2.

1
what is a market
a market is where sellers and buyers come together to carry out an economic transaction

what is demand
demand is the quantity of a good or service that consumers are willing and able to purchase at
various prices during a specific time period, ceteris paribus.

what is individual demand

is the demand of one consumer for a product

what is market demand

is the total demand of all consumers for a product

what is the relationship between an individual consumers demand and market demand

what is the basic law of demand

 as the prices of the product decreases, the quantity demanded of the product will
usually increase, ceteris paribus
 the demand curve slopes downwards
 price and quantity demanded move in opposite directions
 and inverse relationship exists

draw a demand curve

what is the extension of demand

an increase in quantity demand due to a fall in price

what is the contraction of demand

a decrease in quantity demanded due to a rise in price
what are the non-price determinants of demand
o incomes :
o tastes and preferences
o future price expectations
o price of related goods
o number of consumers

define substitutes, and explain how it affects demand

substitutes: a good which can be replaced by another good

define complement, and explain how it affects demand

complement: by demanding one good, a consumer will demand another

define normal goods

normal goods( demand rises as income rises

define inferior goods

inferior goods(demand falls as income rises)

how can an increase in demand be illustrated

a shift to the right of the demand curve

how can a decrease in demand be illustrated

a shift to the left of the demand curve

what are the assumptions underlying the law of demand

-income effect
-substitution effect
- law of diminishing marginal utility

what does “income effect” mean

a fall in price increases the real purchasing power of consumers, it like their income increases,
because now they can buy more with their given salary, so the quantity increases

what does “substitution effect” mean

a fall in price of good x makes it relatively cheaper compared to substitutes
some consumers will switch to good x leading to higher demand
much depends on whether products are substitutes

explain the law of diminishing marginal utility

marginal utility is the change in total satisfaction from consuming an extra unit of a good or
services
standard economic theory believes in the idea of diminishing returns. the marginal utility of extra
units decline as more is consumed

what is inflation?
inflation is the rate in which the price for goods and services increase

2.2
what is supply
supply is defined as the quantity of a good or services that producers are willing and able to offer
at various prices during a specific time period, ceteris paribus
what is individual producers supply
is the supply of one product from one firm at every price

what is market supply

is the sum of all the individual supplies of a product at every price

draw a supply curve

explain the law of supply

 the law of supply says that as the price of a product increases, the quantity supplied will
usually increase, ceteris paribus
 price and quantity supplied move in the same direction
 a positive relationship exists
 firms respond to the profit motive

extension of supply
is an increases in quantity supplied due to a rice in price

contraction of supply
is a decrease in quantity supplied due to a fall in price

the non-price determinants of supply

- changes in costs of factors of production
- prices of related goods (in cases of joint and competitive supply)
- indirect taxes and subsidies
- future price expectations
- changes in technology
- number of firms

what is joint supply

 - joint supply (when two or more goods are derived from the same product so that it is
not possible to produce more of one without producing more of another
what is competitive supply
- when the production of two goods are similar resources and processes, if a supplier
produces more of one good it means producing less of the other.

how can an increase in supply be illustrated

a shift to the right of the supply curve

how can a decrease in supply be illustrated

a shift to the left of the supply curve

what are the assumptions underlying the law of supply

- law of diminishing marginal returns
- increasing marginal costs

define the law of diminishing marginal returns

states that adding more of one factor of production, while holding at least one other factor of
production constant, will at some point yield lower marginal returns

explain marginal cost

refers to the cost of producing one more unit of a good

illustrate marginal product graph and total product graph

equation for marginal cost
change in total cost/change in total product

illustrate marginal cost

2.3
define market equilibrium
occurs when quantity demanded is equal to quantity supplied and there Is no tendency for the
price or quantity to change

define equilibrium price

the price determined in a market when quanitity demanded is equal to quantity supplied and
there is no tendency for the price or quanittiy to change

define disequilibrium
occurs when quanitity demanded is not equal to quantity supplied

define excess supply

surplus: amount by which quantity demanded is lesser than quanitity supplied

define excess demand

shortage: amount by which quantity demanded is greater than quantity supplied

illustrate an increase in demand

illustrate a decrease in demand

illustrate an increase in supply

illustrate a decrease in supply

define the price mechanism

the system where prices are determined by demand and supply in competitive markets, resulting
from the free interaction of buyers and sellers (these interaction determine the allocation of
resources)

the relationship between the price mechanism and the 3 economic questions
- what to make: the rising price of a product will result in more producers allocating resources to
make that product
- how to make: rising labour costs would tell producers to make their products with less labour
and more capital, or to move production to places with lower labour costs
- for whom: rising prices will mean that consumers are no longer willing and/or able to buy the
product

what is a feedback loop

the interdependency between two or more compnoenets of a system where the change in syaye
of one componenet,

what does the negative feedback loop do

it helps to stabilize systems after a disturbance, when there is a change in the system, they act to
bring back equilibrium.

what causes disequilbrium and triggers price change

the shifts in supply and demand

what are the two ways that negative feedback is created

- signals
- incentives

explain how the negative feedback loop works

price increase (due to less supply or increase demand-shortage)
- quantity supplied increases to decrease price and return price decrease (due to more supply or
decrease in demand)
- quantity supplied decreases to increase price and return

what is the signaling function of prices

the function of the price mechanism where information is provided to consumers and producers
about what should be consumed and produced

explain how the signaling function of prices works

rising prices:
- signal to consumers that they should consume less of a product
- signals to producers that they should make more of a product

declining prices:
- signal to consumers that they should consume more of a product
- signal to producers that they should make less of a product

what are the assumptions of incentive function of prices

it assumes that consumers and producers are rational and they will behave according to the laws
od demand and supply

what is the incentive function of prices

the function of the price mechanism where motivation is provided to consumers and producers to
reallocate resource in a market

explain how the incentive function of prices works

if the price of a product rises rational consumers would buy less of it and reallocate resources to -
other products
if the price of a product rises rational producers would produce more of a product reallocating -
resources towards that product
,if prices were declining the opposite would be true -

what is rationing function

the controlled distribution of resources, it is necessary at any time when goods and resources are
scarce

explain rationing in the market system

it is when prices rise and therefore only those both willing and able to purchase good will have
.access to them, therefore products are rationed by prices

what is the difference between productive efficiency and allocative efficiency

productive efficiency refers to producing goods by using the fewest possible resources at the
lowest possible cost
allocative efficiency refers to producing the optimal combination of goods from society’s point
of view

what is pareto optimality

state of allocation of resources where it is impossible to reallocate without making one worse off

define consumer surplus

the difference between the price that consumers pay and the price that they are willing to pay

define producer surplus

the difference between the price producers are willing and able to sell it and the price earned
from selling the good at the market price

define community surplus

the sum of consumer surplus and producer surplus, the total benefit gained by society when the
market is at equilibrium

draw a demand and supply curve and show the consumer surplus

draw a demand and supply curve and show the producer surplus
draw a demand and supply curve and show the community surplus

how to calculate the consumer surplus and producer surplus

find the area of the triangle

define rational behavior

2.4
behavior of a consumer or producer that seeks to maximize utility or profit respectively
behavior that exhibits stable preferences over time

what are the assumptions underpinning rational consumers

clear preferences for goods and services 
highly developed analytical skills 
perfect information 
maximize utility 
what are the limitations of the assumptions of rational consumer choice
biases- rule of thumb, anchoring and framing availability -
bounded rationality -
bounded self-control-
bounded selfishness
imperfect information-

what is the anchoring effect

a strategy that people use to make guesses about things they do not know by thinking about
.things they do know and then making an adjustment

give an example of the anchoring effect

If you were asked to guess the population of Cape Town, South Africa (and you didn’t know it),
you might think of the population of your own city and consider some comparisons between
your own city and Cape Town to come up with a guess about Cape Town’s population size.

what is the framing effect

a form of cognitive bias where human thinking and decision making is affected by the way in
which a problem is stated or framed

give an example of the framing effect

In this experiment, participants were asked to assess two different proposals for how a disease
could be cured. When the cure proposals were framed in terms of the percentage of people who
would live, people were more likely to choose it than when the proposal was expressed in terms
of the percentage that would die, even when the probabilities were exactly the same 

what is the availability effect

A mental shortcut that relies on immediate examples that come to a given person's mind when
evaluating a specific topic, concept, method or decision.

