Summary

14 May 2017 16:55

Definition
Positive Normative
- Objective -Subjective
- Can be Tested - Cannot be Tested
- Based on Fact - Based on Value Judgment
Excess Supply: More of a product is produced than demanded.
Excess Demand: More of a product is demanded than is produced.
Ad Valorem Tax: A percentage tax of the cost of a unit and thus leads to a pivotal shift.
Bonded Rationality: Our decision making is restricted by incomplete information, an inability to process this information and limited time.
Consumer Surplus: The difference between the price a consumer was willing to pay for a good or service and the market price.
Cross Elasticity of Demand: A measure of responsiveness of demand for a good (X) following a change in price of another good (Y).
Demand: The Quantity of goods or services consumers are both willing and able to buy at a given time.
Demerit Goods: Overproduced and overconsumed these are goods which are negative for society.
Division of Labour: The process of splitting up the production process and allocating each task to a different warden.
Effective Demand: Situation where a consumers desire to buy is back by s financial ability to pay for it.
Elastic in Supply: A more than proportionate change in supply following a change in price.
External Benefit: The positives that accrue to a third party by consuming or producing a good or service
External Costs: The costs that accrue to the third parties that are outside of the decision to consume or produce that good or service.
Externalities: Positive or negative good affecting a third party when the good is produced or consumed by an individual.
Heuristics: Making decisions based upon a rule of thumb or cognitive shortcut.
Income Elasticity of Demand: The measure of the responsiveness in demand for a good or service following a change in income.
Indirect Tax: A charge or levy applied on production or consumption of goods and services, used to raise prices / increase production cost or reduce output of the good.
Inelastic in Supply: A less than proportionate change in supply following a change in price.
Inferior Good: An increase in income will result in a decrease in demand for these goods
Market Equilibrium: The state at which demand and supply are equal and thus prices are stable.
Market Failure: Occurs when the free markets lead to an inefficient allocation of resources, this is when government intervention is requiredto bring about economic efficiency and improve social welfare.
Merit Goods: Underproduced and underconsumed, these are goods which benefit society not just individuals.
Need: The minimum that is required for an individual to survive, i.e. food, water etc.
Negative Externality: The consumption or production of a good is negative for a society thus a 3rd party is affected.
Normal Good: An increase in income will result in an increase in demand for these goods
Positive Externality: When the consumption or production of a good or service results in a net social benefit
Price Elastic: A change in the price of a good or service will lead to a more than proportionate change in the quantity of that good or service demanded.
Price Elasticity of Supply: A measure of responsiveness of supply to a change in price.
Price Elasticity: A measure of the responsiveness of demand following a change in price of a good or service.
Price Inelastic: A change in the price of a good or service will lead to a less than proportionate change in the quantity of that good or service demanded.
Private Benefit: The positives that accrue to the individual by consuming or producing a good or service
Private Costs: The costs that accrue to the individual economic agent.
Producer Surplus: The difference between the price that a producer is willing to sell a good for and the actual revenue they receive (market price)
Production Possibility Frontier: Shows the combinations of economic goods which an economy is able to produce if all resources in the economy are fully and efficiently employed.
Public Goods: Goods for which it is impossible to stop others benefitting from it, once it is consumed by one person. This causes a free rider problem. (Street lights, flood defences, etc.)
Rational Theory: Individuals act in their own self-interest and make logical and consistent decisions to maximise satisfaction.
Regulation: Legally enforced laws by the government to control the production or consumption of a good or service.
Social Benefit: The positives that accrue to a society by consuming or producing a good or service
Social Costs: The costs that accrue to society as a whole thus including private and external costs.
Specialisation: Refers to the individual firms or economies deciding to focus on the production of one good or part of a good.
Subsidy: A sum of money granted by the state or a public body to help an industry or business keep the price of a commodity or servicelow.
Supply: The quantity of a good or service that produces are willing and able to sell at a given price at a given point in time.
The Fundamental Economic Problem: There are unlimited wants for limited resources, therefore scarcity exists.
The Law of Demand: Ceteris Paribus - as the price of a good or service increases the quantity demanded falls; likewise as the price of a good or service falls thequantity demanded increases.
The Law of Diminishing Marginal Returns: Increasing the production of a good or service will increase the output of said good or service but at a diminishing rate.
The Law of Diminishing Marginal Utility: The value, or utility, attached to consuming the last product bought falls as more units are consumed over a given period of time.
The Law of Supply: As the price of a good rises the quantity supplied also rises and vice versa.
Want: The desires of individuals of the consumption of goods & services. Economists believe individual wants are unlimited.

