Flashcards · 9708 · AS Topic 2

The price system and the microeconomy (AS Level) flashcards

27 cards on AS Topic 2, subtopics 2.1 to 2.5. Pick a subtopic or study them all.

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2.1 Demand and supply curves

Effective demand: Willingness to buy at a price, backed by the ability to pay. A want has no money behind it.
Individual demand and market demand: Individual demand: the quantity one buyer will purchase at each price. Market demand: the sum of all individual demands at each price (add quantities at each price, not prices at each quantity).
Change in demand versus change in quantity demanded: A change in demand is a shift of the curve, caused by a non-price determinant (income, prices of related goods, tastes, population, expectations). A change in quantity demanded is a movement along the curve, caused by the good's own price. The same split applies to supply.
Which way does each event shift supply: higher costs, better technology, an indirect tax, a subsidy, more firms?: Higher costs: left. Better technology: right. Indirect tax: left. Subsidy: right. More firms: right.
Exam trap: what does a rise in income do to demand for an inferior good?: It shifts demand left. Inferior goods are the exception to the rule that higher income shifts demand right (which holds for normal goods).

2.2 Price elasticity, income elasticity and cross elasticity of demand

PED, YED and XED: formulas: PED = %ΔQd ÷ %ΔP (own price). YED = %ΔQd ÷ %Δincome. XED = %ΔQd of A ÷ %ΔP of B. Elasticity has no units; percentage change = (new − old) ÷ old × 100.
Income rises from 2,000 to 2,500 and demand from 50 to 57.5. Find YED and classify the good.: Income +25%, demand +15%. YED = 15 ÷ 25 = +0.6: a normal good that is income inelastic (a "necessity"). Above +1 would be income elastic ("luxury"); negative would be inferior.
The price of B falls from 5 to 4 and demand for A rises from 400 to 460. Find XED and say how A and B are related.: Price of B −20%, demand for A +15%. XED = 15 ÷ −20 = −0.75: complements. A positive XED means substitutes; a larger size means a closer relationship.
How does PED change along a straight-line demand curve?: Slope is constant but PED varies: elastic at high prices and low quantities, unitary at the midpoint, inelastic at low prices. Total revenue is highest at the midpoint. For Q = 60 − P, at P = 45 point PED = −45 ÷ 15 = −3.
PED and total expenditure: what does a price rise do when demand is elastic, unitary and inelastic?: Elastic: total expenditure falls. Unitary: unchanged. Inelastic: rises. Example: PED −2.5 and a 4% price rise cut quantity 10%, so revenue becomes 1.04 × 0.90 = 0.936 of the original.
Why does a government seeking tax revenue prefer to tax goods with inelastic demand?: Quantity falls by less, so more revenue is raised. But for the same reason the tax is less effective if the aim is to reduce consumption. Also: estimates come from past data, and elasticities differ between short and long run.

2.3 Price elasticity of supply

PES: definition and formula. Price rises from 60 to 66 and quantity supplied from 300 to 345. Find PES.: How strongly quantity supplied reacts to a change in the good's own price. PES = % change in quantity supplied ÷ % change in price = 15 ÷ 10 = 1.5: elastic.
Straight-line supply curves and PES: Through the origin: PES = 1 everywhere. Meeting the price axis: PES above 1 everywhere. Meeting the quantity axis: PES below 1 everywhere. Vertical: 0. Horizontal: infinity.
Factors that make supply more price elastic: Spare capacity, stocks of finished goods, mobile factors, a long time to respond, quick production, free entry for new firms and plentiful inputs.
Supply is Qs = 15P − 60. Find PES when price rises from 10 to 12.: Qs rises from 90 to 120: +33.3%. Price +20%. PES = 33.3 ÷ 20 = 1.67. The curve meets the price axis (Qs = 0 at P = 4), so PES is above 1, as expected.
Why does PES rise with time, and why does it matter?: Momentary: supply cannot change. Short run: at least one factor fixed. Long run: all factors can change (e.g. PES 0, then 0.3, then 1.8). Low PES means slow reactions, lasting shortages and large price rises; high PES means brief shortages and small price changes.

2.4 The interaction of demand and supply

Equilibrium and disequilibrium: Equilibrium: the price where buyers' plans and sellers' plans match, so nothing pushes price up or down. Disequilibrium: any price where the two quantities differ (excess demand or excess supply).
Qd = 60 − 2P and Qs = 3P. Find the equilibrium, then the new one when supply rises by 10 at every price.: Equilibrium: 60 − 2P = 3P, so P = 12 and Q = 36. New supply Qs = 3P + 10: 60 − 2P = 3P + 10, so P = 10 and Q = 40. Price falls, quantity rises.
Joint demand, alternative demand, derived demand and joint supply: Joint demand: complements used together. Alternative demand: substitutes. Derived demand: demand for an input comes from demand for the product it makes. Joint supply: one process yields two products, so more of one means more of the other.
The three functions of price in a market: Rationing: price rises until quantity demanded matches the limited quantity available. Signalling: price changes transmit preferences and show scarcity. Incentivising: higher price and profit draw resources into the market, and encourage buyers to economise.
Demand rises and supply falls at the same time. What can you say?: Price definitely rises; the change in quantity depends on the relative size of the two shifts. With two shifts, one outcome is certain and the other is unclear.

2.5 Consumer and producer surplus

Consumer surplus: The difference between what consumers are willing to pay and what they actually pay. On a diagram: the area under the demand curve and above the price.
Producer surplus: The difference between the price producers actually receive and the minimum they would accept. On a diagram: the area above the supply curve and below the price.
How do you calculate a consumer or producer surplus triangle?: Surplus = ½ × base × height. The base is the quantity traded; the height is the vertical gap between where the curve meets the price axis and the market price.
What happens to consumer and producer surplus when a per-unit tax is imposed?: Both fall: buyers pay more and sellers receive less on a smaller quantity. Part of the lost surplus becomes tax revenue; the rest is a deadweight welfare loss.
Demand rises. How does the elasticity of supply decide who gains most surplus?: Inelastic supply: a big price rise, so producer surplus rises a lot. Elastic supply: a small price rise and a big quantity rise, so more of the gain goes to consumers.
Producer surplus versus profit: Producer surplus is revenue minus the cost of the variable inputs, so it is larger than profit when fixed costs exist.