give an example of the availability effect

 people are more likely to buy insurance for natural disasters if they can easily remember recent
incidents such as floods, earthquakes and storms; they are less likely to purchase insurance if
they cannot recall such incidents. 

what does bounded rationality mean

the idea that human rationality is limited in predictable ways

what are the factors of bounded rationality

- cognitive limitations
- information imperfection
- time constraints
- suboptimal decisions

what does imperfect information mean

a situation in which the parties to a transaction have different or limited information

what does satisfice mean

to make choices that are satisfying but not maximizing

what is bounded self-control

the idea that human beings have some self-control but that is limited

what does hyperbolic discounting mean

the tendency for people to increasingly choose a smaller sooner reward over a larger later reward
as the delay occurs sooner rather than later in time

what does bounded selfishness mean

the idea that human beings, while somewhat selfish, also act as conditional cooperators

what is choice architecture

the way choices are structured for consumers

what does choice architects include

physical positioning of products -
language used to present a choice -
the sequencing and range of offering -

what is default choice

a situation where an option is automatically set for consumers, but that they can change it if they
wish

what is restricted choice

a situation where consumer choices are limited

what is mandated choice

a situation when an organization forces a consumer to make a choice at a defines point in time

what is nudging
any arrangement of the choice architecture that alters peoples choice without limiting choices or
significantly. changing incentives

what is profit maximization

the process by which a firm determines the price, input and output levels that result in the highest
profit
what are the advantages of firm trying to maximize profits
owners and shareholders reach the largest possible returns to their original investment -
entrepreneurs are rewarded with profit and profits are a mojor incentive for investment in new -
businesses
firms use these profits to fund research and development, innovating to find new markets and -
maintain their competitive edge
it’s a clear and measurable goal for employees and managers -

what are the alternative objectives other than profit maximization that businesses can set
corporate social responsibility -
market share-
satisficing -
growth-

what Is corporate social responsibility

the idea that firms should and will take responsibility to look after a range of stakeholders
including those in the local community and environment

what is market share

the percentage of a market that a firm controls

what is satisficing
to make choices that are satisfying but not maximizing

2.5
?What is the price elasticity of demand

a measure of how much the quantity demanded of a product changes when there is a change in the
price of a product

?what are the determinants of price elasticity of demand

number of substitutes -
whether the good is a nessecity or luxury -
proportion of income spent on the good -
time period considered-

what are substitute goods

goods that have similar characteristics and uses to consumers

?explain why the “number of substitutes” affect the price elasticity of demand
the more substitutes there are for a product , the more elastic the demand for it will be
the closer more similar the existing substitutes for a product are the more elastic the demand for it
will be
what is a necessity good
a good or service whose quantity demanded does not change much In response to a price change
because consumers consider it essential

?explain why the “ degree of necessity good’ affect the price elasticity of demand
the greater the level of necessity for the consumer, the more inelastic the demand of the good will
be, the more widely a good is defined the more inelastic is its demand

what is disposable income

the income remaining after deduction of taxes and social security charges available to be spent or
saved as one wishes

explain why the” proportion of income spent on a good” affects the price elasticity of demand
the higher the proportion of income spend on a good the more elastic the demand

?explain why the “time period considered” affects the price elasticity of demand
the demand for a good will be more inelastic in a short period of time than in a longer period of
time

equation for PED

values of PED that interpret the elasticity of demand

when PED > 1 price elastic -

when PED < 1 price inelastic -
when PED = 1 unitary elastic -
when PED = 0 perfectly inelastic -
when PED= infinity perfectly elastic -

what is price elastic

change in demand is more than the change in price

what is price inelastic

change in demand is less than the change in price

what is unitary elastic

a change in price leads to a proportionality equal change in the quantity demanded

what is perfectly inelastic

a change in price leads to no change in the quantity demanded

what is perfectly elastic

a change in price would lead to an infinite charge in the quanitity demanded

illustrate an inelastic demand curve

illustarte an elastic demand curve

illustarte a unitray elastic demand curve

illustrate a perfectly inelastic and a perfectly elastic

what happens if demand is price elastic

increasing price would reduce Total revenue -
reducing price would increase Total revnue -

what happens if demand is price inelastic

increasing price would increase Total revenue -
reducing price would reduce Total revenue -

what is the equation for total revenue

price x quantity

what do firms have to do to increase revenue when a productd demand is elastic

it should not raise the price, depending on how elastic the demand is, it may be benefecial to
decrease the price of the good instead

what do firms have to do to increase revenue when a products demand. is inelastic

it should raise the price of the good

if there is a unitary elastic demand what can firms do to increase revenue

they cannot increase revenue by changing its price

moving along the demand curve, how does elasticity change, and why
the value of PED falls as we move downwards along the curve
at lower prices or in the case of very low priced goods. consumers are less concerned and
impacted by changes in the price of inexpensive products, therfore their demand doesn’t change
much. however when the price is high, the impact on consumers is bigger and peoples reaction to
changes in the orice of expensive products is more sensetive

what are primary commodities

are goods that come directly from natural resources or “land” they tend to be unprocessed raw
materials that are sold without needing to be processed further

what are manufactured goods

are man-made goods that have been produced from raw materials which have been transformed
through a production process

are there substitites in primary commodities, and how does that effect its elasticity
lack of substitues for primary goods that’s why the ped is low and its inelastic

are there substitiues in manufactures goods

there are subsititues for manufactured goods that’s why the ped is high and its elastic

what is YED
income elasticity of demand is a measure of how much quanitity demanded of a good will
change in response to a change in consumer income

the equation for YED

we don’t ignore the (-) symbol here

if a rise income of 10% led to a fall In QD of a product by 5% what is the YED

its -0.5 , this means that for every 1 per cent change in peoples incomes the quantity demanded
of a product will deacrease by 0.5 per cent

the values of YED

what does income elastic deman mean

a change in income leads to a proportionately greater change in the quantity demanded

illustrate an income elastic demand curve

what does incomes inelastic demand mean
a change in incomes leads to a proportionately smaller change in the quantity demanded

illustarte an income inelastic demand curve

what does perfectly income inleastic demand mean

a change in income leads to no change in the quanitiy demanded

illustrate a perfectly income inelastic demand curve

what does YED with no classification mean

a change in income leads to a proportionatelt equal change in the quantity demanded

illustrate a “no classification” YED demand curve

if income rose by 10% and QD rose by 2% for cheese, what is the YED and what type of
? good and what is the elasticity

normal good neccesity inelastic 0.2

if income rose by 10% and QD rose by 20% for smart phones, what is the YED and what
type of good and what is the elasticity

normal good superioc elastic 2

if income rose by 10% and QD fell by 3% for coach travel, what is the YED and what type
of good and what is the elasticity
inferior good and elastic 0.3-

how to distinguish between the types of good

less than one is a necessity
more than on is service and kuxury good

how to know from a graph if it’s a normal good or an inferior good

if the graph is negative then its an inferior good
if the graph is positive then it’s a normal good

what is the importance of YED for firms

make predictions about what may happen to sales and revenues in different economi scenarios -
making decisions on which markets to enter and which products to sell (high YED markets will -
see large increase in demand as income levels rise)
maintain awareness of YED of product and changing incomrd of their target consumers in -
order to make the most of the possible opportunities

what does sectoral change mean

the change in the structure of the economy to increase or decrease production in one sector or
another

why is a knowledge of YED important for explaining sectoral changes in the strucutre of
the economy
low income countries focus output on primary products -
higher level of income countries demand for manufactured goods as consumers have met their -
basic needs
highhh level of income countries demand for services -