Equation

Factors
Factors of Production
• Land - What we grow
- What we extract
- Both land and sea included
- Where factories, shops etc. are placed.
• Labour - Human capital
- Skills possessed
• Capital - Manmade aspects of production
- Machinery
- Infrastructure
• Entrepreneurship - Individuals who organise and manage land, capital and labour.
- In order to produce goods & services.
- Takes risks in order to make profits.

Advantages and Disadvantages of the Division of Labour:

Advantages Disadvantages
• Individuals • Individuals
- Repetition of a single task makes individuals experts. - Monotonous and Repetitive can cause a fall in productivity
- Requires a minimal range of skills to complete a singular task - Lack of mobility between sectors
• Firms • Firms
- Output increases - High staff turnover due to monotony
- Less training time & money spent - Difficult to coordinate as firm grows.

Dependencies of Demand:
Income Prices of Other Goods Population Trends Legislation Advertising
Demand for a normal good rises when incomes A rise in price of one good may cause a rise in Increase in population As fashion trends change The demand for seatbelts and Influences

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Demand for a normal good rises when incomes A rise in price of one good may cause a rise in Increase in population As fashion trends change The demand for seatbelts and Influences
rise demand for another good increases demand demand varies cigarettes has been affected by consumers' choices
Demand for inferior goods decreases when legislation
incomes rise

Non-Price Factors Affecting Supply:

At a given price, P, the supply curve may shift due to:
• Costs of Production - Workers' Wages
- Rent
- Change in price of raw materials
• Technologies - Changes rate of output
• Other Ventures - Focus of resources change
• Government Intervention - Tax on a good causes a decrease in supply
- Subsidy on a good causes an increase in supply
• Weather (industry Dependent) - Agricultural issues (Can wipe out supply)

Factors of Price Elasticity

• Number and Closeness of Substitutes The more substitutes that exist, the more price elastic a good or service will be and vice versa.
• Degree of Necessity There are some goods and services that we need to survive so will continue to be bought despite a higher price, addictions can also be a factor.
• Producer Definition A widely defined product (meat) may be more price inelastic than a narrowly defined product (beef), which may be more elastic.
• Percentage of Income The greater the proportion of income a product is, the more price elastic it is.
• Time Period In the short term, goods & services are more price inelastic due to one's inability to change consumption habits.

Interpreting Price Elasticity of Demand

P.E.D. > 1 Elastic
P.E.D. < 1 Inelastic
P.E.D. = 0 Perfectly Inelastic
Perfectly Elastic
Unit Elastic

Benefits of Calculating the P.E.D. for Firms:

• Deciding Price Strategy Firms are able to predict what happens to total revenue following a change in price
• Price Discrimination Firms are able to charge different prices to different sections of the market. i.e. charging off peak (elastic) and peak (inelastic) train or plane tickets
• Non-Price Policy Firms influence the elasticity for a product through non-price marketing such as advertising to create brand loyalty

Interpreting the X.E.D

Goods X & Y are substitutes
Goods X & Y are complements
Goods X & Y are close substitutes
Goods X & Y are weak substitutes
With small negative numbers (-1, -2, -3 etc.) Goods X & Y are weak compliments
X.E.D. with large negative numbers (-50, -70, -100, etc.) Goods X & Y are close compliments

Interpreting Income Elasticity of Demand:

