depend on?

A

depend on how choices are framed - the way in which they are presented or perceived, the careful framing of an advert or promotion may influence consumers’ reference points and hence how they code a purchase

111
Q

what are governments doing?

A

in devising policy, they are looking at ways to influence peoples behaviour by devising appropriate incentives, behaviour economics is useful here
- people may be nudged into behaving in a certain way, eg moving from opting in to opting out system for schemes such as pensions
- the UK behavioural insights team uses ideas from behavioural economics to design policies to nudge people into making better choices for themselves

112
Q

how do you measure total revenue, average revenue and marginal revenue?

A
  1. Total revenue (TR) -> TR = P*Q
  2. Average revenue (AR) -> AR = TR/Q
  3. Marginal revenue (MR) -> MR = ΔTR/ΔQ
113
Q

what does regression analysis allow?

A
  • Regression methods estimate demand as a function of lots of
    influencing factors not just price.
  • Can be contemporary (seek to explain current conditions)
    and/or for forecasting future (e.g. sales and revenue
    predictions).
  • Can use to predict changes in demand, but also elasticities,
    which predict sensitivities to changes in own price, competitors
    prices, income etc.
  • Can be used to inform pricing practices and/or strategies.
  • Can also estimate demand functions as time-series (e.g.
    change of sales over time).
114
Q

what do the signs in price elasticity of demand mean?

A

Sign:
* ‘-’ for ‘ordinary’ goods as ‘law of demand’ means price increase (+) leads to decrease (-) in quantity demanded.
* However, some special cases exist with ‘+’ elasticity!:
- Veblen goods
- Giffen goods
Magnitude:
- Size of the elasticity (ignoring the sign) shows sensitivity

115
Q

what happens to elasticity when you increase or decrease price?

A

when elasticity is above 1, increasing price would decrease TR
when elasticity is below 1, increasing price would increase TR

116
Q

why is the neoclassical approach to individal behaviour criticised?

A
  • Does not explain how preferences arise or are changed.
  • Static – doesn’t show how adjustments made
  • Assumes rational behaviour with well-informed consumers.
  • Considers absolute utility not hierarchy of needs.
  • Consumers assumed to behave independently.
117
Q

what are the limitations to the characteristics approach?

A
  • Difficult to identify and measure characteristics
  • Products have multiple characteristics
  • Indifference curves are still theoretical (practical limitations)
  • Consumer tastes changes (influenced by advertising!)
118
Q

what factors are consumers affected by in the behaviourial approach?

A

a) Previous experience
b) Importance
c) Promotional effects e.g. special offers

This leads to a decision-making process:
Recognition Search Evaluate Choose Implement Hindsight

119
Q

When are goods classed as inferior, necessity and luxury?

A

Inferior is elasticity is negtive
Necessity if elasticity is less than 1
Luxury if elasticity is more than 1

120
Q

What is neoclassical theory?

A

Theory that focuses on supply and demand as driving forces behind production, pricing, and consumption of goods

121
Q

What happens to demand when price for the substitute good increases or decreases?

A
  • Increase in price on one substitute good causes increase in demand for other (right curve shift)
  • decrease in the price of one substitute good causes a decrease in demand for the other (left curve shift)
122
Q

What are veblen and giffen goods?

A

Veblen goods are high luxury products, not many substitutes.
- Giffen goods are inferior products eg bread, rice where there are lots of substitutes,
- people consumer more as price rise for both
-

123
Q

When calculating the cross price elasticity, what does it mean for complements and substitutes?

A
  • The cross price elasticity of demand for complementary good is negative. The closer to zero, less complementarity the product is. As price is for one increases, an item closely associated for consumption decreases because the demand for the main good dropped.
  • the cross price elasticity of demand for substitute goods is positive, as the demand for one good increases when the price of the substitute increases.
124
Q

When does diminishing marginal returns set in?

A

When we add more of a variable factor to a fixed factor
- at first productivity rises but then reaches a point and falls, this is DMR, which means MC go up.

ECON (10 decks)

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