Economics Mirco Y12

What is marginal revenue?

Change in total revenue as a result of changing the level of output by one unit.

What are fixed costs?

Costs that do not vary with the level of output. Sometimes referred to as sunk costs as firms cannot avoid paying them even if they choose to produce no ouput at all.

What are variable costs?

Change according to level of output produced.

What is marginal cost?

Change in total cost as a result of a firm changing the level of ouput by one unit.

What is the law of diminishing returns?

As the input of a variable factor is increased, the additional output produced by each additional unit of input falls, meaning SRAC increases. Production process is constrained by the fixed factor.

What are internal economies of scale?

A reduction in a firms LRAC as a result of output increasing.

What are the 6 internal economies of scale?

• Purchasing: bulk buying

• Technical: investing in sophisticated tech

• Marketing: advertising

• Managerial: employing specialists who perform roles more efficiently

• Financial: cheaper and easier to raie finance

• Risk-bearing: diversifying, reducing risk

What are internal diseconomies of scale?

An increase in LRAC as a result of a firm increasing level of output.

What are examples of internal diseconomies of scale?

• Co-ordination problems: difficult to run large firm and check on everything

• Slows decision making: numerous management tiers

• Worker productivity decreases: workers feel less important in big firm = less productive

What is the minimum efficient scale?

The lowest level of output at which a firm can produce at the lowest possible cost. Output at this level is productively efficient.

What are external economies of scale?

Reduction in firms LRAC that results from growth of an industry.

What are examples of external economies of scale?

• Skilled labour: moving close to area that needs training

• Ancillary economies: related industried may emerge nearby

• Specialisation: large industry allows firms to specialise in certain sectors of market

• Reputation enhancement: industry becoming more well known

• Improved infrastructure: growth of industry may encourage gov to improve infrastructure that services industry

What are external diseconomies of scale?

Increase in a firms LRAC that results from the growth if an industry.

What is the impact of economies of scale?

• Nature/size of industry: in small business e.o.s are less important

• PED: firms with inelastic PED may make more profit if they restrict output

• Production is relative to MES: near MES = firms wary of increasing output as they may experience d.o.s

• Limited benefits to global advertising: language and cultural barriers

• D.o.s: as output increases = AC increases

• Monopoly supplier: can’t achieve purchasing e.o.s if there is one supplier

• X efficiency: firm may start to slack so AC increases

What is opportunity cost?

The sacrifice of the next best alternative foregone when a choice is made.

What are free goods?

A good with no opportunity cost as there is no scarcity attached to its consumption or production.

E.g. air

What is an economic good?

Having a degree of scarcity, meaning there is an opportunity cost associated with their consumption or production.

What is specialisation?

When individuals, firms or countried concentrate on the production of one product or task.

What is division of labour?

Whereby the production process is broken down into many separate individual tasks.

What is the impact of specialisation on individuals?

• Increased productivity = higher wages = increasing standard of living. More value = more bargaining power as you are professional

• Concentrating on what you are good at = job satisfaction

• More skilled = reduced risk of unemployment as you are more valuable to firm

HOWEVER

• Workers find themselves replaced by capital due to technological advancements = occ. immobility. Skills become obsolete

• Become bored of repeating same task = decreasing productivity/motivation

What is the impact of specialisation on firms?

• Increased rev = higher price = better quality = increased profitability

• Decreased costs as less workers employed for each unit produced = increased profitability. Saving money on training

• Producing more and better quality output = increased market power = outcompete rivals

HOWEVER

• Firms becoming reliant on specialised worker

• Forced to pay skilled workers higher wages

• Specialising in narrow product range = vulnerable to changes in consumer demand

What are the types of demand?

• Joint demand: g&s demanded together, known as complements

• Competitive demand: goods that compete to provide same function, known as substitutes

• Composite demand: good that has multiple uses, e.g. oil

What would cause shifts in the demand curve?

• Income

• Price of substitutes: demand switching if price increases

• Price of complements: increased price = decreased demand

• Consumer preferences

What are inferior goods?

Goods which are consumed because more desirable alternatives cannot be purchased with income avaliable.

What are normal goods?

A rise in income will make it more afforable to buy more of a good so demand will increase.

What is marginal utility?

Additional utility gained from consuming an extra unit of a g&s.

What is the law of diminishing marginal utility?

As the no. of units consumed increases the utility derived from each additional unit of consumption decreases.

What are the types of supply?

• Competitive supply: firms having range of different products, e.g. using land to produce onion or peppers

• Joint supply: producing some goods jointy, e.g. cows producing milk and leather

What cause shifts in supply?