2.6
 what is PES
the price elasticity of supply is the measure of the responsiveness of quantity supplied of a good
to a change in its price

what is the equation of PES

what are the values of PES

>1 price elastic supply

<1 price inelastic supply
1 unitary elastic supply
0 perfectly inelastic supply
infinity perfectly elastic supply

what does PES elastic mean

a change in price leads to a proportionately greater change in the quantity supplied

what does PES inelastic mean

a change in price leads to a proportionatelt smaller change in the quantity supplies

what does PES unitary mean

a change in price leads to an equal change in the quantity supplied

what does PES perfectly inelastic mean

a change in price leads to no change in the quantity supplied

what does PES perfectly elastic mean

a tiny change in price would lead to an infinite change in the quanitiy supplied

illustrate a price elastic supply PES diagram

illustrate a price inelastic supply PES diagram

illustrate a unitary elastic supply PES diagram

illustrate a perfectly inelastic supply PES

illustrate a perfectly elastic supply PES

the determinants of PES

TICCS+F
-Time
- the ability to store: Inventory/stock
- unused Capacity
- rate at which Cost increases
- Substititution of factors of production
- the number of firms in the industry

explain: time a determinants of PES

- the production process time affects the price elasticity of supply for a product
- supply is price inelastic when it takes a long time to produce a good or service as the quantity
supplied cannot be easily increased following an increase in price
- the shorter the production time the more elastic the supply
explain: the ability to store as a determinant of PES
- the ability to store refers to the level of stocks or inventory held by a firm
- high levels of inventory- price elastic supply
- low level of stock- relatively low PES price inelastic

explain: unused capacity as a determinant of PES

- refers to the degree of spare productive capacity
- a firm with unused capacity – relative

explain: the rate at which costs increase as a determinant of PES

- it is the marginal cost, and it is the additional cost associated with producing one extra unit of
output
- marginal cost= change in total costs / change in output
- if a firm can produce more without marginal costs of production increasing at a faster rate
supply is price elastic and vice versa

explain why the high level of demand of a product with no additional costs of production
has no effect on the selling price

the supply curve of supplying this product is perfectly price elastic because the firm can supply
an extra unit of output at zero cost.

explain: substitution of factors of production as a determinant of PES

- aka the mobility of factors of production, refers to the level of ease and cost of factor
substitution in the production process
- the more mobile the factors of production the more price elastic supply tends to be
and the greater the value of PES will be
- this means that if the production of a good or service can be varied, supply is more price elastic
explain: substitution of factors of production as a determinant of PES
- the greater the number of firms in the industry the higher the value of PES as the market is able
to respond to higher prices by increasing the quantity supplied

how can firms be responsove and competitive to changes in the market using their
knowledge of PES
- create spare capacity
- keep larger volumes of stocks
- invest in improves storage systems to prolong the shell-life of products
- use or upgrade to the latest technologies to increase production capacity and improve capital
mobility
- improve distribution systems (how and when the product get to the customers)
- develop and train employees in order to improve laboul mobility to perform a range o jobs

explain the reason why the PES for primary commodities is generally lower than the PES
for manufactured products
 1- time- the output of primary sector products tend to take a relatively long time, so supply
is fixed in the short run. however manufactured products using machinery can be
produced faster in less time
2- inventory- primary products can be easily damaged when strored so it can be difficult to
hold them for any segnificant period of time however manufactured product can be
stored for longer times even tho they can become dated over time
3- marginal costs- with mass production output is continuous with large numbers of
identical goods being produced. but for primary products it is not simple to produce an
extra unit
4- capacity- manufactured products are capital-intensive meaning its realtively easy to
increase output. howeve primary products are land and labour intensive which can be
expensive so this limits the ability of firms to increase quantity supplied depsite the
increae in price.
5- substitution- capital equipment used in manufacturing is more flexible and adaptable
than resources used in the primary sector.

2.7
what are the reasons for government intervention in markets
- to earn government revenue
- to support firms
- to support households on low incomes
- to influence the level of production
- to influence the level of consumption
- to correct market failure
- to promote equity

what are the sources of government revenue

- tax revenue (direct tax or indirect taxt)
- the sale of goods and services ( intervention via state-owned enterprises)
- privatization proceeds (short-term policy)
- sovereign wealth funds ( state-owned investments funds)
- public sector borrowing- government borrowing is required when its other sources of revenue do not
meet its spending needs

how can goverments provide support to firms

- through subsidies
- tax concessions (reduction in tax or discounts)
- protecting domestic infant industries (newly established firms in markets with foregin competitors)
- business development loans (low interest rate finance)
- research and development funding
- financial bailouts ( governments save failing businesses important to the economy)

how can government protect domestic infant industries

- tariffs
- quotas
- subsidies to domestic producers
- administrative barriers

what are direct taxes

levies or charges on incomes and wealth

what are indirect taxes

levies imposed on spedning

what are tariffs

taxes imposed on imported products from foregn suppliers

what are quotas

quantitative limits on the value or volume of imports

what are subsidies to domestic producers

money given to lower cost of production

what are administrative barriers

imposed on foreign products entering the country

how do government support households on low incomes

- government funding for the provision of essential infrastructure helps to ptomote equity to help
eradicate absolute poverty
- income redistribution through government tax and expenditure goods

what are the main forms of government intervention in markets

- price controls
-indirect taxes and subsidies
- direct provisions of servies
- command and control regulation and legislation
- consumer nudges
PRICE CONTROL
define price controls
are government regulations establishing a maximum or minimum price to be charged for certain goods
and services

define price ceilings

maximum price occurs when the government sets a price below the market equilibrium price to encourage
output and consumption it’s a lower price than the market equilbrium to protect consumers of a certain
good or service from high prices they cant afford

examples of where price ceilings are imposed

- rental property market

draw a diagram to show the impacts of price ceilings on the residential rental property market

the price ceilings resulted in more demand QD than is supplied QS at the lower price PC
the results in excess demand at all price below the equilibrium price PC as shown by the shaded area

draw a diagram to show the welfare loss of price ceilings

possible consequences of price ceilings

- it produces shortages
- it generates a rationing problem
- it promotes the creation of parallel black markets
- it eliminates allocative efficiency and generates welfare loss
- there are consequences for market stakeholdres

effect of price ceilings on consumers

effect of price ceilings on producers

effect of price ceilings on workers

effect of price ceilings on governments

define price floor

a minimum price set abov the market equilibrium to encourage supply of a certain good or service

its a higher price than the market equilbrium so the producers don’t get paid less
so if the makret equilibrium was 5 rials the price floor would be 10 rials, so now the product cannot be
sold for less than 10 rials

this causes the quantity supplied to be greater than the quantitiy demanded this is because the prices are
set higher than the equilibrium and therefore the deman will decrease and supply will increase

examples of where price floors are used

- national minimum wage
- supporting farmers

explain price floor in the labour market

this is done by imposing a minimum wage that employers must pay their workers

possible consequences of imposing a minimum price

- it produces surpluses
- it promotes the creation of black markets
- the government needs to dispose of the surplus
- it might create firm inefficiency
- it eliminates allocative efficiency and generates welfare loss
- there are consequences for market stakehloders

the effect of price floors on consumers

the effect of price foors on producers

the effect of price floors on workers

the effect of price floors on governments

draw a diagram showing the consequences of a price floor and explain it

the guaranteed minimum price offered gives an incentive for producers to supply more (s1) than is
demanded (d1) at a higher price (p2) this results in excess supply at all prices above P1 as shown by the
shaded area. this surplus is either stored at excess inventory by producers who bear the costs of storing it
or is more likely to be bought by the government at a price of P2 to support the producers.

