Economics Theme 1

Question 1

What 3 assumptions do economists make? Why?

Answer 1

Economic agents are rational and make rational decision
Consumers wish to maximise utility
Producers wish to maximise profit

Economists can’t be sure that this will be the case, because economics is a social science, and actions will not always lead to the same results.

Question 2

Ceteris Paribus definition. Why is it used?

Answer 2

All other factors remain the same

Allows economists to identify the impact of a change in one variable.

Question 3

Why is economics considered to be a social science?

Answer 3

It looks at individuals and groups, and how they interact with each other. It could be subject to personal prejudice.

Question 4

Why can’t scientific experiments be made in econonomics?

Answer 4

Economics is a social science, and can therefore be subject to personal prejudice. Unlike natural sciences, elements of a test may not be static and lead to the same results.

Question 5

Positive statement / Normative statement definitions

Answer 5

Positive statement: A statement that is objective, factually based and can be tested so that it can be accepted or rejected.
Normative statement: A statement that is subjective, contains a value judgment, and cannot be tested.

Question 6

How do value judgments influence decision making and policy?

Answer 6

A value judgment cannot be verified factually. Different economists may make different judgements from the same change.

Question 7

Basic economic problem definition

Answer 7

The basic economic problem occurs when there are finite resources available to supply infinite wants.

Question 8

Renewable and non-renewable resources definitions

Answer 8

Renewable resources: Resources that can be replenished, and if used sustainably will not run out.
Non-renewable resources: Resourced that are in finite supply and therefore will run out if used.

Question 9

Opportunity cost definition

Answer 9

The loss of the value of the next best alternative foregone.

Question 10

What is the importance of opportunity costs to consumers, producers and governments?

Answer 10

There is a cost for every decision made, which is the cost of the value of the next best alternative foregone. All resources are scarce and decisions must be made in order to allocate these well, and keep the opportunity costs to a minimum.

Question 11

What 5 things do production possibility frontiers depict?

Answer 11

The maximum productive potential of an economy
Possible and unobtainable production
Opportunity cost
Economic growth or decline
Efficiency of allocation of resources

Question 12

Production possibility definition

Answer 12

The maximum possible combination of two products that an economy can produce given the current resources available.

Question 13

What is the difference between a movement along the PPF curve and a shift in the PPF curve

Answer 13

Producing anywhere along the PPF curve shows a full use of resources. If there is a movement along the curve, there is still full use of resources, but they are being used differently. A shift of the PPF curve shows economic growth/decline caused by an increase/decrease in the factors of production in the economy.

Question 14

What is the difference between consumer goods and capital goods?

Answer 14

Consumer goods: Final goods that have an immediate benefit to the consumer.
Capital goods: Goods that are bought by firms and used to produce other goods. They have a derived demand.

Question 15

Specialisation definition

Answer 15

Specialisation is when economic units, such as individuals, firms or economies, concentrate on producing one specific good or service.

Question 16

Division of labour definition

Answer 16

Division of labour: A concept created by Adam Smith. Through specialisation, breaking down large tasks into smaller components, each worker becomes a specialist, and therefore better at their individual task. This leads to improved efficiency and productivity.

e.g.Henry Ford’s Model T production line

Question 17

What are the advantages of specialisation and divison of labour in organising production?

Answer 17

Increased output per worker per hour
Workers have a better understanding of their job roles
Increases supply of a firm
Efficient use of time as there is no switching between tasks
Technical economies of scale

Question 18

What are the disadvantages of specialisation and divison of labour in organising production?

Answer 18

Work can become monotomous
May increase absenteeism and demotivation
Increased labour turnover so increased recruitment costs
May be limited to the size of the market - small firms can’t afford to introduce these changes
Increased threat of structural unemployment (smaller tasks make it easier to replace labour with machinery)
Less flexible workforce as workers can only do one job
Interdependency in production - production may be disrupted if one group of workers strike

Question 19

What are the advantages of specialisation and divison of labour for a country?

