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Demand: the quantity of a good or service that consumers are willing and able to purchase at a given price in a particular time period
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Law of demand: quantity demanded increases when prices decrease and vise versa
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ASSUMPTIONS
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Income effect: lower price = higher income = higher demand
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Substitution effect: consumers replace higher priced products with lower priced ones.
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Diminishing marginal utility: as consumption increases, the satisfaction gained from consuming one additional unit of a product decreases.
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Future price expectations
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Income
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Tastes and preferences
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Price of related goods (substitutes)
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Price of related goods (complementary)
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Number of consumers
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Supply: quantity of goods and services that firms are willing and able to sell at any given price
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Law of supply: As price increases, supply increases
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ASSUMPTIONS
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Diminishing marginal returns: after some optimal level of capacity is reached, adding an additional factor of production will actually result in smaller increases in output
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Increasing marginal costs: firms are willing and able to increase production only if they receive a higher price for the additional units of output.
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Costs of factors of production
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Price of related goods
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Indirect taxes
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Subsidies
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Future price expectations
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Changes in technology
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Market equilibrium: When the quantity demanded for a product is equal to the quantity supplied of the product
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Equilibrium price: the point where the demand for the product matches the supply of the product
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Market disequilibrium: when the quantity demanded for a product is either higher or lower than the quantity supplied for the product
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Excess supply: e price of a product is set above equilibrium price, creating a surplus in the market represented by the higher quantity supplied than demanded
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Excess demand: price for a product is set below equilibrium price, resulting in a higher demand and a lower supply
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The price mechanism: the interactions between buyers and sellers in order to allocate resources, therefore determining production and consumption choices
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Signalling function: aspect of the price mechanism that signifies to producers and consumers where resources are required
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Incentive function: as price changes, the mechanism provides an incentive for producers and consumers to change their behaviour in order to maximize their benefits
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Rationing function: Higher prices, lower the quantity demanded therefore helping to preserve the good or service
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Consumer: Benefit to buyers who can purchase the product at a lower price than they were willing and able to pay
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Producer: Benefit to firms who receive a price that is higher than the price at which they were willing to supply at
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Social: Sum of consumer and producer surplus at a given market price and output, thereby maximizing economic welfare
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decision-making process based on the assumption that people make choices that result in the optimal level of benefits
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ASSUMPTIONS
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Consumer rationality
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Utility maximization
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Perfect information
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LIMITATIONS
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Biases (rule of thumb, anchoring, framing and availability)
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Bounded rationality
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Bounded self control
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Bounded selfishness
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Imperfect information
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Choice architecture: the deliberate design of different ways of presenting choices to members of society, and the impact of these methods on decision-making.
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Nudge theory: the practice of influencing the choices that people make. Nudges are created by choice architects using small prompts or tweaks to alter social and economic behaviour, but without taking away the power for people to choose.
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profit maximization: Sales level where profits are the highest
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CSR: commit ethical objectives to benefit stakeholders
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Market share: a firm's portion of the total value of sales revenue
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Satisfaction: aim for a satisfactory or adequate level or profit
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Growth: increasing the size and scale of operations of a firm
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The responsiveness of quantity demanded for a good in relation to a change in the price for the product
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Price elastic: if a slight change in the price or income leads to a large change in the demand for the product.
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Price inelastic: if a change in price or income has little impact on the demand for a good or service.
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Formula: PED = % change in QD / % change in price
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DEGREES OF PED VALUES
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PED > 1 → price elastic demand
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PED < 1 → price inelastic demand
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PED = 0 → perfectly price inelastic demand
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PED = ∞ → perfectly price elastic demand
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PED = 1 → unitary elastic demand
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The degree of responsiveness of quantity supplied of a product due to a change in its price
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Formula: PES = % change in quantity supplied / % change in price
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DEGREES OF PES VALUES
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PES > 1 → price elastic supply
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PES < 1 → price inelastic supply
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PES = 0 → perfectly price inelastic supply
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PES = ∞ → perfectly price elastic supply
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PES = 1 → unitary elastic supply
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The degree of responsiveness of demand following a change in income
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Formula: YED = % change in QD / % change in income
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YED SIGNS
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YED + < 1 → normal goods
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YED + > 1 →Luxury goods
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YED - → Inferior goods
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Earn government revenue
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Support firms
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Support households on low incomes
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Influence the level of production
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Influence the level of consumption
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To correct market failure
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Promote equity
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PRICE CONTROLS
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Government regulations establishing a maximum or minimum price to be charged for certain goods and services. They consist of price ceilings and price floors.
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price ceilings: limits the maximum price in order to encourage output and consumption.
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Price floor: binding minimum price in order to encourage production and supply
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INDIRECT TAXES
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A government levy or charge on the sale of goods and services, rather than on incomes or wealth.
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specific: charge a fixed amount of tax per unit sold
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Ad valorem: impose a percentage tax on the value of a good or service.
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SUBSIDIES
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a sum of money granted to help keep the price of a commodity or service low.
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DIRECT PROVISION
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Government provides certain goods and services deemed to be in the best interest of the public.
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Market failure: when the signalling, incentive and rationing functions of the price mechanism fail to operate optimally, which leads to a loss in economic welfare. It is when there is a misallocation of resources
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private benefits: advantages or gains of production and consumption enjoyed by an individual firm or person.
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Private costs: actual expenses incurred by an individual firm or person
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Social benefits: benefits of consumption or production, that is, the sum of private benefits and external benefits
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Social costs: costs of consumption or production, that is, the sum of private costs and external costs
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MPB: additional value enjoyed by households and firms from the consumption or production of an extra unit of a particular good or service.
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MPC additional expense of production for firms or the extra charge paid by customers for the output or consumption of an extra unit of a good or service
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MSB: total gains to society from an extra unit of production or consumption of a particular good or service
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MSC total expenses to society from an extra unit of production or consumption of a particular product
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The external costs or benefits of an economic transaction, causing the market to fail to achieve the socially optimal level of consumption and production
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Positive consumption: When consuming a good or service, provides a benefit to an unrelated third party
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Positive production: the positive effect an activity imposes on an unrelated third party
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Negative consumption: when consuming a good causes a harmful effect to a third party
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Negative production: the production process results in a harmful effect on a third party.
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INTERVENTION TO CORRECT EXTERNALITIES
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Indirect taxes, carbon taxes, education, international agreements, subsidies, direct provision
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Collective consumption goods that have two key characteristics of being non rivalrous and non excludable
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Non rivalrous: a person’s consumption of a public good does not limit the benefits available to other people.
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Non excludable: firms cannot exclude people from the benefits of consumption
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FREE RIDER PROBLEM
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When people have access to a good or service without having to pay for it. As a result, the good or service will be under provided or not provided at all in the free market
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A source of market failure that exists when one economic agent (buyer or seller) has more information than the other in an economic transaction. It occurs owing to incomplete information or inaccessibility to information.
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Adverse selection: the undesired decisions or outcomes that occur when buyers and sellers have access to imperfect information.
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Moral hazard: situation where a party protected from risk behaves differently than if they were fully exposed to the risk.
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GOVERNMENT RESPONSES
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legislation
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Provision of information
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PRIVATE RESPONSES
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Signalling: used by parties with access to more information to maximize their own level of satisfaction
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Screening: used by parties with access to less information to maximize their own level of satisfaction
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Cheatography n. The art of mapping complex subjects into clear, instantly navigable reference guides.
