Flashcards · J205 · Topic 2

The role of markets and money flashcards

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2.1 The role of markets

Market: Wherever buyers meet sellers to swap goods, services or resources for payment.
Primary, secondary and tertiary sectors: Primary: extracts or grows natural resources. Secondary: manufactures and builds. Tertiary: provides services.
Factor market and product market: Factor market: where land, labour, capital and enterprise are bought and sold. Product market: where completed goods and services change hands.
How are factor markets and product markets linked?: Households sell labour in the factor market and earn wages, which they spend in product markets. Firms sell output there and use the receipts to buy factors. A fall in product demand leads to a fall in demand for factors.
Good versus service: A good is a physical, storable item. A service is an intangible activity, produced and consumed together.
What usually happens to the tertiary sector as an economy develops?: Its share of jobs usually rises. Example: tertiary jobs rising from 4.5 million to 8.4 million is (8.4 − 4.5) ÷ 4.5 × 100 = +86.7%.
Specialisation: Focusing a worker, firm, region or country on a narrow set of jobs or products.
Five potters each make 6 mugs a day alone. With separate stages the team makes 42. Daily wages are £300. Find the change in cost per mug.: Output rises from 30 to 42, +40%. Cost per mug falls from £300 ÷ 30 = £10.00 to £300 ÷ 42 = £7.14, about −28.6%.
Specialisation: one benefit and one risk for workers, regions and countries: Workers: skill and higher pay, but boredom and narrow skills. Regions: skills and suppliers gather, but one industry's decline hits the whole area. Countries: more output and choice through trade, but import dependence and exposure to world prices.
Why does specialisation require exchange?: Specialists make more of a few things than they need, so they must trade the surplus for everything else. Exchange lets everyone enjoy a wider range than they could make themselves.

2.2 Demand

Demand: How much buyers will purchase, and can afford, at each price over a stated period.
Market demand, and how to build a market demand schedule: Every buyer's quantity added together at each price. List the prices in order, add every individual's quantity at each price, then plot price (vertical) against quantity (horizontal).
Extension/contraction versus increase/decrease in demand: Extension or contraction: a movement down or up the curve because the good's own price changed. Increase or decrease: a shift right or left caused by a non-price factor.
Which way does demand shift when: income rises (normal good), income rises (inferior good), a substitute gets dearer, a complement gets dearer?: Normal good: right. Inferior good: left. Substitute dearer: right. Complement dearer: left.
Research links a food to health benefits. Shift or movement?: A shift right: a change in tastes, a non-price factor, so more is demanded at every price. A fall in the food's own price would instead be a movement along the curve.
Price elasticity of demand (PED): formula. Price rises from £50 to £55 and quantity falls from 2,000 to 1,700. Find PED.: PED = % change in quantity demanded ÷ % change in price. Price +10%, quantity −15%: PED = −15 ÷ 10 = −1.5, elastic. Revenue falls from £100,000 to £93,500.
Perfectly inelastic, inelastic, unitary, elastic and perfectly elastic demand: PED size and curve shape: Perfectly inelastic: 0, vertical. Inelastic: 0 to 1, steep. Unitary: 1. Elastic: over 1, shallow. Perfectly elastic: infinity, horizontal.
Determinants of PED: Availability of substitutes, whether a necessity or luxury, the share of income spent, time, habit, and how narrowly the good is defined.
Why is a price cut on an elastic good not always a good idea?: Quantity rises by a larger percentage than price falls, so revenue rises. But extra output costs more to make, so profit may not rise, and rivals may cut prices too. PED is an estimate that changes over time.
Slope versus elasticity: Slope is steepness. Elasticity is a percentage comparison, and it varies along a straight-line demand curve. Calculate PED rather than judging by the look of the curve.

2.3 Supply

Supply: What producers will offer for sale at each price over a set time, if they are both willing and able.
Law of supply: Higher price, larger quantity supplied (other things equal).
Market supply: Sum of all producers' quantities at each price. Example: stalls supplying 24 and 20 jars at £5 give a market supply of 44 at £5.
Which way does the supply curve shift when: costs rise, technology improves, a tax on production is added, a subsidy is given, producers leave?: Costs rise: left. Better technology: right. Tax on production: left. Subsidy: right. Fewer producers: left. A change in the good's own price is a movement along S.
Price elasticity of supply (PES): formula. Price rises from £8 to £10 and quantity from 320 to 416. Find PES.: PES = % change in quantity supplied ÷ % change in price. Price +25%, quantity +30%: PES = 30 ÷ 25 = 1.2, elastic.
PES shapes: perfectly inelastic, inelastic, unit elastic and elastic straight-line supply curves: Perfectly inelastic (0): vertical. Inelastic: a line that meets the quantity axis. Unit elastic (1): a straight line through the origin. Elastic: a line that meets the price axis. Perfectly elastic: horizontal.
Determinants of PES: Spare capacity, stocks, time, factor mobility, length of the production period, perishability and ease of entering the market.
Why does PES matter to consumers?: Inelastic supply makes prices jump when demand rises or supply is hit. Elastic supply keeps prices steadier, because output can expand quickly.
Consequences of a decrease in supply for consumers and producers: Price rises and quantity falls. Consumers pay more and buy less. Producers sell fewer units at a higher price, so their revenue may fall if demand is elastic.