draw a diagram showing the consequences of a national minimum wage and explain it

suppliers in this case: employees

consumers in this case: employers
the NMW is the price floor, it is higher than the market equilibrium DL= SL
this causes the supply of labour to be greater than the demand of labour
because the emloyees are motivated because of the good wage, the demand of labour is lower because the
employers cant afford more employees as they have to pay higher wages. in the short run this can cause
unemployment

draw a diagram showing the welfare loss of price floors

how to calculate revenue/expenditure for firms
price x quantity supplied

how to calculate revenue/expenditure for consumers

pricex quantity demanded

how to calculate the change in producer/supplier revneue after the price control is set
change in revenu= revenue 2 (after price control) – revenue 1 (equilibrium price)

how to calculate the shortage generated by a price ceiling

the quantity demanded- the quantity supplied

how to calculate the surplus generared by a price floor

quantity supplied- quantity demanded

how to calculate government expenditure

minimum price x surplus

INDRIECT TAXES
define indirect tax

a payment taken indirectly from the consumers income through their expenditure on goods and services

what are the categories of indirect taxes

- specific
- Ad valorem

what is a specific tax

taxes that charge a fixed amount of tax per unit sold

whar is an Ad valorem tax

tax imoses a percentage tax on the value of a good or service that is sold
draw a specific tax and an Ad valorem tax diagram explain them

figure a: s1 is the original supply curve and s2 is the curve after the tax s1+tax as the amount of tax is the
same regardless of the price of the good, the new suply curve shifts upwards parallel to the original one,
by the amount of the tax per unit

figure b: the tax is a percentage of the price, so the amount of tax increases as the price of the good
increases. the supply curve shifts upwards by the amount of the tax per unit, but the gap between s1 and
s2 will be bigger as the price is higher.

what is the difference between the specific tax diagram and the Ad valorem diagram
the difference is that specific tax shifts the supply curve upwards parallel to the original supply curve,
while for a percentage tax, the gap between the two supply curves increases as the price rises

explain what happens when a tax is imposed on a good or service

this tax is paid by the firm to the government. this means that for every level of output, the firm will try to
pass the tax on to the consumers, shifting the supply curve upwards by the amount of tax.

the effect of indirect taxes on consumers

consumer expenditure on the good changes from (equilibrium price) x (equiibrium quantity) to
(new equilibrium price) x ( new equilibrium quantity)
consumers are worse off after the tax because they end up paying a higher price and consuming a smaller
amount of the good

the effect of indirect taxes on producers

the effect of indirect taxes on governments

the effect of indriect taxes on employment

how to calculate total revenue collected by the government from the tax
per unit tax x new quantity consumed after the tax

how to calculate the consumer expenditure before the tax

previous equilibrium price x the equilibrium quantity before the tax

how to calculate the consumer expenditure after the tax

new price paid by consumers x new quantity consumed after the tax

how to calculate producer revenue before the tax

previos equilibrium price x the equilibrium quantity before the tax

how to calculate producer revenue after the tax

new price received by producers x new quantity sold after the tax

subsidies
define subsidies
subsidies are per-unit payments that are used to lower production costs and increase the output of the
market

what are the aims of subsidies

- to increase revenues of producers
- to make basic necessities and merit goods more affordable to low-income consumers
- to encourgae the consumption of a good or service that is considered beneficial to consumers
- to support growth of a particular industry
- to encourage exports and protect national industry from foreign competition
- to correct positive externalities, improving the allocation of resources

draw a diagram showing the effects of a subsidy on market outcomes

the effect of subsidies on consumers

the effect of subsidies on producers

the effect of subsidies on government

the effect of subsidies on employment

the effect of subsidies on society as a whole

the disadvantages of subsidies

- it is expensive for the government as it would have to raise a significant amount of tax revenue to
finance its expenditure
- subsidies can reduce incentives for firms to cut costs or be more competitive
- there are opportunity costs in using government funds in this way
how to calculate total cost of the subsidy to the government
=per unit subsidy x new quantity consumed after the subsidy

how to calculate consumer expenditure before the subsidy

= previous equilbrium price x the equilbirium quantity before the subsidy

how to calculate consumer expenditure after the subsidy

new price paid by consumers x new quantity consumed after the subsidy
how to calculate Producer revenue before the subsidy

= previous equilibrium price × the equilibrium quantity before

how to calculate producer revenue after the subsidy

= new final price received by producers × new quantity sold after the subsidy

define direct provision

occurs when the government directly provide or supplies goods and services deemed to be in the best interest
of the public not nessecirily for free

give examples of direct provision of services by the government

- mental health and intellectual disability services
-public healthcare services
- national defence and security

define command control and regulation and legislation

refers to the direct rules or laws govering an activity or industry, stating what is permitted and what is illegal

what are examples of CAC

- minimum age laws for the purchase of demerit goods such as alcohol etc
- environmental protection laws that specify allowable quantities of pollution or the ollution-control tech that
must be used in certain industries
- outlawing tobacco advertising
- banning smoking in public areas

limitations of CAC
- it can be expensive and time consuming for firms to change their processes to meet these standards
- legislation is inflexible and applies to all firms in the regulated industry
- they do not offer any incetives for firms to improve the quality of their production beyond the standards set
by the law
define nudge theory
is the practice of influencing the choice that people make

examples of consumer nudges as a form of government intervention

- providing information about social norms in order to influence choice and behaviour
- making use of online technologies to encourage recycling such as smartphone apps that motivate users
to recycle more
- using automatic enrolment schemes which require individuals to make an effore to opt our of these
schemes
- using highly visible speed camers and other speed warning systems to prompt motorists to drive slower
and to observe speed limits on residential roads

disadvantages of consumer nudges as a form of government intervention

akin to manipulation and deception people wont react to the nudge

define government failure

a failure that arises when the cost of attempting to prevent or correct free market imperfections turns out
to be greater than the social costs of the original market failure itself

positive consequences of government intervention in markets

- promoting general economic well-being and fairness
- maximizing social welfare
- creating greater economic opportunities

the impact of price ceilings on market price and output

price: lower than free market equilibrium
output: excess demand (shortage)

the impact of price floors on market price and output

price: higher than free market equilibrium
output: excess supply ( surplus)

the impact of indirect taxation on market price and output

price: higher than free market equilibrium
ouput: decrease in quanitity demanded

the impact of subsidies on market price and output

price: lowe than free market equilibrium
output: increase in quantity demanded

the impact of price ceilings on consumers firms and governments

consumers: increase in consumer surplus
firms: decrease in producer surplus
government: supply goods and services to match the shortage

the impact of price floors on consumers firms and governments

consumers: decrease in consumers surplus
firms: increase in producer surplus
government: buy g and s to eliminate the surplus
the impact of indirect taxation on consumers firms and governments
consumers: decrease in consumer surplus; tax incidence depends on PED
firms: decrease in producer surplus; lower profitability
government: increase in tax revenues, depending on values of PED

the impact of subsidies on consumers firms and governments

consumer:increase in consumer surplus; subsidy incidence depends on PED
firms: increase in producer surplus; higher profitability
government: increase in government spending to finance the subsidies

the effectiveness of government intervention is dependent on several factors, what are they
- value judgements, economics is subjected to different presepctives
- the ceteris paribus assumption
- the values of price elasticity of demand and price elasticity of supply for different products such as
demerit goods
- the law of unintended consequences

2.8 market failure- externalities and common pool

2.8.1
define market failure
refers to any situation when the price mechanism allocates scarce resources in an inefficient way

when does market failure occur

when the signaling, incentive and rationing functions of the price mechanism fail to operate optimally,
which leads to a loss in economic welfare

what are the results of market failure

- under-provision of certain goods and services
-over-provision of certain goods and services
- under-consumption of certain goods and services
-over-consumption of certain goods and services

examples of market failure

- under provision of merit goods liked education and health
- over provision of demerit goods like tobacco and alcohol
- under provision of public goods like street lights and public roads
- the abuse of monopoly power by charging customers prices above market equilibrium

define external benefits

the advantages or gains of production or consumption to a third party (individual and/or firm not directly
involved in an economic transaction)

define external costs

are the disadvantages or losses incurrec from production or consumption by a third party not directly
involved in an economic transaction

define private benefits

the advantages or gains of production and consumption ejoyed by an individual firm or person
define private costs
the production and consumption are the actual expenses incurred by an individual firm or person

define social benefits

the true benefits of consumption or production that is the sum of private benefits and external benefits
(also referred to as positive externalities). social benefits= private benefits+positive externalities

when does the socially optimum output occur

when the marginal social benefit (MSB) equals the marginal social cost (MSC), at the output level where
MSB=MSC

define marginal private benefit

the additional value enjoyed by households and firms from the consumption or production of an extra unit
of a particular good or service

define marginal private cost

the additional expenses of production for firms or the extra charge paid by customers for the output or
consumption of an extra unit of a good or service

define marginal social benefit

refers to the total gains to society from an extra unit of production or consumtion of a particular good or
service. it is the sum of the benefits for private individuals and the positive externalities to others in
society

define marginal social society

the total expenses to society from an extra unit of production or consumption of a particular product. the
total costs of producing or consuming an additional unit of output includes both private or direct costs of
producers and consumers plus the costs to others in society

define allocative effecicncy

when social or community surplus is maximized. this occurs at the socially optimum level of output
MSB=MSC. this is because at this level of output, it is not possible to reallocate resources to make one
party better off without making others worse off

how is community surplus maximized

removing any excess demand or supply
draw a diagram: allocative effecicny maximixing social surplus and explain it

social surplus is show by the area A+B. at the market equilbrium there is no excess demand or supply and
resources are allocated effeciently at point X thereby maximizing social welfare

