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102 Cards in this Set
- Front
- Back
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4 principles of economics |
- People face trade offs -Rationality - Opportunity costs -Incentives are important |
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Preferences are transitive? A>B B>C, prefer what? |
More is preferred to less Consumers do everything to maximise their utility Prefer A to C bc there is more of A |
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consumers are.. |
rational economic agents who aim to maximise their personal utility |
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budget constraint? |
the range of choices affordable to the consumer |
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Real income= |
Income/Price |
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Budget Constraint: If price of one product decreases what happens to the budget constraint? |
pivots outwards, affordable set gets bigger |
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Budget constraint: If income decreases what happens to budget constraint? |
Inward parallel shift |
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What is the utility along the indifference curve? |
constant |
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Marginal rate of substitution: |
Rate at which a person will give up the good measured on the y-axiz to get an additional unit of the good measured on the x axis and at the same time remain indifferent (i.e.. total utility is constant) |
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what does the magnitude of the slope of the indifference curve show? |
The marginal rate of substitution |
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what happens as you move down the indifference curve? |
marginal rate of substitution falls reflects the law of diminishing marginal utility |
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4 things to remember about indifference curves: |
1. downward sloping to reflect tradeoffs 2. Convex shape which reflects diminishing marginal utility 3. Indifference curves cannot intersect because of transitive differences 4. A higher indifference curve represents a higher level of satisfaction than a lower indifference curve |
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Where does the optimal solution occur between the indifference curve and budget constraint? |
equilibrium occurs at tangency, not at intersect |
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Two effects on demand? |
-Substitution effect -Income effect |
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income effect: |
as the price of a good decreases a consumers real income increases allowing consumers to buy more units of good |
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substitution effect: |
as the price of the good decreases, consumers will purchase more of that good((i.e./substitute) instead of an alternative good |
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inferior goods: |
as income increases demand decreases |
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substitutes when price of one good falls, demand of other good? |
decreases (reduces quantity demanded) |
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complements: as price of one good falls the quantity demanded of another |
increases |
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market demand is.. |
horizontal summation of individual demand curves |
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what happens to demand curve when quantity in demand in increased or decreased? |
decrease: movement shift leftward on curve increase: rightward moment down demand curve |
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What happens to demand curve when there is an increase/decrease in demand? |
Increase: shift to right Decrease: shift to left |
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Price elasticity of demand: |
The responsiveness of quantity demanded to a change in price |
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PED calculation: |
percentage change in quantity demanded/percentage change in price always negative |
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as we move down a linear curve demand becomes ... price inelastic |
more |
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when PED >1 demand is ... when PED < 1 demand is When PED=infinity demand is.. When PED=0 (vertical) demand is... |
Elastic Inelastic perfectly elastic Perfectly inelatstic |
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when MR=0, Total revenue is ... |
maximised |
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marginal revenue= |
change of revenue/change in quantity |
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PED=1 demand is |
unit elastic: increase in price TR is unaffected decrease in price, TR IS unaffected |
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cross price elasticity of demand: complement and substitute |
the responsiveness of demand for 1 product to a change in the price of another good percentage change in quantity of good a/ percentage change in price of good y complement:-ve substitute: +ve |
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income elasticity of demand: normal inferior |
the responsiveness of demand to a change in consumers income normal: +ve inferior: -ve |
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Profit= |
revenue- costs |
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Inputs to economic system: |
land labour capital entrepreneurship |
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How do firms minimise costs to aid profit maximisation: |
1) technical efficiency 2)optimal level of production |
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short run: |
when at last one factor is fixed |
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long run: |
all factors are variable- firms output decision is no longer constrained by a fixed factor |
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marginal product: |
change in total product resulting from one-unit increase in a variable factor |
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law of diminishing returns: |
when increasing amounts of a variable factor are used with a given amount of a fixed factor, there will come a point when each additional unit of the variable factor will produce less extra output than the previous unit |
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when does MP initially exceed the MP of previous worker: |
specialisation/division of labour increasing marginal returns |
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marginal cost: |
total cost of producing one extra unit of output change in total cost/change in quantity |
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why is marginal cost curve u shaped? |
- economies due to specialisation -eventually diminishing marginal returns set in |
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law of supply: |
the higher the price, the greater the quantity suppliedlower the price of a good, the smaller quantity supplied |
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why is supply curve sloping upwards? |
-firms look for profits -a firms MC increases as quantity produced increases -higher prices encourage firms to switch production -new firms might be encouraged tp produce the good |
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main factors that change supply? |
-price of factors of production -price of related goods produced -expected future prices -no of suppliers -technology |
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equilibrium: if price is too high... |
quantity supplied exceeds quantity demanded (surplus) |
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oligopoly |
a few large firms selling differentiated or homogeneous products |
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Perfect competition: 4 features |
1. many buyers and sellers 2.homogenous products 3.perfect info 4. free entry and free exit |
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when firm wants to maximise profits, selects its output so as to maximise difference between .... and ...., when MC= .... |
TR and TC, MR |
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in perfect competition: price = ( efficiency) production occurs at bottom of .... (.......efficiency) |
MC allocative AC productive |
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allocative efficiency |
This occurs when there is an optimal distribution of goods and services, taking into account consumer’s preferences. |
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monopoly |
-a single firm supplies the whole market -no close substitutes -very large barriers to entry : high sunk costs, brand loyalty, legal protection |
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monopolies is short run and long run? |
monopolists earn economic profit P>MC (not allocatively efficient) Technically efficient |
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outcomes of a monopolistic market structure: |
-higher prices -lower levels of production -economic profit for the monopolist - redistribution of welfare from consumers to the monopolist |
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consumer surplus: |
