1.2

Question 1

What does rational mean?

Answer 1

Economic agents are able to consider the outcome of their choices and recognise benefits

Question 2

What is demand?

Answer 2

What customers desire backed up with the ability to buy

Question 3

What are the effects of demand?

Answer 3

Substitution effect:
-As price of a product decreases, it becomes more attractive to other similar products. Consumers are more likely to switch to the cheaper option leading to an increase in quantity demanded

Income effect:
-When price of a product falls, consumers effectively have more purchasing power which leads to an increase in quantity demanded

Diminishing marginal utility:
-As people consume more of a particular product, the extra satisfaction they derive from each additional unit will start to diminish so consumers are willing to pay less for each unit

Question 4

Types of demand

Answer 4

Effective demand - Demand that is backed up with the ability to pay
Derived demand - Demand for a FoP that is used to produce another good/service
Composite demand - Where goods have more than one use
Joint demand - Where demand for one product is directly and positively related for demand for another good

Question 4

What causes movement and shifts along the demand curve?

Answer 4

Shifts - Changes in income, taste/fashion, population, substitutes, government policy and advertising
Movement - Price change

Question 4

What is supply?

Answer 4

The quantity of goods and services that producers are willing and able to supply at a given price in each time period

Question 4

Factors that shift supply

Answer 4

Nature conditions
Unexpected events
Changes in productivity of labour
Technology
Government policy

Question 5

What is PED?

Answer 5

PED measures the responsiveness of quantity demanded when there is a change in price

Question 6

What is the formula for PED?

Answer 6

PED = %QD / %P

Question 7

Values of PED

Answer 7

0 = Perfectly inelastic
-Qd is completely unresponsive to a change in price

0-1 = inelastic
-Qd is less than proportional to price

1 = unitary
-Qd is equal to price

1 - infinite = Elastic
-Qd reacts strongly to price change

Infinite = Perfectly elastic
-Qd will fall to 0 with any change in price

Question 8

Factors influencing PED

Answer 8

Availability of substitutes
-High availability means high PED

Addictiveness of products
-Addictiveness turns products into habits resulting in low PED

Time period
-In short term, consumers are less responsive to a change in price resulting in a low PED
-In long term, consumers may feel the price increase more and look for substitutes, resulting in high PED

Question 9

What is YED?

Answer 9

YED measures the responsiveness of quantity demanded for a good when income changes

Question 10

Values of YED

Answer 10

0-1 = Normal necessity
-Demand increases less when income increases
-Income is inelastic

YED > 1 = normal luxury
-Demand increases proportionality more when income increases
-Income is elastic

YED < 0 = Inferior good
-Demand decreases as income increases

Question 11

Factors influencing YED

Answer 11

-During a recession, income falls so demand for inferior goods rises and demand for normal goods fall
-During a period of economic growth, demand for normal goods rise and demand for inferior goods fall

Question 12

What is XED?

Answer 12

Measures the responsiveness of quantity demanded of one good to a change in price of another related good

Question 13

Values of XED

Answer 13

XED < 0 = Complementary goods
-Negative value means two goods are complements
-The higher the value, the stronger the relationship

XED > 0 = Substitutes
-Positive value means two goods are substitutes
-The higher the value, the stronger the relationship

XED = 0 = Unrelated goods

Question 14

What is PES?

Answer 14

Measures the responsiveness of quantity supplied to a change in price

Question 15

Values of PES

Answer 15

0 = Perfectly price inelastic
-Qs is unresponsive to a change in price

0-1 = Relatively price inelastic
-Qs is less than proportional to a change in price

1-infinite = Relatively price elastic
-Qs is less proportional to a change in price

infinite = perfectly price elastic

Question 16

Factors influencing PES

Answer 16

Mobility of FoPs
-If producers switch between producers products, PES will be price elastic

Availability of raw materials
-If raw materials are scarce, PES will be low

Spare capacity
-If there is spare capacity, supply will be price elastic

Question 17

Where is excess demand?

Answer 17

Excess demand is where price is set below equilibrium
There is a shortage in the market so firms can charge higher prices and still sell their goods

Question 18

Where is excess supply?

Answer 18

Where price is set above equilibrium
Firms have unsold goods. This will encourage them to put these goods on sale, causing price to fall

Question 19

What is the price mechanism used for?

Answer 19

To allocate resources

Question 20

What are the price mechanisms?

Answer 20

Rationing function - Limited resources can be rationed and allocated to the people who are able to afford them
Signalling function - Acts as a signal where resources should be used
Incentive function - Acts as an incentive for people to work hard. Buyers realise the more money they have, the more products able to be bought

Question 21

Example of Local markets in context with price mechanism

Answer 21

During the pandemic for British supermarkets, less imports from other countries meant fewer goods on shelves. All demand for food is high and supply is low, there is excess demand so only consumers who value food highly buy it. This is rationing function

Question 22

Example of national markets in context with price mechanism

Answer 22

As population of London is high relative to the rest of the UK, house prices will rise through rationing function High house prices offer an incentive for firms to allocate resources to the production of more houses as there is profit to be made. This is an example of incentive function

Question 23

Example of global markets in context with price mechanism

Answer 23

Disequilibrium of supply and demand of oil means the high price deters consumers who don't value oil highly, which leaves the market open only to consumers who did which is rationing function

Question 24

What is a direct tax?

Answer 24

A tax levied upon income, wealth and profits

Question 25

What is an indirect tax?

Answer 25

A tax imposed by the government that increases supply costs of producers

Question 26

Where is tax shown on a graph?

Answer 26

Shown by the vertical difference between the pre- and post- tax supply curves. This is because of the tax, less can be supplied to the market at each price level

Question 27

What are the two types of indirect taxes?

Answer 27

Specific tax - Set tax per unit - This is a fixed amount Ad valorem tax - % tax - This is a variable amount

Question 28

What is the relationship between PED and taxes?

Answer 28

If the coefficient of PED > 1: most of the burden of an indirect tax will be absorbed by the supplier If the coefficient of PED < 1: most of the indirect tax can be passed on to the final customer

Question 29

Justification of indirect taxes

Answer 29

-Key source of tax revenue to pay for overall government spending -Can be used to change consumer and producer behaviour which might alter the pattern of demand -Regressive to low-income families

Question 30

What are subsidies?

Answer 30

Payments by the government to suppliers that reduce costs The effect of a subsidy is to increase supply and reduce market equilibrium price

Question 31

What do subsidies lead to?

Answer 31

Cost of production decreases -> Profit margins rise -> signals for firms to supply more -> incentivised by more profit -> supply increases

Question 32

Justifications of subsidies

Answer 32

-Helps poorer families with food and childcare costs -Reduces costs of healthcare treatments, training, transport -Encourages investment -Producers can become "subsidy dependent" -Subsidies can be expensive -Subsidies can lead to excess production

Question 33

What is consumer surplus?

Answer 33

The difference between the price consumers are willing to pay and the price they actually pay Consumer surplus found below the demand curve and above the price line

Question 34

What is producer surplus?

Answer 34

The difference between the price producers are willing and able to supply and the price they actually receive Producer surplus found above the supply curve and below price line