micro

• PED determinants

  • availability of close substitutes
  • percentage of income spent on the product
  • nature of the product
  • time period
  • broad or specific market definition
• conditions of supply

  • production costs
  • productivity of labour
  • taxes in businesses
  • production subsidies
  • technology
• determinants of PES

  • time taken to expand supply
  • size of spare capacity
  • available stocks
  • ease of switching production
• functions of prices

  • rationing function
  • signalling function
  • incentive function
  • allocative function
• what is the rationing function

  increasing prices rations demand to those most able to afford a good or service
• what is the signalling function

  prices provide important information to market participants
• what is the incentive function

  prices create incentives for market participants to change their actions
• what is the allocative function

  the function of prices that acts to divert resources to where returns can be maximised
• when does market failure occur

  when any of the functions of prices breaks down, or whenever a market leads to misallocation of resources
• what is complete market failure

  when the free market fails to create a market for a good or service
• what is partial market failure

  when a market exists but doesn’t provide resources in the optimum quantities
• what is an externality

  a knock on effect of economic transactions upon third parties
• what is environmental market failure

  negative externalities that lead to some form of environmental damage- may include overuse of non renewable resources such a oil, coal and gas
• what are property rights 


  the legal rights of ownership or use of an economic resource
• what is the reason for environmental market failure

  • a lack of clearly defined property rights related to environmental resources
  • individual firms do not suffer any penalty for polluting the atmosphere etc
  • leads to the overuse of these and the rapid depletion of non-renewable resources
• what is the tragedy of commons 


  the overuse or exploitation of resources that are not owned by individuals or organisations
• what is a merit good

  • goods that are under consumed in a free market
  • examples include education, health care, healthy foods
• why are merit goods under consumed

  • people may not be aware of the potential private benefits
  • people may not be afford the product
  • people may not take into account the wider benefits to society of their use of merit goods
• what is a demerit good

  • goods that are over consumed in a free market
  • examples include alcohol and tobacco
• why are demerit goods over consumed

  • people may not be aware of the damage to their health
  • goods are too cheap and so people can too easily afford them
  • individuals do not take account of the wider external costs
• reasons for government intervention

  • correct any market failure
  • achieve a more equitable distribution of income and wealth
  • achieve the governments macroeconomic objectives for the economy
• what are the different types of government intervention

  • indirect taxation
  • subsidies
  • minimum and maximum prices
  • regulation
  • correcting information failure
• what are the two types of indirect taxation

  • unit taxation- involves a fixed amount being added per unit
  • ad valorem- adding s percentage of the price of a good or service eg VAT
• advantages of indirect taxation

  • indirect taxes are normally placed on inelastic goods - strong government revenue which can be assigned to specific areas of spending
  • price mechanism allows consumers and products to decide how to adjust their behaviour
  • internalises an external cost
• disadvantages of indirect taxation

  • indirect taxes placed on inelastic goods - quantity demanded barely decreases - reduces impact of the taxes
  • regressive - takes a larger percentage of a poorer persons income
  • international competitiveness decreases
• what are subsidies

  • government grants paid to producers to encourage increased production of certain goods and services eg merit goods
  • can be used to promote the use of products that reduce external costs
• advantages of subsidies

  • subsidies can increase consumption of merit goods - equilibrium quantity closer to the social optimum
  • makes goods more affordable so reduces the effects of relative poverty
• minimum price


  price floor that establishes a legal level below which price cannot fall
• advantages of minimum prices

  • gives producers guaranteed minimum price and income - generates reasonable standard of living eg in the case of farmers in less developed countries
  • encourages the production of essential products
  • excess supply may be bought up and stored to be used in times of shortage
• disadvantages of minimum prices

  • consumers pay a higher price- reduces disposable income
  • can encourage over production especially in agriculture, excess supply is put into storage so increased costs
  • if governments have to purchase excess supply there is an opportunity cost
  • may reduce international competitiveness if prices are raised above foreign competitors
  • may encourage people to seek cheaper and potentially more harmful alternatives leading to government failure
• maximum price


  upper limit/ price ceiling above which prices are not allowed to rise
• advantages of maximum prices

  • without them, some people will not be able to afford certain goods or services - so it promotes equity and fairness
• disadvantages of maximum prices

  • creation of excess demand implies queues, waiting lists can have serious implicates in some markets eg healthcare in the UK
  • may lead to the establishment of black markets
  • some people who want a good or service will not be able to afford it - leads to frustration and dissatisfaction
• regulation

  • rules/laws used to control/restrict actions of economic agents to reduce market failure
  • eg banning smoking in public places, minimum legal drinking age, maximum emissions levels on new cars
  • if firms/ consumers do not adhere, they may be punished
  • 2 forms- external regulation and self regulation
• external regulation 


  external agencies eg CMA imposing rules and restrictions
• self regulation 


  organisations in particular industries voluntarily regulating themselves
• deregulation

  • the removal of rules/regulations in order to increase market efficiency
  • reduces firms cost to produce- consumers benefit from lower prices
• correcting information failure

  • an attempt increase demand of merit goods and decrease demand of demerit goods by providing information that consumers may lack
  • eg compulsory labelling on food with the traffic light system of salt, fat etc
  • eg strong health warnings on cigarette packets
  • eg TV ads discouraging excessive al hook consumption
• pollution permits

  • legal rights to exploit economic resource to a specific degree eg fishing permits, co2 permits
  • government will set a fixed supply of permits - perfectly inelastic supply
  • market mechanism provides powerful incentives to firms to decrease co2 emissions as they have to pay
• what is government failure

  where government intervention in a market leads to misallocation of resources