Economics (Micro) Final

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Economics
Micro (Final)
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What is the definition of price elasticity of supply?
The responsiveness of a change in supply to a change in price
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What is the formula for PES?
Percentage change in quantity supplied/Percentage change in price
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What is meant when PES is relatively elastic?
If supply is elastic, firms can increase supply quickly at little cost. The
numerical value for PES is >1. This is a shallower gradient on a diagram. Supply is responsive to the change in price
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What is meant when PES is relatively inelastic?
If supply is inelastic, an increase in supply will be expensive for firms and
take a long time. PES is < 1. This is a steeper gradient on a diagram. Supply is not responsive to the change in price
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What is meant when PES is unitary?
Quantity supplied changes by the same percentage as price
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What is meant when PES is perfectly elastic?
Supply is perfectly elastic when PES = infinity. Any quantity demanded can
be met without changing price. This is a horizontal line on a diagram
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What is meant when PES is perfectly inelastic?
A perfectly inelastic supply has PES = 0. Supply is fixed, so if there is a
change in demand, it cannot be met easily. This is a vertical line on a diagram
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What are the factors affecting PES?
Time; spare capacity; level of stocks; how substitutable factors are; barriers to entry to the market
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How does time affect PES?
In the short run, supply is more price inelastic, because producers
cannot quickly increase supply. In the long run, supply becomes more
price elastic
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How does spare capacity affect PES?
If the firm is operating at full capacity, there is no space left to increase
supply
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How does the level of stocks affect PES?
If goods can be stored, such as CDs, firms can stock them and increase
market supply easily. If the goods are perishable, such as apples, firms
cannot stock them for long so supply is more inelastic
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How does the substitutability of factors affect PES?
If labour and capital are mobile, supply is more price elastic because
resources can be allocated to where extra supply is needed
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How do barriers to entry affect PES?
Higher barriers to entry means supply is more price inelastic, because it
is difficult for new firms to enter and supply the market
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What is the definition of demand?
Demand is the quantity of a good or service that consumers are able and willing to
buy at a given price during a given period of time
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What is meant by the law of demand?
A rise in price leads to fall in demand (inversely proportional)
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What are the conditions of demand?
Population, income, related goods, advertising, tastes, expectations, seasons - PIRATES
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How does population affect demand?
The larger the population, the higher the demand
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How does income affect demand?
If consumers have more disposable income, they are able to afford
more goods, so demand increases
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How does related goods affect demand?
If
the price of the substitute falls, the quantity demanded of the original good
will fall because consumers will switch to the cheaper option
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How does advertising affect demand?
This will increase consumer loyalty to the good and increase
demand
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How do tastes affect demand?
The demand curve will also shift if consumer tastes
change
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How does expectations affect demand?
This is of future price changes. If speculators expect the
price of shares in a company to increase in the future, demand is likely to
increase in the present
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How do seasons affect demand?
Demand changes according to the season. For example, in the
summer, the demand for ice cream and sun lotions increases
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What is meant by derived demand?
This is when the demand for one good is linked to the demand for
a related good. For example, the demand for bricks is derived from the demand for
the building of new houses
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What is meant by composite demand?
This is when the good demanded has more than one use. An
example could be milk. Assuming there is a fixed supply of milk, an increase in the
demand for cheese will mean that more cheese is supplied, and therefore less butter
can be supplied
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What is meant by joint demand?
This is when goods are bought together, such as a camera and a
memory card
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What is meant by the law of diminishing marginal utility?
The law of diminishing marginal utility states that as an extra unit of the good is
consumed, the marginal utility, i.e. the benefit derived from consuming the good,
falls. Therefore, consumers are willing to pay less for the good
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What is meant by supply?
Supply is the quantity of a good or service that a producer is able and willing to
supply at a given price during a given period of time
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What are the conditions of supply?
Productivity, indirect taxes, number of firms, technology, subsidies, weather, costs of production - PINTSWC
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How does productivity affect supply?
Higher productivity causes an outward shift in supply, because
average costs for the firm fall
