1.2 How Markets Work

Question 1

What does the word rational mean?

Answer 1

Economic agents are able to consider the outcome of their choices and recognise the net benefits (pros and cons)

Question 2

How do consumers, producers, workers and the government act rationally?

Answer 2

Maximising their utility

Maximise profits

Balancing welfare consideration of both pay and benefits

Placing the interests of the people they serve first in order to maximise their welfare

Question 3

How is rational decision making flawed?

Answer 3

Consumers are often more influenced by emotional purchasing decisions than rational of net benefits

Question 4

What is demand?

Answer 4

The amount of a good or service that a consumer is willing and able to purchase at a give price at a given time period.

Question 5

What causes a movement on the demand curve?

Answer 5

Change in price

Question 6

What is the law of demand?

Answer 6

There is an inverse relationship between price and QD

Question 7

What causes a shift in the demand curve?

Answer 7

Conditions of demand

• change in real income
• changes in taste or fashion
• advertising or branding
• changes in the prices of substitutes
• changes in the prices of complementary good
• changes in population size/distribution

Question 8

What is marginal utility?

Answer 8

The additional utility (satisfaction) gained from the consumption of an additional product

Question 9

How do u calculate total utility?

Answer 9

The marginal utility of each unit consumed is added together

Question 10

What is the law of diminishing marginal utility?

Answer 10

The additional products consumed, the utility gained from the next unit is lower than the utility from the previous unit

Question 11

How does the law of diminishing marginal utility help explain the reason why the demand curve is downward sloping?

Answer 11

First unit purchased the utility is high and consumers are willing to pay high price

The more they purchase there is less utility and willingness to pay the initial price

Lowering the price makes it more attractive so consumers keep consuming

Question 12

What is the price elasticity of demand?

Answer 12

How responsive the change in quantity demanded is to a change in price

Question 13

How do you calculate PED?

Answer 13

% change in QD
————————-
% change in price

Question 14

How do you calculate % change?

Answer 14

New - old
—————- *100
Old

Question 15

“How do we know how elastic a good is?

Answer 15

If PED = 0 it is perfectly inelastic
If PED is between 0-1 it is relatively inelastic
If PED = 1 it is unitary elasticity
If PED > 1 it is relatively elastic
If PED is infinite it is perfectly elastic

Question 16

What factors influence/ determinants of PED?

Answer 16

Elastic:
- availability of substitutes
- time period
- proportion of income
- nature of product (addictive)

Question 17

What is income elasticity of demand?

Answer 17

How responsive the change in quantity demanded is to a change in income

Question 18

How to calculate YED?

Answer 18

% change in QD
————————
% change in income

Question 19

What does negative and positive YED mean?

Answer 19

Negative YED: a rise in income will lead to a fall in quantity sold

Positive YED: a rise in income will lead to an increase in the quantity sold

Question 20

YED 0<1 what is the type of good

YED >1 what is the type of good

YED <0 what is the type of good

Answer 20

Necessity
Luxury
Inferior

Question 21

What are the factors that influence YED?

Answer 21

. During a recession wages usually fall and demand for inferior rises and luxury goods fall

. During economic growth, wages increase, demand for inferior goods fall and luxury rise

.Influences on income: minimum wage, taxation

Question 22

What is cross price elasticity of demand (XED)?

Answer 22

Changes in the prices of complementary goods and substitutes affect the demand

how responsive the change in quantity demanded for good A is to a change in price of good B

Question 23

How to work out XED?

Answer 23

% change in QD of good A
————————————
% change in P of good B

Question 24

XED<0 What is the good?

XED>0 What is the good?

XED=0 What is the good?

Answer 24

Complementary goods

Substitutes

Unrelated goods

Question 25

Why is PED significant to firms?

Answer 25

. Important to firms seeking to maximise their revenue
- product inelastic=raise prices
-elastic = lower prices

Question 26

Why is PED significant to governments?

Answer 26

. Important to governments with regard to taxation and subsidies
- taxing inelastic = raise tan revenue without harming firms
- consumers are less responsive so tax with be passed to consumers
-
. If they subsidies price elastic there can be a greater than proportional increase

Question 27

Why is XED significant to firms?

Answer 27

. Important to firms as they seek to maximise their revenue
- help them adjust pricing strategies for substitutes and complementary

. Helps understand the likely impact of competitors price strategies

Question 28

What is supply?

Answer 28

The amount of a good/service that a producer is willing and able to supply at a given price in a given time period

Question 29

Why is supply upward sloping?

Answer 29

Positive relationship between price and quantity supplied

Question 30

What are the factors effecting supply?

Answer 30

. Cost of production
. Indirect taxes
. Subsidies
. New technology
. Change in the number of firms in the industry

Question 31

Explain how the factors of supply effects the supply curve.

Answer 31

COP increases, less revenue/profit, less investment, less supply, supply curve shits left

Indirect taxes increase, supply curve shifts left

Subsidies increases, supply curve shifts right

New technology increases, shifts right

Increase number of firms, shifts right

Question 32

What is price elasticity of supply?

Answer 32

How responsive the change in quantity supplied is to a change in price

Question 33

How to calculate PES?

Answer 33

%changeinQS
PES = ———————-
%changeinprice

Question 34

What are determinants of PES?

Answer 34

• availability of raw materials
• ability to store goods
• spare capacity
• time period

Question 35

What is short run?

Answer 35

Any period of time which at least 1 factor of production is fixed

Question 36

What is long run?

Answer 36

Period of time which all the factors do production are variable

Question 37

What is a market?

Answer 37

Any place that brings buyers and sellers together

Question 38

When does equilibrium occur in a market?

Answer 38

Demand = supply

Question 39

When does disequilibrium occur?

Answer 39

excess demand (when demand is greater than supply) - can occur when prices are too low or when demand it so high

Excess supply (when supply is greater)- can occur when prices are two high or when demand falls unexpectedly

Question 40

What is price mechanism?

Answer 40

The interaction of demand and supply in a free market

Question 41

What are the three price mechanisms?

Answer 41

Rationing, signalling, incentive

Question 42

What is price mechanism rationing?

Answer 42

Prices allocate scarce resources

Prices rise when resource becomes more scarce

Question 43

What is price mechanism signalling?

Answer 43

Prices provide information to producers and consumers where resources are required

Question 44

What is price mechanism incentive?

Answer 44

When prices rise it incentivises producers to reallocate resources from a less profitable market to this market in order to maximise their profits

Question 45

What is consumer surplus?

Answer 45

The difference between the amount the consumer is willing to pay for a product and the price they have actually paid

Question 46

What is producer surplus?

Answer 46

The difference between the amount that the producer is willing to sell a product for and the price they actually do

Question 47

What area is consumer surplus on the supply and demand diagram?

Answer 47

Area between the equilibrium price and demand - underneath the demand curve