Economics Unit2: Micro ch 3,4,5,6

Chapter 3,4,5,6

Demand

is the quantity of a good or service that customers are willing and able to buy at a given price, in a particular period of time.

The law of demand

the quantity demanded for a good or service falls as its price rises, ceteris paribus. Likewise, the quantity demanded rises as prices fall, ceteris paribus.

The income effect

as the price of a product falls, the real income of consumers rises, ceteris paribus. This means consumers are able to buy more products at lower prices.

The substitution effect

as the price of a good or service falls, more consumers are able to pay, so they are more likely to buy the product, that is, substitute it for alternative products that consumers might have previously bought.

The law of diminishing marginal utility

as people consume more of a particular good or service, the utility (satisfaction) gained from the marginal unit of consumption declines. Hence, consumers will purchase more of the same product only at a lower price.

Non-price determinants of demand

Habits, fashions and tastes, Income, Substitutes and complements, Advertising, Government policies, Economy (whether the country is in a recession or boom), Future price expectations

Movements along the demand curve

Caused by increase/decrease in price - contraction or expansion

Shifts of the curve

Caused by the non-price determinants

The demand curve

shows the inverse relationship between price and quantity demanded

Supply

refers to the quantity of goods or services that firms are willing and able to sell at any given price, per time period.

The law of supply

states that there is a positive relationship between the quantity supplied of a product and its price, ceteris paribus. Reasons - more firms enter if there are higher prices, existing firms earn higher profit margins

The law of diminishing marginal returns (DMR)

occurs when employing additional variable factors of production (such as labour) causes the marginal return (additional output) to eventually decline. The diminishing marginal returns from each successive worker, for example, lead to higher production costs, meaning that firms require a higher price to create incentives to produce more output.

Increasing marginal costs

occur when the additional costs of each extra unit of output start to rise (due to diminishing marginal returns). Hence, firms are only willing and able to increase production if they receive a higher price for the additional units of output.

Marginal cost

the cost of producing an additional unit of output. It is calculated as the change in total costs divided by the change in total output MC = TC/Q.

The supply curve

an upward sloping linear line, due to the law of supply.

Non-price determinants of supply

Changes in costs of factors of production (FOPs), Prices of related goods (in the cases of joint and competitive supply), Indirect taxes and subsidies, Future price expectations, Changes in technology, Number of firms

Competitive market equilibrium

Market equilibrium is the condition that holds when a market is cleared of any shortage or surplus.

Market disequilibrium

occurs when the quantity demanded for a product is not equal to the quantity supplied. This is inefficient due to shortages (excess demand) or surpluses

Excess supply

occurs when the price is set above the equilibrium, that is, a surplus exists

Excess demand

occurs when the price is set below the equilibrium, that is, a shortage exists

Functions of the price mechanism

the price mechanism refers to the means by which the market forces of demand and supply determine the allocation of an economy's resources between competing uses. (Resource allocation (signalling and incentives functions) and Rationing (of scarce resources))

The rationing function

deters some consumers from buying a product or resource through high prices, rationing (preserving) it. It serves to ration scarce resources when the demand for a product exceeds its supply.

The signalling function and incentives function (resource allocation)

result in the reallocation of resources if prices change due to changes that affect the demand for or supply of a product. Info to producers on where resources are required, providing motivation to change behaviour to maximise benefits

Consumer surplus

benefits to buyers who are able to purchase a product for less than they are willing to do so. It is the difference between the price that customer actually pays and the price they were willing and able to pay

Producer surplus

difference between the price that firms actually receive and the price they were willing and able to supply at

Community surplus (or social surplus)

sum of consumer and producer surplus at a given market price and output. It represents the total benefit available to society from an economic activity.

Allocative efficiency

In a competitive market economy, allocative efficiency occurs at the market equilibrium because both consumer and producer surplus are maximized at this point. Resources are allocated in an optimal way such that changing the price would result in consumers or producers being worse off.

Rational consumer choice

refers to the decision-making process based on people making choices that result in the optimal or maximum level of benefits or utility for an individual.

Assumptions:

Consumer rationality assumes that individuals use rational methods to make sensible choices, such as choosing the products that offer the best value for money. Utility maximization assumes that people decide on the option that gives them the highest level of utility (satisfaction). Perfect information assumes that decision makers have equal and easy access to information in order to make well-informed choices or decisions.