Flashcards · YEC11 · AS Topic 1

Markets in action (AS Level) flashcards

41 cards on AS Topic 1, subtopics 1.3.1 to 1.3.6. Pick a subtopic or study them all.

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1.3.1 Introductory concepts

Positive statement vs normative statement: Positive: can be tested against evidence (true or false). Normative: a value judgement about what ought to be. A statement with a number in it is still normative if it says "should".
Why is economics called a social science, and what does ceteris paribus mean?: It studies human behaviour and cannot normally run controlled experiments on whole economies. Ceteris paribus: other things held equal while one variable changes, so a model can isolate one relationship.
Opportunity cost: The next best alternative forgone when a choice is made. Not the money cost, and not all the alternatives.
A farmer has 100 hours. A tonne of potatoes takes 10 hours, a tonne of onions 4 hours. Opportunity cost of 1 tonne of potatoes?: Maximum potatoes 10 t, maximum onions 25 t. 1 t of potatoes costs 25 ÷ 10 = 2.5 t of onions (and 1 t of onions costs 0.4 t of potatoes).
Free good vs economic good: Free good: no opportunity cost in use, so a zero price clears the market. Economic good: scarce, uses resources and has an opportunity cost.
PPF: what does a movement along it, an outward shift and a point inside it show?: Movement along: resources reallocated between the two goods (opportunity cost is the slope). Outward shift: productive potential rises. Point inside: idle or inefficiently used resources. Moving to the frontier is not growth.
Why is a PPF usually bowed out (concave to the origin)?: Resources are not equally suited to both goods, so the marginal opportunity cost of making more of one good rises. A straight-line PPF means constant opportunity cost.
The four functions of money: Medium of exchange, measure (unit) of value, store of value, and method (standard) of deferred payment. Inflation erodes the store of value.

1.3.2 Consumer behaviour and demand

Rational choice: the standard assumption: Consumers maximise utility; firms maximise profit.
Movement along a demand curve vs shift of it: Movement along: the result of a change in the good's own price and nothing else. Shift: caused by anything else. A shift right means more is demanded at every price.
Diminishing marginal utility and the demand curve: Each extra unit adds less utility, so a consumer will pay less for it, and the individual demand curve slopes down.
Give four reasons consumers may not maximise utility: Any four of: herding (copying the crowd), habit, inertia (not switching to a better deal), poor computational skills, the need to feel valued, framing and bias.
PED, YED and XED: formulae and what the sign tells you: PED = %ΔQd ÷ %Δ own price (usually negative). YED = %ΔQd ÷ %Δ income (positive = normal, negative = inferior). XED = %ΔQd of A ÷ %Δ price of B (positive = substitutes, negative = complements).
Price rises from 1.20 to 1.32; quantity falls from 900 to 855. PED, and what happens to revenue?: Price +10%, quantity −5%, PED = −5 ÷ 10 = −0.5 (inelastic). Revenue rises from 1,080 to 1,128.60, as inelastic demand predicts.
PED and total revenue after a price rise: Inelastic (0 to −1): revenue rises. Unitary (−1): unchanged. Elastic (below −1): revenue falls.
Why is PED not constant along a straight-line demand curve?: The slope is constant but the percentage changes are not. The upper section is elastic, the midpoint is unitary and the lower section is inelastic. Revenue peaks where PED = −1.
Why does PED matter to government?: Indirect taxes raise more revenue on inelastic goods but change behaviour less; elastic goods respond more but yield less. YED helps plan for services as incomes shift.

