Economics - the price mechanism, taxes, subsidies and externalities

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  • Created by: crwxox
  • Created on: 19-11-16 13:57
Define market equilibrium
When the price is such that the quantity that consumers wish to buy is exactly balanced by the quantity that firms wish to supply
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What is consumer surplus
The value that consumers gain from consuming a good or service over and above the price paid
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What is marginal social benefit
The additional benefit that society gains from consuming an extra unit of a good
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What is marginal cost
The cost of producing an additional unit of output
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What is allocative efficiency?
Achieved when society is producing an appropriate bundle of goods relative to consumer goods
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What is producer surplus?
The difference between the price received by firms for a good or service and the price at which they would have been prepared to supply that good or service
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What is the price mechanism?
The system where the market forces of supply and demand determine prices
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In a free market, what is decided by the price mechanism?
The economic problem
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Describe the 4 functions of the price mechanism (AIRS)
Allocating scarce resources among competing users. Incentives of businesses responding to a change in price. Rationing of scarce resources when market demand outstrips supply. Signalling where resources are required and where they are not.
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What is market failure?
When a market, left to its own deices doesn't allocate resources efficiently
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What can market failure result in?
Welfare losses to society
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What is welfare?
The sum of consumer and producer surplus
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What are four causes of market failure? (PIME)
Public goods, information gaps, merit and demerit goods and externalities
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What is indirect tax?
A tax levied on expenditure on goods or services (affects supply)
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What is direct tax?
A tax charges directly to an individual based on a component of income (affects demand)
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Describe the two types of indirect tax?
Ad valorem - a percentage added to prices e.g. VAT. Specific - an amount per unit e.g. per pack of cigarettes
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What is the incidence of a tax?
The way in which the burden of paying a sales tax is divided between buyers and sellers
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How does PED determine the incidence of a tax?
If the PED is perfectly inelastic the sellers will pass the whole burden of the tax onto the consumer. If the PED is perfectly elastic, the sellers would absorb the entire tax
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How do you work out the incidence of a tax from a graph?
The buyer pays between P0 and P1. The seller pays between P0 and p1-tax
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What does ad valorem tax do to the supply curve?
It steepens it
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Does indirect tax affect the demand curve?
No
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What is progressive direct tax?
In proportion to income
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What is regressive direct tax?
Takes up a higher proportion of low earners income and is the same for everyone
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How can a government encourage the production of a good or service?
By giving subsidies
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What is a subsidy?
A grant given by the government to producers to encourage production of a good or service (affects supply)
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Why may the government reduce the size of a subsidy on a good or service?
1. The cost is too high 2. The good costs less to produce due to other factors e.g. improvements in technology, so a subsidy is no longer needed
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What is an externality?
If a third party, not directly involved in the economic transaction, is affected
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How are externalities created?
When social costs and benefits differ from private costs and benefits
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What are private costs and benefits?
Experienced by the individuals and firms directly involved in the decision
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What are external costs and benefits?
Costs and benefits that fall on 3rd parties
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What are social costs and benefits?
The total costs and benefits experienced by society as a result of a decision or action
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What is a negative externality?
When the social cost is greater than private cost
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Give three examples of negative externalities in consumption
Passive smoking, air travel and road congestion
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Give two examples of negative externalities in production
Over fishing and pollution
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What is a positive externality?
When social benefit is greater than the private benefit
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Give an example of a positive externality
Inoculation against disease
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Describe the relationship between externalities and market failure
The greater the externality, the greater the market failure
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What are merit goods?
Goods for which positive externalities exist
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Describe two features of merit goods
They contain more benefits than consumers realise. Consumers don't consume enough of them when left to the free market
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What are demerit goods?
Goods for which negative externalities exist
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Describe two features of demerit goods
In a free market, consumers consume too much of them. Consumers expect greater benefits than actually exist
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Give five solutions to externalities leading to market failure
Government provision e.g. NHS, taxes, subsidies, regulation and information provision
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Other cards in this set

Card 2

Front

What is consumer surplus

Back

The value that consumers gain from consuming a good or service over and above the price paid

Card 3

Front

What is marginal social benefit

Back

Preview of the front of card 3

Card 4

Front

What is marginal cost

Back

Preview of the front of card 4

Card 5

Front

What is allocative efficiency?

Back

Preview of the front of card 5
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