E1.2 - how markets work

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assumptions of rational decision making
consumers aim to maximise utility. firms aim to maximise profit. governments aim to maximise social welfare
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demand
the quantity of a good or service that consumers choose to buy at any possible price in a given period
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quantity demanded
the quantity of a good that people are willing to buy at a particular price at a given time
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causes of a shift in demand
Population, Income, Related goods, Advertising, Taste/fashion, Expectations, Seasons
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law of diminishing marginal utility
inverse relationship between price + qd. satisfaction derived from consumption of additional unit decreases as more is consumed. consumers assumed to act rationally. consumers are less willing to pay high prices at high quantities
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relatively elastic PED
more than 1. increase in price leads to a bigger decrease in demand. flatter negative gradient
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relatively inelastic PED
less than 1. increase in price leads to a smaller decrease in demand. steep negative gradient
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unitary elastic PED
equals 1. increase in price leads to a proportionate decrease in demand. curved negative gradient
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perfectly elastic PED
equals infinity. horizontal
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perfectly inelastic PED
equals 0. vertical
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PED
the responsiveness of a change in demand to a change in price
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factors influencing PED
necessities=inelastic. luxuries=elastic. substitutes=elastic. LR vs SR. addictive goods=inelastic. proportion of income small=inelastic big=elastic. durability=elastic. peak vs off peak
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YED
responsiveness of a change in demand to a change in income
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relatively elastic YED
more than 1. increase in income leads to a larger increase in quantity demanded. flatter positive gradient. normal goods (luxury)
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relatively inelastic YED
less than 1. increase in income leads to a smaller increase in quantity demanded. steep positive gradient. normal goods
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unitary elastic YED
equals 1. increase in income leads to a proportional increase in quantity demanded. unitary positive gradient
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negatively elastic YED
less than 0. increase in income leads to a decrease in quantity demanded. negative gradient. inferior goods
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perfectly inelastic YED
equals 0. chance in income doesn't affect the quantity demanded. vertical gradient
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inferior goods
income↑ demand↓. YED less than 0. negative gradient. eg tesco value
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normal goods
income↑ demand↑. YED more than 0. positive gradient
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luxury goods
income↑ bigger increase in demand. YED bigger than 1. flatter positive gradient. eg holidays
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XED
responsiveness of a change in demand of good A to a change in price of good B
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weak substitutes XED
less than 1. steep positive gradient.
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close substitutes XED
more than 1. flatter positive gradient.
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weak compliments XED
less than 0. steep negative gradient.
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strong compliments XED
less than -1. flatter negative gradient.
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unrelated goods XED
equals 0. no effect on each other
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significance of PED
determine the extent of the effects of subsidies/taxes. also revenue for firms (inelastic=↑revenue). elastic PED, ↓consumer burden, responsive, output efficiently↓. inelastic PED ↑consumer burden, unresponsive so output doesn't fall accordingly
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supply
the quantity that producers are willing and ready to sell at various prices in a given time
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quantity supplied
the quantity of a good/service that producers are willing and ready to sell at a particular price at a particular point in time.
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causes of a shift in supply
changes in the COP for firms. technology, taxes, subsidies, productivity, interest rates, number of firms, weather, exchange rates, any factor affecting investment.
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reasons for positive slope of supply
profit incentive - producers can increase total revenue by increasing quantity supplied
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PES
the responsiveness of a change in supply to a change in price.
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unitary elastic PES
equals 1. increase in price leads to a proportionate increase in quantity. unitary positive gradient
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relatively elastic PES
more than 1. increase in price leads to a larger increase in quantity supplied. flatter positive gradient
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relatively inelastic PES
less than 1. increase in price leads to a smaller increase in quantity supplied. steep positive gradient
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perfectly elastic PES
equals infinity. horizontal line
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perfectly inelastic PES
equals 0. vertical line
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factors affecting PES
time- sr(inelastic) lr(elastic). availability of FOP. ease of entry into market. working below full capacity. stocks
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equilibrium point
where supply=demand. where all products supplied to the market are cleared(bought) so there is no excess. ↑price-excess supply. ↓price-excess demand
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excess demand
price set below equilibrium- demand extends, supply contracts. suppliers increase prices so the market clears and is in equilibrium
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excess supply
prices set above equilibrium- supply extents, demand contracts. suppliers decrease prices so market clears and reaches equilibrium
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rationing function
resources are scare (demand exceeds supply). price mechanism allocates these goods to those who are prepared to pay most for them. prices will rise and fall until equilibrium is reached
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incentive function
through their choices, consumers send information to producers. rising prices give incentive to firms to produce more as profit incentive.
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signalling function
prices adjust to demonstrate where resources are required. ↑demand↑price=signal to producers to expand production to meet higher demand. ↓demand↓price=signals to firms to contract their supply.
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consumer surplus
price above the equilibrium that the consumer is willing to pay above what they actually pay.
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producer surplus
price below equilibrium that the producer is willing to accept to supply below what they actually accept.
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shifts in supply on CS/PS
↑supply↑CS↑PS. ↓supply↓PS↓CS
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shifts in demand on CS/PS
↑demand ↑CS↑PS. ↓demand↓CS↓PS
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indirect taxes
tax on expenditure - ad valorem or specific. supply↓. consumer burden over producer burden. elastic demand/inelastic supply=lower incidence of tax on consumer
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subsidies
grant given by the government. supply↑. producer gain over consumer gain.
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alternative views of consumer behaviour
influences of other peoples behaviour - fitting into fashion/trends, herd behaviour. habitual behaviour - addiction, comfort zone. consumer weakness at computation - can't make educated+ rational comparisons, poor self control
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Card 2

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demand

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the quantity of a good or service that consumers choose to buy at any possible price in a given period

Card 3

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quantity demanded

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Card 4

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causes of a shift in demand

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Card 5

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law of diminishing marginal utility

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