Microeconomics

What is a positive statement?

Objective statements based on empirical evidence and tend to be statements or fact

What is a normative statement?

Value judgements based on opinions and beliefs

Why are positive statements useful?

Positive statements help us understand the economic world through empirical analysis

Why are normative statements useful?

Normative statements are used to express opinions and guide policy decisions based on ethical, political, or value-based considerations

What is the basic economic problem?

There are infinite wants and finite resources. Resources are scarce in relation to wants

What are the four factors of production?

Land = natural physical resources

Labour = human input

Capital = man-made resources

Enterprise = the ability and willingness to organise, coordinate and take risks in the production process

What are the rewards to the factors of production?

Land = rent

Labour = wages

Capital = interest

Enterprise = profit

What is opportunity cost?

The value of the next best alternative foregone when a choice is made

What do rational economic agents aim to maximise?

Consumers = total utility

Workers = wages and benefits from work

Producers = profit

Government = social welfare

What is a PPF?

Shows the maximum possible output combinations of two goods or services an economy can achieve when all resources are fully and efficiently employed

Why are PPFs curved?

Law of Diminishing Returns

What is the Law of Diminishing Returns?

The marginal (extra) output of consumers goods diminishes as more factor resources are allocated to it

What causes an outward shift in the PPF?

An increase in the quantity of the factors of production

An increase in the quality of the factors of production

An advance in technology

What causes an inward shift in the PPF?

A decrease in the quantity of the factors of production

A decrease in the quality of the factors of production

Why may a PPF be a straight line?

Indicates resources are equally efficient at producing both goods shown o the PPF axes - opportunity cost is constant

What is factor mobility?

Occurs when factors of production can easily be moved from one use to another

What is geographical mobility?

Resources can move easily between regions/areas/countries

What is occupational mobility?

Resources can move easily between different types of work

What is geographical immobility of labour?

In practice, labour may not be fully mobile because of regional house price variation, family & social ties, children in school etc

What is occupational immobility of labour?

Can occur because of insufficient education and training, a lack of transferable skills, inability to afford training etc

What are the advantages of specialisation and the division of labour?

Increased output

Lower costs

Economies of scale

What are the disadvantages of specialisation and the division of labour?

Higher staff turnover

Dependency

Structural unemployment

Lack of variety

What is money?

Anything generally accepted in payment of a debt; removes the needs to barter, avoiding the double coincidence of wants

What are the characteristics of money?

Acceptable to all

Portable

Durable

Easily divisible

Uncounterfeitable

Scarce in supply

What are the four functions of money?

Medium of exchange = money facilitates transactions between buyer and seller; specialisation and the division of labour requires a means of exchanging goods and services; money promotes this

Unit of account = a nominal unit of measure used to value/cost/price products, assets, debts, incomes and spending

Store of value = an asset that holds value over time

Standard for deferred payment = the accepted way in each market to settle debt

What is the mobility/immobility of land?

Land is not geographically mobile but can be occupationally mobile

What is the mobility/immobility of labour?

Capital can be both occupationally and geographically mobile

What is specialisation?

The concentration of individuals, firms, or nations on producing a limited range of goods and services

What is the division of labour?

A form of specialisation where the tasks needed to produce an item are divided among workers

What did Adam Smith argue?

That specialisation leads to increased productivity and economic growth in the 'Wealth of Nations'

What is an economic system?

A network of individuals, organisations and institutions used by a society to resolve the basic problem of what, how much, how and for whom to produce

What are the characteristics of a free market economy?

Private ownership of resources

Owners of resources and producers are free to buy/sell Economic agents are motivated by self-interest

Consumers have sovereignty - they determine what is produced by being willing and able to buy goods and services

Income depends on the market value of an individual's work Resources are allocated by the price mechanism (market mechanism)

What is a free market economy also known as?

A laissez-faire, market or capitalist economy?

What are the advantages of a free market economy?

Resources can be bought and sold

Consumer sovereignty

Freedom of choice

Profit-motive and self-interest incentivises

Incentive to worker harder for higher wages; productivity rises

Firms face competitive forces driving down prices

Incentive to innovate and invest in new ideas (dynamic efficiency)

What is Adam Smith's invisible hand?

If economic agents act in their own best interests, the forces of demand and supply in the market can promote an efficient allocation of scarce resources for society

What are the disadvantages of a free market economy?

