Flashcards · 9214 · Topic 1

How markets work flashcards

71 cards on Topic 1, subtopics 3.1.1 to 3.1.6. Pick a subtopic or study them all.

Study mode needs JavaScript. Every card is listed below, so you can still cover the answers and test yourself.

All 71 cards

For a quick read-through or printing. Cover the right-hand side to test yourself.

3.1.1 Economic foundations

Need and want: what is the difference?: A need is something required to survive or function at a basic level. A want is something people would enjoy having but can manage without. Both can change over time and between people.
Scarcity: Not enough resources to meet every want: the basic economic problem.
Opportunity cost: The benefit of the best alternative forgone when a choice is made.
A customer can spend 5,000 on a car or 3,000 on a trip, but not both. They choose the car. What is the opportunity cost?: The trip, worth 3,000 to them. Opportunity cost is only the next best option forgone, never the total of all the alternatives.
Economic resource: A scarce input with alternative uses, used to produce goods and services.
The three key decisions every economy must make: What to produce, how to produce it, and who benefits (who gets the output).
The four factors of production and the reward to each: Land: rent. Labour: wages. Capital: interest. Enterprise: profit.
Exam trap: is money a factor of production?: No. Capital means equipment made to produce other goods (ovens, vans, factories), not money. Money is a means of payment.
A carpenter can make 2 desks or 6 chairs a day. What is the opportunity cost of 1 desk, and of 1 chair?: 1 desk costs 6 ÷ 2 = 3 chairs. 1 chair costs 2 ÷ 6 = 1/3 of a desk (about 0.33).
How to produce: method X costs 900 a day for 450 units; method Y costs 1,260 a day for 840 units. Which is cheaper per unit?: X: 900 ÷ 450 = 2.00 per unit. Y: 1,260 ÷ 840 = 1.50 per unit. Y has the lower cost per unit. Then check what could change the answer, such as breakdowns, training or uncertain demand.
The central purpose of economic activity: Production, to meet needs and wants.

3.1.2 Resource allocation

Market: Buyers and sellers interacting to establish a price.
Product market: Households buy goods and services from firms.
Factor market: Firms buy land, labour, capital and enterprise; households sell their labour and receive wages.
How does the price mechanism move resources to a product when demand for it rises?: Demand rises → price rises → profit rises → firms hire more factors of production → more of the scarce resources move into making that product. A rising price signals scarcity, attracts producers and rations buyers.
Primary, secondary and tertiary sectors, with an example of each: Primary: extracting natural resources (mining, fishing, farming). Secondary: manufacturing, processing and construction (furniture factory, builders). Tertiary: services (retail, banking, health).
Good versus service: A good is tangible: it can be stored and owned. A service is intangible and is usually used as it is provided.
Give three reasons why an economy's output and jobs may shift towards the tertiary sector: Higher incomes (more spending on services), mechanisation of farming (fewer primary jobs needed) and depletion of natural resources.
Primary jobs are 60 out of 200 in year 1 and 50 out of 250 in year 2. What is the change in the primary share?: Year 1: 60 ÷ 200 = 30%. Year 2: 50 ÷ 250 = 20%. The share fell by 10 percentage points (not "10%").
Specialisation: Concentrating on a limited range of tasks, products or services.
Division of labour: Splitting production into separate tasks, each done by one worker. It is specialisation by task within a firm.
Division of labour: one benefit and one cost for the worker, and for the firm: Worker: more skill, speed and possibly pay; but boredom, narrow skills and redundancy risk. Firm: more output and lower unit cost; but the whole line stops if one task fails, and staff turnover may rise.
Exports total 300 million, 210 million from one product. That product's price falls 20%. By what percentage do total export earnings fall?: Product earnings: 210 × 0.8 = 168. Total: 168 + 90 = 258. Fall: 42 ÷ 300 = 14%. The more concentrated a country's exports, the bigger the risk from specialising.

