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181 Cards in this Set
- Front
- Back
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The law of demand |
The quantity demanded for a good of service falls as its price rises |
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Market |
Any place where transactions takes place between buyers and sellers |
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Demand |
The willingness and ability of consumers to pay a certain price in a market to obtain a particular good or service |
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Three causes of the law of demand |
The income effect The substitution effect Diminishing marginal returns |
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The income effect |
As price falls, the real income of customers rise |
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The substitution effect |
As the price of a good or service falls, more customers are able to pay, so they are more likely to buy the product |
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Diminishing market returns |
As people consume more of a particular good or service, the utility gained from the marginal unit declines, so customers will only purchase more at a lower price |
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Four non-price determinants of demand |
Habits, fashion and tests Income Substitutes and complements Advertising Government policies Economy position |
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Substitutes |
Products that can be used instead of each other |
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Complements |
Products that are jointly demanded (have a derived demand) |
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Derived demand |
When the demand for one good is directly influenced by another good |
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Normal good |
When the demand for a product increases with a rise in income |
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Inferior good |
When demand for a good falls as income rises |
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The linear demand equation |
Qd = a - bP a = demand irrespective of price b = slope of the demand curve |
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Supply |
The willingness and ability of firms to provide a good or service at a given price level |
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Two reasons for the positive relationship between price and supply |
Existing firms can earn higher profit margins of they supply more More firms enter the market as higher prices allow them to cover production costs |
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Four factors affecting supply |
Production costs
Indirect taxes Number of firms entering the market Technological advances Subsidies Weather/Climate |
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The linear supply equation |
Qs = c + dP
c = supply irrespective of price d = slope of the supply curve |
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Market equilibrium
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When the quantity demanded for a product is equal to the quantity supplied of the product
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Excess supply
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Occurs when the price is set above the equilibrium, and therefore more of the good is supplied than demanded
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Excess demand
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Occurs when the price is set below the equilibrium, and therefore more of the good is demanded than supplied
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Equilibrium equation |
a-bP = c + dP
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The basic economic problem
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The scarcity of resources against the infinite nature of human wants and desires
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Opportunity cost
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The next best alternative foregone when a choice is made
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Two functions of resource allocation |
Signalling Incentivising |
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Consumer surplus
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The benefits to buyers who are able to purchase a product for less than they are willing to do so
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Producer surplus
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The difference between the price that firms actually receive and the price they are willing to pay for it
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Allocative efficiency
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When resources are distributed so that consumers and producers get the maximum possible benefit
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Price elasticity of demand
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The degree of responsiveness of quantity demanded for a product following a change in price
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PED equation
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% change in quantity demanded / % change in price
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PED values |
0 : Perfectly inelastic
0 to -1 : Inelastic -1 : Unit elastic -1 to -∞ : Elastic -∞ : Perfectly elastic |
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Four determinants of PED |
Substitution Income Necessity Fashion/Addiction/Habits Advertising/Brand loyalty Switching costs Durability/Frequency of purchasing Time |
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Three reasons why firms would be interested in PED values |
Inelastic demand opens opportunity to increase price and profits
Price discrimination can be imposed if different PED values are identified Firms can pass on most of the incidence of tax for inelastic goods |
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Cross price elasticity
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The responsiveness of quantity demanded for one product following a change in price for another product
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XED equation
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% change in quantity demanded for good A / % change in price of good B
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How XED determines relationships |
Complements have a negative XED value
Substitutes have a positive XED value An XED value of 0 means the two products are unrelated |
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Three reasons why firms would be interested in XED values |
Allows firms to predict how demand for their good will change
Affects the pricing strategy of a firm Informs firms of the extent at which consumers will switch suppliers |
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Income elasticity of demand
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The degree of responsiveness of quantity demanded following a change in income
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YED equation
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% change in quantity demanded / % change in income
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Normal good
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Products that customers tend to buy more of as their income level increases
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Inferior goods
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Products with a negative income elasticity of demand, meaning demand falls when income rises
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Luxury goods
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Superior goods and services as their demand is highly income elastic, meaning their demand increases proportionally greater when income rises
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Three reasons why firms would be interested in YED |
Estimating impacts of income changes on different markets
Indicating firms on the classification of their good, and therefore the vulnerability Allowing firms to understand and predict changes in demand for their products |
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Price elasticity of supply
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The degree of responsiveness of quantity supplied of a product following a change in its price along a given supply curve
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PES equation
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% change in quantity supplied / % change in price
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PES values |
0 : Perfectly inelastic
0 to 1 : Inelastic 1 : Unit elastic 1 to ∞ : Elastic ∞ : Perfectly elastic |
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Four determinants of PES |
Time period Spare capacity Ability to stockpile The ease and cost of factor substitution |
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Why a firm would be interested in PES |
