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Economics AOS 1:

Terms in this set (33)

Opportunity Cost:
Is when we decide to use our resources (our money) in some way, which necessarily involves us foregoing, or giving up the opportunity to use those resources (money) in another way. Opportunity cost exists for individuals, businesses, governments and other nations. Opportunity cost for a business is when an employer decides to employ new staff rather than invest in new technology. The opportunity cost is what could have been benefited from investing in the technology.
Relative Scarcity:
Describes when a nations wants are virtually unlimited but there are not enough resources to satisfy these wants, therefore there is an imbalance between wants and needs. E.g. households can satisfy their most important needs such as food, water and shelter; however, they may need to abandon such lesser priorities such as an in home cinema.
How the market mechanism allocates resources:
Demand is the quantity or volume of goods demanded by consumers and businesses at any given price. The supply of a good or service is the quantity supplied by the producer or supplier at a given price. The intersection of the demand and supply curve represents the market clearing price or the equilibrium price of that good. In a competitive market economy, the market (price) mechanism allocates resources by allocating them in the area where consumers demand can be met by supply at a price in which both parties are happy. This determines relative prices of goods and services which then ultimately determine the way productive resources; for example, land, labour, capital and enterprise are allocated in the economy. The use of price signals by both parties will indicate each party's willingness to allocate resources into that area at each price level.
One factor that may have influenced the allocation of resources in the bicycle market: (SUPPLY AND DEMAND SIDE)
Supply side: change in production costs (e.g. costs of raw materials) , change in producer productivity, less or more efficient technology, change in climatic conditions, change in number of producers, sellers or firms, change in producer preference and expectations, obstacles or inducements to production, change in laws relating to use of bicycles or cares, change in taxes imposed on bicycle importers.
Demand side: change in disposable income, change in trends and fashions, price of substitutes or complementary goods, future availability, change in taxes, change in population.
One circumstance that would result in an increase in the price elasticity of demand for bicycles:
If a substitute good such as a scooter, becomes cheaper, more easily available or more fashionable - this will cause a small increase in the price of bicycles to result in a larger proportion of a decrease in demand.
If the price of complementary good such as helmets increases considerably - this would again cause consumers to seek alternatives to bicycles, and at each price level, demand would be more elastic.
Two conditions that are present in a perfectly competitive market:
Total consumer sovereignty: consumers alone determine what goods and services are produced based in their purchasing patterns.
Homogenous products: very high levels of competition occur when producers sell identical products without the distortions of branding, advertising and other marketing tools to persuade consumers.
No barriers to entry and exit: to ensure that perfect competition exists, firms need to be able to set up and compete if they choose to enter a market, and existing firms need to be able to leave the market if they so desire.
Firms are the same size and all firms are price takers: no one firm can influence price through their size as all firms are competing equally. All firms are price takers.
Two ways the government can bring about increased competition:
Reducing tariffs on imports: tariffs make foreign goods less attractive, thereby reducing overseas competition for local firms. Reducing these tariffs would cause local firms to lift their efficiency, product quality and cut production costs on order to compete with overseas firms, thereby increasing competition in the market.
Deregulating key markets: removal or partial removal of unsuccessful government restrictions to competition will cause the market to become more competitive as more firms will be able to start in that market. This happened in the domestic aviation market as there was a two-firm regulation and the market was then deregulated and now flights are cheaper than ever.
Market power and example of a firm using its market power:
Market power exists when a firm has the ability to influence or has control over some aspect of the market in which it operates. An example of market power could be when a firm uses its market power to influence the price of a product as a firm with a lot of market power is a price maker not a price taker.
Negative externalities:
Negative externalities refer to the cost associated with the production or consumption of goods or services that are passed onto or spill over to affect an uninvolved third party. An example of negative externalities in production is when a steel factory disposes of its waste in a nearby river, polluting the river. The producer does not pay the cost of the pollution.
One major source of market failure and how the government could intervene:
(Provision of public goods):
Public goods would result in an inefficient allocation of resources if the government did not intervene because some socially desirable goods are so important that everybody should be able to access them. However, these services and goods are costly to run and cannot be offered at a low price (e.g. healthcare and education). This means that the poor cannot afford these goods and the government must provide these goods and services as public goods.
The government could intervene in the market failure regarding public foods and use the annual budget to pay for the public services such as healthcare. This would mean that through the budget everybody would be able to afford these important goods and services and resources would be allocated more efficiently.
All nations seek to improve living standards of their people: Explain and outline aspects of living standards:
Living standards (a nation's standard of living) relates to the overall well-being of the people of that nation. Living standards have two aspects, material and non-material living standards. Material living standards measure the level of access the population has to goods and services. This can be done by dividing the value of real GDP by the population. Non-material living standards are a subjective measure and covers things such as health, safety, happiness and living environment. They cannot be measured in the same way as material living standards.
Key questions answered by economies:
What and how much to produce: This refers to the types and quantities of goods and services that will be produced with the available resources.