Answer 19

Reduced unit costs (e.g. through bulk buying), more competitive
Improved quality (through better skills and training)
Enables trade with other economies specialising in different fields
PPF shifts outwards

Question 20

What are the potential disadvantages of specialisation and divison of labour for a country?

Answer 20

Decrease in demand for domestic products
Increased interdependency between countries, which may disrupt trade if production in another country is disrupted
A country’s exports can be subject to trade restrictions
More vulnerable to structural unemployment

Question 21

What are the four functions of money?

Answer 21

Medium of exchange
Measurement of value
Store of value
Standard of deferred payment

Before money, barter was used. This had problems which money solves through its functions.

Question 22

What is the difference between a free market, mixed and command economy?

Answer 22

Free market: Basic economic problem solved by market forces / price mechanisam. Consumers maximise personal welfare, producers maximise profit.

Mixed: Resources allocated by a combination of the market mechanism and the government. The state provides public goods, controls macroeconomic variable and encourages free trade. Consumers still maximise personal welfare, producers maximise profit.

Command: Resources are allocated by the government through rationing and planning. There are no market forces.

Question 23

What are the characteristics of a free market economy?

Answer 23

Private sector ownership
Free enterprise
Limited government intervention
Firms compete for market share
Society competes for employment and salaries
Allocation of resources is determined by market forces

Question 24

What are the characteristics of a command economy?

Answer 24

Resources are allocated by the government
Greater equality<br></br>Low unemployment
No demerit goods in the economy
Communism
Lack of competition, innovation and efficiency

Question 25

What is the role of the state in a mixed economy?

Answer 25

Reduce negative externalities
Provide public goods
Control demerit goods
Supply merit goods
Control macroeconomic variables
Provide legal framework
Encourage free trade
Encourage competition

Question 26

What are the advantages and disadvantages of free market economies?

Answer 26

Advantages:<

Competition, lower prices
Consumer choice
Rewards entrepreneurship
Encourages innovation
Productive efficiency
Economic growth

Disadvantages:

Wealth and income inequality
Less control of demerit goods supply
Little regulation
Less support for vulnerable

Question 27

What did Adam Smith write about free market economies?

Answer 27

There is an invisible hand that self-regulates the behaviour of the market place. Individuals seek to maximise personal gains - each individual’s self-interest leads to an efficient allocation of resources, which benefits society as a whole.

Question 28

What did Friedrich Hayek believe about free market economies?

Answer 28

The state should not interfere too much - its role is to maintain the law. Government interference leads to totalitarian rule which restricts freedom and undermines democracy. There should be some government intervention, but most decision making should be left to individuals and firms and the price mechanism.

Question 29

What did Karl Marx believe about capitalism? (free market economies)

Answer 29

Labour will be exploited, so they will unite to overthrow capitalists. This will lead to socialism, where entire communities own the means of production and workers are paid wages. This will lead to communism, where the government own the means of production and output is distributed centrally.

Question 30

What are the two underlying assumptions of rational economic decision making?

Answer 30

Consumers aim to maximise utility
Firms aim to maximise profits

Economic agents won’t always do this (e.g. profit satisficing, sales maximisation, revenue maximisation, consumer weakness at computation, behavioural economics)

Question 31

What is the difference betweeen a shift in the demand curve and a movement along the demand curve?

Answer 31

A movement along the demand curve shows demand increasing or decreasing because of a change in price.
A shift of the demand curve shows demand increasing or decreasing because of a factor other than price.

Question 32

What is the difference betweeen a shift in the supply curve and a movement along the supply curve?

Answer 32

A movement along the supply curve shows supply increasing or decreasing because of a change in price.
A shift of the supply curve shows supply increasing or decreasing because of a factor other than price.

Question 33

What factors may cause a shift in the demand curve?

Answer 33

Population
Income
Related goods
Advertising
Taste
Expectations
Season

Question 34

What factors may cause a shift in the supply curve?

Answer 34

Change in costs of production
Joint/Competitive supply
Technological progress
Prices of other products (if a firm can switch between which products it produces)
Government policy (e.g. taxes, subsidies, regulation)
Expectations of future events

(Change in price will result in a movement along the supply curve)

Question 35

Explain the concept of diminishing marginal utility.