Firms can be more competitive if they are more price elastic
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Tax
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A compulsory levy or charge imposed by the government on firms or consumers
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Indirect tax
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A government levy on expenditure, the sale of goods and services
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Specific tax
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A fixed amount of tax charged on each unit sold
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Ad valorem tax
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A tax imposed which is a percentage of the value of a good or service
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The effect of specific and ad valorem taxes on supply curves |
Specific taxes cause left shifts in the supply curve, whereas ad valorem taxes pivot the curve
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Two motives of indirect taxation |
Correct market failure Obtain government revenue |
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Deadweight loss
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The combined loss of consumer and producer surplus
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Incidence of tax |
The proportion of tax paid by various stakeholders |
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How PED impacts incidence of tax |
When demand is price elastic, firms have to pay a greater incidence of tax
When demand is price inelastic, consumers have to pay a greater incidence of tax |
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Subsidy
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Financial assistance from the government to firms
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Three reasons for a subsidy |
To encourage the output of merit goods To limit negative externalities To protect certain industries and to prevent a subsequent decline in employment |
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Price ceiling |
When the government sets a legal maximum price below the market equilibrium to encourage output and consumption
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Price floor
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The imposition of a price guarantee set above the market price to encourage supply or reduce consumption
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Market failure |
When the price mechanism allocates scarce resources in an inefficient way
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Four examples of market failure |
Under provision of merit goods
Under provision of public goods Over provision of demerit goods Abuse of monopoly power |
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Private benefits
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The benefits of production and consumption enjoyed by a firm, individual or government that is directly involved
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Private costs
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The actual costs for a direct consumer or producer of a good or service
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Social benefits
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The true benefits of consumption and production on people directly involved and third parties
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Social costs
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The true costs of consumption and production of a good or service on those directly involved and third parties
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Externalities
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The spillover effects and external costs or benefits of an economic transaction on third parties
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Third party
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An individual or group not directly involved in the consumption or production of a good or service, but affected by it
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Marginal private benefit (MPB)
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The additional value enjoyed by households and firms from the consumption or production of an extra unit of a good or service
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Marginal private cost (MPC)
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The additional cost of production for firms or the extra charge paid by customers for the output or consumption of an extra unit of a good or service
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External costs
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Costs incurred by a third party in an economic transaction for which no compensation is paid
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Three examples of external costs |
Second hand passive smoking
Air pollution caused by fumes from a factory Noise pollution from a nightclub Litter on public beaches |
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External benefits
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Benefits enjoyed by a third party from an economic transaction
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Three examples of goods with external benefits |
National defence
Education Public firework displays Sewage and waste disposal systems |
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Marginal social benefit (MSB)
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The added benefit to society from the production or consumption of an extra unit of output
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Marginal social cost (MSC)
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The extra cost of an economic transaction to society and third parties
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Demerit good
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Over consumed products that create negative spillover effects to society, thus having negative externalities
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Three examples of demerit goods |
Cigarettes
Drugs Prostitution |
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Three advantages of imposing a tax on demerit goods |
It increases price and therefore should decrease quantity demanded
It charges the consumer and not the third party It creates tax revenue for the government |
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Three disadvantages of imposing a tax on demerit goods |
The demand for many products is price inelastic due to addiction for example
The tax is regressive, so increases inequality It encourages smuggling and informal sector activity |
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Tradable permit
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Pollution rights issued to firms (used in cap and trade schemes)
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Three examples of regulations to deal with negative externalities |
Laws to regulate where people can drive
Laws to make smoking illegal in certain areas Legal minimum age for purchases Regulating the number of night flights to minimise noise pollution |
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Two positives of using rules and regulations against negative externalities |
Consumption of any good can be reduced
Makes people more aware of externalities of their consumption |
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Two negatives of using rules and regulations against negative externalities |
Costly to enforce at times
Restrictions can lead to the formation of black markets |
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Merit good
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Under consumed products that create positive externalities when they are produced or consumed
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Three examples of merit goods |
Education
Healthcare provision Organic foods |
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Three limitations to subsidising merit goods |
It is difficult to quantify what subsidy would be sufficient
If demand is inelastic, a lower price would have little effect Opportunity cost of the expenditure |
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Two examples of legislation for merit goods |
Compulsory education for children
Required vaccination of people |
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Two positives and two negatives of education and advertising merit goods |
Changes behavioural and consumer patterns
Have long term influences Can be costly Not always effective or resonating with the audience |
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Three disadvantages of direct provision of merit goods |
Nationalisation can lead to economic efficiencies
Opportunity costs of money spent on provision In the case of shortages, supply has to be rationed which can be difficult to justify |
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Public good
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Goods and services that exert positive externalities and are non-rivalrous and non-excludable
