Theme 1, MICROECONOMICS
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- Created by: gracelead
- Created on: 10-06-18 15:22
what is meant by ceteris paribus?
all other factors are equal
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what can economists not do?
conduct scientific experiments
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what is the difference between a positive and normative statement?
Positive statements are objective and can be measured with factual evidence whereas normative statements are value judgements, they are subjective and based on opinion
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what is the basic economic problem?
Scarcity, wants are unlimited, resources are finite
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what is an opportunity cost?
the opportunity cost is the value of the next best alternative
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what are the four factors of production?
Land, Labour, Capital and Enterprise
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what is the difference between renewable and non renewable?
renewable resources can be replenished, non renewable cannot.
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what do production possibility frontiers show?
the depict the maximum productive potential of an economy using a combination of two goods or services when resources are fully and effectively employed, shows the opportunity cost of producing each product
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how can the PPF show economic growth?
by an outward shift
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what is a capital good?
goods which can be used to produce other goods such as machinery
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what is a consumer good?
goods which cannot be used to produce other goods such as clothing
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what is specialisation?
occurs when each worker completes a specific task in a production process, famously stated by Adam Smith who showed through the division of labour worker productivity can increase
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what are the advantages of specialisation?
higher output and higher quality, greater variety of goods and services, more opportunities for economy of scale, more competition increases incentives to lower costs.
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what are the disadvantages of specialisation?
work becomes repetitive, more structural unemployment, less variety for consumers, higher work turnover for firms so workers become dissatisfied and leave more often
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what is absolute advantage?
occurs when a country can produce more of a good with the same factor inputs.
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what is a free market economy?
governments eave markets to their own devices, so the market forces of supply and demand allocate scarce resources.
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who were Adam Smith and Friedrich Hayek?
famous free market economists,
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free market economy
What to produce: determined by what the consumer prefers. How to produce it: producers seek profits. For whom to produce it: whoever has the greatest purchasing power in the economy, and is therefore able to buy the good
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what are the advantages of a free economy?
Firms are likely to be efficient because they have to provide goods and services demanded by consumers. They are also likely to lower their average costs and make better use of scarce resources. Therefore, overall output of the economy increases.
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what are the advantages of a free economy?
The bureaucracy from government intervention is avoided. Some economists might argue the freedom gained from having a free economy leads to more personal freedom.
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what are the disadvantages of a free economy?
The free market ignores inequality, and tends to benefit those who hold most of the wealth. There are no social security payments for those on low incomes.There could be monopolies, which could exploit the market by charging higher prices.
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what are the disadvantages of a free economy?
There could be the overconsumption of demerit goods, which have large negative externalities, such as tobacco. Public goods are not provided in a free market, such as national defence. Merit goods, such as education, are under provided.
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what is a command economy?
This is where the government allocates all of the scarce resources in an economy to where they think there is a greater need. It is also referred to as central planning.
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what did Karl Marx think about the free market?
he thought it was unstable and saw profits coming from the exploitation of labour and by not paying workers to cover the value of their work
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command economy
What to produce: determined by what the government prefers. How to produce it: governments and their employees. For whom to produce it: who the government prefers
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what are the advantages of a command economy?
It might be easier to coordinate resources in times of crises, such as wars. The government can compensate for market failure, by reallocating resources. They might ensure everyone can access basic necessities.
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what are the advantages of a command economy?
Inequality in society could be reduced, and society might maximise welfare rather than profit. The abuse of monopoly power could be prevented
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what are the disadvantages of a command economy?
Governments fail, as do markets, and they may not be fully informed for what to produce. They may not necessarily meet consumer preferences. It limits democracy and personal freedom.
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what is a mixed economy?
This has features of both command and free economies and is the most common economic system today.
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what is the mixed economy controlled by?
both the government and the forces of supply and demand
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mixed economies?
What to produce: determined by both consumer and government preferences.How to produce it: determined by producers making profits and the government.For whom to produce it:who the government prefers and the purchasing power of private individuals
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what is a consumers utility?
total satisfaction received from consuming the good or service
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the rational decision making model?
1-identify the problem.2-Find and identify the decision criteria.3-Weigh the criteria.4-Generate alternatives.5-Evaluate alternative options.6-Choose the best alternative.7-Carry out the decision.8-Evaluate the decision
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limitations of the rational decision making model?
This is not always the best or most realistic way for firms to make decisions. Although it might be fairer than making an intuitive decision, it takes significantly longer to decide, which is not practical in a firm with strict time constraints.
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administrative man theory assumptions
satisfactory is selected, decisions can be made heuristically
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what are heuristics?
Heuristics simplify the decision making process to come to a reasonable decision.
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what is demand?
Demand is the quantity of a good or service that consumers are able and willing to buy at a given price during a given period of time.
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factors that shift the demand curve?
