1.2 How Markets Work

Question 1

What are the underlying assumptions of rational economic decision making

Answer 1

• consumers aim to maximise utility
• firms aim to maximise profits

Question 2

What is demand

Answer 2

The quantity of a good or service that consumers are able and willing to buy at a given price during a given period of time

Question 3

Factors that shifts the demand curve (CATSDIES)

Answer 3

1)complementary goods
2)advertising
3)trends
4)seasonality
5)demographic
6)income
7)external shocks
8)substitutes

Question 4

What are the three types of demand

Answer 4

Derived demand, Composite demand and Joint demand

Question 5

What is derived demand

Answer 5

When demand for one good is linked to the demand for a related good

Question 6

What is composite demand

Answer 6

When the good demanded has more than one use

Question 7

What is joint demand

Answer 7

When goods are bought together

Question 8

What does the law of diminishing marginal utility state

Answer 8

For any good or service, the marginal utility of that good or service decreases as the quantity of the good increases

Question 9

What is a normal good

Answer 9

A good that when incomes increase the demand for that good will increase

Question 10

What is an inferior good

Answer 10

A good that when incomes increase the demand for that good decreases

Question 11

What are complementary goods

Answer 11

Goods that are consumed together

Question 12

What are substitute goods

Answer 12

Goods which are alternatives for one another

Question 13

What is price elasticity of demand

Answer 13

The responsiveness of a change in demand to a change in price

Question 14

What is the formula for price elasticity of demand (PED)

Answer 14

PED=% change in QD/ % change in P

Question 15

What is the numerical value for a price elastic good

Answer 15

> 1

Question 16

What is the numerical value for a price inelastic good

Answer 16

<1

Question 17

What is a unitary elastic good

Answer 17

A good that has a change in demand equal to the change in price. PED=1

Question 18

What is a perfectly inelastic good

Answer 18

A good that has a demand which does not change when price changes. PED=0

Question 19

What is a perfectly elastic good

Answer 19

A good which has a demand that falls to zero when price changes. PED= infinity

Question 20

What are the 6 factors influencing PED

Answer 20

1)Necessity
2)Substitutes
3)Addictiveness or habitual consumption
4)Proportion of income spent
5)Durability of the good
6)Peak and off-peak demand

Question 21

What is income elasticity of demand

Answer 21

The responsiveness of a change in demand to a change in income

Question 22

What is the formula for income elasticity of demand (YED)

Answer 22

YED= %change in QD/ % change in income

Question 23

What is a luxury good

Answer 23

A good that causes an even bigger increase in demand when incomes increase

Question 24

What is cross elasticity of demand

Answer 24

The responsiveness of a change in demand of one good, to a change in price of another good

Question 25

What is the formula for cross elasticity of demand (XED)

Answer 25

XED= %change in QD of (X) / % change in price of (Y)

Question 26

Complementary goods numerical XED is Positive, negative or equal to zero.

Answer 26

Negative

Question 27

Substitute goods numerical XED is Positive, negative or equal to zero.

Answer 27

Positive

Question 28

Unrelated goods numerical XED is Positive, negative or equal to zero.

Answer 28

Equal to zero

Question 29

What is rational decision making

Answer 29

A process of selecting the best option based on a careful, logical evaluation

Question 30

What is supply

Answer 30

The quantity of a good or service that a producer is able and willing to supply at a given price during a given period of time

Question 31

What are the seven factors that shift the supply curve (PINTSWC)

Answer 31

1)productivity 2)indirect taxes 3)number of firms 4)technology 5)subsidies 6)weather 7)cost of production

Question 32

What is joint supply

Answer 32

When increasing the supply of one good causes an insane or decrease in the supply of another good

Question 33

What is price elasticity of supply

Answer 33

The responsiveness of a change in supply to a change in price

Question 34

What is the formula for price elasticity of supply (PES)

Answer 34

PES=% change in QS / % change in price

Question 35

What is the numerical value of elastic supply

Answer 35

PES>1

Question 36

What is the numerical value of inelastic supply

Answer 36

PES<1

Question 37

What is the numerical value for perfectly inelastic supply

Answer 37

PES=0

Question 38

What is the numerical value for perfectly elastic supply

Answer 38

PES=infinity

Question 39

What are the five factors influencing Price elasticity of supply (PES)

Answer 39

1)time scale 2)spare capacity 3)level of stocks 4)how substitute factors are 5)barriers of entry to the market

Question 40

What is the market clearing price

Answer 40

At market equilibrium, price has no tendency to change.

Question 41

What are the three main functions the price mechanism uses to allocate resources

Answer 41

1)rationing 2)incentive 3)signalling

Question 42

How is the function of rationing used in the price mechanism

Answer 42

When there are scarce resources, price increases due to the excess of demand

Question 43

How is the function incentive, used in the price mechanism

Answer 43

Something that encourages a change in behaviour of a consumer or producer

Question 44

How is the function of signalling used in the price mechanism

Answer 44

The price acts as a signal to consumers and new firms entering the market. The price changes show where resources are needed in the market