2.4 Price

The three jobs the price mechanism does: Signal: tells producers and consumers where demand is high or low. Incentive: rewards producers who supply more and consumers who buy less when price is high. Rationing: decides who gets scarce goods: those willing and able to pay.
Equilibrium price: The price at which quantity demanded equals quantity supplied, where the demand and supply curves cross and the market clears.
Marmalade: at £7 demand and supply are both 60. At £5 demand is 90 and supply 24. At £9 demand is 30 and supply 96. What happens at £5 and £9?: At £5: excess demand of 66, so the price rises. At £9: excess supply of 66, so the price falls. Equilibrium: £7 and 60 jars.
In the marmalade market supply rises by 33 at every price, so at £6 demand and supply are both 75. Describe the change.: Supply shifts right; new equilibrium £6 and 75 jars. Price −14.3%, quantity +25%. Revenue rises from £420 to £450.
Effect on equilibrium price and quantity of each shift: D right, D left, S right, S left: D right: price up, quantity up. D left: price down, quantity down. S right: price down, quantity up. S left: price up, quantity down.
Input costs rise. Trace the effect on the market.: Less is worth supplying at each price, so supply shifts left. At the old price demand exceeds supply, so price rises, contracting demand and extending supply until they match. Consumers pay more and buy less.
Demand rises and supply is inelastic (full capacity or a growing season). What happens?: Price rises sharply while quantity rises little. Consumers lose and existing producers gain revenue. Over time supply becomes more elastic and new firms may enter, so the price effect shrinks.
Price and an efficient distribution of resources: is the outcome always fair?: Resources move to the uses where consumers show most demand, which is efficient. But price reflects ability to pay as well as need, so an outcome can be efficient but not fair.
Limits of markets in deciding what is produced and for whom: Markets may under-provide goods people need but cannot afford, and some effects of production and consumption fall on third parties.

2.5 Competition

Competition: Rivalry between producers selling to the same customers.
Market share: The part of all the market's sales that one firm wins, as a percentage. A firm with 30% of a £1,200m market has sales of £360m.
Barrier to entry: Anything that makes it hard for new firms to enter (high start-up cost, patents, strong brands).
Monopoly and oligopoly: Monopoly: one producer, or one so dominant it faces little rivalry. Oligopoly: a handful of big, interdependent firms that make most of the sales.
Why do firms compete, and how?: For profit, market share, survival and growth. They compete on price, and through non-price methods: quality, design, service and advertising.
New firms enter a market. Analyse the effect on price.: Supply increases, shifting right. At the old price there is a surplus, so price falls until the market clears. New equilibrium: lower price, higher quantity. Consumers gain; existing producers face lower margins.
Competitive market, oligopoly and monopoly: firms, entry, price and choice: Competitive: many firms, easy entry, market price, wide choice. Oligopoly: few large firms, hard entry, watch rivals' prices, limited choice. Monopoly: one firm, very hard entry, most control over price, little choice.
Why do oligopolists often avoid price wars?: Interdependence: one firm's decision affects its rivals, so a price cut can be matched, leaving every firm with lower profit. They compete on quality, branding and advertising instead.
Is a monopoly price always higher than a competitive one?: Not certainly. Barriers protect profit, so rivals cannot force price down, but a large firm may have lower average cost from economies of scale and could pass some of it on.
Evaluate competition for consumers and producers: Consumers: lower prices, wider choice and better quality, most when switching is easy. Producers: margins shrink and weak firms exit, but efficient firms innovate and gain share. Risk: if many rivals fail, survivors may later raise prices.