1.3.3 Supply

Extension of supply vs increase in supply: Extension: a movement along the supply curve caused only by a change in the good's own price. Increase: the whole curve shifts right because some other factor changed (costs, technology, subsidy, number of firms).
PES formula and the five values: PES = % change in quantity supplied ÷ % change in price. 0 perfectly inelastic; 0–1 inelastic; 1 unitary; above 1 elastic; infinity perfectly elastic.
Price rises from 40 to 50 and quantity supplied from 200 to 210. PES?: Price +25%, quantity +5%. PES = 5 ÷ 25 = 0.2, inelastic.
Straight-line supply curves: which way round tells you PES?: Through the origin: PES = 1 everywhere. Meets the price axis first: PES above 1 everywhere. Meets the quantity axis first: PES below 1 everywhere.
Factors that make supply more price elastic: Spare capacity, stocks of finished goods, mobile factors of production, and a longer time period (the long run, when all factors can change).
Specific tax vs ad valorem tax: effect on the supply curve: Specific (fixed sum per unit): parallel shift up/left by the tax. Ad valorem (percentage of price): the curve pivots, so the gap widens at higher prices.

1.3.4 Price determination

Market equilibrium: Quantity demanded equals quantity supplied, so price has no tendency to change.
Price is set above equilibrium. What happens?: Excess supply: quantity supplied exceeds quantity demanded. Unsold stock builds up, sellers cut price, quantity demanded extends and supply contracts until equilibrium is restored.
The three functions of the price mechanism: Rationing (a higher price limits demand to scarce supply), incentive (a higher price encourages more supply) and signalling (price changes tell buyers and sellers about scarcity).
Consumer surplus and producer surplus: Consumer surplus: willingness to pay minus price paid; area under demand, above price. Producer surplus: price received minus the minimum supply price; area above supply, below price.
Demand is P = 50 − Q and the price is 20. Consumer surplus?: Q = 30. Consumer surplus = ½ × 30 × (50 − 20) = 450.
Who bears more of an indirect tax?: Whichever side is less price elastic. With inelastic demand, most of the tax is passed on to consumers as a higher price. Sellers are legally liable, but incidence is shared by elasticity. Tax revenue = tax per unit × the new quantity.

1.3.5 Market failure

Market failure: The market quantity is above or below the level that is best for society, so resources are misallocated.
Externality, and the social cost and benefit identities: A cost or benefit to third parties that is not reflected in the market price. MSC = MPC + MEC. MSB = MPB + MEB.
Diagram: negative production externality: Price on the vertical axis, quantity on the horizontal. MSC lies above MPC (= supply). The market produces Qm where MPC = MPB; the social optimum Qs, where MSC = MSB, is lower. The welfare loss is the triangle between MSC and MSB from Qs to Qm.
Public good: the two characteristics and the problem they cause: Non-rival (one person's use does not reduce another's) and non-excludable (non-payers cannot be stopped from using it). Free riders will not pay, so the market may not provide it at all.
Asymmetric information and moral hazard: Asymmetric information: one side of a deal knows more than the other. Moral hazard: taking more risk because someone else bears some of the cost. Say who bears it.
Market bubble: A sustained rise in price well above fundamental value, driven by expectations of further rises (speculation).

1.3.6 Government intervention in markets

Maximum price vs minimum price: where must each be set to work, and what does it cause?: Maximum price: below equilibrium; causes excess demand (a shortage), possibly black markets. Minimum price: above equilibrium; causes excess supply (a surplus).
Diagram: a subsidy on a good with external benefits: The supply curve shifts down (right) by the subsidy per unit. Price falls and quantity rises towards the social optimum. The cost to government is subsidy × new quantity, which is not the welfare gain.
Tradeable pollution permits vs a pollution tax: Permits (cap and trade) fix the quantity of pollution and let the permit price adjust. A tax fixes the price of polluting and lets the quantity adjust.
Government failure: Intervention that results in a net welfare loss. Not every side effect is government failure: welfare must fall overall.
Causes of government failure: Distortion of price signals, unintended consequences, excessive administrative costs and information gaps (for example, not knowing the size of an external cost).
Property rights as a solution to market failure: Legal ownership lets the owner exclude others and gain or lose from use, so the owner has an incentive to protect a resource or to charge for damage to it.