Econ T1 (HL/SL)

Demand, Supply, Competitive market equilibrium, PED, PES, YED, The role of government in microeconomics, Market failure - externalities, Econ of the environment and public goods.

Opportunity cost

The value of the next best alternative given up when a decision is made.

What are the Factors of Production?

Resources or inputs used in the production process to produce goods and services. These include Capital, Entrepreneurship, Land, Labour.

What is Capital?

equipment or materials used for the production of goods and services (reward: interest)

What is Entrepreneurship

Person or people who bring together the FoPs for the production of goods and services to make a profit (reward: profit)

What is Land

provides raw materials for the production of goods and services (reward: rent)

What is Labour

workers used in the production of goods and services (reward: wages)

What are Production possibility curves (PPF)

illustrate the maximum output combinations of goods and services in an economy, when all resources are fully employed. Shift right => rise in either quantity or quality of FoPs.

What is demand

The quantity of goods and services consumers are willing and able to buy at a given time, ceteris paribus.

Ceteris paribus

all other variables remain the same

What is a normal good

most goods are normal goods, meaning thata rise in income, ceteris paribus, will lead to an increase in demand. (e.g electronics)

What is an inferior good

if income increases the demand for an inferior good will decrease. (e.g. public transport)

What are the determinants of demand

Market size, Expectations, Related goods, Income, Tastes and preferences => MERIT

Define market size

Increase or decrease in population or market size

Define expectations

(e.g) consumers expecting a rise or fall in future prices

Define related goods

Price and availability of substitute products (goods &services which can be used in place for another to fulfill the same need or desire. e.g. Coke and Pepsi)

Price and availability of complementary goods (goods & services which are usually consumed along another product. e.g. tennis racket and balls)

Define income

changes in the real income levels of a nation

Define tastes and preferences

Extremely difficult for an economist to quantify but there seems to be a link between the popularity of a good or service and level of demand. (e.g. Dubai chocolate)

Define Supply

The quantity of goods and services producers are willing and able to produce at a given time, for a given price, ceteris paribus.

What are the non-price determinants of supply

Cost of production, Expectations, Number of sellers, Technology, Subsidies and taxes (CENTS)

Define cost of production

Expenses firms incur in producing goods or services

Define expectations

producers’ beliefs about future market conditions

Define number of sellers

total number of firms producing a particular good or service

Define technology

Increase or decrease in production methods which improve efficiency

Define subsidies and taxes

subsidies: financial support from gov. to producers

taxes: charges imposed by gov. on producers

change in D or S

when D or S curve shifts left or right caused by a change in MERIT or CENTS

Movement in D or S

Movement along original D/S curve. Change in Qd or Qs of the product caused by a change in the other (i.e Qd caused by change in Supply)

Define market equilibrium

occurs when S=D, in other words resources employed by firms to produce a good or service is exactly equal to the no. of consumers.

Allocative efficiency 

occurs when Price=Marginal cost (marginal social cost if externalities are present. In other words, resources employed in a way that they are equal to the consumers’ willingness and ability to purchase it.

Market disequilibrium

not allocatively efficient. too few or too many goods and services produces, from society’s POV.

Rationing

Scarcity= limited S of goods and services to be shared amongst consumers. Price of a good or service has a rationing function because it distributes products so that no shortages or surpluses are present. 

 All consumers in the market who are willing and able to buy a good at the market price can purchase it, and all firms in the market who are willing and able to sell their goods at the market price can sell them

Allocation of Resources

Distribution of FoPs across different markets within the economy.

Signalling

When P changes in a market it sends a signal to producers and consumers that the conditions of the market are changing.

Incentive

anything that motivates a person to perform an action or behave ina particular way

Consumer surplus

The difference between the price the consumer is willing to pay for a product and the market price of that product.

Producer surplus

The difference between the price a producer is willing to sell their product for and the market price for that product

Social surplus

Consumer surplus + Producer surplus

Elasticity

Economic concept based on change. It measures how consumers and producers respond to changes  in variable that affect D and S.

Price elasticity of demand (PED)

responsiveness of Qd for a good to a change in its price.

PED = %ΔQd / %ΔP

price elastic

If PED>1, then demand is price elastic => change in goods price leads to a proportionately greater change in Qd.

untitary elasticity

If PED=1, PED is unitary

Price inelasticity

If PED<1, then it is price inelastic. This means a change in P of a good leads to a less-than-proportionate change in Qd.

PED on a graph

The more horizontal the curve, the more elastic it is. The more vertical it is, the more inelastic it is.

The relationship between revenue and PED

When D of a product is price elastic, total revenue rises when price is reduced and decreases when price is increased. When D for a product is inelastic, total revenue increases when price is raised and decreases whenprice is decreased.

Define Price elasticity of Supply (PES)

PES is the responsiveness of the Qs of a good to a change in its price.

PES = %ΔQs / %ΔP

PES is usually positive due to the law of supply

Price elastic supply

If PES>1 the goods S is price elastic. Meaning achange in price leads to a proportionately greater change in quantity supplied.

unitary elasticity of S

PES=1, the PES is unitary. (unlikely)

price inelastic supply

PES<1, goods S is price inelastic. Meaning a change in the price of a good leads to a less-than-proportionate change in the quantity supplied.

Determinants of PES

Easier the access to FoPs the more elasitc PES tends to be.

Spare capacity and available stock => S relatively price elastic.

