Microeconomics Theme 1 <3

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112 Terms

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Ceteris paribus
all other things remaining constant
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positive statement
a statement with facts and is value free scientific approach.
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normative statement
statement with opinion and value judgement and is a nonscientific approach
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The basic economic problem
how to allocate scarce resources given unlimited want
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3 economic agents
1. Households
2. Firms
3. Government
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3 key questions
1. What to produce?
2. How to produce it?
3. Who to produce for?
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Difference between renewable and nonrenewable resources
nonrenewable resources are finite whereas renewable resources can replenish themselves and are infinite
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Rational consumer
wish to maximise their satisfaction or utility
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Rational Producers
wish to maximise profits by producing at the lowest cost
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Rational Government
wish to improve the economic and social welfare
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opportunity cost
the value of the next best alternative forgone when a choice is made
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Production Possibility Frontier (PPF)
the maximum potential output combination of two goods an economy can achieve when all its resources are fully and efficiently employed
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factors causing an outward shift in ppf
increase in quality or quantity of factors of production
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factors causing an inward shift in ppf
decrease in quality or quantity of factors of production
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Efficient allocation of resources
B
B
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inefficient allocation of resources (we could produce more given FoP at no OC)
D
D
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unattainable (given current FoP)
E
E
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maximum productive potential of an economy
A/B/C
A/B/C
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economic growth on ppf
outward shift
outward shift
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economic decline on ppf
inward shift
inward shift
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division of labour
splitting the production process into different parts to increase output
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specialisation
the process of becoming particularly skilled in a task
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Adam smith concept of division of labour
a worker will be able to make 20 pins a day if he worked alone but if 10 workers who are specialised in different parts of production then they'll produce 48000 pins a day
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4 Advantages of division of labour
1. Increased productivity
2. Lower cost per unit
3. Workers can concentrate on one task
4. Increased output
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3 Disadvantages of division of labour
1. Work can become tedious
2. Workers can get bored and leave
3. All stages of production will become co reliant on each other so if one stage breaks down the others are affected as well
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4 Functions of money
1. Medium of exchange
2. Store of value
3. Measure of value
4. Standard of deferred payment
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free market economy
an economy in which decisions on the three key economic questions and the problem of scarcity is determined by the market force (demand and supply)
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command economy
a centrally planned economy in which the role of the state is to be a social planner and the decisions on the three key economic questions and the problem of scarcity is determined by the government
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mixed economy
a mixture of free market economy and command economy
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Adam Smith and the free market
he thought when individuals follow their own self interest they indirectly promote the good of society then the free market producers would respond to changes in consumer wants in a way that reduces waste and the governments role should be limited to proving public goods
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Friedrich Hayek and the free market
he thought when the government plans economies it leads to failure, requires force and restricts freedom
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Karl Marx
he thought capitalism was inherently unstable because workers were exploited and there would be a revolution and the economy would follow communism
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5 characteristics of command economy
1. State ownership of resources
2. Price determined by the state
3. Resources allocated by the state
4. The role of the state is to be a social planner
5. A greater equality of income and wealth
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5 characteristics of free market economy
1. Private ownership of resources
2. Producers aim to maximise profits
3. Consumers aim to maximise utility
4. Resources are allocated by the price mechanism
5. The role of the state is to reduce constraints
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the role of the state in a mixed economy
fix market failure
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demand
the quantity of a good or service that consumers are willing and able to buy
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movement along the demand curve
change in price
change in price
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shift in demand curve
Population
Advertisement
Substitutes
Income
Fashion/trends
Interest rates
Complements
Population
Advertisement
Substitutes 
Income
Fashion/trends
Interest rates
Complements
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diminishing marginal utility
Decreasing satisfaction or usefulness as additional units of a product are acquired
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contraction and extension in demand
knowt flashcard image
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percentage change formula
change/original x 100
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elastic demand
%change in price leads to a more than proportional %change in quantity demanded (more than 1)
%change in price leads to a more than proportional %change in quantity demanded (more than 1)
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inelastic demand
%change in price leads to a less than proportional %change in quantity demanded (less than 1)
%change in price leads to a less than proportional %change in quantity demanded (less than 1)
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price elasticity demanded (PED)
how responsive quantity demanded is to a change in price
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PED formula
% change in Qd / % change in P
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Determinants of PED
Substitutes
Proportion of income
Luxury/necessity
Addictive
Time period
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Income elasticity demanded (YED)
how responsive quantity demanded is to a change in income
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YED formula
% change in Qd / % change in Y
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inferior goods
there are other alternatives so when income rises demand falls (negative YED)
more than 1 - income elastic
less than 1 - income inelastic
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normal good
there are no other alternatives so when income rises demand rises (positive YED)
more than 1 - income elastic (normal luxury)
less than 1 - income inelastic (normal necessity)
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Cross Elasticity of Demand (XED)
how responsive quantity demanded of good A is to a change in price of good B
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XED formula
%change in Qd of Good A / %change in P of Good B
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Joint demand (complements)
two goods are complements so if price increases for one demand would decrease for the other (negative XED)
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competitive demand (substitutes)
a good has substitutes so if the price of the good increases the demand for the substitute increases (positive XED)
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supply
the quantity of a good the producer is willing and able to sell
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movement in supply
change in price
change in price
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shift in supply
cost of production changes
government subsidy
entry of new things into the market
cost of production changes 
government subsidy
entry of new things into the market
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contraction and extension in supply
knowt flashcard image
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price elasticity supplied (PES)
how responsive quantity supplied is to a change in price
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PES formula
% change in Qs / % change in P
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perfectly elastic
infinity
infinity
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relatively elastic
greater than 1 but less than infinity
greater than 1 but less than infinity
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perfectly inelastic
0
0
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relatively inelastic
less than 1 but greater than zero
less than 1 but greater than zero
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determinants of PES
Time period
Production time
Factor mobility
Spare capacity
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Factors of production
Land