• Cost of production: decreased c.o.p = increased supply

• Indirect tax: increased tax on good = decrease supply

• Subsidies

• Price of related goods

• Globalisation

• Falling wages

• Technological prgress

What is price elasticity of demand?

The responsivenss of the quantity demanded to change in price of product.

% change in QD/% change in price

What is income elasticity of demand?

Responsiveness of quantity demanded to change in income.

% change in QD/% change in income

What is cross elasticity of demand?

Responsiveness of demand for one product in relation to change in price of another.

% change in QD of product A/% change in price of product B

What is the elasticity of PED?

• Elastic: PED > 1

• Inelastic: PED between 0 and 1

• Unit elastic: PED = 1

What are the determinants of PED?

• Availabilty of close substitues: higher no. of subs = higher PED. Stronger subs = higher PED

• Relative expense of product with respect to income: product taking up small prop. of income, doubling price isnt an issue

• Nature of product: necessity goods and addictive goods are inelastic

• Time: SR consumers find it hard to switch income due to inertia

What is the evalution of the determinants of PED?

• Availability of close substitutes: brand loyalty, no. of subs change overtime = inaccurate PED

• Nature of product: what we think is a necessity varies, e.g. having a car

• Time: some people may never change consumer habits due to inertia

How is PED useful?

• Total revenue: informs how to maximise rev by changing price

• Volatility of supply: indicates whether prices are likely elastic or not as a result in change in supply, could pass on higher prices to consumers

• Tax: indicates whether high taxes can be easily passed on to consumers

• Sales discount: showing if sales would be effective

• Price discrimination: inelastic PED for some consumer groups can be charged higher prices

• Trade unions: If they’re aware of inelastic good, can push for higher wages as they know firms can increase price

How is PED not useful?

• Only valid for marginal price changes: inform firm what happens as a result of small change

• Estimate: not fully reliable

• May be outdated

• Ceteris paribus may not hold

What are the determinants of YED?

• Nature of good: depends on income level of country

• Time period: time lag, what is considered necessity will change over time

• Income is not the only factor: take into account quality, advertising etc

• Temporary or permanent: if rise in income is temporary, may not consume more

• Proportionate change in spending: small change in income may not change spending habits

What is the elasticity of YED?

• Normal good: YED > 0

• Inferior good: YED < 0

• Luxury good: YED > 1, elastic

• Necessity good: 0 < YED < 1, inelastic

How is YED useful?

• Diversification: if income inelastic = low growth in profits, firms should diversify to income elastic goods to increase profits

• Whether or not to increase price elasticity of supply: income elastic = invest in capital

• Whether to enter or leave industry: if income expected to rise = signal new firms to enter

How is YED not useful?

• Estimates

• Outdated

• Ceteris paribus may not hold

• Other factors that impact demand and profits

• YED relies on you being able to accurately predict changes in income

What is the elasticity for XED?

• Substitutes: + XED

• Complements: - XED

How is XED useful?

• Strong positive XED: firms aware of pricing, can consider collution, lower XED by advertising

• Strong negative XED: firms consider alliances with complement goods to increase demand

• Weak XED: firms dont need to pay attention to pricing behaviour of those firms

How is XED not useful?

• Outdated

• Estimate

• Only applicable for marginal price changes

• Ceteris paribus may not hold

• Other factors impact firms demand

What is PES?

Responsiveness of quantity supplies to a change in price.

% change in QS/% change in price

What are the determinants of PES?

• Availabiity of f.o.p: spare capacity = avaliable supply is elastic, high unemp = output can increase by increasing no. of workers at firm

• Availabilty of stocks of product: stock allows suppliers to store goods at warehouse

• Time period: overtime supply become more price elastic

What is consumer surplus?

Difference between price consumers are willing to pay for a product and price they actually pay.

What is producer surplus?

Difference between price a producer is willing to accept and what is actually paid for the product.

What is market failure?

Free market mechanism does not lead to an optimal allocation of resources.

Where is the free market equilibrium?

MPB = MPC

What are externalities?

Those not directly involved in a particular decision are affected by actions of others

Where is the socially optimum level of output?

MSB = MSC

What is a merit good?

Consumption of this good is more beneficial to individuals than they realise.

What is a demerit good?

Consumption of this good is less beneficial to individuals than they realise.

What is asymmetric information?

A situation in which information is not shared equally between two parties carrying out a transaction.

What is moral hazard?

When the party with superior info alters their behaviour in such a way that benefits themselves while imposing costs on those with inferior info.

