Edexcel A-Level Economics A - How Markets Work

Flashcards covering key definitions, elasticity formulas, market equilibrium dynamics, price mechanism functions, surplus concepts, taxes, subsidies, and behavioral consumer economic concepts from the Edexcel A-Level Economics A Unit 1.2 transcript.

'Rational' in Classical Economic Theory

Economic agents are able to consider the outcome of their choices and recognise the net benefits of each one, selecting the choice with the highest benefits.

Rational Consumer Assumption

The assumption that consumers act rationally by maximising their utility.

Rational Producer Assumption

The assumption that producers act rationally by selling goods/services in a way that maximises their profits.

Rational Worker Assumption

The assumption that workers act rationally by balancing welfare at work with consideration of both pay and benefits.

Rational Government Assumption

The assumption that governments act rationally by placing the interests of the people they serve first in order to maximise public welfare.

Demand

The amount of a good/service that a consumer is willing and able to purchase at a given price in a given time period.

Effective Demand

Demand where a consumer is both willing and able (can afford) to purchase a good or service.

Demand Curve

A graphical representation of the price and quantity demanded (QD) by consumers, simplified by economists into straight lines for analysis.

Contraction in Quantity Demanded (QD)

A movement up and along the demand curve caused by an increase in price (ceteris paribus), resulting in a fall in QD.

Extension in Quantity Demanded (QD)

A movement down and along the demand curve caused by a decrease in price (ceteris paribus), resulting in a rise in QD.

Law of Demand

The fundamental relationship stating that there is an inverse relationship between price and quantity demanded (QD).

Conditions of Demand

Factors other than price that change the demand for a good/service, causing a shift in the entire demand curve.

Real Income

Determines how many goods/services can be enjoyed by consumers; it has a direct relationship with demand for normal goods.

Substitute Goods

Goods in competitive demand where an increase in the price of Good A leads to an increase in demand (rightward shift) for Good B.

Complementary Goods

Goods in joint demand where an increase in the price of Good A leads to a decrease in demand (leftward shift) for Good B.

Marginal Utility

The extra utility (satisfaction) gained from the consumption of an additional unit of a product.

Total Utility

The overall satisfaction gained from consuming a given number of units, calculated by adding together the marginal utility of each unit consumed.

Law of Diminishing Marginal Utility

States that as additional units of a product are consumed, the utility gained from the next unit is lower than the utility gained from the previous unit.

Price Elasticity of Demand (PED)

Reveals how responsive the change in quantity demanded is to a change in price.

Formula for Price Elasticity of Demand (PED)

$$\text{PED} = \frac{\%\Delta \text{ in QD}}{\%\Delta \text{ in P}}$$

Formula for Percentage Change

$$\%\text{Change} = \frac{\text{new value} - \text{old value}}{\text{old value}} \times 100$$

Perfectly Price Inelastic Demand

A PED value of $0$, where quantity demanded is completely unresponsive to a change in price.

Relatively Price Inelastic Demand

A PED value between $0$ and $1$, where the percentage change in QD is less than proportional to the percentage change in price.

Unitary Elasticity of Demand

A PED value of $1$, where the percentage change in QD is exactly equal to the percentage change in price.

Relatively Price Elastic Demand

A PED value between $1$ and $\infty$, where the percentage change in QD is more than proportional to the percentage change in price.

Perfectly Price Elastic Demand

A PED value of $\infty$, where quantity demanded will fall to zero with any percentage change in price.

Determinants of PED

Factors that influence PED: availability of substitutes, addictiveness of the product, price as a proportion of income, and the time period.

Income Elasticity of Demand (YED)

Reveals how responsive the change in quantity demanded is to a change in income.

Formula for Income Elasticity of Demand (YED)

$$\text{YED} = \frac{\%\Delta \text{ in QD}}{\%\Delta \text{ in Y}}$$

Normal Necessity Good

A good with a YED value between $0$ and $1$, meaning demand increases proportionately less when income increases.

Normal Luxury Good

A good with a YED value greater than $1$, meaning demand increases proportionately more when income increases.

Inferior Good

A good with a negative YED value ($\text{YED} < 0$), meaning demand decreases when income increases.

