1.3.3 price determination

Question 1

Why does supply of food tend to be unstable? [5]

Answer 1

• Poor technology on individual farms
• Geographical distance between farms makes coordination difficult
• Supply side shocks which destroy output, such as droughts
• Price elastic nature of supply in long run which encourages producers to enter the market when the price is high
• Imperfect information

Question 2

What is the wealth effect?

Answer 2

A theory suggesting individuals tend to spend more when the value of their assets (such as homes) increases, leading to increased consumer confidence and potentially boosting economic growth.

Question 3

What is thought to happen due to the wealth effect as house prices increase?

Answer 3

The ratio of the market value of the house to the mortgage increases, and consumers experience an increase in equity. This leads to a rise in consumer spending and shift to the right of the AD curve.

Question 4

What are the limitations of using supply and demand in explaining real world problems? [5]

Answer 4

• Models can only show certain markets
• Demand curve assumes as price goes down, consumers demand more. In reality, this is not the case
• Supply curve assumes as price increases, suppliers produce more
• Assumes perfect information in the market
• Assumes consumers + producers always act rationally

Question 5

What type of market is the supply and demand model useful for?

Answer 5

Competitive markets, where there are many buyers and sellers.