Normal Good: An increase in income will result in an increase in demand for these goods
(i.e. more than proportional increase in demand due to increase in income.) Luxury Good
(i.e. less than proportional increase in demand due to increase in income.) Necessity Good
Inferior Good: An increase in income will result in a decrease in demand for these goods

Determinants of P.E.S.
• Spare Capacity A firm working at less than maximum level of production, i.e. it has a lot of space capacity, will be able to quickly increase output, thus supply is more elastic.
• Availability or Ease of Factors of Production If firms are able to easily purchase more factors of production or if existing factors of production can be utilised in a different way then supply is more elastic
• Time Period In the short run, firms may be unable to increase their factors of production (inelastic). In the long run firms may be able to do so with greater ease (elastic)
• Costs If total costs rise significantly with the increase in supply then the producer may be less willing to increase supply (inelastic). However if total costs do not rise
by much then there is a greater incentive for producers to increase supply (elastic)

Interpreting Price Elasticity of Supply

P.E.S. > 1 Elastic
P.E.S. < 1 Inelastic
P.E.S. = 0 Perfectly Elastic
Perfectly Inelastic
Unit Elastic

Functions of Price
Signalling Function
Rationing Function
Incentive Function
Changes in price provide information to both consumers and producers about changes in market conditions.
If price was increased it would show consumers that the good is of a high quality or that it is fashionable, this causes an increase in demand.
Changes in supply of a good or service will be reflected by changes in price, which may either incentivise or discourage demand.
If price increased suppliers show that there is a lack of supply
Changes in price act as an incentive to either supply or demand a good or service.

The Purpose of Money

• Store of Value Money can be saved or spent. Individuals can 'smooth' their spending.
• Unit of Account Money is a standardised unit of measurement of the value of a good or service.
• Medium of Exchange Money allows consumers and producers to exchange goods and services in a convenient way to avoid double coincidence of wants.

Theories of Irrationality: Explanation Example

• Availability Bias Judging a situation based on how readily available one remembers instances of its Student does poorly in an exam so is convinced he always does badly.
occurrence.
• Anchoring Effect Focusing on one value or price to inform one's decision about something else In restaurants when highly overpriced goods are placed next to overpriced goods to
make them appear cheaper.
• Gamblers Fallacy Believing that a repeated pattern of outcomes must be reversed at some point. If one constantly makes good investments in a company that 'must' change at some
point.
• Optimism Bias Those that are successful in life can be overconfident in making decisions Someone who wins the lottery may invest it all poorly resulting in loss
• Status Quo Bias Making decisions based upon routine and remaining unchanged Constantly buying a cup of coffee in the morning despite rising price
• Confirmation Bias Selecting information which matches your own perception of something Buying a newspaper whose views and opinions match your own
• Herd Behaviour Making a decision based on the actions of those around you Selling your shares because others are selling their shares.
• Altruistic Bias Making decisions in the interest of others Giving to charity.

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• Altruistic Bias Making decisions in the interest of others Giving to charity.

What does the Free Market do well?

• Resource Allocation Allocated effectively through the price mechanism
• Competition Between firms drives efficiency and reduce prices, improves quality and variety
• Consumer Sovereignty Consumers determine what is produced
• Greater Innovation Producers aim to maximise market share
• Excess Prices change in order to remove excess
• Variety Greater variety in goods and services boosts standard of living

What does the Free Market do badly?

• Uncompetitive Markets Monopolies form and restrict output and control prices
• Merit Goods Underproduced and under consumed due to lack of benefit for firms and consumers
• Externalities These exist due to no restrictions
• No Public Goods Due to no government spending people would not benefit from public goods
• Demerit Goods These are overproduced because they have high desirability and therefore profit for firms
• Wealth and Income Inequality This grows due to monopolies and centralisation of market sectors

Costs of Smoking
Private External
- Loss of money - Second hand smoke
- Health Problems - Environment
- Unattractive - NHS pressures
- Addiction - Smell
- Bad Teeth - Litter
- Orange Fingers - Possible Pollution

Characteristics of a Public Good

• Non-Rival The consumption of a good or service by one person does not inhibit or reduce another person's benefit from this good or serv ice.
• Non-Excludable It is impossible to prevent an individual from benefitting from a good or service even if they have not contributed towards i ts provision
• Market Failure Occurs when under the free market no one would buy a public good and instead would wait for someone else to do so. There is n o profit to be made therefore a
missing market.

