S-Cool Revision Summary

S-Cool Revision Summary

 Ceteris paribus This is a Latin phrase meaning 'all other things being equal'. It is used in economics because it would be difficult to assess the relationship between one variable and another without assuming that all other variables remain constant. It's a bit like having the 'control' in science experiments. Complements Goods are complementary if they 'go together' in some way. For example, tea and sugar are complements, as are petrol and cars. Cross price elasticity of demand This is very similar to the price elasticity of demand, except two goods are involved. It is defined as the responsiveness of the demand for one good to a change in price of a different good. It can be calculated by dividing the percentage change in the quantity demanded of good A by the percentage change in the price of good B. Elastic demand The demand for a good is relatively elastic when, for a given percentage change in its price, the percentage change in the quantity demanded is larger. Goods with lots of substitutes tend to have relatively elastic demand (e.g. a type of chocolate bar). Elastic supply The supply for a good is relatively elastic when, for a given percentage change in its price, the percentage change in the quantity supplied is larger. Supply is more likely to be relatively elastic if the time period in question is longer, or the supplier has the ability to change the good he is producing at short notice (maybe because his production process is transferable across different product areas). Full capacity A firm (or an industry, or an economy) is said to have full capacity if all resources (machines, labour, etc.) are being used and so it is not possible to increase output. Giffen goods Giffen goods are very inferior goods! Whilst the substitution effect of, say, a price rise causes demand to fall (as with all goods), the income effect acts in the opposite direction and is very strong. This means that the overall effect of a price rise for a Giffen good is an increase in its demand! Very unusual! A good example is potatoes during the famine in Ireland 150 years ago. Income effect of a price change If the price of a good rises, ceteris paribus, then, assuming that one's nominal incomeremains constant, the amount that one can really buy with this income has fallen. One's real income has fallen. The opposite happens for a price cut. In other words, price changes will affect consumers' demand for goods via changes in their real incomes. Income elasticity of demand It measures the responsiveness of the quantity demanded to a given change in real income. It can be calculated by dividing the percentage change in the quantity demanded of a good by the percentage change in real income. Inelastic demand The demand for a good is relatively inelastic when, for a given percentage change in its price, the percentage change in the quantity demanded is smaller. Goods with very few substitutes tend to have relatively inelastic demand (e.g. petrol). Inelastic supply The supply for a good is relatively inelastic when, for a given percentage change in its price, the percentage change in the quantity demanded is smaller. Supply is more likely to be relatively inelastic if the time period in question is very short, so that firms do not have the time to react to changes in price. Inferior goods An inferior good is one where its income elasticity of demand is negative. This means that the demand for inferior goods falls as real incomes rise and vice versa. Bus travel is a good example of an inferior good. Infinity Perfectly elastic curves have infinite elasticity. Infinity, in a sense, does not exist. Think of the biggest number possible and then you can always add one to it. In this context, infinity is a very large number! Luxuries Luxuries are goods whose income elasticity of demand is greater than one. So, for a given rise in real incomes of, say, 10%, the demand for these goods rises, but by a larger percentage, say, 20%. Examples include holidays abroad and expensive meals out. Necessities Normal goods are often sub-divided into necessities and luxuries. Necessities are goods that do have a positive income elasticity, but the value is below one. So, for a given rise in real incomes of, say, 10%, the demand for these goods rises, but by a smaller percentage, say, 5%. Basic foodstuffs are good examples of necessities. Nominal income A consumer's nominal income is the amount of money they actually have. If a worker receives £100 a week after tax, that is his nominal income. If the prices of various goods change this may affect his real income (i.e. the amount he can actually buy), but his nominal income remains unchanged. Normal goods A normal good is one where its income elasticity of demand is positive. This means that the demand for normal goods rises as real incomes rise and vice versa. Most goods are 'normal'. Perfectly competitive markets Firms in perfectly competitive markets have perfectly elastic demand curves. These are markets where conditions are perfect and resources move freely and quickly to their most optimal position. For much more detail, see the topic on 'Market structure'. Perfectly elastic demand If a good has perfectly elastic demand, then its demand curve is horizontal, implying that the demand for the good in question is infinite at the given market price. Sales will be zero if the price is raised, and there is no point reducing the price because the firm can sell as much as it wants at the given market price. This is an unusual situation which is only seen in the unrealistic theory of perfectly competitive markets (see the topic of 'Market structure' for muchmore detail). Perfectly elastic supply If a good has perfectly elastic supply, then its supply curve is horizontal, implying that the supply of the good in question is infinite at the given market price. Perfectly inelastic demand If a good has perfectly inelastic demand, then its demand curve is vertical, implying that the demand for the good in question will remain unchanged regardless of the size of the price change. Perfectly inelastic supply If a good has perfectly inelastic supply, then its supply curve is vertical, implying that the supply of the good in question will remain unchanged regardless of the size of the price change. Price elasticity of demand It measures the responsiveness of the quantity demanded to a given price change. It can be calculated by dividing the percentage change in the quantity demanded of a good by the percentage change in its price. Price elasticity of supply It measures the responsiveness of the quantity supplied to a given price change. It can be calculated by dividing the percentage change in the quantity supplied of a good by the percentage change in its price. Real income Real income refers to what one's income can actually buy, allowing for rises in the general price level. If one's income rises by 10% in a given year, but the average price level has risen by 10% as well, then you can't actually buy any more with this increase in nominal income - your real income has remained unchanged. Revenue The revenue of a firm is the amount of money it takes in from its sales. It is not the profit, which is the revenue minus costs. Revenue is measured by multiplying the quantity sold by the price at which the goods were sold. Spare capacity A firm (or an industry, or an economy) is said to have spare capacity if there are enough idle resources (machines, labour, etc.) around to increase output if required. Substitutes A substitute good is one that directly competes with the good in question, For example, tea and coffee are substitutes. One could substitute car travel for bus travel. Substitution effect of a price change If the price of a good rises, ceteris paribus, then it is likely that the demand for this good will fall and the demand for other goods will rise. Consumers substitute their expenditure from the good which is relatively more expensive towards goods that are relatively cheaper. This is the substitution effect, and is always negative, whether the good is normal, inferior or Giffen. Unitary demand The demand for a good is unitary when, for a given percentage change in its price, the percentage change in the quantity demanded is exactly the same. Unitary supply The supply of a good is unitary when, for a given percentage change in its price, the percentage change in the quantity supplied is exactly the same.