Unit 3 Economics

VCE Unit 3 Economics revision flashcard set.

Incentives

Rewards or penalties influencing an individual or organisations decisions and behaviours. Can lead to unintended consequences if not considered.

Opportunity Cost

Value of the next best alternative use of resources, sacrificed opportunity is forgone.

Types of Factors of Production

Land, Labour, and Capital

Land Resources

Productive inputs occurring in nature eg. soil, trees, animals, clean air.

Labour Resources

Intellectual skills, manual effort, and knowledge that people provide.

Capital Resources

Man made resources used in the production process. Combines natural/land and labour resources to create more sophisticated goods/services in the future. If it isn’t used for production it is just considered a consumer good.

Production

A process of using resources (inputs) to make goods/services (outputs). Factors of production are therefore necessary to produce things we value.

Relative Scarcity or the Fundamental Economic Problem

People have unlimited needs and wants compared to finite resources at our disposal.

What are the three basic economic questions?

What/how much to produce? How should it be produced? For whom it should be produced?

Economic Models

Simplified versions if reality to look at certain interactions within an economy, by isolating important factors. All economic models have assumptions underlying their use, the level to which it is ‘good’ is determined by how well it answers the question it set out to ask.

PPF

The Production Possibility Frontier (or Production Possibility Curve) is a line on the Production Possibility Diagram that highlights the limit of what is possible to produce in a hypothetical economy with only two goods/services being produced.

Productive (technical) efficiency

At specific points on the PPF output gained from input of available resources is at the maximum, impossible for the economy to produce more of one without sacrificing production of another (lack of productive capacity). Increase in efficiency/volume of productive resources causes whole PPF to shift outwards.

Allocative efficiency

Production is aligned with the best possible combination of goods/services to maximise living standards, best meeting the needs/wants of society. At this point any changes decrease national living standards. Dependent on values placed on various goods/services in each economy. Prices are assumed to measure the additional benefits that consumers generate from each unit of consumption, help the allocation of scarce resources.

Dynamic efficiency

How quickly resources can be reallocated from one use to another. Represented by the speed in which movement between points of allocative efficiency occur. Dynamic efficiency indicates that resources are highly mobile, meaning some markets are highly dynamically efficient (eg. alcohol production to hand sanitiser production).

Intertemporal efficiency

The optimal balance between current consumption (spending) and investment/increasing future consumption (saving). The balance of current consumption and it’s environmental damage it can cause (future consumption is dependent on the environment allowing it.

Law of diminishing marginal returns

Economic theory stating that after a threshold of optimal capacity is reached, adding additional factors of production with result in smaller increases in output.

Diminishing marginal utility

Each additional unit consumers will add to a persons satisfaction, however benefit received with each extra unit falls with each successive unit consumed.

Market, and Australia’s market type

Defined as an institution where buyers (consumers/demanders) of goods/services, negotiate the price for each good and services with sellers (producers/suppliers). Can be virtual, physical, or variations of both. Australia is market capitalist meaning most decisions are made through the operation of markets instead of centralised economic planning.

What do market price changes do?

Generate signals that create positive/negative incentives to help resource owners make decisions in the economy.

Characteristics to determine market structure

1. Number of buyers/sellers

2. Extent to which product differentiation is evident

3. Freedom of business entry in market

4. Freedom of business exit in market

5. Degree to which buyers/sellers posses information about products for sale

Perfect competition

Best form of market decision making occurring when the markets are free and competitive. Occurs when these things are evident:

1. Strong competition/absence of market power

2. Low barriers to entry/exit

3. Homogenous products

4. Consumer sovereignty

5. Absence of gov. control

6. Good knowledge of market

7. Consumer behaving rationally

Strong competition

Many rival sellers of identical products, no one seller with market power allowing market price fixing. Firms in the market are price takers. Opposite to a perfect monopoly.

Perfect monopoly

A single firm in the market controls output of industry, lots of market power, price maker.

Consumer sovereignty

The particular types of goods/services produced closely reflect what consumers purchase.

