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Microeconomics SL (Market Failure (• PEOP - A positive externality of…
Microeconomics SL
Market Failure
• PEOP - A positive externality of production exists when society as a whole would like greater production of a good than those that are the direct producers of the good.
• NEOC - A negative externality of consumption exists when society as a whole would like less consumption of a good than those that are the direct consumers of the good.
• PEOC - A positive externality of consumption exists when society as a whole would like greater consumption of a good than those that are the direct consumers of the good.
• NEOP - A negative externality of production exists when society as a whole would like less production of a good than those that are the direct producers of the good.
Elasticity: a measure or responsiveness. It measures how much something changes when there is a change in one of the factors that determines it
Elasticity of demand
Price Elasticity of Demand: PED, Cross elasticity of demand; how much the demand for a product changes when there is a change in price of another product :XED, Income elasticity of demand: how much the demand for a product changes when there is a change in consumer's income: YED
Inelastic demand: The value of PED is less than 1 and greater than 0. A change in price of the product leads to a proportionally smaller change in the quantity demanded of it
Elastic demand: The value of PED is greater than 1 and less than infinity. A change in price of a product leads to a greater than proportionate change in the quantity demanded.
Determinants of PED
The number and closeness of substitutes: The more substitutes there are for a product , the more elastic the demand will be. Products with few substitutes will tend to have relatively inelastic demand, demand falls relatively little as price goes up.
The necessity of the product and how widely the product is defined: Food being a necessity has a very inelastic demand, however as food is defined and broken down, for example into categories of meat, the demand for each would be relatively elastic since consumers can easily change .
The time period considered:As the price of products changes, it often takes time for consumers to change their buying and consumption habits. PED thus tends to be more inelastic in the short term and then becomes more elastic, the longer the time period it is measure over
Elasticity of supply: measure of how much the supply of a product changes when there is a change in the price of the product
Inelastic supply:The value of PES is less than 1 and greater than 0. Change in price of a product leads to a less proportionate change in the quantity supplied.
Elastic Supply:The value of PES is greater than 1 and less than infinity . A change in price of the product leads to a greater than proportionate change in the quantity supplied.
Unit Elastic Supply:The unit of PES is equal to 1. A change in the price of the product leads to a proportionate change in the quantity supplied of it.
Determinants of PES:
How much costs rise as output is increased:If total costs rise significantly as a producer attempts to increase supply then it is likely that the producer will not increase supply so supply will be relatively inelastic.
The time period considered:The longer the time period considered the more elastic the supply will be.
The ability to store stock:If a firm is able to store high levels of stock of their product, then they will be able to react to price increases with swift supply increases and so the PES for the product will be relatively inelastic.
Government intervention: subsidies, indirect taxes, price controls
Subsidies:
Financial assistance from the government to encourage output to reduce the price of certain merit goods
Indirect Taxes:
a government levy (charge) on the sale of certain goods and services
E.g. specific tax – imposes a fixed amount of tax on each product (cigarettes)
Price controls
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Price ceiling: occurs when the government sets a price below the market equilibrium price to encourage output and consumption
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Results in more demand (QD) than is supplied (QS) at the price lower than the market equilibrium – consumers enjoy having a lower price set by governments, but suppliers contract their supply because they aren’t gaining from the lower price
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Market equilibrium, Price mechanism, efficiency
Equilibrium: May be defined as "a state of rest, self-perpetuating in the absence of any outside disturbance."
As equilibrium may be moved by "outside disturbance", in the case of demand and supply, this would be a change in one of the determinants of demand or supply, other than the price of the product, which would lead to a shift in either of the curves.
Whenever there is a shift of the demand or supply curve, the market will, if left alone, adjust to a new equilibrium, market-clearing, price.
Market Efficiency:
Consumer surplus – benefits to buyers who are able to purchase a product for less than they are willing to do so
E.g. Coffee is essentially the same cross all producers, however where it is sold will vary
Producer surplus – the difference between the price firms actually receive and the price they were willing and able to supply at
E.g. Oil industry in Iraq would supply oil at a low price because it is cheaper to extract on land.
Price Mechanism:
Resource allocation - finite supply of resources whilst there are infinite wants so scarcity exists (what to produce)
Opportunity cost - a benefit/ profit of something that must be given up to acquire something else
Incentive functions - result in the reallocation of resources if price changes due to changes that affect the demand for supply of a product
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