Cross Price Elasticity of Demand (XED)

Reveals how responsive the change in quantity demanded for good A is to a change in the price of good B.

Formula for Cross Price Elasticity of Demand (XED)

$$\text{XED} = \frac{\%\Delta \text{ in QD}_A}{\%\Delta \text{ in P}_B}$$

Complementary Goods (XED)

Products with a negative XED value ($\text{XED} < 0$); a higher negative value indicates a stronger complementary relationship.

Substitute Goods (XED)

Products with a positive XED value ($\text{XED} > 0$); a higher positive value indicates a stronger substitute relationship.

Unrelated Goods (XED)

Products with an XED value equal to $0$ ($\text{XED} = 0$), indicating no relationship between the two goods.

Revenue Rule of PED

States that to maximise revenue, firms should increase the price of products that are price inelastic in demand and decrease prices on products that are price elastic in demand.

Supply

The amount of a good/service that a producer is willing and able to supply at a given price in a given time period.

Supply Curve

A graphical representation of price and quantity supplied, sloping upward due to the positive relationship between price and quantity supplied.

Extension in Quantity Supplied (QS)

A movement up and along the supply curve caused by an increase in price.

Contraction in Quantity Supplied (QS)

A movement down and along the supply curve caused by a decrease in price.

Conditions of Supply

Factors that change the supply of a good/service irrespective of price level, shifting the entire supply curve left or right.

Price Elasticity of Supply (PES)

Reveals how responsive the change in quantity supplied is to a change in price.

Formula for Price Elasticity of Supply (PES)

$$\text{PES} = \frac{\%\Delta \text{ in QS}}{\%\Delta \text{ in P}}$$

Perfectly Price Inelastic Supply

A PES value of $0$, where quantity supplied is completely unresponsive to a change in price, resulting in a vertical supply curve.

Relatively Price Inelastic Supply

A PES value between $0$ and $1$, where the percentage change in QS is less than proportional to the percentage change in price.

Relatively Price Elastic Supply

A PES value between $1$ and $\infty$, where the percentage change in QS is more than proportional to the percentage change in price.

Perfectly Price Elastic Supply

A PES value of $\infty$, where quantity supplied falls to zero with any price decrease, but supply is unlimited at a particular price.

Determinants of PES

Factors influencing PES: mobility of factors of production, availability of raw materials, ability to store goods, spare capacity, and time period.

Factors of Production

The four resources used in production: land, capital, labour, and entrepreneurship.

Land (Factor of Production)

Non-man-made resources used in production, such as coal.

Capital (Factor of Production)

Man-made resources used in production, such as an MRI machine or fertiliser.

Labour (Factor of Production)

Workers involved in the production process.

Entrepreneurship (Factor of Production)

The individual(s) involved in organising the other factors of production.

Short-run Period of Production

Any period of time in which at least one factor of production is fixed and acts as a limiting factor.

Long-run Period of Production

Any period of time in which all factors of production are variable (also called the planning stage).

Market

Any physical or virtual place that brings buyers and sellers together to trade at an agreed price.

Consumer Sovereignty

The power of buyers to agree to a price by purchasing, or exercise choice not to purchase if they do not agree on the price.

Equilibrium

Occurs in a market when demand equals supply ($\text{Demand} = \text{Supply}$).

Market Clearing Price

The equilibrium price at which sellers clear their stock at an acceptable rate and buyer utility is maximised.

Market Disequilibrium

Occurs whenever there is excess demand or excess supply in a market.

Excess Demand

Occurs when demand is greater than supply ($\text{Demand} > \text{Supply}$) due to low prices or unexpectedly high demand.

Market Response to Excess Demand

Sellers gradually raise prices, causing a contraction in QD and an extension in QS until market equilibrium is reached.

Excess Supply

Occurs when supply is greater than demand ($\text{Supply} > \text{Demand}$) due to high prices or an unexpected fall in demand.

Market Response to Excess Supply

Sellers gradually lower prices, causing a contraction in QS and an extension in QD until market equilibrium is reached.

Dynamic Markets

Real-world markets that are constantly changing, causing market equilibrium to shift over time.