What is the evaluation of merit/demerit goods?

• Value judgement: sometimes not clear if demerit good or not, e.g. contraception

• Strength of merit/demerit good

• Information failure is reducing

• Which group is consuming it: sweets are more harmful to people with diabetes

• Not worse than govt. failure

What are the positive impacts of tax?

• Solves market failure

• Encourages consumption of less harmful substitues

• Elastic demand could mean consumption falls a lot

• Market based sollution: keeps free market allocating resources but internalises externality

• Raises revenue for government

What are the negative impacts of tax?

• May be ineffective in reducing consumption

• Information provision may be better

• Consumption of substitutes could still be harmful to consumer

• Formation of shadow markets

• Producers may not always pay full cost of tax

• May be regressive

• Difficult to know how much tax to impose

What is the impact of enforcing regulation?

• Simple and easy to understand

• Information provision

• Fairer

• Bad goods need banning

• Revenue

What are the disadvantages of regulation?

• Might not be enforceable: people can cheat

• Government failure: may be socially inefficient to ban everything

• Creates no incentive to improve

• Shadow economy

• Costly and time consuming to implement

• Revenue: taxes may be a better way to collect rev

What are tradable pollution permits?

Giving firms a legal right to pollute a certain amount.

What are the advantages of TPP?

• Allows firms to emit specific level of pollution

• Market based: incentivises firms to reduce pollution as they can sell unused permitys

• Polluter pays principle

• Revenue for government

What are the disadvantages of TPP?

• Optimal level of pollution is unknown

• Hard to work out how to allocate permits

• PED for permits: large firms = permits inelastic as its small % of overall costs = doesnt change polluting levels

• Costly to enforce

• Difficult to measure pollution levels

• Political interference

What is state provision?

When gov is main provider of g&d which is free at point of use.

What are the advantages of state provision?

• Greater accessibility

• Increased equality

• Economies of scale: cheaper than subsididing private producers

What are the disadvantages of state provision?

• Costs

• Results in overconsumption

• Exploitation of provision: taking for granted = unaware of true value

• Inefficiency: no profit incentive = slack

• Reduced choice

What are information campaigns?

Involves providing info to public so that consumer make informed decisions.

What is government failure?

Where gov intervention in economy to correct market failure creates inefficiency and leads to misallocation of scarce resources.

What are the causes of government failure?

• Distortion of price signals

• Unintended consequences

• Excessive administrative costs

• Information gaps

• Unnecessary intervention

What are public goods?

Goods consumed collectively which are no excludable and non rival.

What are private goods?

Considered rivalrous, excludable and rejectable.

What are the advantages of provision of public goods by the government?

• Free rider problem: private sector will not provide good

• Positive multipler: building infrastructure provides jobs in area

• Economies of scale: gov can benefits from e.o.s lowering AC

• Avoids inequality: if police had to be paid for, only wealthy areas would be protected

What are the disadvantages of provision of public goods by the government?

• Technology: goods are increasing excludable

• Costly

• Government failure

• Miss out on private sector efficiency and innovation

• Tax collection: some countries dont have rev to provide public good

What is the market economy?

Resources are allocated through market forces of supply and demand. There is no gov involvement.

What are the advantages of market economies?

• Competition: more firms competing = lower prices, encouraged to expand output = benefiting from e.o.s

• Quality and innovation: firms will invest in R&D = increased consumer satisfaction = increase in market share

• Choice

• Allocation efficiency: able to allocate resources anywhere, no excess supply or deman

• Productice efficiency: prevents firms from becoming slack

• Higher levels of entrepreneurship: increase emp and economic growth

• Higher levels of productivity

• Higher levels of economic growth

• Environmental standards: improved

What are the disadvantages of market economies?

• Market failure: not always efficienct allocation of resources

• Income inequality

• Concentrated competition: markets can be dominated by one firms

• Public goods: not be provided at all by free market due to free rider problem

What is a command economy?

Resources are state owned and allocated centrally.

What are the advantages of command economies?

• Industrial power

• Social welfare improves

• Lower prices of basic necessities for consumers

• Monoplising is avoided

• Strategic goal alignment: gov could set goal

• Economies of scale

What are the disadvantages of command economies?

• Inefficiency: no competition = high levels of inefficiency = higher prices. Production delays.

• Shortages: depressing price of necessities causing excess demand, e.g. waiting lines

• Lack of innovation and choice

• Lack of economic growth/international competitiveness: no incentive to expand etc

• Shadow economies arising

What is a mixed economy?

An economic system where resources are allocated through mixture of market and direct public sector involvement.