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U3 AOS1 --> Microeconomics P1, U3 AOS 1 - Microeconomics P2 - Coggle…
U3 AOS1 --> Microeconomics P1
the concept of relative scarcity, including needs, wants, resources, opportunity costs and the production possibility frontier (PPF) model, and the three basic economic questions
Types of resources:
Land (natural): things that exist naturally on earth, e.g. water and minerals.
Labour: human effort e.g. teachers or real estate agents
capital: anything that is human-made and used to produce goods and services, e.g. machinery, equipment and technology
Opportunity Costs: An opportunity cost is the value of the (next best) opportunity that you give up in making a decision under relative scarcity.
Relative Scarcity: Scarcity is the problem that all economies face, where limited resources are unable to meet unlimited needs and wants.
An economy cannot produce everything its people want and need.
The Production Possibilities Frontier (PPF)
the three basic economics questions:
what to produce?
for whom to produce?
how to produce?
the role of relative prices in markets on the allocation of resources
relative prices:
relative price is the price of one good or service compared to another
relative prices determine where suppliers allocate their resources (land, labour, and capital) as it indicates profit making opportunities.
for example:
the price of tickets to see ___ is originally AUD $100 in Australia and AUD $100 in the USA.
If the price in the USA decreases to $50:
it becomes cheaper in the USA
it becomes relatively more expensive in Australia (even though the price didn't change)
resource allocation (example)
in this example (if we assume the profit motive) more resources would be allocated to the Australian shows as the price is relatively higher there.
we are assuming that costs of production have remained constant
Types of effiency
Allocative Efficiency = Point on the PPF where the collective needs and wants of society are being maximised. 'Socially optimal allocation of resources'
Productive Efficiency = getting the most our of our resources. Maximising output given the resources available. It assumes
no wastage and resources
firms are producing at the lowest cost
Dynamic Efficiency: How quickly we can reallocate resources to meet changing needs and wants of society. (move from producing one combination to another). An improvement in dynamic efficiency means increasing the speed at which resources are being reallocated
Intertemporal efficiency: Balancing out the current needs and wants of society with their future needs and wants. Finding the optimal balance between now and the future.
WHAT IS EFFICIENCY: efficiency is a measure of how we use our scarce resources. An improvement in effiency means we are getting more out of limited resources etc
the law of demand
LAW: inverse relationship between quantity demanded and price. (as price increases quantity demand decreases and vice versa. Where quantity demanded is how much people are willing and able to purchase at given price
The Income Effect: assumes we have a fixed level of disposable income. As the price of a good increases we have less income to afford it (vice versa)
The Substitution Effect: As the price rises consumers will 'substitute' away other more (relatively) affordable goods (vice versa)
the law of supply and the theory of the law of supply, including the profit motive
the law of supply (theory):
Quantity supplied (Q) and price (P) have a positive relationship.
As P increases, Q increases and as P decreases, Q decreases.
Where quantity supplied is how much firms are willing and able to produce at a given price.
The Profit Motive:
Firms have one motive, to maximise their profits.
As the price for a particular g/s increases, this should increase the profit available to firms (assuming costs remain constant)
Therefore businesses will allocate (reallocate) resources to g/s which have the highest relative price.
non-price factors likely to affect supply and the position of the supply curve, including changes in the costs of production, number of suppliers, technology, productivity and climatic conditions
non-price factors:
non-price factors, shift the whole supply curve e.g. 'affect the position'
they will increase or decrease quantity supplied (Q) at EACH price
changes in the costs of production:
costs of production = labour, machinery, equipment, energy etc. used by firms in the production process.
changes in the costs of production will change the willingness of firms to produce
an increase in costs of productions = less profitable to produce (profit motive)
productivity:
measures output (g/s produced) per input (hours worked or materials used)
productivity is really an extension to costs of production, an increase in productivity reduces unit costs for firms (e.g. decrease in costs of production)
technology:
improvements in technology allow firms to produce more at each price point
increase in the quantity supplied at each price (shift to the right)
climate conditions (supply shocks):
in agricultural industries, weather and climate are important factors which determine the ability of firms to produce.