P-population I-income R-Related goods A-Advertising T-Tastes and fashions E-Expectations S-Seasons
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what is derived demand?
This is when the demand for one good is linked to the demand for a related good
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what is composite demand?
This is when the good demanded has more than one use
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what is joint demand?
This is when goods are bought together
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what does the the law of diminishing marginal utility state?
for every extra unit of the good is consumed the marginal utility falls
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what is price elasticity of demand?
the responsiveness of a change in demand to a change in price
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what is the formula for price elasticity of demand?
percentage change in quantity demanded divided by the percentage change in price
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price elastic goods
very responsive to a change in price, the change in price leads to an even bigger change in demand, numerical value is bigger than 1
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price inelastic goods
demand that is relatively unresponsive to a change in price, numerical value of less than 1
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unitary elastic good
change in demand which is equal to a change in price. PED=1
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perfectly inelastic goods
demand which does not change when price changes. PED=0
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perfectly elastic goods
has a demand which falls to zero when price changes PED= infinity
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factors influencing PED
necessity, substitutes, addictiveness or habitual consumption, proportion of income spent on the good, durability of the good, peak and off-peak demand.
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if a firm sells a good with an inelastic demand
they are likely to put most of the tax burden on the consumer because they know a price increase will not cause demand to fall significantly
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if a firm sells a good with an elastic demand
they are likely to take most of the tax burden upon themselves, because they know if the price of the good increases demand is likely to fall.
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what is a subsidy?
payment from the governments to firms to encourage the production of a good and to lower their average costs.
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what is income elasticity of demand?
responsiveness of a change in demand to a change in income
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what is an inferior good?
a good which falls in demand as income increases
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what is a normal good?
the demand increases as income increases
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what is a luxury good?
an increase in income causes an even bigger increase in demand
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what is cross elasticity of demand?
responsiveness of a change in demand of one good X to a change in price of another good Y
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what is a complementary good?
complementary goods have a negative XED, if one good becomes more expensive the quantity demanded for both goods will fall.
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what is a substitute?
Substitutes can replace another good, so the XED is positive and the demand curve is upward sloping
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what are unrelated goods?
Unrelated goods have a XED equal to zero.
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what is supply?
Supply is the quantity of a good or service that a producer is able and willing to supply at a given price during a given period of time.
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what factors that shift the supply curve?
P-productivity I-indirect taxes N-number of firms T-technology S-subsidies W-weather C- costs of production
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what is joint supply?
This is when increasing the supply of one good causes an increase or decrease in the supply of another good.
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what is price elasticity of supply?
The price elasticity of supply is the responsiveness of a change in supply to a change in price
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the formula for price elasticity of supply
percentage change in quantity demanded divided percentage change in price
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factors influencing PES
Time scale. Spare capacity, Level of stocks,how sutainable factors are, barriers to entry to the market.
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if supply is elastic then firms can...
firms can increase supply quickly at little cost. The numerical value for PES is >1
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If supply is inelastic then firms can...
an increase in supply will be expensive for firms and take a long time. PES is
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A perfectly inelastic supply...
has PES = 0. Supply is fixed, so if there is a change in demand, it cannot be met easily.
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Supply is perfectly elastic when...
PES = infinity. Any quantity demanded can be met without changing price.
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what is market equilibrium?
price has no tendency to change, and it is known as the market clearing price.
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what are the functions of the price mechanism?
The price mechanism determines the market price. Adam Smith called this ‘the invisible hand of the market’. solves the economic problem of scarce resources
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what is the rationing function?
scarce resources=price increase->discourages demand and consequently rations resources
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what is the incentive function?
This encourages a change in behaviour of a consumer or producer. For example, a high price would encourage firms to supply more to the market, because it is more profitable to do so.
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what is the signalling function?
The price acts as a signal to consumers and new firms entering the market. A high price signals firms to enter the market because it is profitable but discourages demand
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what is consumer surplus?
This is the difference between the price the consumer is willing and able to pay and the price they actually pay. This is based on what the consumer perceives their private benefit will be from consuming the good.
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what is producer surplus?
This is caused by a shift in the supply curve from S1 to S2, which could be due to lower average production costs, for example. Therefore market price decreases and producer surplus increases.
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what is economic welfare?
This is the total benefit society receives from an economic transaction. It is calculated by the area of producer surplus and consumer surplus added together.
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what is an indirect tax?
Indirect taxes are imposed by the government and they increase production costs for producers. Therefore, producers supply less. This increases market price and demand contracts.
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what is an Ad Valorem tax?
percentages, such as VAT, which adds 20% of the unit price. This is the main indirect tax in the UK.
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what is a specific tax?
set tax per unit, such as the 58p per litre fuel duty on unleaded petrol.
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When demand is perfectly inelastic, or supply is perfectly elastic...
the incidence of the tax falls wholly on the consumer
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If demand is more elastic (PED>1)
the incidence of the tax will fall mainly on the supplier.