2.8.2 positive externalities

define externalities
external costs or benefits of an economic transaction causing the market to fail to achieve the social
optimum level of production or consumption

define positive externalities

benefits enjoyed by a third party from an economic transaction, exerted by the production and
consumption of public goods and merit goods

define merit goods

are products that create positive externalities when they are produced or consumed MSB> MPB

examples of positive externalities of production

- new tech produced
- tree farming

examples of positive externalities of consumption

- education
-helath care
- vaccines

disadvantages of merit goods

-rivarlous
- excludable
examples of products with external benefits
- street lights
- lighthouses
- police
-emergency systerms
-vaccines
define positive externality of consumption
it’s the benefits enjoyed by a third party exerted by the consumption of a certain product
you getting vaccinated will mean that it is less likely for another person to get covide the risks will go
down that is the third party benefit

draw a diagram and explain it: positive externalities of consumption (of merit goods)

what curve moves: the consumption - consumers  benefits  so the MPB and MSB  the demand
curve
what way does it move: its positive so this way 

here positive consumption exists because the marginal social benefit of consumption (MSB curve) is
greater than the marginal private benefit (MPB curve) at all levels output ip to the socially optimal level
of output. this is due to the existences of positive externalities of consumption. there is market failure at
the free market equilbirium (because free markets do not usually produce the goods that have positive
externalities the government does like public goods that’s why we say there is a free market failure) there
is under-consumption of the merit good. the socially desireable level of output is where MSB=MSC. In
other words, at output level Qopt. the green shaded area represents the potentail welfare gain due to the
under consumption. the green shaded area is the quantity not consumed between the Qe and the Qopt so
the people see this as a loss so it’s a potentail welfare gain.

draw a diagram and explain it: positive externalities of production (of merit goods)
what curve moves production  firms  cost  so the MPC and MSC the supply curve
what way does it move: positive so this way 
here the MPC is greater than the MSC (so here the firms cost will be higher than the society wich is good
for the society so that’s why its positive) this is true for all levels of production up to the socially optimal
level of output (Qopt) when the MSC=MPB the existence of positive externalities is fully used. the
market failure is at the market equilbrium where there is an under consumtion of the merit good. the green
shaded area is the potential welfare gain as a result of the under consumption. government intervention is
needed to lower the price from Pe to Popt thereaby encouraging the consumption of the merit good uo to
Qopt.

2.8.3 negative externalities

define negative externalities

expenses incurred by third parties in an economic transaction for which no compensation is paid

examples if negative externalities of production

- air pollution caused by factories and trafic
- farm production

example of negative externalities of consumption

- child obesity from consumption of junk food and carbonated soft drinks
- second-hand smoking
- consumption of alcohol

define demerit goods

products that create negative spillover effects to others in society. hence their production and
consumption results in MSC> MPC, causing a welfare loss to society

example of demerit goods

- alcoholic beverages
- junk food
- cigars
- single use plastic
draw a diagram and explain: negative externalities of production of demerit goods

what curve moves production  firms  cost  so the MPC and MSC the supply curve
what way it moves, its negative so 
the marginal social costs (MSC curve) is greater than the marginal private cost (MPC curve). in a free
market wuthout government intervention, the level of output will be at Qe where the MPC=MPB of
production. however the socially optimal level of output is at Qopt where the MSC=MSB, with a higher
price of Popt being charged. hence from societys point of view there is over-production of demerit goods
and a welfare loss shown by the green shaded area. society would benefit from reducing the output of the
demerit good from Qe to Qopt, as this level of output eliminates the negative externalities as shown by
the vertical distance between MSC and MSB at all output levels beyong Qopt.

draw a diagram and explain: negative externalities of consumption of demerit goods

what curve moves: the consumption - consumers  benefits  so the MPB and MSB  the demand
curve
its negative so it moves this way 
the marginal social benefit (MSB curve) is less than the marginal private benefit (MPB curve). in a free
market without government intervention equilibrium output is at Qe wich exceesd the socially optimal
level at Qopt where the MSC=MSB of consumption. hences from society point of view there is over-
consumption of demerit goods and a correxonding welfare loss as shown by the green shaded area.
essentially society would benefit from reducing consumption of the demerit goods from Qe to qopt, as
this level of output eliminates the negative externalities (as shown by the vertical distance between MSC
and MSB at all consumption levels beyond Qopt

how to calculate welfaere loss

to calculte a welfare loss or unrealised potential welfare gain we need to use the formula for a triangle
Area of a triangle =12=12 base × height

2.8.4 common pool resources

define common pool resources

are those that are non-exculdable but rivarlous in consumption and create a situation of tragedy of the
commons. they result in getaive externality and unsustainable production

examples of commoon pool resources

- fisharies
-rivers
-forests

what are the three key characteristics of common pool resources

- non-excludable
-rivalrous
- tragedy of the commons

define non-excludability as a characteristic of common pool resources

is one of the two characteristics of pure public goods, where it is not possible to exclude someone from
using a good or service even if they have not paid for it, because it is no practical to charge a price

define rivarlous as a characterisitc of common pool resources

the usage of resources reduces the amount that is available for others to use ot consume

define tragedy of the commons as a characterisitc of common pool resources

refers to the degradation, depletion or destruction of a common pool resource caused by the problems of
rivalry and overuse

what is the result of the exploitation of common pool resources

results in unsustainable production and negative externalities

example of common pool resources

overfishing

2.8.5 government intervention in response to externalities and common pool resources

what are the possble government intervention responses to externalities and CPRs
- indirect taxes
-carbon taxes
- legislation and regulations
- awareness creation
-tradable permits
- international agreements
-collective self-governance
- subsidies
- government provision
fill this in

INDIRECT TAXES
define indirect taxes
make producer or consumer pay for the negative externalities of production and consumption

when is the imposition of indirect taxes used

negative externalities of production

draw and explain: imposing indirect taxes on production in response to externalities and CPRs
the main purpose of using an indirect tax is to make the price of the product equal to D=MPB=MSB,
thereabu creatinf a more socially efficient allocation of resources.
the indirect tax taises costs, for the producer, thereby causing the S=MPC curve (the supply curve of the
private firms) to shift leftwards towards the S=MSC curve. the lower supply causes the price to rise from
Pe to Popt and the quanitity demanded to fall from Qe to Qopt
the consumers pay a higher price (Popt to Pe) and the producer pays the remainder (Pe to P0).

ads and disads of imposing an indirect tax on the production or consumption of products with negative
externalities
+ increasing the price of the product and therefore should decrease the quantity demanded
+ creates tax revenue for the government which can be used to deal with the external costs of negative
externalities
- the demand of some of the products (addictive) are price inelastic, so the tax may have a little impact on
consumption and production
- tax can have a greater impact on low-income earners than high-income earners (equity problem)
- it encourages smuggling amd unofficial market activities

CARBON TAXES
define carbon taxes
a tax on greenhouse gas emissions or the carbon content of fossil fuels in order to reduce pollution from
particular industries by internalizing negative externalities of production. this creates incetive for firms to
reduce pollution

when is the imposition of carbon taxes used

- negative externalities of production
- common pool resources
draw and explain : carbon tax on polluting firms

factory pollution causes a divergence between the marginal private costs (MPC) and marginal social costs
(MSC) of production. the effect of the per unit carbon tax (Popt-P0) is a fall in production from Qe to
Qopt and a higher price for the product from Pe to Popt. the government earns tax revenue as shown by
the shaded green area

ads and disads of carbon taxes to solve externalities

+ easy to apply
+ tax revenues will be collected and can be invested in promoting innovation and new technologies
- difficult to measure the pollution created and establish the amount of tax
- difficult to identify to what extent each firm Is responsible for the pollution
- firms pay for the pollution they create but the pollution still takes place

