Micro Economics revision cards

Economic problem: How to allocate scarce resources to fulfill unlimited wants.

Resources are limited in two ways:

1) Limited in physical quantity e.g. land has a finite quantity.

2) Limited in use e.g. labour and machinery - can only be used for one purpose at one time

Opportunity cost: relates to the loss of the next best alternative which is forgone when a choice is made.

Production possibility curv: a simple model to show the maximum combinations of two goods that can be produced using the existing resources efficiently.

Land- The natural resource, includes mineral deposits such as oil and coal, even rivers, lakes and the sun which are important for tourism.

Labour- Physical and mental work of people, less developed countries may have less skilled labour.

Capital- This is the physical resources that can be regarded as anything man made. Factories, machinery, vehicles and infrastructure are examples.

Entrepreneurship- A particular form of human capiital. Enterprise is the ability to organise the forms of resource and is also the ability and inventiness of those prepared to task risks.  

Specialisation - when we concerntrate on a product or a task. Specialisation happens at all suffciencies.

+ higher output
+variety of products
+bigger market
+competition and lower prices

Division of labour- occurs when production is broken down into many seperate tasks. Division of labour raises output per person as people become proficient through constant repetition of tasks "learning by doing".

+lowers cost per unit
+means production is more efficient
+means workers get good at a particular task

-unrewarding repetitive work - requires little skill or motivation
-some workers recieve little training - cannot get a job out of this field
-mass produced goods can lack variety 

Market- A place where buyers and sellers meet to exchange goods and services

How do markets allocate resources? 

The price mechanism. In general if a good becomes scarcer the price will rise if it becomes less scarce the price will fall. 

Producer surplus- The difference between the price a firm is willing to supply a product for and what price the product actually sells at. 

Demand- The quantity of a good or service that consumers are willing and able to buy at a given price and in a given time period.

THERE IS AN INVERSE RELATIONSHIP BETWEEN THE PRICE OF AN ITEM AND THE QUANTITY DEMANDED

The demand curve- Shows the relationship between the price of an item and the quanitity demanded over a period of time. 

Determinants of demand:

• tastes/ preferences
• number of consumers in the market 
• the income of the consumers in the market
• prices of related goods
• future expectations of the price of the good

Consumer surplus- the difference between the amount that consumers are willing and able to pay for a good or service above the market price of that good or service.

Right shift in demand - causes higher consumer surplus

Right shift in supply - causes higher consumer surplus

Supply- the quantity of a product that a producer is willing and able to supply onto the market at a given price in a given period.

AS THE PRICE LEVEL RISES PRODUCERS EXPAND.

Determinants of supply:

• changes in costs of production
• government taxes or subsidies
• changes in climate or weather
• changes in a price of a subsitute or complementary product
• the number of producers in the market

The supply curve- a curve showing the relationship between the price of an item and the quanitity supplied over a period of time.

PED- Measures the responsivness of demand of a product to a change in price of that product.

% change in price
% change in quantity 

PED IS ALWAYS NEGATIVE

PED = -1>1 = inelastic demand
PED = 1< or -1> = elastic demand 

Factors affecting PED

• numer of close subsitutes
• necessity or luxury
• proportion of consumers income spent on that good
• time period allowed after change
• habitual consumption
• peak and off peak demand
• definition of a good or service

Inelastic- Change in prices causes a less than proportional change in quanitiy demanded.

Elastic- Change in price causes a more than proportional change in quanitity demanded.

Inelastic- a rise in price means a rise in revenue

Elastic- a fall in price means an increase in revenue

YED- measures the relationship between a change in quantity demanded for a good and a change in real income.

% change in quantity demanded
% change in income 

Normal goods- positive income elasticity of demand so when income rises demand rises

Inferior goods- negative income elasticty of demand so demand falls when income rises

XED- measures how demand for one good is affected by the change in price of another good

% change in demand for X
% change in price for Y

XED is positive- increase in price Y means increase in demand for X - SUBSITUTE GOOD

XED is negative- increase in price Y means decrease in demand for X - COMPLEMENTARY GOOD

PES- Measures the responsiveness of quantity supplied to a change in price over a given time period.

% change in quantity supplied
% change in price 

Factors affecting PES

• how long the production process is
• the time period looked at
• whether the product can be stored
• whether the supplier has the space capacity

Market failure- occurs when  the free market, left to its own devices fails to achieve allocative and productive efficiency.

