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Economic Goods

Resources that are scarce.

Short Run

A time period where at least one factor of production is fixed.

Long Run

A time period where all factors of production are variable.

Productivity

The output per unit of input.

The Economic Problem

Resources are scarce but wants are infinite.

Scarcity

There a a finite umber of resources

Free Goods

Goods that are unlimited in supply and therefore have no opportunity cost.

Economic Agents

Consumer, Business and Governments.
Agents involved in Economic transactions.

Production Possibility Frontier

The maximum potential output of a combination of goods an economy can achieve when all its resources are fully and efficiently employed, given the level of technology.

Opportunity Cost

The next best alternative foregone.

Economic Growth

increase in the actual or productive potential of the economy

Capital Goods

Goods intended for use in production, rather than by consumers.

Consumer Goods

Goods designed for use by final consumers.

Renewable Resources

A resource whose stock level can be replenished naturally over a period of time.

Non-renewable Resources

A resource whose stock level decreases over time as it is consumed.

Ceteris Paribus

other things being equal

Positive Statement

A statement based on facts which can be tested as true or false and are value-free.

Normative Statement

A statement based on value judgements which cannot be tested as true or false.

Adam Smith

The Father of Economics;

• The Invisible Hand (workings of the Price Mechanism)

• Specialisation

• Division of Labour

Division of Labour

Specialisation of workers on specific tasks in the production process.

Specialisation

The process of breaking down the production process into steps and then each worker is assigned a step. This would then increase labour productivity (Output per Worker).

Barter

An exchange of goods/services for other goods/services.

• Does not involve money.

• Double coincidence of wants.

Money

Anything which is acceptable to a wide number of people and organisations as payment for goods and services.

Free Market Economy

Where all resources are privately owned and allocated via the price mechanism. There is minimal government intervention.

Command Economy

Where there is public ownership of resources and these are allocated by the government.

Mixed Economy

Where some resources are owned and allocated by the private sector and some by the public sector.

Market

A channel where goods and services are exchanged.

Utility

The capacity of a good or service to satisfy some human want.

Rational Decision Making

Where consumers allocate their expenditure on goods and services to maximize utility, and producers allocate their resources to maximize profits.

Demand

The quantity of goods or services that will be bought at any given price over a period of time.

Demand Curve

Shows the quantity of a good or service that would be bought over a range of different price levels in a given period of time.

Why does the demand curve slope downwards

Slopes downward - Price and Quantity have an inverse (negative) relationship.

Marginal Utility

The additional satisfaction that a consumer gains for consuming one additional unit of a product.

Diminishing Marginal Utility

As successive units of a good are consumed, the utility gained from each extra unit will fall.

% Change equation

y2 - y1 / y1 × 100

Price Elasticity of Demand (PED) and equation

The responsiveness of demand to changes in price.
The value is always negative.
% ∆QD / % ∆P × 100

Unitary Price Elasticity (Ped)

Ped \= 1

Perfectly Price Inelastic (Ped)

Ped \= 0

Price Inelastic (Ped)

Ped is < 1

Perfectly Price Elastic (Ped)

Ped \= ∞

Price Elastic (Ped)

Ped \> 1

Total Revenue

Price × Quantity

Income Elasticity of Demand (YED)

The responsiveness of demand to changes in income.

YED formula

%∆QD / %∆Y × 100

what goods have Negative Income Elasticity of Demand

Inferior Good (As income increases, QD decreases)

what goods have Positive Income Elasticity of Demand

Normal Good (As income increases, QD increases)

what is Cross Price Elasticity of Demand (XED)?

The responsiveness of demand for one good to changes in the price of a related good. (Either substitutes or complements).

XED formula

% ∆ in QD of Good A/ % ∆ in Price of Good B × 100

what goods have Negative Cross Price Elasticity of Demand?

Complements (As the Price of one good increases, the Demand for the second good decreases)
The 2 goods are in joint Demand.

what goods have Positive Cross Price Elasticity of Demand?

Substitutes (As the Price of one good increases, the Demand for the second good increases)
The 2 goods are in competitive Demand.

Supply

The quantity of a good or service that firms are willing to sell at a given price over a given period of time.

Supply Curve

Shows the quantity of a good or service that firms are willing to sell to a market over a range of different price levels in a given period of time.
An upward sloping curve - Price and Supply have a direct relationship.