improvements in climate = more supply
deterioration in climate = less supply
number of suppliers:
the amount of suppliers producing a particular good or service will directly impact the position of the supply curve (e.g. the quantity supplied at each price)
the supply curve, including movements along and shifts of the supply
the supply curve:
shows the law of supply graphically
is a linear relationship between the price and quantity supplied
shows the ability and willingness of firms to produce at each price
movements along the curve - contraction:
caused by a change in price
if there's a decrease in price, there'll be a decrease in the quantity supplied and cause a movement
movements along the curve - expansion:
if there's an increase in price, there'll be an increase in the quantity supplied.
shift to the right (increase)
shows that there's an increase in quantity supplied at each price.
shift to the left (decrease)
shows that there's a decrease in quantity supplied at each price.
the demand curve, including movements along and shifts of the demand curve
expansion in demand (movements along): as prices decrease (P1 to P2), the quantity demanded expands (Q1 to Q2)
contraction in demand (movements along): as prices increase (P1 to P2), the quantity demanded contracts (Q1 to Q2).
shift to the right --> increase in demand.
shift to the left --> decrease in demand
the effects of changes in supply and demand on equilibrium prices and quantity traded
equilibrium:
when the market is a 'state of rest'
there is no shortage and no surplus
suppliers and consumers are happy
where the demand and supply curves intersects
if the supply curve shifts to the right, price lowers, and the quantity rises
easier to tell on graphs (but easy stuff)
how the market will move from one equilibrium to another (surplus & shortage)
surplus:
a surplus is where (at current prices), Qs is greater than Qd 'there is too much stuff'
a surplus would be caused by either: decrease in demand or increase in supply
shortages:
a shortage is where (at current prices) Qd is greater than Qs 'there is not enough stuff'
a shortage would be caused by either: increase in demand or decrease in supply
markets will clear shortages:
consumers will bid-up prices to obtain the scarce g/s (contraction along the demand curve)
suppliers will respond to the increased prices by reallocating resources towards this market (expansion along the supply curve)
markets will clear surpluses:
suppliers will discount prices to clear excess stock (profit motive) (contraction along the supply curve)
consumers will respond to the decreased prices by consuming more (income/substitution effect) (expansion along the demand curve)
the conditions for a free and perfectly competitive
markets:
where buyers and sellers meet to make mutually beneficial exchanges
one way of allocating goods, services and resources (using prices)
there are many types of markets (market structure), you only need to study one
conditions for a free and perfectly competitive market:
no government intervention e.g. free from regulations
many buyers and sellers = competition
no barriers to entry or exit for suppliers = easy to reallocate resources (dynamic efficiency)
symmetry of information = buyers and sellers have the same information
homogenous products = goods and services are identical with no differentiation
consumer sovereignty exists = consumers allocate resources through their purchasing decisions
non-price factors likely to affect demand and the position of the demand curve, including changes in disposable income, the prices of substitutes and complements, preferences and tastes, interest rates, population demographics and consumer confidence
changes in disposable income:
disposable income = wages - taxes + transfers
increase in disposable income= more spending
decrease in disposable income = less spending
changes in the price of complementary products:
complementary products are sold separately but consumed together. Example = a notebook and pen
if there's an increase in price of complement = that will decrease demand for the original good
changes in the price of substitute products:
substitutes are different goods and service which satisfy the same needs and wants. Examples = Pepsi and Coke
increase in price of a substitute = then it'll change the buyer's behaviour, because they'll buy another substitute for cheaper
changes to preferences and tastes:
consumers preferences and tastes are constantly changing.