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If demand is more inelastic (PED
the incidence of the tax will fall mainly on the consumer.
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effects of subsidies
Subsidies increase output and lower prices for consumers, which could help families on low and fixed incomes. They increase the employment rate, by making workers more skilled through apprenticeship schemes and lowering the cost of employing workers.
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effects of subsidies
They reduce inequality in society, if the subsidy is progressive. Subsidies could help control inflation, by keeping costs of production low. They could help boost demand during periods of economic decline.
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effects of subsidies
Subsidies could encourage the consumption of merit goods, which creates positive externalities. Long run aggregate supply could increase if the subsidy is aimed towards a capital project.
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effects of subsidies
There could be government failure, if the government provides an inefficient subsidy or if the subsidy distorts the market price. Government revenue could be better spent elsewhere. The opportunity cost of the subsidy should be considered.
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effects of subsidies
usually the tax payer who pays for the subsidy, and they might not receive any direct benefit from the subsidy. If demand is price inelastic, the subsidy will have a big effect on equilibrium price.greater consumer gain than when demand is elastic
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If demand is price elastic, the subsidy will have...
will have a large effect on quantity, and therefore benefit producers more.
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A consumer subsidy encourages...
consumers to purchase more of a particular good or service
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Consumer subsidies affect
demand and do not shift the supply curve
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Producer subsidies lower...
the cost of production and shift the supply curve.
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consumers do not always act rationally because...
the influence of other peoples behaviour, consumer weakness at computation, the importance of habitual behavioural
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when does market failure occur?
the free market fails to allocate resources to the best interests of society, there is inefficient allocation of scarce resources
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what is an externality?
An externality is the cost or benefit a third party receives from an economic transaction outside of the market mechanism.
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Negative externalities are caused by...
demerit goods
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Positive externalities are caused by...
merit goods
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what is the the under-provision of public goods?
Public goods are non-excludable and non-rival, and they are under-provided in a free market because of the free-rider problem.
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what is an information gap?
imperfect information leading to a miss allocation of resources.
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what is a private cost?
costs such as rent, cost of machinery and labour, insurance, raw materials and transport
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what is a social cost?
calculated by private cost + external costs.
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what is the social optimum position?
MSC=MSB, it is the point of maximum welfare
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what is an external cost?
costs when producing or consuming a good such as pollution leading to a deadweight welfare loss or deadweight welfare gain.
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Government policies for negative externalities: indirect taxes
to reduce the quantity of demerit goods consumed.If the tax is equal to the external cost of each unit, then the supply curve becomes MSC rather than MPC, so the free market equilibrium becomes the socially optimum equilibrium
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Government policies for negative externalities: subsidies
encourage the consumption of merit goods. This includes the full social benefit in the market price of the good.
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Government policies for negative externalities: regulation
to enforce less consumption of a good
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Government policies for negative externalities: provide the good directly
The government could provide public goods which are under-provided in the free market, such as with education.
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Government policies for negative externalities: provide information
so there is no information failure, and consumers and firms can make informed economic decisions.
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Government policies for negative externalities: property rights
this encourages innovation because entrepreneurs can create new ideas, which are protected, and earn profit.
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Government policies for negative externalities: personal carbon allowances
They could be tradeable, so firms and consumers can pollute up to a certain amount, and trade what they do not use.
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what is a public good?
missing from the free market but offer benefits to society.
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Quasi (non-pure) public goods...
have characteristics of both public and private goods. They are partially provided by the free market
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why might the government set a maximum price?
The government might set a maximum price where the consumption or production of a good is to be encouraged. This is so the good does not become too expensive to produce or consume.
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Maximum prices have to be set...
below the free market price
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why might the government set a minimum price?
The government might set a minimum price where the consumption or production of a good is to be discouraged. This ensures the good never falls below a certain price.
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Minimum prices have to be set...
above the free market price
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Causes of government failure: Distortion of price signals
Government subsidies could distort price signals by distorting the free market mechanism. A free market economist would argue that this could lead to government failure.inefficient allocation of resources because the market mechanism cant act freely.
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Causes of government failure:Unintended consequences
This is when the actions of producers and consumers have unexpected, or unintended, consequences.
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Causes of government failure:Excessive administrative costs
The social benefits of a policy might not be worth the financial cost of administering the policy. It might cost more than the government anticipated. The government has to consider whether the policy is good value for money.
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Causes of government failure:Information gaps
Some policies might be decided without perfect information. This might require a full cost-benefit analysis, and it could be time-consuming and expensive.
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Other cards in this set
Card 2
Front
what can economists not do?
Back
conduct scientific experiments
Card 3
Front
what is the difference between a positive and normative statement?
Back
Card 4
Front
what is the basic economic problem?
Back
Card 5
Front
what is an opportunity cost?
Back
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