the total amount in excess of the market price that consumers would have been willing to pay to get the good. |
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producer surplus: |
the total amount of revenue in excess of the marginal costs of production that firms get at the market price |
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monopolistic competition |
-each firm faces its own downward sloping demand curve and has some discretion over price products are close substitutes firms demand curves may be fairly elastic competition is based upon price, quantity and marketing |
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why do only normal profits exist in the long run in monopolistic competition? |
due to nature of the 'tangency equilibrium' (zero economic profit as P=AC) |
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are monopolistic competition efficient? |
- Efficiency concerns because P>MC (Not allocatively efficient) allocative efficiency occurs when P=MC |
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mutual interdependence: |
that any independent action that one firm takes will impact upon the performance of rival firms in the market |
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kinked demand curve is what type of model? |
non collusive model |
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kinked demand curve explains what? |
sticky prices (occurs when no collusion) widely price stability |
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problems with kinked demand curve: |
price stability may be due to there factors doesn't explain how prices are set in 1st instance model lacks empirical observation |
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"pay off" |
what individual receives depending on his chosen strategy |
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nash equilibrium: |
the point at which a competitor is pursuing the best possible (dominant) strategy given the likely strategy of the other competitors in the game |
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firms resolve the prisoners dilemma by |
colluding -price fixing -control output -restricting their aggression towards each other on non-price/quantity variables |
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2 types of collusion: |
- overt (explicit) L written agreement -tacit: no explicit agreement, each firm mutually recognises that cooperation is rewarded by higher profits |
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methods of tacit collusion: |
-repeated interaction -repitition -reputation for co-operation may develop -credible pushiment strategies |
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two 'trigger' strategies (punishments); |
- Grim trigger: if your rival cheats on you once, never co-operate again -tit for tat: you do to your rival what they did to you last round |
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concentration ratio: |
measure of seller concentration in a market |
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Concentration ratio range? |
Range between 0-100 percent higher measures=higher concentration=less competition |
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HH Herfindahl-Hirschman Index: |
takes account of all firms in industry -sum of the squares of the market shares of each firm usually between 0 (perfect comp) and 10,000 (monopoly) |
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asymmetric inefficiency: |
Adverse selection: sellers have info that buyers do not Moral Hazard: one side takes actions that the side cannot observe |
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gresham's law: |
the bad money will drive out the good money |
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lemons problem: |
The lemons problem refers to issues that arise due to asymmetric information possessed by the buyer and the seller of an investment or product, regarding its value. |
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goods/services need to signal their worth: |
- guarantees/warranties -brand names -licensing |
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markets need to signal their worth: financial -- |
credit reference evidence of no claims bonus for insurers |
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role of education: |
-improves human capital -acts as a signal to higher productivity |
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pooling equilibrium: |
if cost is too higher, no one will buy good if too low, all will buy product (education) if pooling equilibrium exists all workers paid the same wage |
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separating (signalling) equilibrium: |
-if costs are too higher low productive workers they will refrain from undertaking education - if cost are too low to induce high productive workers from undertaking education separating equilibrium exists and high productive workers will be paid Wh and low productive workers WL |
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how firms differentiate between 'equally qualified' applicants: |
-raise entry requirements for jobs -Only recruit from top unit -Rigourous interviews -Probationary contracts |
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principal-agent problem: |
1 party, agent, is acting on behalf of other party, principal agent has more info about his actions that the principal. agent may have an incentive to act inappropriately if interests of him and principal are not aligned (rise to opportunistic behaviour) |
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spence 1974: for signals to be effective,.. |
then the cost of attaining them must be set so as buyers are able to differentiate between the different types of sellers |
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brand loyalty what happens to demand curve: |
change of slope: steeper, less elastic |
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3 types of good: |
- search goods -experience goods -credence goods |
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search goods: type of advert: |
consumer can establish a products quality by inspection before purchase e.g. furniture, clothing more informational, characteristics of product |
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experience goods: type of advert: |
goods where consumer must consume the product to determine quality e.g.. processed foods persuasive, celebrity endorsements, images |
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credence goods: types of advert: |
where consumer cannot determine quality of good, even after consumption i.e./ repair services, medial care persuasive, information based |
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arbitrage: |
selling product to band of people who have to pay more to pay more profit |
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3 degrees of price discrimination: |
1st: Perfect price discrimination 2nd: quality discrimination 3rd: multi-market discrimination |
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1st degree price discrimination: |
Perfect price discrimination: involves selling at a different price to each customer, firm can successfully extract all consumer surplus, ex/airplane industry |
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2nd degree price discrimination: |
firm sells at different prices depending upon how much of the good the customer buys i.e./bulk buying discounts |
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3rd degree: |
multi-market price discrimination -identifying groups of consumers with different price sensitivities to the variation in the price of a good -usually mechanism to stop arbitrage |
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5 michael porter forces: |
-Intensity/Form of Industry Rivalry -Threat of Substitutes -Bargaining powers of customers -Bargaining powers of suppliers -Threat of substitutes -Threat of new entry |
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main barriers to entry: |
brand loyalty, economies of scale, control of inputs, high capital requirements, strategic actions by incumbents |
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the differentiation strategy: |
involves making your product different from your rivals ex/airlines |
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low cost strategy: |
improve profitability by reducing costs to the minimum cost |
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when are price strategies viable? |
when market is sensitive to demand- relatively elastic |
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criticisms of micheal porter forces? |
- externally orientated - no mentions of internal factors -qualitatively based tool -generic strategies -stucj in the middle might not be so bad |
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law of demand |
the higher the price of a good, the smaller is the quantity demanded, |
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why does a higher price reduce quantity demanded? |
- substitution effect - income effect (buying power increases) |
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absolute advantage: |
a person who is more productive than others |
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comparative advantage: |
if the person can perform the activity at a lower opportunity cost than anyone else |