Perfect knowledge of the Market

Price system is able to work when both buyers and sellers gave complete accurate knowledge about current trends in market prices and features of products involved. Lack of information results in poor/irrational decisions being made (price signals are unreliable). Assumes businesses act in self-interest and profit maximisation, meaning resources need mobility to match consumers changing demands.

Consumer rationality

Acting in a way that prioritises their own self interest, discouraged by high prices.

Monopoly power

Maximise revenue from consumers.

Monopsony power

Only one of a purchaser of output to minimise expense (such as coles and woolies bulk buying from farmer for cheap).

Normal profits

Prices sit at just enough for businesses to justify continued operation in that market, derived through perfect/near perfect competition.

Supernormal profits

Above the market level, only made in short term and quickly eroded by new suppliers entering market to share some of these relatively high profits. Means that businesses in these perfectly competitive markets are price takers.

Natural monopoly, provide example of one

Industries with one producer as this makes the most economic sense. If not it would result in significant duplication, higher per unit costs, and higher prices for consumers. An example of a natural monopoly is Australia Post.

Monopolistic competition

Similar to perfect competition but includes product differentiation, where each firm has monopoly over their specific product but competes with chosen substitutes. Firms have higher market power, able to get away with charging higher prices for products (price makers).

Oligopoly

Small number (relative) of businesses dominate market, and collectively exercise market power (raising prices). An example being banking in Australia. Known as a duopoly when there are two main sellers. Creates further barriers to entry and exit to keep market power.

Lower prices (through market efficiency/operations)

As firms in comp. markets are price takers exploitation of consumers through artificially higher prices is impossible (consumers have higher purchasing power).

Draw backs of competition

Aggressive cost cutting by profit-hungry rival firms struggling to survive. In the short term this reduces public safety, product durability, quality assurance, and customer satisfaction. Government often have safeguards against these things such as restrictions on business take overs and mergers. The size of businesses being small in perfect competition may also prevent efficiency due to lack of access to economies of scale that reduce unit costs.

Cost reductions causes

Cheap bulk buying of resources, expensive technology (only available on large scales), spreading costs out (eg. on research), and improved management strategies.

Demand

Occurs in a market when consumers use their income to purchase a particular quantity of a good/service/resource.

Law of Demand

States that the quantity of a particular good/service that buyers are prepared to purchase varies inversely with the change in price, assuming ceteris paribus.

Income effect

Price increases can make certain products unaffordable/completely not purchasable as greater percentage of income is required for it’s purchase. Perceived value differs between consumers, and suppliers may be asking for an amount that exceeds customer expectations.

Substitution effect

When one goods price increases relative to another, consumers look for cheaper substitutes so quantity demanded likely will fall.

Expansion (Demand)

Downward movement along the demand curve.

Contraction (Demand)

Upwards movement along demand curve.

Non-price factors affecting Demand

Cause shifts in demand curve.

1. Changes to disposable income

2. Interest rates

3. Prices of substitutes/complements

4. Preferences and tastes

5. Population and demographics

6. Consumer confidence

Disposable income (relating to demand)

Income a household receives from providing factors of production (wages for labour, interest for capital, rent for land) plus gov. payments, and minus direct taxes on this income. Total consumers can spend on goods/services, influenced by pay increases, tax cuts, and capital gains from buying/selling assets. Impact on movement of demand for specific items is dependent on status of good (normal vs inferior).

Inferior good

Refers to brands/products seen as cheaper “worse” alternatives for lower incomes.

Interest rates

Reward for lending (saving) or cost of borrowing, expressed as a percentage of the principal (amount borrowed or lent). Biggest impact on those indebted such as with home loans. Impacts the discretionary income after paying interest (disposable income minus essential payments/commitments eg. rent/utilities), the discretionary nature indicates some degree of choice for households.

Price of substitutes

A substitute is a viable good/service that may be used instead of a product in question, fulfilling a similar need/want. As substitutes get cheaper the demand curve for the original good will shift left.