Income elasticity of demand (YED)

The responsiveness of demand of a product following a change in the real income levels

YED = %ΔQd / %ΔY

YED elastic

YED > 1 = elastic (luxury goods)

YED inelastic

0 < YED < 1, inelastic (necessities)

YED unitary elasticity

YED = 1, unitary elasticity

Negative elasticity

YED < 0, negative elasticity and deemed inferior goods and services.

5 reasons why governments intervene

1. raising government revenue to fund public services

2. support for producers (important for overall welfare of society)

3. support households on low income and reduce income inequality.

4. Influence supplier behaviour (industries which have a negative effect on society’s welfare)

5. Influencing levels of consumption (protect welfare of citizens [ie. recreational drugs])

define indirect tax

Tax placed on a good or service raising the production cost of the business.Tax on expenditure not income.

define specific tax

fixed amount of tax placed upon product. e.g. $4 per pack of cigarettes.

Ad valorem tax

tax placed on a range of goods and services which is a percentage of the selling price. 

Excise taxes

taxes applied ton a narrow range of goods in order to reduce its consumption.

What is the tax incidence or burden of taxation

When a tax is placed on a good the producer would like to pass on the entire tax tot the consumer. However, this would create a surplus (S>D) and therefore depending to the relative elasticities the producer will be forced to absorb some of the tax themselves.

The lower the PED the more the consumer will increase.

What is a welfare loss

a reduction in economic efficiency that occurs when the market fails to produce the socially optimal quantity of a good or service leading to a decrease in economic well-being.

Caused by for example taxation, subsidies, price control and externalities.

Impact of PES on tax incidence

When PES>PED, the consumer incidence > producer incidence. PES<PED, producer incidence > consumer insidence.

why do governments favour taxing goods with price inelastic demand?

Revenue collected is high. Tax incidence falls more on consumer than producer and higher incidence on producer is more likely to cause unemployment (due to output cut).

Define subsidy

money paid by government to producers to encourage the consumption and production of a good or service

reasons for subsidies

Support goods/services with social benefits (e.g., renewable energy).

Support key industries (farming, steel, energy) for security.

Promote economic development and job creation.

Protect domestic firms from foreign competition.

Effect of PED 

If D is elastic the gain in producer surplus is greater that the gain in consumer surplus. This is because price doesnt fall as much as it would if D was inelastic.

Define maximum prices (price ceiling)

Price set by gov. to prevent the price of a good or service from rising above a certain level. Maximum prices are set to protect low-income households from rising prices in a market they can afford. 

Effects of maximum prices

Excess demand (shortages), because the Qd is greater than the Qs.

Rationing function of price no longer works effectively. The price cannot rise to clear the market because of the price ceiling.

Other methods of rationing will be born, such as queueing (firs come, first served), preferential consumer selection etc.

Parallel markets develop (ie. black market)

Quality of rented housing decreases

In long term, new investments in rented housing fall.

Define minimum prices (price floors)

Lower limit set by gov. to prevent the price of a good or service from falling beyond a certain level. They are used to protect the producers in markets. 

Used in past agricultural markets, less prevalent today.

Effects of Min. prices

As the price increases, the quantity demanded decreases because of the income and substitution effects.

At min. price the Qs is greater than Qd meaning there is an excess supply or surplus.

To maintain this min. price the government has to buy and store this surplus. Storing is an additional cost for the scheme.

Min. price brings in additional agricultural producers and increases (excess) supply in the long run, but reduces supply in other markets.

Define market failure

A misallocation of resources or inefficient resource allocation which doesnt maximies the welfare of a country’s citizens.

Define negative externalities

Costs to a third party caused by production or consumption of a good or service, which occur when MSC>MSB.

Marginal private benefit (MPB)

the additional benefit obtained by consumer or producer from consumption or production of one additional unit of a product.

Marginal social benefit (MSB)

Equal to MPB a good provides plus any external benefit it creates. 

MSB=MPB=D

Marginal private cost (MPC)

the additional cost incurred by the consumer or producer of one additional unit of a good or service

Marginal social cost (MSC)

The total cost to society as a whole when one or more unit of a good or service is consumed/produced.

MSC=MPC=S, when no externalities present (with production)

Socially optimum level of output-

point where MSB=MSC

when does welfare loss occur

Occurs when MSC>MSB (costs/negative externalities) or MSB>MSC (benefits/positive externalities)

Indirect (pigouvian) taxes

A tax on any market activity that compensates for the negative externalities created by consumption/production of a demerit good. (e.g. carbon tax)

positive externalities

spillover benefits that positively impact third parties as a result of the consumption or production of a good or service.

Define a merit good

a good or service that society says should be consumed due to the significant social benefits associated with it. (e.g. education)

Merit goods are an example of market failure because they tend to be under-consumed in free markets leading to an under-allocation of resources.

define a demerit good

goods that society says shouldnt be consumed due to their association with significant social costs. (e.g. alcohol & recreational drugs)

Demerit goods are an example of market failure because they tend to be overconsumed leading to an over-allocation of resources.

associated with negative externalities.

define public goods

public services such as defence. They are non-excludable and non-rivalrous.

define non-excludable

When a person cannot be excluded (left out) from using a service or good, regardless whether they have paid for it.

Define non-rivalrous

when one person using a service or good doesnt prevent others from using it.

What is a free rider

a person using a service they arent paying for

what are common access resources

natural resources including forests and pastures (etc.), which are non-excludable but rivalrous. 

private goods are

rivalrous and excludable. (food, clothing, cars)

Club goods are

non-rivalrous but excludable (e.g. netflix, toll roads etc.)