Theme 1 Economics | Quizlet

What is a positive statement

A statement that is objective

What is a normative statement

statement that is opinion

What is the basic economic problem?

Although wants are infinite, needs are finite and limited

What are the 4 factors of production

land, labor, capital, entrepreneurship

What does a PPF diagram show

The maximum combination of capital and consumer goods that the economy can produce with its current resources and technology

What are capital goods

Goods that are produced in order to aid the production of consumer goods

What are consumer goods

Goods that are demanded and bought by households and individuals

What is specialisation

When a country or firm specialises in producing a small range of goods.

Why is it important for countries to specialise

In order to ensure all factors of production including workers, undertake the tasks they are best a

What did Adam smith state

Specialisation can increase labour productivity

What are the advantages of specialisation

Labour productivity increase

Higher quality of goods and services

Workers only need to be trained to do one task

Disadvantages of specialisation

Poor quality of work, as the work is boring

No industrial training so structural employment is likely.

Advantages of specialisation for a country

Comparative advantage leads to greater output worldwide

Disadvantages of specialisation for a country

Countries become dependant on one export (LEDCs reliance on agriculture)

High interdependence which can be impacted by war

What is a free market economy

Individuals can make own choices and own factors of production, no government intervention, decisions are based on satisfaction and profit

what was the invisible hand, who propogated the theory

resources are moved out of production of a good when the consumer no longer wants it, the market allocated resources to everyone's benefit (Adam smith)

advantages of free market economy

consumer sovereignty

high motivation (potential for reward)

firms are in competition so they are productively efficient

disadvantages of free market economy

high inequality

lack of merit goods and no control of demerit goods

risk of monopolies

what is a command economy

all factors of production expect labour are owned by the government, and labour is directed by government

no private property

what is a mixed economy

both free market mechanism and government planning allocate a significant amount of resources

what is the governments role in a mixed economy

creating a framework of rules (preventing monopoly abuse)

redistributes income (taxation and benefits)

produce public and merit goods (streetlights)

what are the underlying assumptions of rational economic decision making

customers aim to maximise utility

producers aim to maximise profit

governments aim to maximise wellfare

what is a movement along the demand curve

a movement from a to b (A-B is extension, B-A is a contraction)

what causes a movement along the demand curve

a change in the price of a good

how can the law of diminishing marginal utility be explained on a graph

demand curve slopes downward showing inverse relationship between price and quantity

What do we have to assume in order to predict or explain how people spend their money

Assume they behave rationally and spend money according to what gives them the greatest satisfaction or welfare

What's the difference between total utility and marginal utility

Total represents the satisfaction gained by customer as result of their overall consumption of a good (eg. Satisfaction from eating whole bar of chocolate)

Marginal represents the change in satisfaction from the consumption of the next unit of a good (increased satisfaction from eating another bar of chocolate)

What is the law of diminishing marginal utility

As more of a good is consumed, each additional unit provides less additional satisfaction

Why does the law of diminishing marginal utility explain why the demand curve slopes downward

If more of a good is consumed there is less satisfaction derived from the good, this means that consumers are less willing to pay high prices at high quantities since they aren't getting as much satisfaction

What is another reason the demand curve slopes downward

In order to maximise satisfaction with income, consumers need to spend so that satisfaction gained per penny is as high as possible. So curve is downward sloping because if price rises marginal utility per penny failed so consumers buy less of the good

Define price elasticity of demand

Responsiveness of demand to a change in the price of a good

What is the formula for PED

%change in QD/% change in price

What are most values of PED and why

Negative, since a rise in price leads to a fall in output

PED = 1, is called what

Unitary elastic, QD changes by same percentage as price

PED is bigger than 1, this means what

Relatively elastic, QD changes by larger percentage than price so demand is relatively response to price

PED is smaller than 1, this means what

QD changes by smaller percentage than price so demand is relatively unresponsive to price.

PED=0, this means what

A change in price has no effect on output, so demand is unresponsive to price

Give 3 factors that influence PED

Availability of substitutes (people can switch to similar products if prices rise)

Necessity

How large a % of total expenditure the good makes up (small percentage means price change is inconsequential)

Why is PED significant

Determines the burden of tax, on wether it lies with consumers or producers

What happens to the incidence of tax if the demand curve is elastic

Lower burden of tax for consumers, higher burden for producers

What happens to incidence of tax if demand curve is inelastic

Lower burden of tax for producers, higher burden of tax for consumers

What happens to revenue if PED is inelastic

Decrease in price leads to an increase in revenue, vice versa

Define income elasticity of demand

Responsiveness of demand to a change in income

What is the formula for YED

%change in quantity demanded/%change in income

What is the good called when YED is less than 0, and give an example

Inferior good, rise in income leads to fall in demand for good. Tesco value goods

What happens to revenue if PED is inelastic

Increase in price leads to increase in revenue

What is the good called when YED is more than 0

Normal good, rise in income leads to rise in demand for good. Dining out or clothing

What is the good called when YED is more than 1, and give an example

Luxury goods, type of normal good, luxury clothing or sports cars

Why is YED significant for businesses

So businesses know how sales will be affected by changes in income of the population

May also impact the type of goods a firm produces, in prosperity firms may produce more luxury goods

Define cross elasticity of demand (xed)

The responsiveness of demand for one product to the change in price of another

give the formula for xed

%change in quanitity demanded of A/% change in price of B

what does it mean when xed is greater than 0

substitutes, increase in the price of good B will lead to increase in demand of good A. Coke and pepsi

what does it mean when xed is smaller than 0

Complementary goods, increase in the price of good B will decrease demand for Good A. DVD's and DVD players

what does it mean when XED=0

unrelated good, change in price of good a has no impact on good B

why do firms need to be aware of XED

so they are aware of firms producing complimentary goods, they need to know how price changes from other firms will affect them and adjust accordingly.