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How do indirect taxes affect supply?
Inward shift in supply
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How does the number of firms affect supply?
The more firms there are, the larger the supply
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How does technology affect supply?
More advanced the technology causes an outward shift in
supply
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How do subsidies affect supply?
Subsidies cause an outward shift in supply
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How does the weather affect supply?
This is particularly for agricultural produce. Favourable conditions
will increase supply
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How do costs of production affect supply?
If costs of production fall, the firm can afford to supply
more. If costs rise, such as with higher wages, there will be an inward shift in
supply
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What is meant by joint supply?
This is when increasing the supply of one good causes an increase or
decrease in the supply of another good. For example, producing more lamb will
increase the supply of wool
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What is meant by a PPF?
Production possibility frontiers (PPFs) depict the maximum productive potential of an
economy, using a combination of two goods or services, when resources are fully and
efficiently employed. They can be used to calculate opportunity costs
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When is economic efficiency achieved on a PPF?
Economic efficiency is achieved when resources are used for their best use. At all
points on the PPF, resources are allocated efficiently
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What is meant by monopolistic competition?
Monopolistic competition is a form of imperfect competition, with a downward sloping
demand curve. It lies in between the two extremes of perfect competition and monopoly,
both of which rarely exist in a pure form in real life
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What is the first characteristic of monopolistic competition?
There must be a large number of buyers and sellers in the market, each of whom
are relatively small and act independently. This means that no one buyer or seller
has a large price setting power
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What is the second characteristic of monopolistic competition?
There are no barriers to entry or exit, allowing new firms to enter when
supernormal profits are being made and some to leave in the case of losses. As a
result, only normal profits can be made in the long run
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What is the third characteristic of monopolistic competition?
Firms produce differentiated, non-homogenous goods or
services. This means that individual firms do have some price setting power, and so
the curve is downward sloping
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How do profits vary in the long and short run for a firm in monopolistic competition?
In the short run, firms can make supernormal profits, losses or normal profits. However, due
to the lack of barriers to entry/exit, firms can only make normal profits in the long run
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What is a limitation of the model?
The limitation of this model is that information may be imperfect and so firms will not enter
the market as predicted as they are unaware of the existence of abnormal profits
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Are firms in monopolistic competition productively and allocatively efficient?
Since they can only make normal profit in the long run, AC=AR and since they profit
maximise, MR=MC. Therefore, the firm will not be allocatively or productively
efficient, as MR does not equal AR so AC cannot equal MC and AC cannot equal
MR
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Are firms in monopolistic competition dynamically efficient?
They are likely to be dynamically efficient since there are differentiated products
and so know that innovative products will give them an edge over their competitors
and enable them to make supernormal profits in the short run
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What is meant by a demerger?
A demerger is a business strategy in which a single business is broken into two or more
components, either to operate on their own, to be sold or to be dissolved
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What are the reasons for demergers?
Lack of synergies, growth, diseconomies of scale, focussed companies, resources, finance, CMA
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How does a lack of synergies lead to a demerger?
A synergy is when creating a whole company is worth more than
each company on its own. Without this, firms are likely to demerge because they will
be worth more
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How does growth lead to a demerger?
Each part of the firm could grow at different rates. The faster growing part
might be separated
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How does a diseconomies of scale lead to a demerger?
If the firm is so large that average costs rise with more
output, the firm might choose to split
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How does focussed companies lead to a demerger?
The firm might be able to grow faster if it focuses on a few
markets, rather than several
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How do resources lead to a demerger?
If a firm can no longer afford to invest the business, due to a lack of
resources, they might sell off a part
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How does finance lead to a demerger?
Selling off part of the firm can raise valuable finance, which could be better
invested in a more profitable part of the firm
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How does the presence CMA lead to a demerger?
A firm may want to avoid attention from the competition authorities
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How does a demerger impact businesses?
Firms can dispose of underperforming or loss-making parts of the firm. Firms might be able to eliminate diseconomies of scale, since they are better able to
control and coordinate their business. The firm could make a profit by selling off a part