How to produce: Businesses and governments all need to decide what is the best and most efficient way to use available resources in order to maximise production levels. For example, should they use labour-intensive methods or capital intensive methods of production or some combination of both?
For whom to produce: This refers to how the income is earned and how the goods and services produced as a result of production should be distributed amongst members of society.
Market based economy and two characteristics:
A market system is an economy principal where resources are allocated or directed to produce goods and services to meet the wishes of consumers. Consumers, through their spending patterns send out signals to producers as to what and how much to produce, how to produce and for whom to produce.
Features of this type of economy:
• Consumer sovereignty
• The government plays a very minor role in market operation
What brings about a movement along the demand curve:
Price is the only factor which can bring about a change along the demand curve.
Shifts in the supply curve are caused by:
• a change in the price of raw materials used in production
• changes in the technology used to produce a good or service
• changes in producer expectations of future market prices for their good or service
• government charges being altered through the introduction of such things as a carbon tax
• government's providing subsidies or grants to assist production
• Higher production charges associated with changing transport, power or fuel costs etc.
• an increase in wage rates paid to employees
• climatic factors affecting production e.g. floods or cyclones
Shifts in the demand curve are caused by:
• The price of a substitute product increases
• The price of complementary products
• There is an increase on disposable income of consumers
• There is a change in consumer preferences or tastes
• There is a reduction in interest rates; thereby encouraging more credit based There is a change in the size of the market or make up of the (demography) of the population
• Expectations of consumers) improve such that they expect a better economic future
• The impact of advertising on the industry makes the product more popular
• Changes in government regulations that affect consumers of a particular product
Market in a situation of oversupply, how consumers would get back to market equilibrium:
A situation of oversupply comes about when the quantity offered for sale by producers at a given price is greater than the amount consumers are willing to purchase at that price. In cases of oversupply producers would be forced to lower their selling prices, (bringing about a movement along the demand curve for the product) until a level of demand for the product is found to match the willingness of consumers to purchase the quantity being offered for sale.
Put more simply, producers would be forced to lower their prices or reduce supply until they could find sufficient demand to match their supply. In the end a new equilibrium price and quantity would result as both consumers and producers work together to clear the oversupply.
What is meant by PED: Use an example:
Price Elasticity of Demand (PED) is a measure of how much the demand for a product changes when there is a change in one of the factors that determines demand for it. Another way of saying this is: how much demand for a product changes when there is a change in its price. For example if a 10 per cent rise in price results in a more than 10 per cent fall in quantity demanded the PED is said to be elastic.
A product has elastic demand this means:
This means that a given percentage change in price for the product results in a more than proportionate change in quantity demanded. For example, a 10 per cent rise in price results in a more than 10 per cent fall in quantity demanded.
A product has inelastic demand this means:
This means that a given percentages change in price for the product results in a less than proportionate change in quantity demanded. For example, a 10 per cent rise in price results in a less than 10 per cent fall in quantity demanded.
Reasons that could make the demand for chocolate inelastic:
• How easily a product be substituted - there may not be a readily available alternative
• The existence of unused capacity
• Whether or not the item is a necessity or a luxury
• Time - over time demand for products becomes more elastic as more substitutes become available
• Its cost and relative importance to the consumer - low priced items tend to have less significance for consumers as they represent a smaller portion of a person's income
Factors that could influence the elasticity of supply of chocolate:
• How easily resources can be shifted into the production of more chocolates
• The time period- over time the business can get more machinery and workers or expand the size of its production facilities which will enable it to make its supply curve more elastic
• Its ability to store stock - if it can build up stock piles of its chocolate then it can meet changes in demand very quickly
Distinguish between macroeconomics and microeconomics:
Microeconomics is a branch of economics that examines individual decision making by firms and households, and how this impacts on particular markets for goods and services. Examples include examining the market for chocolate bars, or the car manufacturing industry. On the other hand, macroeconomics is a branch of economics that examines the workings and problems of the economy as a whole. Examples include examining the general influences on national spending, output, income, employment and overall material living standards.
Market failure:
Market Failure occurs when an individual's (consumers or producers) pursuit of self-interest through the market forces of demand and supply, leads to a situation where resources are allocated in ways that do not maximise the economic welfare of all members of society. An example of market failure is climate change where the impact of climate change has a negative impact on future generations as they have to pay for the carbon emissions that the current producers and consumers are responsible for. The price of the carbon emissions is presently not built into the price if carbon generating goods and services, and therefore the allocation of resources is not being made in society's best interest. Other examples include market power, public goods and asymmetric information.
Ways the government can intervene in the allocation of resources apart from taxes and subsidies:
Governments are able to address problems associated with market failure by:
• Providing goods and services themselves - for example, roads, hospitals and schools.