Labour

Capital

Entrepreneurship
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Price mechanism
signals to producers that the price is too high/too low
incentive to change the price
rations excess demand/supply
successfully allocates scarce resources
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consumer surplus
difference between how much a consumer is willing and able to pay and the market price
difference between how much a consumer is willing and able to pay and the market price
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producer surplus
difference between how much a producer willing and able to sell a good for and the market price
difference between how much a producer willing and able to sell a good for and the market price
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indirect tax
a tax imposed on goods
a tax imposed on goods
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ad valorem tax
a percentage tax imposed on good
a percentage tax imposed on good
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elastic/inelastic demand in indirect tax
elastic demand more of the incidence of tax is paid by the producer
inelastic demand more of the incidence of tax is paid by the consumer
elastic demand more of the incidence of tax is paid by the producer
inelastic demand more of the incidence of tax is paid by the consumer
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subsidy
money granted by the government
money granted by the government
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herd thinking
Making decisions based on what other people do.
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habitual thinking
people prefer to carry on behaving as they always have
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market failure
the market misallocates resources and isn't operating at the socially optimum level
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types of market failure
Negative externality
Positive externality
Public good
Asymmetric information
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negative externality
cost to the third party and social costs exceeds private costs
cost to the third party and social costs exceeds private costs
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private cost
cost faced by producers directly involved in a transaction
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external cost
cost to the third party
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social cost
private cost + external cost
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marginal private cost (MPC)
the cost of producing an additional unit of output
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Marginal External Cost (MEC)
the cost to the third party for producing an additional unit of output
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Marginal Social Cost (MSC)
The total cost to society of producing an additional unit of output MSC=MPC+MEC
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negative externality causes market failure
social costs exceed private cost
overproduction of the good
misallocation of resources
not operating at the socially optimum level
market failure
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positive externality
benefit to the third party and social benefits exceed private benefits
benefit to the third party and social benefits exceed private benefits
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private benefit
benefits for consumers directly involved in a transaction
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external benefit
benefit to the third party
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social benefit
private benefits + external benefits
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Marginal Private Benefits (MPB)
benefits to consumers for consuming an additional unit of output
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marginal external benefit (MEB)
Benefit to third parties from the consumption of extra unit of output.
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marginal social benefits (MSB)
total benefits to the consumer consuming an additional unit of output MSB=MPB+MEB
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positive externality causing market failure
social benefits exceed private benefits
under consumption of the good
mis allocation of resources
not operating at the socially optimum level
market failure
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public goods
good that are non excludable and non rivalrous
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non excludable
can't be confined solely to those who have paid for it and non payers can enjoy the benefits at no financial cost
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non rivalrous
each persons enjoyment of a good doesn't stop others enjoyment
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free rider problem
difficulty of charging consumers and they will benefit from the product without paying for it
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public goods cause market failure
a good is non excludable and non rivalrous
you can't charge people to use it (free rider problem)
firms have to incentive to provide it
under provision of the good
misallocation of resources
market failure
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asymmetric information
one party to an economic transaction has more information than the other
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asymmetric information causes market failure
information gaps
consumers don't have all the information to make a rational decision
market failure