ec-1.1 the market system

basic economic problem

scarcity: the allocation of finite resources between infinite needs and wants, leading to the need to make choices

basic economic questions

what/how/for whom to produce?

basic economic problem

scarcity: the allocation of finite resources between infinite needs and wants, leading to the need to make choices

basic economic questions

what/how/for whom to produce?

define needs

basic requirements for human survival

define wants

desires that can be satisfied by consuming a good or service

define opportunity cost

the loss of potential gain from the next best alternative(s) when one alternative is chosen.

(effect of opportunity cost) consumers

need to decide how to spend money efficiently

(effect of opportunity cost) producers

choose what to invest in to expand business / choose what to produce to gain the most profit

(effect of opportunity cost) government

choose what to do for society's benefit

production possibilities curve (PPC)

a curve that shows the different combinations of 2 goods that can be produced if all resources are used

(PPC) production possibility frontier

a curve that shows variations in production

(PPC) maximum productive potential / fully employed resources

point along the curve

(PPC) unobtainable

point outside the curve

(PPC) possible but not fully employing resources

point inside the curve

(PPC) positive growth

shift to the right

(PPC) negative growth

shift to the left

(PPC) causes of positive growth

new technology / improved efficiency / education or training / new resources

(PPC) causes of negative growth

war or conflict / less resources / loss of workers / weather

define economic assumptions

assumptions that economists make about individuals, markets, or businesses

(economic assumptions) consumers

aim to maximise benefits

(economic assumptions) businesses

aim to maximise profit

(economic assumptions) why consumers may not maximise benefits

miscalculations / bad habits / copy others' behaviour

(economic assumptions) why businesses may not maximise profit

aim to maximise sales and revenue / prioritise caring for customers / charitable work

define demand

the quantities of a good or service that consumers are willing and able to buy at different prices

law of demand

inverse relationship between price and quantity demanded - when prices increase, quantity demanded will decrease and vice versa

(demand curve) movement

movement: move along the curve

caused by: change in price

demand curve

a curve that shows the relationship between the price of a product and the quantity of the product demanded

(demand curve) shift

shift: curve shifts completely to the right/left

caused by: factors affecting demand

factors affecting demand

advertising / income / income tax / fashion and tastes / substitute goods / complementary goods / demographic changes

(factors affecting demand) advertising

when a product is advertised more, demand will increase

(factors affecting demand) income

when disposable income rises, demand will increase

(factors affecting demand) income tax

when income tax increases, demand will decrease

(factors affecting demand) fashion and tastes

when trends of a product are present, demand will increase

(factors affecting demand) substitute goods

when the price of a substitute increases, demand will increase

(factors affecting demand) complementary goods

when the price of a complementary good increases, demand will decrease

(factors affecting demand) demographic changes

when the population increases, demand for a product increases

define substitute goods

goods bought as an alternative to another

define complementary goods

goods purchased together because they are consumed together

define supply

the quantities of a good or service that producers are willing and able to supply at different prices

law of supply

direct relationship between price and quantity supplied - when prices increase, quantity demanded will increase

supply curve

a curve that shows the relationship between the price of a product and the quantity of the product supplied

(supply curve) movement

movement: move along curve

caused by: change in price

(supply curve) shift

shift: curve shifts completely to the right/left

caused by: factors affecting supply

factors affecting supply

costs of production / changes in technology / indirect taxes / subsidies / natural factors / productivity / competition