3.1.3 How prices are determined

Demand: The amounts buyers will actually take, with money to pay, at each price in one period.
Movement along a demand curve versus a shift of the curve: A change in the good's own price gives a movement along the curve: an extension (price falls) or a contraction (price rises). A change in any other factor shifts the whole curve: right is an increase in demand, left a decrease.
Factors that shift the demand curve: Income, tastes and advertising, prices of related goods (substitutes and complements), population, expectations, and seasons or events.
Factors that shift the supply curve: Costs of production, technology, indirect taxes and subsidies, the number of firms, weather and natural events, and expectations. A tax shifts supply left; a subsidy shifts it right.
What happens when the price is above, and below, equilibrium?: Above: excess supply (a surplus); unsold stock forces the price down. Below: excess demand (a shortage); buyers compete and the price rises. Quantities adjust until demand equals supply.
Effect on equilibrium price and quantity of: a demand increase, a demand decrease, a supply increase, a supply decrease: Demand increase: price up, quantity up. Demand decrease: price down, quantity down. Supply increase: price down, quantity up. Supply decrease: price up, quantity down.
Demand rises and supply falls at the same time. What can you say about price and quantity?: Price definitely rises. Quantity may rise or fall: it depends on the relative sizes of the two shifts.
Substitutes and complements: if the price of A rises, what happens to demand for B?: Substitutes (goods meeting the same need): demand for B rises, a shift right. Complements (goods used together): demand for B falls, a shift left.
Price elasticity of demand (PED): formula. Price rises from 20 to 24 and sales fall from 600 to 540. Find PED.: PED = % change in quantity demanded ÷ % change in price. Price +20%, quantity −10%, so PED = −10 ÷ 20 = −0.5 (inelastic). Revenue rises from 12,000 to 12,960.
PED and total revenue: what does a price rise do to revenue when demand is elastic, inelastic or unit elastic?: Elastic (size above 1): revenue falls. Inelastic (below 1): revenue rises. Unit elastic (equal to 1): revenue unchanged.
Factors that affect PED: Number of substitutes (more = more elastic), necessity or luxury, proportion of income spent, time (longer = more elastic), habit or addiction (less elastic), and how broadly the market is defined (broader = less elastic).
Cross elasticity (XED) and price elasticity of supply (PES): formulas and how to read them: XED = % change in demand for A ÷ % change in price of B. Positive: substitutes; negative: complements; near zero: unrelated. PES = % change in quantity supplied ÷ % change in price; above 1 elastic, below 1 inelastic. Supply is more elastic in the long run.

3.1.4 Production, costs, revenue and profit

Fixed cost and variable cost: Fixed cost does not alter as output alters in the short run (rent, loan repayment). Variable cost changes with output (materials, packaging, piece-rate pay).
Formulas: total cost, average (total) cost, total revenue, profit: TC = TFC + TVC. ATC = TC ÷ output = AFC + AVC. TR = price × quantity sold. Profit = TR − TC (a loss if negative).
TFC = 900, TVC = 2,100, output 300, price 14. Find TC, ATC and profit.: TC = 900 + 2,100 = 3,000. ATC = 3,000 ÷ 300 = 10 (AFC 3 + AVC 7). TR = 14 × 300 = 4,200. Profit = 4,200 − 3,000 = 1,200.
Production versus productivity: Production is the total quantity made. Productivity is output per worker (or per hour). Output can rise while productivity falls: 15 workers making 90 units (6.0 each) → 18 workers making 99 (5.5 each), productivity down 8.3%.
Productivity and labour cost per unit: a worker is paid 600 a week. What happens to labour cost per unit if output rises from 120 to 150?: It falls from 600 ÷ 120 = 5.00 to 600 ÷ 150 = 4.00 a unit. Higher productivity lowers unit cost, leaving room for lower prices, higher wages or more profit.
Economies of scale and diseconomies of scale: Economies of scale: unit (average) cost drops as the firm raises output. Diseconomies of scale: unit cost climbs once the firm has grown too large.
Five types of economy of scale, each with a reason: Managerial: specialist managers. Purchasing: bulk-buying discounts. Financial: cheaper, easier loans. Technical: large machines and mass production. Risk-bearing: many products and markets spread risk.
Causes of diseconomies of scale: Communication and coordination problems, slow decisions, workers feeling remote and losing motivation, and loss of managerial control. All raise average cost.
Total cost is 24,000 at 2,000 units, 33,000 at 3,000 and 52,000 at 4,000. Where are there economies and diseconomies of scale?: Average cost: 12.00, 11.00, then 13.00. AC falls from 2,000 to 3,000 units (economies of scale), then rises to 4,000 (diseconomies). Read average cost, not total cost, which rises throughout.
A market grows from 40,000 to 44,000 units; a firm's sales rise from 6,000 to 7,150. What happens to its market share?: Market share = firm's sales ÷ market sales × 100. Before: 6,000 ÷ 40,000 = 15%. After: 7,150 ÷ 44,000 = 16.25%. Its sales grew 19.2% against market growth of 10%, so its share rose.
Business objectives: name three, and one way they can clash: Profit, sales growth and market share. Low prices can raise sales and market share but cut profit per unit.
Ethical behaviour by producers: costs and benefits: Conflicts include low pay, unsafe conditions, pollution and misleading advertising. Acting ethically may raise costs in the short run but protect reputation, loyalty and recruitment in the long run. The effect depends on how price-sensitive customers are and how competitive the market is.