Define supply

Supply is the ability and the willingness to provide a good or service at a particular price at a given time.

What causes a movement along the supply curve from A to B

A change in price

What is the result of an extension in supply

An increase in QS and P

What is the result of a contraction in supply

A decrease in QS and P

What is joint supply and how can it impact market supply

Production of one good automatically leads to another, production of beef leads to leather

If price of beef rises then farmers kill more cows which leads to more leather

What is competitive supply and how can it impact market supply

Production of one good prevents supply of another

If price of beef rises then farmers kill cows which means they can't produce milk, which causes decrease in supply of milk

Give me 5 conditions of supply

Cost of production

Weather

Technology

Price of other goods

Government legislation

Why does the supply curve slope upward?

If prices are higher firms will increase production to take advantage of high profits. If prices are lower firms will cut back on unprofitable production.

Define price elasticity of supply

The responsiveness of supply to a change in price

What is the formula for PES

%change in quantity supplied/%change in price

What is PES=1

Unitary elastic, quantity supply changes by the same as percentage as price

What is it when PES is bigger than 1

Relatively elastic, QS changes by larger percentage than price so supply is relatively responsive to price

What is it when PES is less than 1

Relatively inelastic, QS changes by a smaller percentage than price, so supply is relatively unresponsive to price

What is perfectly elastic PES

PES=infinity

What is perfectly inelastic PES

PES=0

Give me 3 factors affecting PES

Stocks (if stockpile of goods is available then when price rises they may just use the stockpile)

Working below full capacity

Availability of factors of production (labour may need training so can't be insta increased, number of doctors can't instantly increase)

Define short run

Short Run: The short run refers to a period during which some factors of production, such as plant capacity or labor, are fixed and cannot be adjusted. Supply may be less elastic in the short run.

Define long run

a period during which all factors of production can be adjusted. Firms can expand or contract production capacity. Supply can be more elastic in the long run.

Why is the short run significant for elasticity of supply

In the short run, supply may be less responsive to price changes due to limited flexibility in adjusting production levels.

Why is the long run significant for elasticity of supply

In the long run, firms have more options to adjust production capacity, making supply more responsive to price changes.

Define market clearing price

Where Demand = Supply ie. The equilibrium point all goods supplied to the market have been cleared (bought).

Draw an excess demand graph and explain it

Suppliers are willing to supply QS but consumers demand QD, which results in excess demand as shown by shaded area.

What happens as a result of a shortage in the market due to the mechanism of excess demand

Firms know they can charge a higher price for their goods, so this will cause an extension in supply and contraction in demand back to the point of equilibrium

Draw an excess supply diagram and explain it

At P2 firms are willing to supply at QS but consumers demand QD, meaning excess supply and a fall in price as firms have unsold goods so will put on sales

What is the price mechanism

In a free market economy the price mechanism allocates resources

How is price determined in the price mechanism

Price is determined by the interactions of demand and supply, which also determines how much is bought and sold.

What is the invisible hand

The idea that people pursuing their own self-interest actually benefit the public at large

Individuals and firms acting in their own self interest guided by the invisible hand of the market will produce and consume goods and services in the most economically efficient way possible leading to the optimal allocation of scarce resources and greatest overall prosperity

What is the rationing function in the price mechanism

When a good is scarce, its price rises.

This rations the good — meaning only those willing and able to pay the higher price can buy it.

As a result, limited resources are spread out to those who value them most.

What is the signalling function in the price mechanism

PM acts as a signal where resources should be used

When p rises producers move resources into manufacturing that good, ie. change in price indicates that market conditions have changed.

What is the incentive function in the price mechanism

Incentive to work hard, buyers realise more money means they can buy more products.

Suppliers realise that if they produce more of a good they will make more money.

Name 3 functions within the price mechanism

Signalling

Incentive

Rationing

Give an example of the rationing function

Covid disrupted supply chains, less imports means fewer goods in supermarkets, demand for food is high but supply is low, price of food rises to ration off excess demand so people who value food the highest get it

Give an example of the incentive function

Due to high house prices in London this provides an incentive for firms to keep building more houses

Define consumer surplus

The difference between the price the consumer is willing to pay and the price they actually pay

What is consumer surplus set by

Price mechanism

How do you show consumer surplus on a graph

Difference between demand curve and price curve

Define producer surplus

The difference between the price the supplier is willing to produce their product at and the price they actually produce at, set by the price mechanism

How do you show producer surplus on a graph

Difference between supply curve and price

What does consumer surplus show

Welfare gained by consumers for buying a good

What does producer surplus show

The economic gain for producers by selling the good

how does demand and supply impact consumer and producer surplus

decrease in demand leads to a fall in producer and consumer surplus

Increase in demand leads to an increase in consumer and producer surplus

supply is the same

how do elasticities impact consumer suprlus

perfectly elastic demand means there is no consumer surplus

perfectly inelastic demand means that consumer surplus is infinite

what is an indirect tax

tax on spending

what are the 2 types of indirect tax

AD valorem (tax increases in proportion to the value of the good. VAT)

specific tax (an amount is added to the price, increases with quantity. Petrol tax 10p a litre)

what is the incidence of tax

The tax burden on the taxpayer