Types of Information Failure

Asymmetric Information Exists when either the producer or the consumer has a different level of knowledge about a good or service from one another.
Imperfect Information Exists when the producer or consumer is not fully aware of the true extent of the external benefit or cost of a good or servi ce
Healthcare Private healthcare utilises asymmetric information to increase profits as customers lack the information in relation to treat ments.
Finance The cause of the financial crisis was down to information failure, between both parties in the financial sector and between m ortgage lenders and borrowers
University Application (Non- You as an individual know your ability but the university only has the interview, personal statement and application to under stand your ability.
Economical)

The Graph Explained

- The introduction of a tax increases the cost of production shifting the curve from to
- This shift causes an increase in price to
- Causing a decrease in the quantity demanded to .
- The tax internalises the externality (the producers pay for the change in cost of production)
- This would cause the externality and external loss to be paid for by the producer.

Effects of a Tax:
• Producer:
- Higher costs of production
- Lower revenue
- Cuts to be made (employees, lower investment)
- If an elastic good:
 Revenue Decreases
- If an inelastic good:
 Revenue Increases
• Consumer:
- Higher prices
- People become poorer
- Or people buy less of the good
- Sometimes consumers have to pay for the tax
- Consumers are notified of this
• Government:
- Revenue increases
- (Revenue can stay the same depending on whether it is an elastic or inelastic good)

Taxation Points of Evaluation

• PED Will determine how much the consumer or the producer pays. With price inelastic goods, the taxes are less effective as the producer can pass on cost to consumer
• Indirect Taxes Regressive rates and hit lowest income individuals hardest and thus increases inequality
• Administration Costs Monitoring and collecting tax revenue is expensive
• Tax Revenue Hypothecated and used to subsidise and invest in alternatives

Effects of a Subsidy:
• Producer:
- Cheaper production
- More profit
- More demand
- Increase factors of production
• Consumer:
- Lower prices thus greater demand
- One can buy more
- Better standard of living
- Purchasing power increases
• Government:
- Less tax revenue
- Greater Opportunity Cost

Advantages of Maximum Price Controls Disadvantages

- Protects low income individuals promoting equality - Can lead to black (informal) markets so producers can get the market price
- Does not allow producer to exploit the consumer on - Can disadvantage the supply of a good or service as the profit motive is reduced.

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 - Does not allow producer to exploit the consumer on - Can disadvantage the supply of a good or service as the profit motive is reduced.
an inelastic good or service

Advantages of a Minimum Price Scheme Disadvantages

• Producers: • Producers:
- Cannot be exploited - Firms choose not to buy from the more expensive producers
- Stable income - Because it is optional
- Can lead to increased investment in the market
• Firms: • Firms:
- Pass on extra cost to consumers - Costs of production increase
- on’t buy from (fair trade) producers - Less demand for goods
• Consumers: • Consumers:
- Feeling of doing good - Increased prices
- Less demand
- Or people come out poorer

Positives of Carbon Trading Negatives

• Trading sulphur dioxide permits has limited levels of acid rain • Supply must be harshly limited to promote scarcity
• Easily implemented • Permits have been given away for free (collapse in price)
• Removes need for direct regulation which is expensive • There is an excess in supply therefore price is low

Positives of State Provision Negative of State Provision

- Equality in terms of access to the service - Opportunity cost for the government
- Promotion of merit goods with positive externalities - Competition brings about greater incentives to be efficient
- Government has full control of the quality of the
provision.
- Greater choice for consumers

Situations of Government Intervention:

• Weak Competition - Monopolies form who can set very high prices meaning fewer incentives to offer choice and innovation (Rockefeller)
- Collusion can lead to the same results plus removal of new competition
• Lack of Information - Firms face less competition if consumers have inadequate information to help them make the best decision foe their needs (Medical Decisions)
• Social Objectives - Essential services are provided by governments or a provided by firms which are forced to by governments.