Answer 35

Marginal utility is the amount of satisfaction an individual derives from consuming one extra unit of a product. Marginal utility decreases over time because the individual is less satisfied with each extra unit they produce. Total utility will increase until the point where marginal utility stops increasing. It will then begin to decrease as marginal utility beings to decrease. Consumers often tend to continue consumption after marginal utility reaches zero, before stopping.

Question 36

How does the concept of diminishing marginal utility influence the shape of the demand curve?

Answer 36

If increased consumption of a product provides less marginal utility, the consumer will only buy additional units if the price falls. This is why demand increases when price falls and vice versa.

Question 37

What is the definiton of and formula for PED?

Answer 37

PED measures the responsiveness of demand to a change in price.

% change in Qd / % change in P

Question 38

What is the definiton of and formula for YED?

Answer 38

YED measures the responsiveness of demand to a change in incomes.

% change in Qd / % change in Y

Question 39

What is the definiton of and formula for XED?

Answer 39

XED measures the responsiveness of demand for one good to a change in the price of another good.

% change in Qd of good A / % change in P of good B

Question 40

What is the significance of the PED coefficient?

Answer 40

0 = Perfectly Inelastic
0 to -1 = Inelastic
-1 = Unitary Elasticity
-1 to Infinity = Elastic
Infinity = Perfectly Elastic

Question 41

What is the significance of the YED coefficient?

Answer 41

Positive means it is a normal good
Negative means it is an inferior good

0 to 1 = Inelastic & Normal (often necessities)
1 to Infinity = Elastic & Normal (often luxuries)

Question 42

What is the significance of the XED coefficient?

Answer 42

Positive means the products are substitutes
Negative means the products are complements<
<0 (negative) = Complements
0 = Unrelated
>0 (postitive) = Substitutes

Question 43

What factors influence PED?

Answer 43

Availability of substitutes
Luxury vs necessity
Proportion of income spent on good
Habits / addictive
Time period (more elastic in long run)

Question 44

What factors influence YED?

Answer 44

Necessity vs luxury
Consumers’ income levels
Standard of living
The trade cycle

Question 45

What factor influences XED?

Answer 45

Substitute vs complement vs no relationship

Question 46

Explain the relationship between PED and total revenue.

Answer 46

Inelastic good price rise –> Increase in total revenue (Increase in revenue from price is greater than decrease in revenue from demand)
Inelastic good price fall –> Decrease in total revenue (Increase in revenue from demand is less than decrease in revenue from price)
Elastic good price rise –> Decrease in total revenue (Increase in revenue from price is less than decrease in revenue from demand)
Elastic good price fall –> Increase in total revenue (Increase in revenue from demand is greater than decrease in revenue from price

Question 47

What is the definition of and formula for PES?

Answer 47

PES measures the responsiveness of supply to a change in price.

% change in Qs / % change in P

Question 48

What is the significance of the PES coefficient?

Answer 48

0 = Perfectly Inelastic
0 to 1 = Inelastic
1 = Unitary Elasticity
1 to Infinity = Elastic
Infinity = Perfectly Elastic

Question 49

What factors influence PES?

Answer 49

Availability of raw materials
Length and comlexity of production process
Mobility of factors of production (how easily can switch to producing other products instead)
Level of stocks
Spare/excess production capacity

Question 50

What is the difference between the short run and the long run?

Answer 50

In the short run at least one of a firm’s factors of production are fixed.
In the long run all factors of production are variable.
Short run economic growth is when the economy uses spare capacity to increase GDP.
Long run economic growth is when the productivie capacity of the economy increases.

Question 51

What is the significance of the short run and long run for PES?

Answer 51

PES is more elastic in the long run as factors of production are not fixed, so producers adjust to market conditions. Whereas in the short run it can be difficult to do this, because at least one factor of production is fixed, so it is more difficult for producers to change production and the PES is more inelastic.

Question 52

How are equilibrium price and quantity determined?