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Two key characteristics of public goods |
Non rivalrous: when a person’s consumption of a public good does not limit the benefits available to other people
Non excludable: people can not be excluded from consuming the good |
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Three examples of public goods |
National defence
Emergency services Public firework displays |
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Free rider problem
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Where those who do not pay cannot be excluded from the benefiting from the provision of public goods
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Common access resources
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Refers to communal or public property that are rivalrous by nature, but non excludable
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Tragedy of the commons
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The consequences of the abuse and inefficient use of common access resources
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Three government responses to sustainability threats |
Legislation Carbon taxation Cap and trade schemes |
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Carbon tax
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A per unit tax on greenhouse gas emissions
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Cap and trade schemes |
Give firms an allowance (or a ‘cap) of permits for emissions
If the exceed this cap, they have to buy permits off other firms who did not use all of their permits |
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Two criticisms of cap and trade schemes |
Schemes are anti-competitive and cause losses of jobs
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Asymmetric information
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When one economic agent within a transaction has more information or knowledge than the other, giving them an advantage
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Three government responses to asymmetric information |
Legislation (health warnings on cigarette packets)
Regulation (rules and standards on misleading advertising) Provision of information (nutritional information) |
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Three examples of abuse of monopoly power |
Monopolists charging excessively high prices
Collusion Predatory pricing |
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Predatory pricing
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Setting low prices, perhaps below production costs, to put rivals out of business
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Three government responses to the abuse of monopoly power |
Legislation
Regulation Nationalisation (government taking control of the industry) Trade liberalisation (to increase competition) |
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The short run
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The period of time when at least one factor of production, such as land or capital, is fixed in the production process
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The long run
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The period of time when all factors of production are variable, and so costs of production are variable
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Diminishing returns
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Occurs in the short run when a variable factor input is successively added to a fixed factor, which eventually reduces the marginal revenue
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Average product
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The output per unit of factor input
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Marginal product
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The extra output due to a change in factor inputs
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Total product
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The sum of all physical output for a given amount of factor inputs
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At what point average and total product is maximised |
Average product is maximised when MP=AP
Total product is maximised when MP=0. |
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Economic costs
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The explicit and implicit costs of all resources used by a firm in the production process
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Explicit costs
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The identifiable and therefore accountable costs related to the output of a product
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Implicit costs
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The opportunity costs of the output
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Fixed costs
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Costs that do not change with the level of output
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Variable costs
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Costs that continuously rise with every added unit of output produced
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Marginal costs
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The costs required to produce an extra unit of output
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Increasing returns to scale
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When factor inputs are increased by a certain amount, leading to output increasing by proportionally more
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Decreasing returns to scale
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When factor inputs are increased by a certain amount, leading to output increasing by proportionally less
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Constant returns to scale
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When factor inputs are increased by a certain amount, leading to output increasing by the same proportion
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Internal economies of scale
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Generated and enjoyed within the firm that operates on a large scale, leading to lower average costs
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Four economies of scale |
Specialised labour (attraction of skilled and experience workers)
Financial (favourable loan conditions) Marketing Purchasing (bulk buying) |
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External economies of scale
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Having specialised backup services available in a particular region where firms are located
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Diseconomies of scale
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When a firm becomes too large to manage effectively, causing its unit costs to increase
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Two internal diseconomies of scale |
Loss of coordination
Demotivation of workers |
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Two external diseconomies of scale |
Traffic congestion
Higher rents Labour shortages in a particular industry |
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Revenue
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The money received from the sale of a firm’s output
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Average revenue
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The typical price received from the sale of a good or service
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Marginal revenue
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The extra revenue received from the sale of an extra unit of output
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Normal profit
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The minimum revenue needed to keep a firm in business
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Economic / abnormal profit
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When total revenue exceeds the economic costs of a transaction, encouraging firms to produce
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Break even
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When a firm reaches the point at which it is making neither a profit or loss
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Negative economic profit
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Occurs when a firm is making a loss
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Profit maximisation
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The assumed fundamental goal of private sector firms to, and occurs when there is the greatest positive difference between total revenue and total costs
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Revenue maximisation
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Opting to earn less profits by charging lower prices to raise popularity and outcompete rival firms
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Growth maximisation