Income/wealth inequality, and poverty

Market failure can reduce social welfare

Lack of provision of public goods

Over-provision of goods with negative externalities

Under-provision of goods with positive externalities Information gaps may cause market failure

Unemployment/worker exploitation/low pay for someEnvironmental depletion/degradation

Resources may be wasted on advertising and marketing Firms may develop monopoly power and push up prices Macroeconomic instability

Who is Friedrich Hayek?

He had a strong belief in the individual in an economy rather than government. Hayek did not support active government intervention to stimulate growth. Hayek favoured market economies - he thought a small group of individuals in government would never have enough information to meet people's needs

What are the characteristics of a Command (Centrally planned) Economy)?

Government owns and allocates resources deciding what, how and for whom to produce

Government sets productions targets and growth rates according to its view of people's wants

Goods are allocated through rationing

Workers are given job by the government

Market prices do not inform resource allocation

Queuing is used to ration scarce goods

What are the advantages of a Command (Centrally planned) Economy)?

Resources are allocated by the government to maximise social welfare

Relatively even distribution of income/wealth

Workers are given jobs by the state; there is no unemployment

Adequate provision of public goods

Government should take externalities into account in decision-making

Environmental protection possible

Government can invest in economy's infrastructure easily

Policies to manage the macroeconomy

Welfare safety net

National interest considered rather than individual profits

What are the disadvantages of a Command (Centrally planned) Economy)?

Danger of government failure

Difficult for the government to set and correct output planning targets and fix prices appropriately

Government may not have enough information to make good decisions eg malinvestment by state

Very bureaucratic - lots of red tape which reduces efficiency

Underemployment

Lack of choice for consumers

Lack of incentives to be innovative and entrepreneurial Lack of incentives to work hard, causing lower productivity Corruption is likely to develop

Shadow market activity can flourish

What is mixed economy?

There is a mix of private and public (government) sectors

Resources are allocated by the price mechanism, when it works efficiently, but the government intervenes to correct market failures

What are traditional economies?

Those characterised by family groups, low productivity, little specialisation, barter trade and no surplus production for investment

What are transition economies?

Are in the process of moving from a command economy to a mixed/free market economy. Markets are liberalised, state assets are privatised, state subsidies are removed. This can cause some short-term problems such as inflation and unemployment

What did Karl Marx argue?

Free markets are chaotic and there is often surplus labour; labour specialisation and population growth push wages down - workers are exploited

Capitalism would eventually push workers towards revolution against the capital owners

Communism is not the same as Socialism, but both favour more government intervention in the economy

What is effective demand?

Demand supported by intention and ability to buy

What is latent demand?

Willingness to buy but not yet ability to buy

What is joint or complementary demand?

Demand for one good is closely linked to the demand for another

What is competitive demand?

Two or more goods that are close substitutes for each other

What is derived demand?

When demand for one product drives the demand for another

What is composite demand?

Good is demanded for more than one use

What is individual demand?

A consumer's demand for a good/service

What is market demand?

All consumers' demands in the market summed together

What is the Law of Demand?

As price falls, the quantity demanded increases and vice versa. Demand slopes downwards to the right

What is an extension in demand?

A movement along the demand curve from A to B (lower P, higher Qd)

What is a contraction in demand?

A movement along the demand curve from B to A (higher P, lower Qd)

What does Ceteris Paribus mean?

All other influencing factors are held constant

What causes shifts in demand (non-price determinants of demand)?

Change in tastes/preferences

Change in incomes

Change in the price of related goods (complements or substitutes)

Change in size/structure of the population

Changes in interest rates

Changes in the law

Changes in expectations

Why does the demand curve slope downwards?

Substitution effect - consumers substitute in favour of the good that become relatively cheaper; if price of good X falls, consumers buy more of good X

Real income effect - if the price of good X falls, the consumer buying good X will gain purchasing power; this extra 'income' available for spending can be used to buy more X

What is the Law of Diminishing Marginal utility?

As a consumer buys and consumes more units of a good, the extra satisfaction gained diminishes. This means at higher quantities, consumers are less willing to pay a higher price, helping to explain the downward sloping demand curve

What is Total Utility?

The total satisfaction the consumer gets from purchasing units of a good. Rational consumers aim to maximise their total utility

What is Marginal Utility?

The change in total utility from consuming an extra unit of a product

What is Joint Supply?

Two or more goods that derive from a single production process; a change in the supply of one good leads to a change in the supply of a by-product

What is Individual Supply?

A producer's supply of a good/service

What is Market Supply?

All producers' supplies to the market summed together

What is the Law of Supply?