Answer 52

The equilibrium price is the point at which demand equals supply and all products will be sold.
A curve may shift left or right, which would change the market equilibrium.
Market forces are always pushing prices towards market equilibrium (where demand and supply meet).

Question 53

How do market forces eliminate excess supply or demand?

Answer 53

If there is excess demand, firms will raise their price so that demand will fall to where supply is at.
If there is excess supply, firms will lower their price so that demand will increase to where supply is at.

Question 54

How is price determined in commodity markets?

Answer 54

(Perfectly elastic supply, Speculation, Inelastic supply, Buffer stock schemes)

Producers in a commodity market are selling homogeneous or very similar goods, so there is little to no product differentiation and products are likely to be unbranded. Therefore, the commodity price is determined by the market as a whole, and the market has perfectly elastic supply.

Commodities are subject to speculation. E.g. if the price of gold is expected to increase, there will be an increase in demand for gold, and the price will therfore increase.

Hard commodies (extracted from the ground) are usually non-rewable, and the production is time-consuming and complicated, so these products have an inelastic supply. Soft commodities (that are grown) also have an inelastic supply because of the time-consuming production process and vulnerability to natural disasters and bad weather conditions.

When possible, buffer stock schemes are used for commodities, so that suppliers can choose when to increase or decrease supply, therefore stabalising prices.

Question 55

What are the three functions of the price mechanism to allocate resources?

Answer 55

Rationing function
Incentive function
Signalling function

Question 56

Explain the rationing function.

Answer 56

Excess demand for a good or service will lead to a rise in its price due to scarcity. The higher price will lead to a decrease in demand as it restrits the number of buyers who are able and willing to buy the product. As the product becomes restricted its availability is effectively rationed. There will be a contraction along the demand curve showing an increase in price and decrease in quantity demanded.

Question 57

Explain the incentive function.

Answer 57

Through their consumption choices, consumers send information to producers about changing wants and needs. Higher prices give producers a motive to increase supply of a good or service, as they can make higher profits. There will be an expansion along the supply curve showing an increase in quantity supplied.

Question 58

Explain the signalling function.

Answer 58

The signalling function provides information to producers about where resources are required and where they are not. A price rise represents scarcity and a price fall represents surplus. This will signal to producers to supply more or less, and where their resources can be best used.

Question 59

Definitions for consumer surplus and producer surplus.

Answer 59

Consumer surplus: The difference between the price a consumer is willing to pay and the price they actually pay.
Producer surplus: The difference between the price a producer is willing to supply at and the price they actually receive.

Question 60

How do changes in supply and demand affect consumer and producer surplus?

Answer 60

Demand shift left: Consumer surplus decrease, Producer suplus decrease
Demand shift right: Consumer surplus increase, Producer surplus increase
Supply shift left: Consumer surplus decrease, Producer surplus decrease
Supply shift right: Consumer surplus increase, Producer surplus increase

Question 61

What is the difference between a direct tax and an indirect tax?

Answer 61

A direct tax is a tax on an income or profit, whilst an indirect tax is a tax on a good or service.

Question 62

What are the impacts of an indirect tax on the consumer, producer and government?

Answer 62

The tax will be paid for by the consumer and producer, and the government will receive the tax revenue. The government will be able to increase spending in the economy or decrease its current account deficit.

The tax will internalise negative externalities and try to achieve the social optimum level of output.

Costs will increase for firms, which will cause supply to shift left. Quantity supplied will decrease and price will increase. The revenue from the higher price will be used by the firm to pay the tax, and the firm will pay the remaining amount and make lower profits. If demand is inelastic the incidence of tax will be greater for the consumer. If demand is elastic the incidence of tax will be greater for the producer.

Producer surplus and consumer surplus will both decrease.

Question 63

What is the difference between a specific tax and an ad valorem tax?

Answer 63

A specific tax is a set amount per unit, whilst an ad valorem tax is a percentage of the selling price.

Question 64

What is a subsidy?

Answer 64

A subsidy is a financial incentive to a firm to produce or consume a given product. It can be a lump sum or per unit.