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Focusing on taking measures to expand as much as possible to new markets
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Satisficing
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The goal of firms to reach a satisfactory or adequate profit margin for investors, instead of pushing to maximise
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Corporate social responsibility
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Taking full acknowledgement and actively reducing the impacts of a firm’s actions where necessary
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Market structure
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The key characteristics of a particular industry
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Four characteristics of perfect competition |
Large number of buyers and sellers
Homogeneity in products Firms are price takers Extremely low barriers to entry |
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Allocative efficiency
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When firms produce at the optimal level of output from society’s point of view
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Productive efficiency
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The output level where average costs are minimised
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Technical efficiency
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When the maximum output is produced with the minimum amount of factors inputs
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Monopoly
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A single supplier/producer which dominates a market
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Monopoly power
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Having over 25% of the total market share
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Four characteristics of a monopoly market structure |
One dominating firm
Firm is a price maker Imperfect sharing of knowledge (asymmetric information) Very high barriers to entry |
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Barriers to entry
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The obstacles that prevent other firms from effectively entering a particular market
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Artificial barriers
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Barriers deliberately established by monopolists to prevent competition
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Three artificial barriers |
Advertising and branding
The existence of intellectual property rights Predatory pricing Loyalty schemes |
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Natural barriers
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Obstacles that simply exist characteristically in the industry
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Three examples of natural barriers |
High set up costs
High research and development costs Legal constraints Competing with economies of scale |
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Natural monopoly
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When the industry of a specific market can only sustain one supplier, to avoid wasteful competition and maximise economies of scale
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Three examples of markets with natural monopolies |
Postal service
Gas piping and supply Water companies Railway networks |
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Three advantages of monopolies |
Huge economies of scale
Innovative and can invest in research and development Eliminates wasteful competition |
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Three disadvantages of monopolies |
Inefficient in resource allocation
Imperfect knowledge exploits consumers Monopolies can abuse power through pricing |
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Four characteristics of monopolistic competition |
Large number of relatively small firms
Heterogeneous goods Low barriers to entry Firms have some control of pricing |
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Price competition
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The use of pricing strategies to compete
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Going rate pricing
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The pricing decision is based on the average price charged in the industry
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Loss leader pricing
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Setting the price of a product below its cost price to entice customers to other products sold by the firm
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Penetration pricing
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Used by new entrants that set a low introductory price to establish some market share
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Promotional pricing
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Charging a low price to attract customers to raise brand awareness and develop customer loyalty
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Psychological pricing
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Charging prices that seem lower than they are ($9.99 instead of $10)
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Three examples of non price competition |
Advertising
Packaging and appearance Product development and improvement Quality of good or service |
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Four characteristics of oligopolies |
Small number of large firms
Mutual interdependence High barriers of entry Very competitive |
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Concentration ratio
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The degree of market power in an industry by adding the combined market shares of the largest few firms
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Game theory
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An economic model that attempts to explain the nature of strategic interdependence in oligopolistic markets by considering the actions of competitors when making a decision
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Collusion
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The agreement between two or more oligopolistic firms to limit competition by restrictive trade practices
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Cartel
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Formed when there is a formal agreement between oligopolistic firms to collude
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Famous example of a cartel |
OPEC |
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Tacit collusion
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When two or more oligopolistic firms implicitly agree to use restrictive trade policies
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Price leadership
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When a firm sets a price that is accepted by other firms as the market price
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Non collusive
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Oligopoly that exists where firms in the industry act strategically by competing independently, taking into account the likely or possible actions of one another
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Price stability
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The nature of price to remain constant in oligopolies because of competitors not matching price hikes, but immediately responding to price reduction
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Price war
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When firms continually reduce prices to outstrip their rivals
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Price discrimination
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The practice of charging different prices to different customers for essentially the same product
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Three necessary conditions for price discrimination to be effective |
The firm must have some degree of market power
Different customer groups with different price elasticities of demand The firm must be able to separate the different consumer groups reselling the good |
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First degree price discrimination
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When a firm can get each customer to pay the highest price that they are willing and able to pay, eliminating all consumer surplus
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Second degree price discrimination
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When discounted prices are used for customers buying in bulk
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Third degree price discrimination
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When a different price is charged to different customers based on their different degrees of price elasticity of demand
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