LEGISLATION AND REGULATION

define legislation
refers to law stipulated by the government as a response to tackling imperfect informatin in markets

define regulation
refers to the act of monitoring and controlling the activity of firms, such as advertising information
required to be legal,decent, honest and truthful

when is the imposition of legislation and regulation requied

- positive externalities of consumption
- negative externalities of consumption/production

draw and explain: legislation and regulation to solve externaliites

 the legislations and regulation shift the
demand curve for the demerit goods from
MPB to MSB owing to reduced benefits of
consumption. Thus, consumption fails from
Q1 to Q2. therefore, this also reduced the
negative externalities associated with the
demerit good.

disads of legislations
- the ban may lead to unemployment in the
corresponding industry as jobs would be lost
of market closed or reduced
- banning a firm would create non-consumption of the good that was being produced, which might be a
good necessary or desirable to consumers.
- the cost of setting and then enfotcing the policy standards may be very difficult to implement, and/or
have a greater cost than the pollution itself

EDUCATION

when is the imposition of positive/negative advertisment required

- positive ext consumption
- positive ext production

draw and explain: education (awareness creation) and positive consumption externalities
the impact of education on the demand curve for merit goods is an outwards shift from MPB to MSB. this
increases consumption from Qm to Qopt. the deadweight loss is from the costs for dunding education and
awareness creation

ads and disads of eduction and awarness

+ behaviour and consumption patterns of individuals and firms change
+ may lead to a cultural change in behaviour
- not always effective
- it takes a long time for the message to be accepted by people
- opportunity cost of government expenditure

define collective self-governance

refers to voluntary communal actions to tackle the problems of negative externalities and the problems
associated with the exploitation of common pool resources

SUBSIDIES

Subsidies
are a form of financial assistance from the government to domestic firms by lowering their costs of
production in order to help the firms comepte against foreign imports. subsidies encourage output reduce
the price of certain products, or keep down the cost of living for the domestic countrys citizens.

when is the impositon of subsidies of

- positive externalities of production and consumption
draw and explain: the effects of a producer subsidy

the specific subsidt given to the public transport provider is shown by the vertical distance between the
MPC and MSC curves. This represents the value of the positive externalities of production and
consumptoin. the subsidy helps to reduce production costs, thus shifts the supply curve outwards from
MPC to MSC. the producer passes some of this per unit subsidy to consumers in the form of lower prices
(from Pm to Popt) and keeps the remainder (P0 to Pm) in the form of lower production costs. Hence, the
subsidy provides an incentive for more people to consume the good, thereby increasing the quantity from
Qm to Qopt and reducing congestion on roads. the total amount spent by the government on the subsidy is
shown by the green shaded area. the area ABC is the deadweight loss.

disadvantages of sibsidies
- cost for governments -opportunity cost
- subsidies can generate production inefficiencies in private firms because part of their revenue is
guaranteed by the government

TRADABLE PERMITS

define tradable permits

government-regualted emissions trading schemes that limit pollution in an industry to a more socially
efficient level. Efficient firms can sell any excess permits that they do not need to use

when are tradable permits imposed

-negative externalities of production
-common access pool resources

ads and disads of tradable permits

+ encourages firms to seek lower-cost methods of reducing emissions wich will lower their overall
production cost
+ the price of permits is determined by the free market wich allows great flexibility
+ provides a way for international cooperation to tackle the global challenge of emissions
- to start with, it is difficult to set an acceptable level of pollution
- difficult to measure a firms pollution
- firms pay for the pollution they create but doesn’t nessecirally reduce pollution

when is the imposition of government provision required

- positive externalities of production and consumption
-public goods

disadvantages of government provision

- economic inefiicincy
- opportunity cost
- issues of inequality

2.8 importance of internationl cooperation

Why is international coopoeration important

To deal with limitations of government policies in dealing with market failures and common pool
resources

What is a framerwork used in dealing with sustainablity issues

The sustainable development goals SDG of the untied nations development programme UNDP, with 17
interconnected targets, wich is an international agreement between 193 countries, addressing global
challenges to sustainability

What are the challenges faced in international co-operation

- cultural differences and local contexts: like laws of driving age
- debates about how much each country can and should contribute to the problems of gloval
warming and climate change

2.9 market failure- public goods

define public goods
collective consumption goods

what are the two key characteristics of public goods

- non-rivalrous
-non-excludable

define non-rivalrous
the consumption of the good or service by one person does not reduce the amount available for others

define non-excludable
firms cannot exclude people from the benefits of consumption even if they do not pay. this means that
non payers can enjoy the benefits of consumption at no direct financial cost to them

what are the example of public goods

- lighthouses
- national defence
- public radio broadcasts
- emergnecy services

why is public goods not provided by the public sectors

no incentives for any private sector firm to provide such goods and services

what is the difference between pure public goods and impure public goods
pure public goods are those with both charestaristics and thosw with one of these charecatarisitcs only are
known as impure or quasi-public goods

examples of public goods that are non-rivalrous and non-excludable to some extent
public roads there is rivalry to a degree which is why many large cities suffer from heavily congested
roads and there is some degree of excludability as drivers need a licnence and money to own and maintain
a car

define the free rider problem

occurs when people have access to use or benefit from a good or service without having to pay for it, as a
result the good or service will be underprovided or not provided at all in a free market

what are the reasons that free-riding is regarded as an economic problem

- free-riding leads to the under-production or over-consumption of a public good or service, so is

highly inefficient

- over-consumption of public goods can often lead to the tragedy of the commons, resulting in
their destruction or even extinction

- free riders do not consider the external costs and negative externalities of their activities

what is the difference between merit goods and public goods

both have positive externalities however merit goods are excludable and provided by private
sector firms whereas public goods are not provided to by the private sector because of the free-
rider problem

define direct provision

occurs when the government directly provides or supplies certain goods and services deemed to
be in the best interest of the public

advantages of direct provision

- public goods would simply not be available if it were not for government provision

- large-scale operation so the government benefits from economies of scale and efficiency gains

- social support

disadvantages of direct provision

- inefficiency and other potential government failure from intervening in markets because
governments do not necessarily now what is best for individuals and the societies

- opportunity cost, because the money could have been better spent on other priorities of the
economy

- the cost to finance such expenditure, which is passed on to taxpayers

2.10
define asymmetric information

when one party in a transaction has more information than the other party

how is asymmetric information a form of market failure

when economic decisions are made based on incomplete information. this happens when not all
of the parties involved in a transaction have perfect knowledge or all the information to make an
economic decision

examples of when consumer has more information that the producer

when individuals purchase insurance, consumer has better information about their own behavior
than the insurer
asymmetric information can lead to opportunistic behavior
means that one party can take advantage of the opportunity that the other party lacks information
resulting in adverse selection or moral hazard

examples of when producers have more information than consumers

the dentists examples, where he completed surgeries the patient didn’t need

what are the two types of asymmetric information

- adverse selection
- moral hazard

define adverse selection

a situation in which one participant has more information before the transaction occurs

example of adverse selection

all-you-can-eat buffet
customers with big appetites will be charged the same price as customers with small appetites.
and will use that information to take advantage of the amount of food on offer. and it’s more
likely people with large appetites go there and the restaurant loses

define moral hazard

a situation in which on participant takes on more risk because they know they will not pay the
consequences of that risk. there is asymmetric information after the transaction has taken place.

real life example of moral hazard

the global financial crisis 2018

what is the difference between adverse selection and moral hazard

adverse selection occurs before the transaction, moral hazard after

examples of moral hazard

in insurance some customers behave more riskily because they know that they are insured.