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Why may a demerger have negative impacts on a business?
The smaller size of the business could lead to a loss of
economies of scale and reduce efficiency
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How does a demerger impact workers?
Workers might become confused, and their roles might be shifted between the
demerged firm and the parent firm. There could also be job cuts or separate firms may need
their own managers and leaders so people could get a promotion
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How does a demerger impact consumers?
The removal of diseconomies of scale could lead to lower prices for consumers, net welfare gain if the demerger results in a higher level of
efficiency, if two firms in the same industry demerge there may be increased choice
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What is meant by specialisation?
Specialisation is the production of a limited range of goods by a
company/individual/country which means that trade is essential as it is the only way
they are able to access all that they need
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What is meant by division of labour?
The division of labour is when labour becomes specialised in a particular part of the
production process
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What are the advantages of specialisation?
The theory of comparative advantage states countries should specialise in
producing those goods where they have a lower opportunity cost, and so they are
relatively best at producing, on the whole,
there is greater output globally
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What are the disadvantages of specialisation?
Countries may become over-dependent on one particular export and if this fails their
economy may collapse, other countries specialise in non-renewable resources and these could run out
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What are the advantages of division of labour?
Enables labour productivity to be increased, higher quality of goods and services, more cost effective to develop specialist tools, time is not wasted, workers only need to be trained to do one specific task
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What are the disadvantages of division of labour?
Monotony in work can become boring which will lead to lower quality, reduction of craftsmanship, structural unemployment may occur
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What are characteristics of a free market economy?
Individuals are free to make their own choices and own the
factors of production without government interference. Resources are allocated through
the price mechanism. The consumer determines what is produced by their willingness to
spend money on a good
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What did Adam Smith believe about the free market?
He believed in the free market economy and the laissez-faire
approach. He explained how there was an ‘invisible hand’ which allocated resources to everyone’s advantage. He concluded that each individual’s self-interest allocated resources efficiently
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What are advantages of a free market economy?
System is automatic due to the invisible hand, consumer sovereignty, high motivation as people know working hard could lead to high potential
rewards, as firms are in competition they will produce goods at the lowest cost ensuring productive efficiency
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What are disadvantages of a free market economy?
High levels of inequality, a lack of merit goods, little control of demerit goods, resources could be wasted on unproductive expenses, monopolies may form
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What is a subsidy?
A subsidy is a payment from the government to a producer to lower their costs of production and encourage them to produce more
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How is a subsidy represented on a diagram?
Subsidies shift the supply curve to the right, which lowers the market price. The vertical distance between the supply curves shows the value of the subsidy per unit
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What are the advantages of a subsidy?
Society reaches the social optimum output and welfare is maximised, brings about equality
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What are the disadvantages of a subsidy?
High opportunity cost, they are difficult to target since the exact size of the externality is
unknown, subsidies can cause producers to become inefficient, subsidies are difficult to remove
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What is meant by a natural monopoly?
A natural monopoly occurs when the most efficient number of firms in the industry is one. They usually arise when there are high fixed costs, usually in the form of infrastructure
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Why is it better to have a single firm operating in a natural monopoly market?
It would be pointless to encourage competition since it would raise average costs
for the industry. If any new firm enters the market, they will be easily priced out as
their costs will be so much higher
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How efficient are natural monopolies?
These firms are neither allocatively nor productively efficient as there is no minimum on
the AC curve and at allocative efficiency there would be a loss
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What are the costs and benefits of a natural monopoly to firms?
The potential to make huge profits for their shareholders through
profit maximisation, finance for investments, reserves to overcome short term difficulties, compete against large overseas
organisations
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Why may a monopoly not profit maximise or reinvest?
Firms may not always choose to profit maximise because of X-inefficiencies, the lack of competition may mean that firms
become complacent and so they may not make maximum profits
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What are the costs and benefits of a natural monopoly to employees?
Monopolists produce at lower outputs, so will employ fewer workers, the inefficiency of the monopoly may mean employees receive higher
wages, particularly directors and senior managers
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What are the costs and benefits of a natural monopoly to suppliers?