Question 65

What are the impacts of a subsidy on the consumer, producer and government?

Answer 65

Supply will shift right as costs are lower for firms. This allows them to increase quantity and decrease price, and consumers will have lower prices. The government will either have to borrow money or sacrifice expendature elsewhere in the economy to fund the subsidy. Consumer surplus and producer surplus will both increase.

Question 66

What are three reasons consumers may not behave rationally?

Answer 66

Consideration of the influence of other people’s behaviour / herding behaviour
The importance of habitual behaviour
Consumer weakness at computation

Question 67

Why might consideration of the influence of other people’s behaviour lead to consumers behaving irrationally?

Answer 67

People are influenced by what others do when making consumption decisions. Herding behaviour is when people follow similar consumption patterns to others, rather than analysing the situation and making their own decision. It often feels safer or allows consumers to feel more socially accepted.

Question 68

Why might habitual behaviour lead to consumers behaving irrationally?

Answer 68

The status quo is the tendency of consumers to stick with their current situation instead of making a change. This may be due to consumers “playing safe”, as trying something new could make them worse off. This is loss aversion (when consumers try to avoid a loss rather than try to acheieve a gain). Consumers also build routines that they don’t want to change.

Question 69

Why might consumer weakness at computation lead to consumers behaving irrationally?

Answer 69

Consumers often have a weakness in day to day computation and will make judgments based on mental short cuts when uncertainty exists or it is too difficult to compute the available information. People also find it hard to forecast future feelings and tend to exagerate small probabilities. Consumers of addictive products tend to base their decision off the immediate gratification they receive, without considering the future problems. There are the three heuristics which also help to explain this.

Question 70

What are the three heuristics?

Answer 70

Availability heuristic
Anchoring heuristic
Representativeness heuristic

Question 71

Explain the availability heuristic.

Answer 71

As a mental shortcut, people make judgments about the likelihood of an event based on how easily an example comes to mind. E.g. if a person has just watched a documentary about burglary, they may think their chances of being burgled are higher than they actually are, and this may influence their consumption decisions. People often make judgments based on events that are fresh in their head.

Question 72

Explain the anchoring heuristic.

Answer 72

People tend to make decisions by comparing a nearby reference point (i.e. using an arbitrary starting number to estimate a different number).
e.g. bread machine costs £230 which is a lot of money so has no sales. Same company releases new machine for £400, and £230 now seems like a good value and sales increase.

Question 73

Explain the representativeness heuristic.

Answer 73

People tend to make mental shortcuts where they use past experiences or stereotypes to guide their decision making. They use this information rather than the more accurate information at hand to make a decision. E.g. a gambler making a bet because they believe they are in a run of good luck. E.g. Guessing if an astrological person is a holistic healer or teacher based on description vs statistics.

Question 74

Market failure definition

Answer 74

Market failure occurs when the allocation of goods and services is inefficient. It often leads to a net loss of economic welfare.

Question 75

What are the three types of market failure?

Answer 75

Negative externalities
Under-provision of public goods
Information gaps

Question 76

Explain negative externalities as a type of market failure.

Answer 76

The costs created by economic agents when producing or consuming a product which result in a loss of economic welfare. This happens when the free-market quantity demanded/supplied is higher than the social optimum quantity demanded/supplied.

Question 77

Explain under-provision of public goods as a type of market failure.

Answer 77

This is when firms do not provide goods and services because they find it difficult to charge for the product.

Question 78

Explain information gaps as a type of market failure.

Answer 78

This is when consumers have asymmetric information; some economic agents have more information about the product than others. This can be caused by failure to disclose information, lack of education/awareness, framing issues (how the product is portrayed) or difficulty estimating the costs and benefits.

Question 79

What is the difference between private, social and external costs and benefits?

Answer 79

Private costs: The costs of consuming or producing a good or service that are paid for by those who use them.
Private benefits: The benefits of consuming or producing a good or service that are received by those who use them
Social costs: The costs of consuming or producing a good or service that are paid for by society.
Social benefits: The benefits of consuming or producing a good or service that are received by society.
External costs: The costs to a third party when social costs are greater than private costs.
External benefits: The benefits to a third party when social benefits are greater than private benefits.