what are the government responses to asymmetric information

- legislation and regulation
- provision of information

what are the private responses to asymmetric information

- signaling
- screening

define legislation
laws enacted by government to limit, prohibit, or require certain behaviors

advantages and disadvantages of legislation

+ cost-effective
+ improves transparency of information
- government can change legislation
- can take time to enact
- is subject to political debate
- needs to be enforced

examples of legislation
tobacco manufacturers in many countries are required to have health warnings on cigarette
packets.

define regulation
regulations is when governments monitor firms and industries to confirm that they are abiding by
relevant legislation

advantages and disadvantages of regulation

+ often necessary to enforce legislation
+ effective in holding companies to account
- expensive
- investigation into malpractice will take time
- subject to political debate
- departments can experience internal problems

examples of regulation
the UKs advertising standards authority regulates the advertising industry and requires adverts to
be legal, decent, honest and truthful.

define provision of information

means the government provides additional information about goods and services, or requires
firms to do so, in order to help buyers make more informed decisions

advantages and disadvantages of provision information

+ cheaper
+ empowers consumers to make their own decisions about what is best for them
- might note always be as effective as strong intervention
- still carries an opportunity cost

examples of provision of information

government can use public broadcasts and announcements to improve information such as
informing smokers, gamblers and drinkers of the

define signaling
a private response to the problems of asymmetric information in which participants with more
information communicate this information to the other party
advantages and disadvantages of signaling to improve asymmetric information
+ can be cost-effective if providing the signal doesn’t require any further action
+ increases the amount of information available to all participants
+ improves market efficiency
- there must be consequences for inaccurate information
- takes time for the newly provided information to be taken up

define screening
a private response to the problem of asymmetric information in which participants with less
information force those with more information to reveal their information

advantages and disadvantages of screening to improve asymmetric information

+ the participant with less information is acting and may be more likely to trust the information
+ increases the amount of information available to all participants
+ improves market efficiency
- can still select the wrong participants

2.11

define perfect competition

a market structure where there is intensive competition with no individual firm being large
enough to have any market power to influence the price or quantity traded

example of perfect competition

farmers market

what are the characteristics of perfect competition

- large number of small firms
- homogenous products/ perfectly substitutable products
- free entry and exit
- perfect information
- perfect resource mobility

draw a perfect competition diagram

define monopoly
a matket form where there is only on firm supplying the market, so the firm is the industry.also
known as price makers

example of monopoly
telecommunication company

what are the characterisitics of monopoly.

- single seller or dominant firm
- no close substitutes
- high barriers to entry
- imperfect information

what are the barriers to entry in a monopoly

1- economies of scale
2- natural monopoly
3- legal barriers
4- brand loyalty
5- anti-competitive behaviour
draw a profit maximizing monopoly diagram short and long term position, explain

this firm will supply at the output level where MC=MR that is at Qpm and charge a price of Ppm
while average costs are AC1. as the firms AR>MC at this level of output abnormal profits are
created

draw a short run normal profit position for a monopolist diagram, explain
when AC=P the monopolist earns normal profits, this happens if the monopolist reduced price as
a deliberate deterrent to potential entrants to the market, however as the monopolist does not face
any real competition it is rational to assume the profit maximizing monopolist will raise its price
above its average cost of production in the long run, so that P=AR>MC and AR>AC

draw a short run loss minimization position for a monopolist diagram, explain

if AC > P it is possible for the

monopolist to make losses.
this should not persist in the
long run as it would suggest
that the monopolist is not
covering its implicit costs,
meaning that is could make
more profit by pursuing the
next best alternive- making it
irrational to stay in this
market in the long run

draw and explain:

monopoly and allocative
inefficiency
it can be seen that at the profit
maximizing output consumers pay more for a lower amount of output this us nit a socially
desirable outcome owing to restricted output and higher price in comparison with perfect
competition
what is the profit maximizing level of output
MC=MR

what is the revenue maximizing level of output

MR=0

why does the monopoly firm not produce beyond the output level where MR=0
since revenue starts falling and profits will not be maximized
if you think about it the MR curve if it continues below 0 so -1 the revenue will be negative too

explain: what type of profits do monopoly make

abnormal profits because TR>TC
and if you think about it they are the only firm and they can set the price so they are making high
profits, and demand is really high too

define profit maximization

the process by which a firm determines the price, input, and output levels that result in the
highest profits

define revenue
the money received from the sale of a firms output of goods and services

define total revenue

the value of money received by a firm from selling its output of goods and/or services

what is the equation for total revenue

price x quantity

define average revenue

refers to the price received from the sale of a good or service

what is the equation for average revenue AR

total revenue / quantity = AR=P

define costs
the expenses or expenditures of a firm in relation to their production

define fixed costs

costs that do not change with the level of output

define variable costs

those directly linked to the level of output
what is the different between total fixed costs and average fixed costs
total fixed costs refers to the sum of production costs that do not change with the level of output
average fixed costs refers to the fixed costs per unit of output

how to calculate average fixed costs

TFC/ Q

how to calculate total fixed costs

AFC X Q

what is the difference between total variable costs and average variable costs
total variable costs incurred directly from the output of a particular good or service
average variable costs refers to direct production costs incurred for each unit of output of a good
or service

how to calculate average variable costs

AVC= TVC / Q

how to calculate total variable costs

AVC x Q

define total costs

is the sum of fixed and variable costs of producing a good or for providing a service

how to calculate total costs

TC= TFC+TVC

define average costs

the unit costs of production

how to calculate average costs AC

AC= TC/Q

how to calculate profit

profit = TR-TC

define marginal revenue

the extra revenue received from the sale of an extra unit of output

how to calculate marginal revenue MR

change in total revenue/ change in output

define marginal cost MC

the cost of producing an extra unit of output

how to calculate marginal cost

change in total cost / change in output

explain why MC=MR is the profit maximizing level of output

if MR>MC additional revenue exceeds additional costs, the profit maximizing firm has to
increase its output

if MC> MR additional costs exceed additional revenue, the profit maximizing firm should reduce
its output

when MC=MR there is no change in profits

define abnormal profits

refers to profit that is greater than normal profit, creating incentives for producers to increases
output

when is the firm earning abnormal profits

AR > AC

define normal profits

when a firm earns just enough revenue to cover its total costs of production and remain
operational in the industry

when is the firm earning normal profits

when AR=AC

define losses
when a firm experiences negative economic profits, that is its total costs of production exceed its
total revenue

when is the firm earning a loss

TC>TR

define market power

refers to the ability of a firm to manipulate the price of a good or service by manipulating the
level of supply and/or demand for the product

draw a diagram showing the profit maximizing position for a price taker
draw a diagram showing perfectly competitive firms as a price takers and explain

the firms selling price is determined by the market forces of demand and supply. the price is not
determined by any individual firm owing to the absence of market power in perfectly
competitive markets. therefore it is only changes in market demand and/or supply that will cause
a change in the price charged by perfectly competitive firms

explain why in perfectly competitive markets the AR and MR are equal to the demand
curve
since they are price takers, every time they sell a good or service they receive the same price for
it, this means that the amount of revenue gained from each sale is equal to the last and so the MR
remains constant

draw a diagram showing the short run abnormal profit in perfect competition , explain
the price (w) is greater than the short run average cost ( z) therefore the firm makes abnormal
profit shown by the shaded area

draw a diagram showing the short run losses in perfect competition , explain

the loss making firm will still produce MC=MR that is at Q. as price c is less than the average
cost b , therefore the firm in this case makes a loss in the short run , shown by the shaded area

draw a diagram showing the long run normal profit in perfect competition , explain
the perefectly competitive firm initially operates at Q1 earning abnormal profit at a market price
P1. however owing to a lack of barriers to entry and the presence of perfect knowledge, other
firms will be able to enter the industry quickly. hence the market supply will increase shifting the
supply curve from s1 to s2. this will lead to a reduction in the pruce to p2 as determined by the
price mechanism. therefore this will shift the D=AR=MR curve lower because firms have to take
and accept the lower market price . hence in the long run perfectly competitive firms can earn
only normal profits, that is AR=AC

define allocative efficiency

the socially optimal situation that occurs when resources are distributed in such a way that
consumers and producers get the maximum possible benefit, that is, no one can be made better
off without making someone else worse off.

