1.2 - how markets work (micro)

What do consumers, firms and government aim to maximise?

• Consumers - utility

• Firms - profit

• Governments - social welfare

What is demand?

The ability and willingness to buy a particular good at a given price and at a given moment in time

What is a movement along the demand curve?

A change in the quantity demanded of a good or service caused or influenced by a change in price ceteris paribus

What factors cause shifts in demand?

• Population

• Income

• Related goods price

• Advertising

• Taste/fashion

• Expectations

• Seasons

Why does the demand curve slope downward?

Law of diminishing marginal utility - the satisfaction derived from the consumption of an additional unit of a good will decrease as more of a good is consumed

What is the equation for price elasticity of demand (PED)?

%ΔQD/%ΔP

What does the PED represent?

The responsiveness of demand to a change in the price of the good

What are the numerical values of PED?

• Unitary - PED = 1

• Elastic - PED < 1

• Inelastic - PED > 1

• Perfectly elastic - PED = infinity

• Perfectly inelastic - PED = 0

What factors influence PED?

• Availability of substitutes

• Time

• Necessity

• % of total expenditure

• Addictive

What is the significance of PED?

• Determines effect of imposition of indirect taxes and subsidies

• The more elastic the demand curve, the lower the incidence of tax on the consumer

• When demand is inelastic, the tax will be mainly passed onto the consumer - tax will be ineffective in reducing output (but higher T revenue for G)

What is the relationship between PED and revenue?

• Elastic - decrease in price leads to an increase in revenue (vice versa)

• Inelastic - decrease in price leads to a decrease in revenue (vice versa)

• Unitary - change in price does not affect total revenue

What is the equation for income elasticity of demand?

%ΔQD/%ΔY

What does YED measure?

The responsiveness of demand to a change in income

What are the numerical values of YED?

• Inferior - YED < 0

• Normal - YED > 0

• Luxury - YED > 1

What is the significance of YED?

• Businesses know how their sales will be affected by changes in income

• Impacts types of goods that firms produce

What is the equation for cross elasticity of demand (XED)?

%ΔQD for A/%ΔP for B

What are the numerical values for XED?

• Substitutes - XED > 0

• Complementary - XED < 0

• Unrelated - XED = 0

• Strong - XED > 1

• Weak - XED < 1

What is the significance of XED?

Firms are aware of their competition and those producing complementary goods

What is supply?

The ability and willingness to provide a good or service at a particular price at a given moment in time

What is a movement along the supply curve?

A change in the quantity supplied of a good or service caused or influenced by a change in price ceteris paribus

What conditions shift supply?

• Costs of production

• Price of other goods

• Weather

• Technology

• Goals of the supplier

• Government legislation

• Taxes and subsidies

• Producer cartels

How is price elasticity of supply calculated?

%ΔQS/%ΔP

What does PES measure?

The responsiveness of supply to a change in the price of the good/service

What are the numerical values of PES?

• Unitary elastic - PES = 1

• Elastic - PES > 1

• Inelastic - PES < 1

• Perfectly elastic - PES = infinity

• Perfectly inelastic -PES = 0
  

What factors affect PES?

• Time

• Stocks

• Working below full capacity

• Availability of factors of production

• Ease of entry into market

• Availability of substitutes

What does the equilibrium point refer to?

The point at which there are no more forces bringing about change

What are the 3 functions of the price mechanism?

• Rationing

• Signalling

• Incentive

What does the rationing function do?

Limited resources rationed and allocated to the people who can afford them and those who value them most highly

What does the signalling function do?

Change in price indicates to suppliers and consumers that market conditions have changed so they should change the quantity bought and sold

What does the incentive function do?

Acts as an incentive to work hard. More money for consumers = more products. More goods produced by suppliers = more money

What is consumer surplus?

The difference between the price the consumer is willing to pay and the price they actually pay, set by the price mechanism

Where is consumer surplus located?

Above the price point and below the demand curve

What is 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

Where is producer surplus located?

Below the price point and above the supply curve

How is community surplus calculated?

Producer surplus + consumer surplus = community surplus

What is an indirect tax?

A tax on expenditure where the person who is charged the tax is not responsible for paying the sum to the government

What are the different types of tax?

• Ad valorem - percentage, proportion to cost of good

• Specific - added to price, increases with amount bought

What is the incidence of tax?

Tax burden on taxpayer

Who will pay the tax if PED is perfectly elastic or PES is perfectly inelastic?

Supplier

Who will pay the tax if PED is perfectly inelastic or PES is perfectly elastic?

Consumer

What is a subsidy?

A grant given by the government and is the opposite of a tax, an extra payment to encourage production/consumption of a good/service

What are the alternative views of consumer behaviour?

• Influences of other people

• Influence of habitual behaviour

• Consumer weakness at computation