For suppliers, the impact of a monopolist will depend on the extent to which they are a monopsonist. If the monopolist buys all or most of the suppliers’ goods, it will reduce the suppliers’ profits as the
monopolist will decrease prices
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What are the costs and benefits of a natural monopoly to consumers?
Consumers tend to be better off than if there was
competition, when firms enjoy economies of scale efficiency will increase and customers will
enjoy a higher consumer surplus, may pay higher prices and see a poorer quality service
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How efficient are natural monopolies?
A monopoly is productively inefficient, since they don’t produce at MC=AC. They
are also not allocative efficient as P>MC but they will be dynamically
efficient as they make SNP
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What are other costs and benefits of a natural monopoly?
Schumpeter argued that monopolies will have large retained profits and will be able
to exploit new products or production techniques without worrying about competitors, creative destruction, cross subsidisation may be bad though
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What is third-degree price discrimination?
When monopolists charge different prices to different people for the same
good or service based on demographics
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What must be fulfilled for price discrimination to occur?
The firm must be able to clearly separate
the market into groups of buyers; the customers must have different elasticities of
demand; and they must be able to control supply and prevent buyers from the expensive market from buying in the cheaper
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What are the costs and benefits of price discrimination?
Firms gain since they are able to increase their profits which can go into R & D, improving dynamic efficiency, consumers lose some of their consumer surplus to the producers and some have to pay a higher price whereas those in the elastic market pay less
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What factors affect the demand for labour?
Wage rates, demand for the product (PED), prices of other factors of production, wages in other countries, technology, proportion of wages to total costs, time, substitutes
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What factors affect the supply for labour?
Wages, population and distribution of age, non-monetary benefits, education, training, trade unions and legislation
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What do wage rates differ upon?
Wage rates differ within an occupation due to age, education, training, work experience,
skill/talent/ability to perform tasks, sex and ethnic background - the last two are illegal to discriminate on
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How are wages determined in a perfectly competitive labour market?
Wages are determined purely by demand and supply and all workers are paid the same
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How are wages determined when there is a monopsony in the labour market?
They employ less people at a lower
wage rate
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How do wages differ when there is a monopoly in the labour market?
There will be higher
wages but this will cause a fall in employment as trade unions use a process of collective bargaining
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How wages differ when there is a bilateral monopoly in the labour market?
The wage
that is set will depend on the relative bargaining strength of both trade unions (union density). In this situation unions have a positive impact on both wages and the employment
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What are some issues in the labour market?
Skills shortages (occupational, geographical immobility), youth employment, wage inequality, gig economy, migration
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What is occupational immobility?
Where workers find it difficult to move
from one job to another because of a lack of transferable skills
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What is geographical immobility?
Where workers find it difficult to
move from one place to another due to the cost of movement
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How can the government intervene and what are arguments for this form of intervention?
They can add a national minimum wage. The wage is able to reduce poverty, reduce male/female wage differentials, more content workforce
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What are arguments against the national minimum wage?
Potential loss of jobs in the industry, raise costs for the companies, wage spiral,
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What are the implications of a maximum wage?
It will lead to excess demand, it will help to reduce inequality, UK may suffer from a loss of the best workers, supply and demand for the highest paid
workers is very inelastic and so may not have an effect
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How does activity in the public sector impact the private?
Public sector workers experienced a pay freeze. This put downward pressure on private sector wages since few people were likely to leave
the private sector for the public sector and so pay rises were limited
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How can the government tackle immobility?
Improve the supply of houses and reduce the price of properties, improve transport links, national advertising, vocational training, encourage greater spending on training within work
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What is the formula for MRP?
Marginal output x Price or difference in total revenue
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Card 2

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What is the definition of price elasticity of supply?

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The responsiveness of a change in supply to a change in price

Card 3

Front

What is the formula for PES?

Back

Preview of the front of card 3

Card 4

Front

What is meant when PES is relatively elastic?

Back

Preview of the front of card 4

Card 5

Front

What is meant when PES is relatively inelastic?

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