As price falls, the quantity supplied decreases and vice versa. Supply slopes upwards to the right

What is an extension in supply?

A movement along the supply curve from A to B (higher P, higher Qs)

What is a contraction in supply?

A movement along the supply curve from B to A (lower P, lower Qs)

Why does the supply curve slope downwards?

Higher market prices motivated firms to supply more as they expect more profit

Producing more increases the marginal cost of production so firms need higher prices to cover these costs (assumes Law of Diminishing Returns)

What causes shifts in supply (non-price determinants of supply)?

Change in the costs of production (raw materials, wages, energy....)

Change in production technology

Change in weather/climate

Events such as strikes, pandemic

Changes in indirect taxes

Changes in producer subsidies

Changes in the price of substitutes in production

Changes in the number of firms supplying to the market

What is meant by equilibrium?

A state of rest -sometimes called market-clearing price

What happens when there is an increase in demand?

Excess demand at the original price so producers are signalled to increase price and extend their supply to restore the market equilibrium

What happens when there is an decrease in demand?

Excess supply at the original price so producers are signalled to reduce price and contract their supply to restore the market equilibrium

What happens when there is an increase in supply?

Excess supply at the original price so price falls which signals to consumers to extend their demand to restore the market equilibrium

What happens when there is an decrease in supply?

Excess demand at the original price so price rises which signals to consumers to contract their demand to restore the market equilibrium

How are substitutes affected by market shifts?

If supply of a good shifts left, this increases the market price, so the demand for a substitute will shift to the right

How are complements affected by market shifts?

If the supply of a good shifts right, this decrease its market price, which will cause demand for the complement to shift right

How is composite demand affected by market shifts?

If the demand for a good increases, the quantity increases, this causes supply to shift left in the market for the good that is in composite demand

How is joint supply affected by market shifts?

If the demand for a good decrease (left shift), then the market equilibrium quantity falls, so the supply of a good in joint supply will decrease (shift left).

How is derived demand affected by market shifts?

If the demand for a final good increases, then the demand for the factors of production used to produce it will also increase

What is price elasticity of demand?

The responsiveness of demand to a change in price

PED = % change in quantity demanded/% change in price

What is the PED value for inelastic demand?

Quantity demanded is not responsive to price changes; the % change in Qd is < the % change in P; value is between 0 and -1

What is the PED value for elastic demand?

Quantity demanded is very responsive to price changes; the % change in Qd is more than the % change in P; value is between -1 and -∞

What is the PED value for unitary demand?

PED = -1; the % change in Qd is the same as the % change in P

What is the PED value for perfectly inelastic demand?

PED = 0

What is the PED value for perfectly elastic demand?

PED = -infinity

What are the points of PED along a demand curve?

PED = -1 at the mid-point of the demand curve

PED is elastic at high prices

PED is inelastic at low prices

PED varies all the way along the demand curve

What happens to TR when PED is elastic?

A rise in P leads to a more than proportionate fall in Qd, so TR falls

A fall in P leads to a more than proportionate rise in Qd, so TR rises

What happens to TR when PED is inelastic?

A rise in P leads to a more than proportionate fall in Qd, so TR falls

A fall in P leads to a more than proportionate rise in Qd, so TR rises

What happens to TR when PED is unitary?

TR will not change when price changes

What factors influence PED?

Availability of close substitutes

Cost of switching suppliers

Breadth of product definition

Degree of necessity

Time frame when making choice

Brand loyalty

% of income spent on product

Habitual demand

What are the uses of PED?

Determination of pricing policy/impact on revenue

Indication of competition faced (number/closeness of substitutes)

Price setting in price discrimination

Government decision on which goods to tax indirectly

What is price elasticity of supply?

The responsiveness of quantity supplied of a good to a change in its price

PES = % change in quantity supplied/% change in price

Why is PED always negative?

Because the quantity demanded is inversely related to price

Why is PES always positive?

Because the quantity supplied is positively related to price

What is the PES value for inelastic supply?

Quantity supplied is not responsive to price changes; the % change in Qs is less than the % change in P; value lies between 0 and +1

What is the PES value for elastic supply?

Quantity supplied is very responsive to price changes; the % change in Qs is more than the % change in P; value lies between +1 and +∞

What is the PES value for perfectly inelastic supply?

PES = 0

What is the PES value for perfectly elastic supply?

PES = + infinity

What is the PES value for unitary supply?

PES = +1; the % change in Qs is the same as the % change in P

What is special about a supply curve that starts at the origin?

It has a PES value of +1