Price of complements

Complementary products are generally consumed together, but sold separately. When complement prices increase, demand for the original product decreases (curve shifts left).

Preferences and tastes

Fashion, public attitudes, and season changes can all influence demand due to the way these things impact preferences/tastes.

Population growth and demographic change

A growing population will generally need more goods/services overall, while an aging population will mean demand for certain products such as healthcare increases (also the case in local levels too such as demand for kindergartens when demographics shift).

Consumer confidence (sentiment)

Measure of household expectations about the future state of the economy and their own personal financial future. Impacts marginal propensity to consume. Low consumer sentiment will also likely increase savings rate (seen during COVID).

Marginal Propensity to Consume (MPC)

How likely consumers are to spend every dollar extra that they have earned.

Supply

Total amount of a specific good or service that is available for/to consumers. Whilst higher prices deter consumers, this is more profitable for suppliers and hence will likely have a positive influence on supply/create an incentive for suppliers.

Law of Supply

Quantity of a particular good/service that suppliers are prepared to sell varies directly with the change in price, assuming other factors do not change (ceteris paribus).

Non-price factors affecting supply

1. Changes in costs of production

2. Number of suppliers

3. Tech/Productivity

4. Climatic conditions/other disruptions

Changes in costs of production

Resources are referred to as the factors of production, and the costs involved with these things influence the price a producer is willing to accept in return for a good, which determines the quantity of supply at every price.

Common costs include:

1. Wages/salaries

2. Technology

3. Deliveries

4. Utility bills

5. Rate of depreciation of assets

6. Gov. assistance and taxes

7. Value of AUD (for imported components of the production process)

Number of suppliers

Easy entry into market and supernormal profits in short term entices new firms into market. This increase in supply shifts the curve right meaning, and firms leaving shifts it left.

Tech/productivity

New technology helps increase productivity. Other factors can also influence this such as wellbeing or health levels in the economy. These things increase or decrease the amount of supply in a time frame, influencing overall supply levels.

Productivity definition, and a type of productivity

The amount of output per input. Labour productivity is the total output for each hour that is worked (volume of output).

Climatic conditions/other disruptions

Terrorism, droughts, flooding, fires, and more all impact the ability for production to occur.

Market equilibrium price

Quantity demanded and quantity supplied are exactly equal. Market is therefore thought to be stable.

Prices above equilibrium

Exceedingly high prices create a market surplus, or glut. For this to be solved prices have to fall. Sellers unhappy due to unsold stock, consumers upset over prices out of desired range (can’t or less likely to access goods).

Prices below equilibrium

Exceedingly low prices create a market shortage, where many buyers walk away empty handed. To solve the shortage prices have to rise.

Equilibrium changes

Markets that are in equilibrium can enter a temporary state of disequilibrium when non-price related factors influence supply/demand.

Elasticity

Concept considering the responsiveness of a change in one variable to changes in a factor that affects that variable.

PED

The price elasticity of demand measures the responsiveness of the quantity demanded of a good or service to a change in price of that good/service. Percentage change in quantity demanded/percentage change in price.

Determinants/factors of PED

1. Degree of necessity

2. Availability of substitutes

3. Proportion of income

4. Time

PES

Responsiveness of the quantity supplied of a good or service to a change in price of that good/service. Percentage change in quantity supplied/percent change in price.

Degrees of PES

Relatively elastic, unit elasticity, relatively inelastic.

Degrees of PED

High elasticity, perfectly elastic, inelastic/low PED, perfectly inelastic, medium/unit elasticity.

Determinants of PES

(Can the business scale up production quickly due to these things?/How easy or hard it is for a business to produce/up production volume of certain goods/services)

1. Production period

2. Spare capacity

3. Durability of goods

Market Mechanism

System of decision making whereby the free forces of supply and demand for goods/services operate to prices.

What do changes in relative prices impact?

Changes to relative prices impact relative profits as well as the allocation of resources between alternative uses. This is known as the price system.

Issues with the market system

Allocation of scarce resources inequitably, determined by income not need. Some members have no income and no access to production process.