Price Elasticity of Supply

The responsiveness of supply to changes in price.
Pes \= %∆QS / %∆P

PES formula

%∆Qs/%∆P

Equilibrium Price

The price at which the Quantity Demanded and Quantity Supplied are equal, ceteris paribis. "Market Clearing Price"

Excess Supply

Where the QS exceeds the QD for a good at the current market price.
QS \> QD

Excess Demand

When the QD exceeds the QS for a good at the current market price.
QD \> QS

Adam Smith's Invisible Hand

the ability of free markets to reach desirable outcomes, despite the self-interest of market participants.

what is Price Mechanism

The use of market forces to allocate resources in order to solve the economic problem of what, how, and for whom to produce.
The interaction of demand and supply to determine the market clearing price.

what is Consumer Surplus

The difference between how much buyers are prepared to pay for a good and what they actually pay.
It is represented by the area under the demand curve above the ruling market price.

what is Producer Surplus and what represents it?

The difference between the market price which firms receive and the price at which they are prepared to supply.
It is represented by the area below the ruling market price and above the supply curve.

Incidence of Tax when Demand is Inelastic

Consumer Tax Burden \> Producer's Tax Burden

Incidence of Tax when Demand is elastic

Consumer Tax Burden < Producer's Tax Burden

Incidence of Tax when Supply is Inelastic

Consumer Tax Burden < Producer's Tax Burden

Incidence of Tax when Supply is elastic

Consumer Tax Burden \> Producer's Tax Burden

Direct Taxes

Tax paid on incomes or profits.
Example; Income Tax and Corporation Tax.

What is an Indirect Tax

A tax levied on the purchase of goods and services.
Its shown by an inward shift of the supply curve.

What shows an indirect tax

shown by an inward shift of the supply curve.

what are Specific Taxes

The amount of tax levied does not change with the value of the goods but with the amount or volume of goods purchased (Excise Duties)
- Parallel to the 1st Supply Curve

what is Ad Valorem Tax

Tax put on (leived) increases in proportion to the value of the tax base. (VAT)

• Steeper Gradient relative to the original Supply Curve.

Incidence of Tax definition

The distribution of the tax paid between consumers and producers.

Consumer contribution to specific tax

Below the new EQ and above the original EQ.

where is Producer Tax on S/D graph?

Below the original EQ and above the original supply curve.

Subsidy

A government grant to firms, which reduces production costs and encourages an increase in output.
Its shown as an outward shift of the Supply Curve.

Market Failure

A misallocation of resources caused by the Market Mechanism.

Reasons for Market Failure

• Missing Markets ( Merit Goods and Public Goods)

• Imperfect Market Information

• Lack of Competition in the market.

• Factor Immobility

• Externalities

• Inequality

Demerit Goods

A good which is over provided by the Market Mechanism and tends to yield more costs to individuals than they realize.
Examples; Tobacco, Drugs, Alcohol, etc..

Externalities

The costs or benefits that are external to an exchange. They are 3rd party effects ignored by the Market Mechanism.

Consumption Externality

An external cost or benefit arising from a consumption activity.

Production Externality

An external effect of production, which neither harms nor benefits the person or firm controlling the production.

External Costs

Negative 3rd Party effects that are excluded from the Market Mechanism.

Private Costs

Cost internal to a market transaction, which are therefore taken into account by the Market Mechanism.

Social Costs

External Costs + Private Costs.

External Benefits

Positive 3rd Party effects that are excluded from the Market Mechanism.

Private Benefits

Benefits internal to a market transaction, which are therefore taken into account by the Market Mechanism.

Social Benefits equals

External Benefits + Private Benefits.

Market Equilibrium Level

Marginal Private Costs (MPC) \= Marginal Private Benefits (MPB)

when Social Optimum Level occurs

when Marginal Social Costs (MSC) \= Marginal Social Benefits (MSB)
This is where society should be.

What is Welfare Loss and a consequence?

The excess of social costs over social benefits for a given output.
A situation where MSB is ≠ to MSC and society does not achieve maximum utility.

Welfare Gain

The excess of social benefits over social costs.

Negative Production Externality

The external costs to third party that occur when a product is produced.

Positive Consumption Externality

The external benefits to a third party that occur when a product is consumed.

what does Internalising the Externality do?

Eliminates the externality by bringing it back into the framework of the Market Mechanism.
\= Creating a market for the Externality.
Examples; Tradable Pollution Permits, Extending Property Rights, Taxes, Regulation, etc..

Non Rivalry

Consumption of goods by one person does not reduce the amount available for consumption by another.

Public Goods

Those goods that have non-rivalry and non-excludability by their consumption.

Non-Excludable

Once provided, no person can be excluded from benefiting.

Examples of public goods

Defense, Police Service, Street Lighting, Judiciary and Prison Service.

Private Goods

Those goods that have rivalry and excludability in their consumption.

Free Rider Problem

If left to the free market, public goods would not be adequately provided for.
The market fails because firms cannot withhold the goods and services from people who refuse to pay.

Information Gaps

Where consumers, producers or the government have insufficient knowledge to make rational economic decisions.