Topic 3

Pure market economy

all decisions made by individuals and firms, which interact through free markets, and little role for the government

Mixed economy

most decisions are made by individuals and firms, which interact through free markets, with some role for government

Centrally planned economy

all decisions made by the government, with no role for markets or individual choice.

Consumer sovereingty

consumers collectively determine the answer to the question of what to produce and how much

Five characteristics of a market economy

use of markets and price mechanism to solve the economic problem

private property

consumer sovereignty

freedom of enterprise

competition

Ways in which mixed economies differ

importance of social welfare payments

provision and funding of healthcare

provision and funding of education

degree of regulation

provision of goods + services

Three reasons why the government intervene in the market economy

resource allocation

income distribution

economic stability

resource allocation

to provide important goods and services that would not otherwise be provided by the private sector, to restrict production of harmful goods.

income distribution

to create a fairer society and look after people

economic stability

to smooth out sharp fluctuations in the economic cycle

to ensure stability in the economy and the financial systems.

What is price elasticity?

the sensitivity of the quantity demanded to a change in its price

What is elastic demand?

In which there is a strong response to a change in price

What is unit elastic demand?

In which there is a proportionate response to a change in price

What is inelastic demand?

In which there is a weak response to a change in price

What is the importance of price elasticity for businesses?

to decide their optimal pricing strategy.

What is the importance of price elasticity for the government?

when pricing goods and services it provides to the community. Also predicts the effect of changes in the level of any indirect taxes

What is the general method for measuring price elasticity?

% change in quantity demanded/ % change in price

What is the total outlay method when measuring price elasticity?

total outlay at any given time = quantity demanded x price

What is price elasticity of supply?

it refers to the responsiveness of the quantity of supplied to small charges in the price of the good or service

How to find the price elasticity of supply equation?

% change in quantity supplied / % change in price

What is perfctly elastic supply?

able to produce as much as needed at any given price, infinite amount of quantity

What is perfectly inelastic supply?

Not changing the quantity despite price, regardless of price they will only supply a single quantity

How do time lags affect price elasticity of supply?

THe larger the production times required for a given good, the more inelastic is its supply

How does the ability to hold/access stock affect price elasticity of supply?

the greater the inventories held of a given good, the more elastic its supply

How does excess capacity affect price elasticity of supply?

the more excess capacity a firm has the more elastic is the supply of the good.

What is demand?

the quantity of a good or service consumers are willing to buy at a particular price at a particular point in time

What is the law of demand?

The inverse relationship between price and quantity demanded, as prices decrease demand will increase

What is the demand curve?

a graph reflecting the price consumers are willing to pay and the quantity consumers are willing to buy

What do movements along the demand curve mean?

Change in quantity demanded due to a change in the price of the product only

What does a shift of the demand curve mean?

Change in demand from factors other than price

Movements along the demand curve are known as?

Expansions or contractions

What is supply?

The quantity of goods and services producers are willing to make at a particular price at a particular point in time

What is the law of supply?

any increase in price will result in an increase in supply.

Why is the law of supply is the case?

it incentivises businesses to produce more

Why is the supply curve sloping upwards?

because existing producers will find it profitable to raise their production, and new producers will be attracted to the market

A movement on the supply curve is caused by?

price only

A shift in the supply curve is caused by?

a factor other than price changed

Price of other goods and services

If one product becomes more profitable then firms are less willing to supply the previous good, and will start producing the more profitable good or service

Expected future prices

If the supplier believes the price will rise in the future, they are likely to increase

production to meet this expected increase in demand.

State of technology

Improvements in technology lower production costs and allow more firms to supply

more goods at a given price.

Price of factors of production

Any fall in the cost of factors of production would allow firms to supply more of a particular good, whereas any rise in factor costs would often lead to a decrease in supply

Quanitity of the good available

The actual quantity of the good available effects supply, the less of a good the more it costs

Climatic conditions

effects agricultural products

What is a market?

A market is a situation where the buyers and sellers have the opportunity to exchange goods and services for money

What is Market equilibrium?

Market equilibrium is a situation where price + output are determined through the interaction of demand and supply. Therefore there is no excess demand or supply

What is the Price Mechanism?

The price mechanism refers to the interplay/ process of the market forces of demand and supply in determining equilibrium prices and quantities

What can the process of the price mechanism also be referred to as?

The ‘invisible hand’

The price mechanism operates in both?

Product and factor markets

In a graph market equilibrium is at the point where?

the demand curve intersects the supply curve

What is the unsatisfactory outcomes with market equilibrium about price?

The market equilibrium price for goods and services may be considered too high or too low.

What is the unsatisfactory outcomes with market equilibrium about quantity?

The equilibrium quantity may be too high or too low, or not produced at all

What is market failure?

Market failure occurs when the price mechanism takes into account private benefits and costs to consumers and producers, but does not take into consideration indirect costs/social costs borne by the whole of society

What are two ways the government can intervene to adress market failure?

Price intervention, and quantity intervention