when they do, so does the demand for certain g/s
changes in population:
change in population or demographics will change demand for certain g/s
changes in interest rates:
interest rates = cost of borrowing an reward for saving
interest rates impact discretionary income
discretionary income = the money you have to spend after necessary expenses
consumer confidence (sentiment):
an index that measures how consumers feel about the future state of the economy, their household finances and how likely they are to make a major household purchase
an increase in confidence = likely to spend more money, an increase in demand
resource allocation (demand)
when there is a change in demand (increase of decrease), suppliers respond to the relative change in prices and either increase or decrease their resources allocation in this market
resource allocation is depicted by an increase or decrease in Q
step it out!!!
shift in the demand curve to the right
shortage
prices will start to increase
sends profit signals to suppliers to reallocate more resources to this marker
U3 AOS 1 - Microeconomics P2
the role of free and competitive markets in promoting an efficient allocation of resources and improved living standards
free and competitive markets:
remember there are specific conditions for a free and competitive market
it is generally agreed amongst economists the markets are the best way to allocate resources in an economy
markets are (generally) most efficient and improve living standards
markets answer our three basic economic questions:
what to produce?
an economy needs to make decisions about how to satisfy the collective needs and wants of society (allocative efficiency) e.g. what to produce
consumers have sovereignty
how to produce?
if a resource is expensive or becomes expensive, then produces are incentivised to find a cheaper substitute and change how they produce
this maximises productive and dynamic efficiency
for whom?
demand and supply will determine the price of resources too and this includes the price of our labour or wages. wages/relative levels of income determine who gets what in a market economy
it could be argued that this promotes technical and dynamic efficiency
markets and living standards:
markets promote most types of efficiency and therefore also increase living standards.
living standards are broken down into two types:
material (e.g. more access to g/s)
non-material (e.g. happiness, environment, freedom)
the meaning and significance of price elasticity of demand and supply
elasticity:
the responsiveness of Qd or Qs to a change in price (in terms of % changes)
the 'steepness' of the curve indicates the relative price elasticity (PED or PES) of demand/supply for a product (steep or flat)
PED/PES is measured by (% change Qd or Qs / % change in P)
inelastic demand:
note the steepness of the demand curve. Quantity demanded is not responsive to a change in price
price has changed by 30% and quantity 10%
PED less than 1 (1/3)
hint: the capital letter 'I' is steep (straight up), and inelastic curves are also steep
elastic demand:
note the flatness of the demand curve. quantity demanded is responsive to a change in price
price has changed by 10% and quantity 30%
PED more than 1 (3/1)
factors affecting price elasticity of demand: degree of necessity, availability of substitutes, proportion of income and time
elastic demand:
quantity demanded is very responsive to a relative to the change in price:
when a product has many substitutes
when a product is not a necessity
in the longer term/over time
when a product represents a high % of household income
relative inelastic:
quantity demanded is less responsive to changes in price:
when product has few substitutes
when a product is a necessity
in the shorter term/time
when price is only very small % of income household income
factors affecting price elasticity of supply, including spare capacity, production period and durability of goods
inelastic supply:
note the steepness of the curve
quantity supplied in unresponsive to a change in price
e.g. (price has changed by 30% but quantity supplied has only changed by 10%)
PES = (10/30 = .33 = inelastic)
elastic supply:
note the flatness of the curve
quantity supplied is responsive to a change in price
price has changed 30% but quantity supplied has only changed 10%
PES = 30/10 = 3 = elastic
inelastic supply curve:
supply will be inelastic when a quantity supplied is not responsive to a change in price, this occurs when:
there is little unused/spare productivity capacity
goods can't be stored and are not durable
time period for production is long
elastic supply curves:
supply will be elastic when quantity supplied is responsive to a change in price and when:
unused or spare capacity
goods are durable or can be stored
production period is short
types of market failure, including public goods, externalities, asymmetric information and common access resources
market failure:
there are specific situations where the market fails to allocate resources efficiently. E.g. when the market does not achieve or promote efficiency (our four types)
characteristics of different goods and services:
degree of excludability:
excludability determines how hard/costly it is to exclude those who don't pay, from receiving the benefit of the good or service
degree of rivalry (depletable):
measures the degree to which consumption by one reduces consumption by another
Public goods
public goods:
are goods that have the following characteristics:
non-excludable
non-depletable (non-rivalrous consumption)
because of these characteristics, public goods (or services) are underproduced by the market (not socially optimal)
this means the market has failed to achieve efficiency
public goods face the free-rider problem
the free-rider problem:
because, the cost is too great to stop those who don't pay from using public goods or its not simply possibly - there is little incentive for people to pay e.g. They 'free-ride'
furthermore, when a 'rational' person notices that other people are not paying, they are even less likely to pay
common access resources
common access resources (CAR):
they have the following characteristics:
depletable (rivalrous consumption)
non-excludable
in a free and competitive market, CAR's are over consumed and depleted and are therefore not available in the LT
according to economic theory, if nobody owns the resources and there is no government intervention. Everyone looks to maximise their own utility (satisfaction of needs and wants) they consumer as many resources as possible.