what is the allocative efficient level

P=MC

show that perfect competition is allocative efficient

MC=P

explain why perfectly competitive markets are also productively efficient

productive efficient occurs at the output level where average costs are minimized that is where
MC=AC. hence there is no wastage or unemployment of scarce resources

what are the two types of imperfect competition

- oligopoly
- monopolistic competition

define oligopoly
is a market structure where a few large forms dominate the industry

define non-collusive oligopoly

is a form of oligopolistic market in which firms act independently, rather than colluding to act as
a monopolist

what are the main characteristics of non-collusive oligopoly

- few large firms
- high barriers to entry
- interdependence : price rigidity and affected and affects competitors prices

define price rigidity

refers to the tendency of prices to remain unchanged in a non-collusive oligopoly. If a firm
lowers its price, rival firms feel compelled to lower their prices, or face a loss of revenue. If a
firm increases its price, then rival firms will keep their prices unchanged and take some of that
firm’s customers. Hence, there is a tendency for prices to stay the same

define monopolistic competition

is a market structure in which many firms exists but each firm only has a small degree of market
power

the characteristics of monopolistic competition

- many firms : they sell differentiated products
- free entry
- product differentiation: sometimes the name of the brand can be different

what is the degree of power in imperfect competition

- varying degrees of market power which determine the extent to which the individual
firms are price makers.

Define natural monopoly

Occurs when only one firm can operate in a market profitably
Why do natural monopoly exists
When the industry can tolerate only one supplier in order to avoid wasteful competition and to
maximize necessary economies of scale to operate in a sustainable way by having a single
prodivder. This is because of high set up csots and fixed costs and sunk costs (irrecovarble costs
upon exit of the industry)

Give examples of natural monopoly

- postal services
- gas pipes
- telephone lines

draw a diagram and explain showing natural monopoly

Significant long run average cost LRAC exists. This is because of the high fixed and sunk costs
that are involved with the product or service. It is only after a considerable quantity of consumers
that economies of scale Q1 can begin to be enjoyed. If another firms was to enter the firm to
compete, the companies demand curve would shift inwards from AR=D1 to AR=D2 and it
would no longer have enough produces to cover its LRAS. Therefore it is only sustainable for
one firm to operate profitably in this market

Draw a diagram to compare a monopoly firm with a perfect competitive market

A profit maximizing monopoly lacks incentive to operate at the lowest point on its AC curve,
instead the rational profit maximizing monopolist will limit market supply to Qpm, enabling it to
charge a higher price Ppm than would be the case in perfectly competitive markets Ppc. There is
also no incentive for a profit maximizing firm to seek allocative efficienty. Owing to the lack of
competition the price found in a monopoly is greater than the firms marginal cost, that is, P>MC.
For a perfectly competitive firm, the output would be higher at Qpc and price would be lower at
Ppc. The resulting welfare loss is shown by the shaded area. It can be seen that at the profit
maximizing output MC=MR consumers pay more for a lower amount of output. This is not a
socially desirable outcome owing to restricted output and higher price in comparison with perfect
competition .

Define collusive oligopoly

An agreement between two or more oligopolistic firms to limit competition by using restrictive
trade practices, such as price fixing or collectively limiting output

Define non-collusive oligopoly

Refers to competing firms with mutual interdependence, this means they consider the likely or
possible actions and reactions of their competitors when determining pricing and non-pricing
strategies.

Define a cartel
Is an anticompetitive agreement between oligopolistic firms in the same industry to collude by
fixing process or to restrict the level of output

Draw a diagram showing collusive oligopoly acting as a monopoly and explain

The collusive oligopolistic firms have decided to fix a profit maximizing price of Ppm for their
good or service at the output level where MC=MR. The profit maximizing quantity is referred to
as Q/n with n being the number of collusing firms. This often yields them economic profits
shown by the shaded red area, as consumers have few substitutes especially as the firms have
chosen to collude, thereby acting as a monopolist in the market.

What are the main characteristics of oligopoly

- interdependence
- risk of price wars
- incentives to collude
 - incentives to cheat

define interdependence
means that oligopolistic firms consider behaviours and decisions of their competitors when
determining pricing and non-pricing strategies as it is in the firms best interest to be fully aware
of the actions and reactions of their oligopolistic rivals, especially given their potentially high
market power and the high intensity of competition in the industry

what are price wars

occurs when firms continually reduce prices in an attempt to undercut the price being charged by
rival firms so as to entice their customers to switch brands.

Why are their incentive to collude

Member firms can set a higher price for their goods or service in order to gain more producer
surplus and maximize their supernormal profits, the individual oligopolies act as a monopoly and
, as consumers have few substitutes, the oligopolistic market can raise prices (illegal)

Why are their incentives to cheat

Because any individual firm willing to sell its product for less than the agreed fixed price with
the other colluding firms has the prospect of gaining considerable revenue.

Why are oligopolistic firms allocatively inefficicnet

- by operating at the profit maximizing level of putput (Q/n) the firm charges more for its
product than the marginal cost of production, that is P=AR>MC
- the oligopoly also earns abnormal or supernormal profit, that is, P=AR>AC
- by being more competitive, the market would be able to supply more ( than Q/n) and
charge customers a lower price (below the profit maximizing price of Ppm

define game theory

attempts to explain the nature of strategic interdependence when making a decision in
oligopolistic markets by considering the actions of competitors and based on probable outcomes

define price competition

is the use of pricing strategies to compete in an industry

define price rigidity

refers to the tendency of price to remain unchanged In non-collusive oligopoly

define non-price competition

refers to all other forms of competition like advertising, branding and packaging

define market concentration

measures the extent to which sales revenue in an industry is dominated by one or more of the
largest firm

define concentration ratio

measures the degree of market power(or market concentration) in an industry by adding the
combined market share of the largest few firms.

Define Herfindahl index

Is a measure of market concentration that gives greater weighting to the marker power of larger
firms by squaring the value of their market share

Define monopolistic competition

Is a market structure where many firms exist, but each firms has a small degree of market power
as they produce differentiated products

Draw and explain: short run abnormal profit in monopolistic competition

A firm in monopolistic competition that earns economic profit in the short run. As a profit
maximizer, the firm operates at the output level (Q*) where MC=MR. its price (P*) at this level
of output is greater than average cost of production (AR=P>AC), so the firm earns abnormal
profit as shown by the shaded area. However in the long run, the absence of entry barriers means
that more firms enter the contestable market, attracted by the prospect of earning economic
profit. However this simply reduce the market price until AR=P=AC, thereby reverting all firms
to a position of normal profit.

Draw and explain: short run loss position in monopolistic competition

It can be seen that the average cost (AC) at the profit maximizing level of putput is higher than
the selling price (p*). Losses will cause firms to exit the industry, thereby reducing the market
supplt and raising the market price until AR=P=AC. This means the industry will revert to a
position of normal profit in the long run.

Draw and explain: long run normal profit in monopolistic competition

The existence of free entry to and exit from the industry means firms in monopolistic
competition will earn zero economic profit in the long run/ they still remain in the industry
because if firms are achieving normal profit ( as AR=P=AC) then they are making the same
amount of profit as they could in their next best alternative. Note that demand curve (D=AR) and
marginal revenue curve (MR) are now more price elastic owing to the presence of more firms in
the market (due to a greater substitution effect). This is also because there firms have less market
power due to the availability of many substitutes.

Why does monopolistic competition have less market power

Because of its many substitutes

Is monopolistic competition allocatively inefficacity compared to monopoly

Is less inefficient

What are the advantages of large firms having significant market power
- economies of scale
- abnormal profits

what are the risks in markets dominated by one or a few very large firms
- likely to supply less output than the social optimum
- price discrimination
- a lack of incentive for a firm to innovate and to provide choice for consumers

how can the government respond to abuse of significant market power

- legislations and regulations
- government ownership
- fines

what are the legislations and regulations that government use to respond to abuse of market
power
- the prevention of mergers as it can lead to socially undesirable market dominance
- promoting competition
- forced pricing strategy
- sale of existing assets: sell part of the firm or demerges

define nationalization
the purchase of privately owned assets or industries by the government. This usually occurs
when the government takes control of an industry previously in the private sector in order to run
it in the best interest of the public