2.6 Production

Production and productivity: Production: the total amount of goods and services produced. Productivity: how much each worker, hour or machine contributes, e.g. output per worker.
A workshop makes 90 items in a 6-hour shift; after training it makes 108 in the same time. Find the change in productivity.: 90 ÷ 6 = 15 an hour, then 108 ÷ 6 = 18 an hour. Productivity rises (18 − 15) ÷ 15 × 100 = 20%.
Who produces in an economy?: Individuals (the self-employed and workers), firms (the main producers, aiming for profit) and the government (which provides some services and sets rules, taxes and subsidies).
Formulas: total cost, average cost, total revenue, average revenue, profit and loss: TC = variable cost + fixed cost. AC = TC ÷ output. TR = price × quantity. AR = TR ÷ quantity (equals price). Profit = TR − TC. Loss = TC − TR.
Fixed cost £1,500 a week, variable cost £4 a repair, price £11. Find the profit or loss at 150 and at 400 repairs.: 150: TC = 1,500 + 600 = £2,100; TR = £1,650; loss £450. 400: TC = 1,500 + 1,600 = £3,100 (AC £7.75); TR = £4,400; profit £1,300. AC falls because the fixed cost is shared across more repairs.
How do profit and costs affect supply?: Higher price with costs unchanged: profit rises and firms supply more (a movement along the curve). Higher costs: profit falls and supply shifts left. Lower costs (technology, subsidy): supply shifts right. Profit attracts entry; losses push firms to cut costs or leave.
Economies of scale: Fall in average cost as a firm increases its scale of production. Total cost still rises; only cost per unit falls.
Six types of economies of scale: Technical (large machines, specialist workers), purchasing (bulk-buying discounts), financial (cheaper borrowing), managerial (specialist managers), marketing (advertising cost shared by more units) and risk-bearing (a wide product range spreads risk).
A cafe chain pays £12 a kg for coffee in small orders and £10.50 in bulk. Name the economy and the percentage saving.: A purchasing economy of scale: (10.50 − 12) ÷ 12 × 100 = −12.5%. Lower average cost lets the firm cut price or raise its margin, and may deter entry.
Why do production and productivity matter, and what are the limits?: For the economy: more output, jobs, incomes, tax revenue and exports. For firms: lower cost per unit and price competitiveness. Limits: extra output may only reflect extra workers, automation can cost jobs, and growth can damage the environment.

2.7 The labour market

Labour market: Where workers sell their work and employers buy it.
Derived demand: Demand for a worker that follows from customers wanting what the worker helps to produce.
Shortage and surplus of labour: Shortage: demand for workers exceeds supply, which pulls the wage up. Surplus: supply of workers exceeds demand, which pushes the wage down.
What shifts the demand for labour?: Changes in demand for the product, in worker productivity, and in the cost or capability of machinery. A change in the wage itself is a movement along the curve.
What shifts the supply of labour?: Changes in the skills, qualifications or training needed, the size of the working-age population (including migration), pay in similar jobs, and working conditions or non-wage benefits.
At £8 an hour 50 workers are demanded and supplied. Supply rises by 40 at every wage, so at £7 demand and supply are both 70. Describe the change.: Supply shifts right. New equilibrium: £7 with 70 workers. Wage falls 1 ÷ 8 = 12.5%; employment rises 20 ÷ 50 = 40%.
Why do some jobs pay more than others?: High wages go with scarce skills, long training and high-value work (low supply, high demand). Low wages go with plentiful workers and easy entry.
Gross pay and net pay: Gross pay: pay before any deduction. Net pay: gross pay minus income tax, national insurance and pension contributions. Income tax and NI go to government; the pension goes into the worker's retirement saving.
Gross pay is £2,400 a month. Income tax £280, national insurance £190, pension £120. Find net pay.: Deductions: 280 + 190 + 120 = £590. Net pay = 2,400 − 590 = £1,810.
£9.80 an hour for 30 hours. Tax 20% above £150 a week, NI 8% above £120, pension 3% of gross. Find net pay.: Gross £294.00. Tax (294 − 150) × 0.20 = £28.80. NI (294 − 120) × 0.08 = £13.92. Pension £8.82. Deductions £51.54, so net pay = £242.46.

2.8 The role of money and financial markets

Money and the problem it solves: Money is anything generally accepted in payment. As a medium of exchange it avoids the double coincidence of wants that barter needs, speeds up trade, supports specialisation and makes prices comparable.
Double coincidence of wants: In barter, each party must want exactly what the other offers. This rarely happens, which is why money is used.
Banks, building societies and insurance companies: the role of each: Banks: deposits, loans, accounts and payments. Building societies: owned by members; savings and mortgages. Insurance companies: collect premiums from many and pay the few who claim, sharing risk.
Interest rate rises: effect on saving, borrowing and investment: Saving rises (higher reward), borrowing falls (higher cost), and investment falls because fewer projects beat the cost of the loan. A fall does the reverse.
A saver has £2,000. The rate rises from 3% to 4%. A borrower has a £9,000 loan; the rate rises from 8% to 10%. Find each change.: Saver: £60 → £80, a gain of £20 a year. Borrower: £720 → £900, an extra £180 a year, or £15 a month. The same rate rise helps savers and hurts borrowers.
Compound interest formula: Balance = amount × (1 + rate)^years. Multiply by (1 + rate) once for each year. Simple interest for one year is just amount × rate.
A firm considers a project. How does it use the interest rate to decide?: Return = extra profit ÷ cost of the project × 100. Invest only if the return is above the interest rate on the loan. A higher rate means fewer projects pass the test.
Why does the financial sector matter to consumers, producers and government?: Consumers: safe saving, credit, mortgages, cover for loss (but debt can become unaffordable). Producers: loans to invest and payments. Government: can borrow, and the sector carries interest rate changes through the economy.
Exam trap: is the financial sector just a place to store money?: No. It enables saving, borrowing and investment, shares risk through insurance, runs the payments system, and transmits interest rate changes through the economy.
Insurance versus saving: Insurance pays out only if a loss happens; savings are yours to withdraw. A bank and a building society both take deposits and lend, but a building society is owned by its members.