Price Mechanism

The interaction of demand and supply in a free market that determines prices to allocate scarce resources between competing wants/needs.

Rationing Function of Price Mechanism

Prices allocate scarce resources so that as resources become scarcer and price rises, only those who can afford them receive them.

Signalling Function of Price Mechanism

Prices provide information to producers and consumers about where resources are required or not required.

Incentive Function of Price Mechanism

Rising prices incentivise producers to reallocate resources to a market to maximise profits, while falling prices encourage reallocation elsewhere.

The Invisible Hand

Adam Smith's phrase referring to the three functions (rationing, signalling, incentive) of the price mechanism.

Consumer Surplus

The difference between the amount the consumer is willing to pay for a product and the price they have actually paid.

Producer Surplus

The difference between the amount that the producer is willing to sell a product for and the price they actually receive.

Social Surplus (Community Surplus)

The sum of consumer surplus and producer surplus ($\text{Consumer Surplus} + \text{Producer Surplus}$), which is maximised at market equilibrium.

Indirect Tax

A tax levied on the consumption of goods/services, paid by consumers through purchases and collected via producers.

Specific Tax

A fixed amount of indirect tax per unit of output, such as $\$3.25$ per packet of cigarettes.

Ad Valorem Tax

An indirect tax that is calculated as a percentage of the purchase price, such as Value Added Tax (VAT).

Consumer Tax Incidence

The portion of an indirect tax paid by consumers through a higher market price, taken from consumer surplus.

Producer Tax Incidence

The portion of an indirect tax absorbed by producers through reduced net price per unit, taken from producer surplus.

Tax Incidence on Price Inelastic Products

Producers pass on a much higher proportion of the indirect tax to consumers because QD falls less than proportionally to price rises.

Tax Incidence on Price Elastic Products

Producers pass on a much smaller proportion of the indirect tax to consumers and pay the balance themselves because QD falls significantly.

Producer Subsidy

A per unit amount of money given to a firm by the government to increase production or provision of a merit good.

Consumer Subsidy Incidence

The share of a subsidy that benefits consumers by lowering the market price they pay.

Producer Subsidy Incidence

The share of a subsidy retained by producers, increasing the total price/revenue received per unit sold.

Total Government Cost of Subsidy

Calculated as $(\text{Subsidy per unit}) \times (\text{New Quantity Purchased})$, equal to consumer incidence plus producer incidence.

Herding Behaviour

A phenomenon where consumers follow the buying patterns of others due to peer pressure, leading to non-rational choices.

Promotional Influence on Consumers

Marketing methods like advertising, celebrity endorsements, and influencer culture that generate emotional rather than rational purchasing choices.

Neuro Branding

The use of advanced behavioural psychology techniques by producers to influence consumer choices.

Rule of Thumb

A mental shortcut used by consumers to make quick estimations of benefits without gathering extensive information.

Consumer Inertia

The tendency for consumers to repeat past choices habitually out of convenience, even when superior or cheaper alternatives exist.

Impulse Purchasing

Unplanned buying encouraged by sellers who exploit habitual patterns, such as placing chewing gum at checkout tills.

Consumer Weakness at Computation

The inability or lack of time for consumers to compare relative prices and calculate net benefits when presented with wide ranges of choice.

Product Placement Rationale

Arranging items at eye level to make computation easy for products sellers want to sell, while placing higher-benefit options high or low.

Demerit Goods Tax Rationale

Indirect taxes applied by governments to demerit goods to reduce quantity demanded and raise revenue for public provision.

Shortage

A market condition where quantity demanded exceeds quantity supplied ($\text{QD} > \text{QS}$) due to excess demand.

Surplus

A market condition where quantity supplied exceeds quantity demanded ($\text{QS} > \text{QD}$) due to excess supply.

Supply Shock

An unexpected event that causes a sudden decrease or disruption in market supply, such as the halting of Ukrainian wheat exports during war.

Chains of Reasoning

A step-by-step logical sequence explaining how a change in market conditions creates disequilibrium and leads to a new equilibrium.

Effect of Price Increases on Total Revenue for Elastic Goods

Total revenue falls because the percentage reduction in quantity demanded is greater than the percentage increase in price.