Question 80

Give an example of an external cost and benefit of production and consumption.

Answer 80

External cost of production: Dumping of toxic waste
External cost of consumption: Passive smoking / anti-social behaviour from drinking alcohol
External benefit of production: Creation of jobs from building a new factory
External benefit of consumption: Becoming better skilled so contributing more to the economy

Question 81

Why do governments intervene in markets?

Answer 81

Reduce negative externalities
Increase positive externalities
Increase supply of merit goods
Decrease supply of demerit goods
Supply public goods that would be undersupplied by the market
Reduce inequality
Support industry

Question 82

What is the difference between public and private goods?

Answer 82

Public goods: When its use by an individual does not stop others from using it, and its consumption does not reduce the amount available for consumption by others.

They are non-rival goods (consumption doesn’t reduce amount available)
They are non-exludable goods (impossible to prevent others from using)

Private goods: When its use by an individual stops others from using it, and its consumption reduces the amount available for consumption by others.

They are rival goods (consumption reduces amount available)
They are excludable goods (possible to stop others from using)

Question 83

Why are public goods often not provided by the private sector?

Answer 83

Public goods are not profitable because consumers are unwilling to pay for them. This is because they are non-exludable, so can be used without payment. These goods are alsonecessary for daily life and national development, so the government takes control of supplying them.

Question 84

Explain the free-rider problem.

Answer 84

This occurs when people can benefit from a good or service without paying for it. If enough people can enjoy a good without paying the cost, there is the danger that the good will be under-provided or not provided at all.

If one sailor builds a light house, all sailors benefit from the illumination. If other sailors don’t contribute to its upkeep, it may be too expensive to continue operation, and it will be under-provided.<

Public good examples: Gardening and street lights

Question 85

What is the difference between symmetric and asymmetric information?

Answer 85

Symmetric information: Consumers and producers have the same level of knowledge about the products, and they know everything there is to know about them and the effects of consumingthem.

Asymmetric information: When there is imperfect knowledge or an inbalance of information. E.g. second hand car sellers often know more about the car than buyers.

Question 86

How can imperfect market information lead to a misallocation of resources?

Answer 86

Without having full information about a product it is difficult for consumers and producers to make decisions regarding price, quality and other relevant factors when buying and selling. This can lead to inefficient decisions to be made and resources to be spent when they could be spent better elsewhere.

Question 87

What is the difference between a quasi-public good and true public good?

Answer 87

Qausi-public goods provide benefits to the public, but could be restricted if necessary.
A true public good must be accessible to everyone all the time

E.g. Roads can be restricted with a toll booth.

Question 88

Why do externalities exist, and how does the government react to them?

Answer 88

In the free market producers and consumers are usually only concerned with the private costs and benefits, which often results in negative externalities. The government aims to decrease production or consumption so that the gap between the social optimum and free market level of output or consumption is smaller, and the negative externality will be smaller. The opposite is true for positive externalities. The government may intervene in markets to encourage or discourage production or consumption. E.g. sugar tax, tradable pollition permits, subsidies. These will internalise the negative externalities as the gap between the private and social costs will decrease, or the social benefits will increase.

Question 89

What are merit and demerit goods?

Answer 89

Merit goods provide external benefits when consumed.
Demerit goods provide external costs when consumed.

Question 90

Why do governments indirectly tax and subsidise?

Answer 90

Increase the price of products that cause negative externalities to reduce them and decrease the price of products that cause positive externalities to increase them.

Question 91

How can a government reduce or eliminate information failure?

Answer 91

Force producers to provide accurate information through accurate labelling (e.g. requiring alcohol percentage)
Public broadcasts to improve knowledge (e.g. adverts showing the impacts of smoking)
Laws forcing companies to be more transparent and publish their financial accounts
Regulate advertising standards to be more informative and less persuasive
Establish organisations to act as regulators (Competition and Markets Authority and Advertising Standards Authority

Question 92

Why do governments introduce maximum prices?