Market Systems:
• Free Market Economy - Limited role of state and whereby the forces of supply and demand lead to the allocation of resources
- Markets will regulate themselves via the 'invisible hand' and will decide what is morally right
- Associated with pure capitalism.
• Mixed Economy - A mixture of government intervention and the market system
- Private ownershiop of means of production with regulation from the state
- Associated with capitalism (real world)
• Command Economy - Large role of the state who own the means of production.
- The state decides what to produce, how it is produced and for whom it is produced.
- State decides upon the wages of workers and the prices of goods and services
- Associated with communism

Advantages Disadvantages
Free Market
- Encourages competition between firms thus increasing quality and decreasing price - Existence of monopolies
- Encourages innovation and entrepreneurship - Inequality
- Negative Externalities
- Boom and Bust Cycles

Command
- Equality of Income - Industries are inefficient due to no profit motive
- Control of prices for necessary goods - Low standards of living due to low domestic food production
- Minimises market failure
- No economic crises

Important
In order to reach market equilibrium a change in price is required.
If there is excess demand price must increase to reach equilibrium
If there is excess supply price must decrease to reach equilibrium
The increase in population will lead to an outward shift in the demand curve causing an increase in both price and quantity demanded. This is a non-price factor.
The rise in price will lead to a movement up the supply curve as producers are more willing to supply a higher quantity at the higher price. This is a price factor.
A negative externality exists when the social cost > private cost.
A positive externality exists when the marginal social benefit > marginal private benefit
Ceteris Paribus, nothing affects supply but price. Any change in price would result solely in a move along the supply curve.
Decreasing Price on an Elastic Good Raises Revenue
Decreasing Price on an Inelastic Good Lowers Revenue
Econs: Individuals who make perfect calculations and can forecast the future well and have all information available to them.
Humans Individuals who are human and make mistakes.
If an external benefit exists then Marginal Social Benefit > Marginal Private Benefit.
If an external cost exists, then Marginal Social Cost must be greater than Marginal Private Cost.
If demand increases consumer surplus increases and vice versa.
If market price increases consumer surplus decreases and vice versa.
If market price increases producer surplus increases.
If no external benefit exists then Marginal Social Benefit = Marginal Private Benefit.
If no external cost exists, then Marginal Social Cost must equal Marginal Private Cost.
If supply increases producer surplus decreases
Increasing Price on an Elastic Good Lowers Revenue
Increasing Price on an Inelastic Good Raises Revenue
Price elasticity of Demand changes over time and is very difficult to calculate, therefore firms work only on an estimation or predictions.
The maximum price line is always below the free market equilibrium price (which the government deem to be too high.)
The minimum price line is always above the free market equilibrium price (which the government deem to be too low)
The point at which the demand curve intersects the y-axis is the maximum price a consumer is willing to pay for a product.
With a maximum price there is excess demand because more people are both willing and able to buy more products but producers are less willing or less able as they make less profit.

With a minimum price there is excess supply as fewer people are willing and able to buy the product but producers are more willing and able as they make more profit.

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Diagrams
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PPF:

Diminishing Marginal Returns:

Demand:

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Supply:

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Consumer & Producer Surplus:

Disequilibrium:

Price Elasticity of Demand:

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Revenue:

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Cross Elasticity of Demand:

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Income Elasticity of Demand:

Price Elasticity of Supply:

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Negative Externalities:

Positive Externalities:

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Indirect Tax:

Ad Valorem Tax:

Incidence of Tax:

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Subsidy:

Maximum Price Controls:

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Minimum Price Controls:

Fixed Supply Goods & Services (Pollution Permits):

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