Maket failure can occur for the following reasons

• negative externalities
• positive externalities
• imperfect information/ information failure
• merit goods
• demerit goods
• public / private goods

Externalities- an affect to a third party arising from an action that they weren't a part of.

Negative externalities- when social costs are higher than private costs

Social costs- private costs + external costs

Positive externalities- when social benefits are higher than private benefits

Social benefits- private benefits + external benefits

Merit goods- Goods that are better for the consumer than the consumer realises.

Consumption of merit goods generates positive externalities.

e.g. health services and education

Demerit goods- Goods that are worse for the consumer than the consumer realises.

Public goods- non exludable and non rival goods which are usually supplied by the government.

non excludable - where it is impossible to exclude or prevent anyone from using the good.

non rival - if a certain amount of people consume the good then another person using the good doesn't diminish the amount that the existing amount of people use. 

Public goods need to be provided centrally by the government.

Quasi public goods -  have only one characteristic of public goods e.g. either non-excludable or non- rival. 

FREE MARKETS WOULD FAIL TO PROVIDE PUBLIC GOODS BECAUSE THERE IS NO INCENTIVE TO PAY FOR THEM

Information failure- occurs when people have inaccurate, incomplete, uncertain or misunderstood data and so make potentially wrong choices not maximising their consumer welfare. 

• evaluating whether the information is trivial or has huge affects on individuals, a whole family or society as a whole
• the government may have to intervene in the market in some way if information failure becomes serious

Examples of information failure:

• misunderstanding the true costs or benefits of a product
• uncertainty about costs and benefits
• complex information
• inaccurate or misleading information
• addiction

The government may choose to intervene in the price mechanism largely on the ground of wanting to change the allocation of resources and achieve what they percieve to be an improvement in economic and social welfare. 

Forms of intervention

• regulation
• indirect taxation
• subsidies
• information provision
• direct provision

Indirect taxation- a tax placed on a good therefore raising a firms production costs and leading to a decrease in spplu. The higher price of the good will then lead to a reduction in the quantity demanded. 

Indirect tax is used to correct negative externalities.
By imposing a tax the government is forcing consumers and producers to allow for the negative externality when they make their decisions

Effectiveness of taxation:

• it must be equal to the externality
• if the externality is internalised
• makes producer pay if inelastic consumer absorbs without significant fall in production
• PED important
• size of the tax
• other polices to correct market failure 

Subsidies- are payments to producers, they are the opposite of taxation and reduce a firms production costs, supply shift to the right, price decreases and therefore the demand increases. They may be used for goods which have positive externalities. 

Subsidies cause higher output and increased quantity demanded. The subsidy should equal the positive externality.

Effectiveness of subsidies:

• it must be equal to the externality
• PED is important in increasing quanitity demanded
• size of the subsidy
• other policies to correct market failure
• rich benefit form subsidies as well as the poor
• costs of the subsidy
• will the reducton in production costs be passed on?

Regulation is the application of rules and laws, used in an attempt to change behaviour. It is likely to be applied in a market, which, left to its own devices would not maximise economic welfare.

For regulation

• easy and cheap to impose
• sets a clear standard
• has an instant effect
• can be backed up by fines or other incentives to comply

Against regulation

• cost of enforcement
• could be wrongly set by government
• consumers may ignore information
• regulationis a crude instrument

Information provision - where a government provides information to enable consumers and producers to make more informed choices, which will maximise their consumer welfare.

Market failure can happend from people having imperfect information.

Information provision doest have any direct effect on market prices but it does influence demand and therefore output and consumption in the long run.

It is difficult to predict accuratly the effects of any single government information campaign. 

When a government directly provides a good as oppose to intervening in a market.

In the case of public goods, these are provided because the free market will find it difficult to make a profit due to the issue of non excludability leading to the free rider problem. 

Pollution permits - give firms a legal right to pollute a certain amount e.g. 100 units of carbon dioxide per year.

If they make less pollution they can sell them and if they need more they can buy them.

Because firms can sell pollution permits, it is an incentive to pollute less.

Problems of pollution permits:

• it is difficult to know how many to give out
• difficult to measure pollution levels
• administrative costs of implementing the scheme
• countries who pollute more than the quota can just buy more from other countries, rich buy from poor countries so no less pollution is released.