in the short-term this may be fantastic
however, in the LT, everyone is worse off
negative and positive externalities
negative externality:
impose a cost on third parties who are not involved in the original transaction.
the soical costs are greater than the private costs
examples: factories releasing carbon into the air (negative on environment), uber eats (the constant driving, bad), servos (the fuel, damaging to environment)
positive externalities:
impose a benefit on third parties who are not involved in the original transaction.
the social benefits are greater than the private benefits
examples: getting education, getting vaccinated (gives society the benefit)
on consumption e.g. consuming a vaccine
con production e.g. production of solar power plants
externalities:
when a transaction (activity) imposes a cost or benefit (spillover) on third parties not involved in the market price of the g/s
positive externalities = impose a benefit
negative externalities = impose a cost
asymmetric information
asymmetric information:
when there is an imbalance of information about the good or service between the supplier and consumer.
this leads to a suboptimal outcome (for the consumer or supplier)
efficiency is not achieved
moral hazards (extension)
when the one party is protected from the downside risk by the other party
the role and effect of indirect taxation, subsidies, regulations, advertising and direct provision as forms of government intervention in the market to address market failure
government intervention:
the government understands that the free operation of the market fails to achieve efficiency (in certain circumstances).
hence they will intervene to alter how resources are allocated with the intention of improving allocative efficiency within the economy.
types of interventions: provide, indirect taxation, subsidies, government regulations/restriction, and government advertising
provide (direct provision):
by providing goods and services, the government is effectively shifting the supply curve to the right.
increasing the resources that are allocated towards the market
subsidy:
a subsidy is a direct payment or tax break to suppliers to encourage production (and therefore consumption) of a good or service.
subsidies will reduce suppliers costs of production and therefore shift the supply curve to the right.
thereby decreasing the price for consumers
indirect tax (excise tax):
works the opposite way to a subsidy
an indirect tax is levied on producers e.g. must pay an amount per unit produced.
will increase their cost of production
supply curve will shift to the left and prices will rise
regulations (laws):
the government will make and enforce laws that intervene in the market to achieve a more efficient outcome
advertising:
the government will fund advertising with the view to change consumers preferences e.g. towards or away from a specific good.
this will impact the demand curve first and force producers to respond.
the demand curve will shift to the right, prices will increase, more resources allocated to this market.
quit campaign: demand curve will shift to the left, prices will decrease, so less resources allocated to this market.
one example of a government intervention in markets that unintentionally leads to a decrease in one of allocative, productive, dynamic or intertemporal efficiency
government failure:
despite their best efforts (mostly) governments sometimes intervene and cause an unintended consequence
in doing this, they may reduce one or more type of efficiency
-such as alcopop tax (supplying less and making it more expensive)