(factors affecting supply) costs of production

when cost of production increases, supply decreases

(factors affecting supply) changes in technology

when technology improves, supply increases

(factors affecting supply) indirect taxes

when indirect taxes increase, supply decreases

(factors affecting supply) subsidies

when subsidies increase, supply increases

(factors affecting supply) natural factors

when natural factors (disasters/weather) occurs, supply decreases

(factors affecting supply) productivity

when productivity increases, supply increaaes

(factors affecting supply) competition

when competition increases, supply decreases

define market equilibrium

occurs at a price where quantity demanded equals its quantity supplied; the market is 'cleared' of shortages or surpluses

define equilibrium price/market clearing price

price at which quantity demanded equals quantity supplied

define equilibrium quantity

quantity at which quantity demanded equals quantity supplied

define excess supply (surplus)

when quantity supplied is greater than quantity demanded

define excess demand (shortage)

when quantity demanded is greater than quantity supplied

removing excess demand using market forces

producers can raise prices / employ more resources and increase supply

define notional demand

speculative demand not always backed up by the ability to pay

removing excess supply using market forces

producers can lower prices / store supply until later date

define effective demand

the actual demand that exists in a market; when a consumer is both willing and able to buy a product

define aggregate demand

total demand in the economy including consumption, investment, government expenditure and exports minus imports

define aggregate supply

the total amount of goods and services economies produce at a given price level in a given time period.

define elasticity

the responsiveness of an economic variable as a result of a change in another variable

define price elasticity of demand (PED)

a measure of how sensitive the quantity demanded is to its price

calculate PED

%change in quantity demanded / %change in price

(%∆ Qd/%∆ P)

define elastic demand

when a change in price leads to a proportionally greater change in quantity demanded

define inelastic demand

when a change in price leads to a proportionally smaller change in quantity demanded

(numerical value of PED) perfect price inelasticity

PED = 0

(numerical value of PED) price inelasticity

PED < 1

(numerical value of PED) unitary price elasticity

PED = 1

(numerical value of PED) price elasticity

PED > 1

(numerical value of PED) perfect price elasticity

PED = ∞ (infinity)

factors affecting PED

substitutes / necessity / % of income spent on a good or service / time

(factors affecting PED) substitutes

goods with many substitutes tend to have elastic demand because consumers can easily change products

(factors affecting PED) necessity

goods considered essential by consumers will have inelastic demand

(factors affecting PED) % of income spent on good or service

if a large proportion of one's income is spent on a good, it is believed to have elastic demand

(factors affecting PED) time

short term: goods are inelastic

long term: goods are elastic

(determine PED through price and TR) price elastic demand

when price decreases, TR increases

(determine PED through price and TR) price inelastic demand

when price increases, TR increases

(determine PED through price and TR) unitary elastic demand

when price decreases, TR does not change

define price elasticity of supply (PES)

a measure of how sensitive the quantity supplied is to a change in price

calculate PES

%change in quantity supplied / %change in price

(%∆ Qs/%∆ P)

define elastic supply

when a change in price leads to a proportionally greater change in quantity supplied

define inelastic supply

when a change in price leads to a proportionally smaller change in quantity supplied

(numerical values of PES) perfect price inelasticity

PES = 0

(numerical values of PES) price inelasticity

PES < 1

(numerical values of PES) unitary price elasticity

PES = 1

(numerical values of PES) price elasticity

PES > 1

(numerical values of PES) perfect price elasticity

PES = ∞ (infinity)

factors affecting PES

FoP / availability of stocks / spare capacity / time

(factors affecting PES) FoP

if producers have easy access to the FoP, supply will be elastic

(factors affecting PES) availability of stocks

when producers can hold stocks of goods, supply will be elastic

(factors affecting PES) spare capacity

if producers have spare capacity, supply will be elastic

(factors affecting PES) time

if producers can react faster to price changes in the market, supply will likely be elastic

PES for manufactured and primary products

- goods that can be produced quickly are likely to have elastic supply

- goods that aren't able to react quickly are likely to have inelastic supply

define factor mobility

a firm's ability to substitute factors of production in the production process

define inventory

stocks of unused raw materials, work-in-progress goods, and/or finished goods

define capacity

the spare available resources a firm has but does not utilize

define income elasticity of demand (YED)

a measure of how sensitive the quantity demanded is to the change in the real income of consumers

calculate YED

%change in quantity demanded / %change in income

(%∆ Qd/%∆ i)

define luxury goods

goods/services used to satisfy wants and indulgences; goods that increase in demand as income increases