3.1.5 Competitive and concentrated markets

Market structure: the three factors used to place a market on the range: The number of producers, the degree of product differentiation and the ease of entry. Markets lie along a range from competitive to non-competitive, not in two boxes.
Characteristics of a competitive market: Many producers, similar products or small differences, easy entry and exit, and buyers who can compare and switch. No single firm controls the price.
Why are profits usually lower in a competitive market?: High profit → easy entry attracts new firms → more supply → lower price → lower profit.
Monopoly and oligopoly: Monopoly: a single producer in the market (loosely, a firm with a very large share). Oligopoly: a market dominated by a small number of large producers, who are interdependent: each must predict rivals' reactions before it acts.
Causes of monopoly and oligopoly power: High start-up costs, economies of scale, legal protection (patents, licences), brand loyalty, control of supplies or outlets, mergers and takeovers, and successful growth.
Why do oligopolists often prefer non-price competition?: If one firm cuts its price, rivals match it to avoid losing sales, so every firm earns less per unit (a price war). Competing on branding, quality, service and advertising avoids this.
Monopoly: possible harm and possible benefit for consumers: Harm: higher prices, lower output and less choice; possibly lower quality and slow innovation. Benefit: lower prices if economies of scale are passed on; high profit can fund investment. A monopoly "can" charge more; it does not always.
In a market of 240,000 units two firms sell 48,000 and 36,000. What is their combined market share?: 48,000 ÷ 240,000 = 20% and 36,000 ÷ 240,000 = 15%, so 35% combined.
Derived demand: Demand for labour that depends on demand for the product the labour makes.
What shifts the demand for labour, and what shifts the supply of labour, to the right?: Demand: higher demand for the product, higher productivity, dearer machines, more firms. Supply: more training places, more working-age people or migration, lower pay in other jobs, better conditions. A change in this job's own wage is only a movement along.
A wage is set above equilibrium (for example by a union deal or a legal minimum). What happens?: Firms hire fewer workers while more people want the job, so there is a surplus of labour: unemployment in that job. Those who keep jobs earn more. A wage below equilibrium gives a shortage and vacancies.
Reasons for wage differentials between occupations: Long or costly training and licences (lower supply), high productivity or valuable output (higher demand), danger or unsocial hours, strong unions, immobility of labour, and plentiful unskilled labour keeping some pay low.

3.1.6 Market failure

Market failure: The market system cannot allocate resources efficiently.
Misallocation of resources: Resources are in the wrong uses, so society gets less than it could from scarce resources.
Social cost and social benefit: formulas: Social cost = private cost + external cost. Social benefit = private benefit + external benefit. Example: private cost 30 per unit plus external cost 12 gives a social cost of 42.
Negative externality: why does the market over-produce?: Private cost is below social cost. The producer ignores the external cost, so supply is higher than the social best: price is too low and output too high. Resources are misallocated towards the good, causing a welfare loss.
Positive externality: why does the market under-produce?: Private benefit is below social benefit. Buyers ignore the external benefit, so demand is below the good's value to society: price and output are too low. Resources are misallocated away from the good.
Negative externality diagram, in words: The social cost curve lies above the private cost (supply) curve. The social optimum is at a lower output and higher price than the market equilibrium. The vertical gap between the curves is the external cost.
Give an example of a negative production, negative consumption, positive production and positive consumption externality: Negative production: factory smoke over a village. Negative consumption: litter dropped after a takeaway meal. Positive production: trees planted by a farm that cool nearby land. Positive consumption: a front garden neighbours enjoy.
Private vs social: Social includes the effect on everyone else.
Market failure vs high prices: A high price is not market failure on its own.
Best output vs zero output: Removing all pollution is rarely the social optimum.
Methods of government intervention to correct market failure, each with its main limit: Tax (hard to set the right level), subsidy (taxpayers pay), regulation or bans (enforcement cost), direct provision (uses public funds), information and education (slow, uncertain).
Why may a tax on a good with inelastic demand do little to cut consumption?: With inelastic demand the price rise cuts quantity only slightly (e.g. PED −0.4 and a 10% price rise gives only −4%). Tax revenue is healthy but consumption barely moves. So the effect depends on PED.