• Making laws prohibiting the production of some socially undesirable goods and services for example - banning drugs and pornography
• Issuing a licence system which controls who can use or access a good or service - for example liquor licensing rules, health controls on food service
• Opening up markets to increased levels of competition - the telecommunications market
• Undertaking public education programs through advertising campaigns
Efficient allocation of resources:
Allocative efficiency represents the most efficient allocation of scarce resources for an economy in the sense that, for any combination of scarce resources, the production of goods and services that occurs is most valued by society. The most efficient allocation of resources occurs when it's impossible to increase production and living standards by changing the way that resources are allocated.
Preconditions that exist for a competitive market:
• Consumer sovereignty exists (meaning that consumers of goods and services, not governments, dictate how resources are used).
• Identical products are sold, that are not differentiated using advertising, design or brand names.
• There should be ease of entry and exit
• It is assumed that owners of resources want to maximise their profit and minimise production costs
• The market can operate effectively only if buyers and sellers have good knowledge about current market trends
Provision of public goods and services:
Some types of goods and services are seen as socially desirable or merit goods and are so important that everybody should be able to use them, even if they are poor and cannot afford to pay for them. These basic goods and services include transport, education, health, energy, housing and communications. However, these goods and services are costly to run and therefore cannot be sold cheaply at a low affordable price otherwise the firms making these goods and services would not make a good profit. The government has therefore been forced to take on the main responsibility for providing public goods and services such as free education, low cost housing and affordable healthcare.
Another related failure of the market in the provision of goods and services is the free rider problem, which occurs as some goods and services are non-excludable, such as; national defence, prisons, lighthouse services, street lighting, fire brigades and other emergency services. This problem occurs in those instances where it is difficult to exclude members of the community who benefit from a service, but who choose not to pay. The free rider problem means that without government intervention many socially desirable public services would be under-produced.
Government correction:
• Using the annual budget to pay for public services
• Using the budget to pay for subsidies for consumers and producers
• Changing government laws and legislation
Externalities:
These are the costs or benefits associated with the production or consumption of goods and services that are passed onto third parties or spill over to affect others. Externalities result in the production of social costs or social benefits faced by society more generally.
Externalities in production:
These are externalities that flow purely from the production of a good or service. A factory producing steel that allows its waste to flow down an adjacent river is an example of a negative externality. When taking its costs of production into account, it does not incorporate costs of polluting the river, sometimes referred to as social costs that are borne by the users of the river. In contrast, a business that invests in research and development (R&D) or training of its employees is seeking to derive benefits (i.e. profit) from their production. However, these activities will tend to confer benefits to third parties or society more generally, such as when trained employees move to a new employer or when the R&D leads to new technological inventions or advances, which improves the welfare of society in general.
Externalities on consumption:
These are externalities that flow purely from the consumption of a good or service. Whilst some externalities in consumption can be positive (such as education and gardening), most are negative. Examples include the external costs associated with the consumption of illicit drugs, alcohol, cigarettes, and some firearms. In a free a market, consumption of these goods and services (also referred to as de-merit goods) would be far greater than occurs currently.
Government correction:
• Government laws or legislation
• Using an indirect tax
• Using government cash subsidies
• Education and advertising to inform the public
Asymmetric information:
Is where one party to a transaction knows more about the product than the other party. This ultimately leads to an over or under-allocation of resources of the production of certain goods and services. There are three types of asymmetric information; adverse selection, moral hazard and principal/agent problems.
Government correction:
• Government laws or legislation
• Advertising and educational campaign
Abuse of market power:
The market only allocates resources efficiently id sufficient competition exists and this heavily relies on there being a large number of buyers and sellers in the market. Healthy competition forces business to continually seek better and cheaper ways to produce output and satisfy consumers. In the absence of effective competition, dominant firms will have greater ability to abuse their market power by engaging in anti-competitive conduct to the ultimate detriment of consumers.
Government correction:
• Government deregulation of key markets
• Reducing tariffs on key imports
• Government promotion of stiffer price competition
• Setting up a government competitor
• Assisting the plight of small businesses more generally
Distinguish between market failure and government failure:
Market failure is when the market fails to allocate resources efficiently to maximise society's needs and wants whereas government failure is when the government intervenes in the market to stop market failure but they end up causing inefficiency and reducing the satisfaction of society's needs and wants. Examples of market failure are the abuse of market power, provision if public goods, externalities and asymmetric information. An example of government failure was the intervention in the aviation, the airline industry causing higher air fares, inefficiency in services and inflated profits for airlines.
Examples of government failure:
1. Aviation: Government regulation of the domestic aviation market through a two-airline policy led to higher air fares, inefficiency in services and inflated profits for airlines.
2. Tariffs: Excessive tariff protection and over-generous government subsidies to local producers often contributed to a high cost structure in Australian manufacturing, inefficient work practices, backward technology, poor product quality, inflated prices for consumers and the failure among local business leaders to develop an export culture.
3. Welfare: An overgenerous welfare system contributed to people being trapped on welfare. Benefits provided a relatively comfortable existence and income was as high as that from part-time and unskilled employment. Apart from inefficiency caused by having idle resources, unemployment reduces national income and places a heavy burden on taxpayers and the government budgets.
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