Answer 92

It is set below the equilibrium price to be effective. It creates lower prices for consumers and prevents them from being exploited, however there could be shortages as demand exceeds supply. It could also encourage trade on the black market.

Question 93

Why do governments introduce minimum prices?

Answer 93

It is set above the equilibrium price to be effective. It protects the earnings of producers, particularly in industries that have prices subject to great fluctuations. It sometimes creates a surplus as supply exceeds demand, which can be a good thing as the surplus can be stored for when there are future shortages.

Question 94

Why do governments introduce tradable pollution permits?

Answer 94

To create a market to internalise the negative externality created from large firms polluting. It also aims to limit greenhouse gasses, as these cause global warming. Firms must pay high prices to pollute or stop polluting all together. The government gives them a choice, with the outcome being positive for the rest of society either way. The government can also later raise funds by selling more permits when they become scarcer. Firms will invest and innovate to become cleaner.

Question 95

What are the potential disadvantages/limitations of tradable pollution permits?

Answer 95

The increased cost for firms could be passed onto the consumer, which would increase prices for consumers without decreasing pollution or internalising the external cost.
Very large firms will buy more permits without seeing a significant increase in their costs, which would limit the impact of the permits.
It may create a barrier to entry in a market, which would restrict cometition
It isn’t worldwide, so even if the EU is successful at reducing pollution, there is still a lot of pollution elsewhere in the world that will impact the EU.
If market price increases to a very high rate, fines may be cheaper than permits.

Question 96

Why do governments intervene with regulation?

Answer 96

The government seeks to provide effective competition within markets to protect the interests of consumers so that they are not exploited by firms. Consumers will have greater choice and lower prices.

Question 97

What are 7 ways governments intervene in markets?

Answer 97

Taxation
Subsidies
Maximum and minimum prices
Tradable pollution permits
State provision of pubic goods
Provision of information
Regulation

Question 98

What are giffen goods?

Answer 98

A giffen good is an inferior good where higher price causes an increase in demand due to the income effect of the higher price outweighing the substitution effect.
E.g. Poor people can eat potatoes or meat. Potatoes are cheaper and more filling. If price of potatoes increases, fewer people can afford meat and will instead buy more potatoes.

Question 99

What are veblen goods?

Answer 99

Veblen goods are normal goods where demand rises as price rises. This is due to people believing more expensive goods are better quaity goods. E.g. luxury cars.

Question 100

Government failure definition

Answer 100

Government failure exists when the government intervenes to correct a market
failure, but the result is a more inefficient allocation of resources and there is a
net loss of economic welfare.

Question 101

What are the 4 causes of government failure?

Answer 101

Distortion of price signals
Unintended consequences
Excessive administration costs
Information gaps

Question 102

Why can distortion of price signals lead to government failure?

Answer 102

The government tries to create incentives and disincentives in order to influence the behaviour of individuals and firms. This creates markets that only survive with government support and markets that are have limited growth because of the government. This distorts the free workings of the market and creates distorted prices, which can lead to inefficiencies.

Question 103

Why can unintended consequences lead to government failure?

Answer 103

Unexpected events can occur due to government intervention if consumers or producers act in a manner that was not foreseen by the government. This can worsen the situation that the government was trying to resolve.

Question 104

Why can excessive administration costs lead to government failure?

Answer 104

Administrative costs are the expendatures of government intervention. Even if the intervention creates benefits, the costs may outweigh the benefits, creating a net loss of economic welfare.

Question 105

Why can information gaps lead to government failure?

Answer 105

Information used by governments can be innacurate due to poor research or inability to predict the future. This delivers wrong signals to markets, meaning decision-making is flawed.

Question 106

What are the 2 types of tax? (other than direct and indirect)

Answer 106

Specific tax
Ad Valorem tax

Question 107

What are 2 real-life examples of government failure?

Answer 107

1920s US government ban on alcohol. Led to a rise in organised crime as the mafia supplied alcohol.
1990s UK landfill tax led to an increase in illegal dumping of rubbish on the roads / fly-tipping.