Definitions of how markets work

Question 1

Rational economic behaviour

Answer 1

A decision making process by individuals and firms by which they act to maximise their welfare

Question 2

Effective demand

Answer 2

The quantity of the good people are willing and able to buy at any given price over a period of time

Question 3

Supply

Answer 3

The quantity of the good firms are willing and able to offer for sale at any given price over a period of time

Question 4

DMU

Answer 4

The law of diminishing marginal utility is a law of economics stating that as a person increases consumption of a product while keeping consumption of other products constant, there is a decline in the marginal utility that person derives from consuming each additional unit of that product. Marginal utility is defined as the change in utility as an additional unit is consumed

Question 5

PED

Answer 5

A measure of the responsiveness of the quantity demanded of a product to a change in its price in percentage terms

Question 6

Income elasticity of demand YED

Answer 6

A measure of the responsiveness of the quantity demanded of a product to a change in income in percentage terns

Question 7

Cross elasticity of demand XED

Answer 7

A measure of the responsiveness of the quantity supplied of a product to a change in its price, in percentage terms

Question 8

Price elasticity of supply

Answer 8

A measure of the responsiveness of the quantity supplied of a product to a change in its price, in percentage terms

Question 9

Normal goods

Answer 9

These are goods for which demand increases when income increases. This means the YED is positive. The term does not refer to the quality of the good.

Question 10

Inferior goods

Answer 10

These are goods for which demand increases when income rises. This means the YED is negative. Inferiority, in this sense, is an observable fact rather than a statement about the quality of the good.

Question 11

Complements

Answer 11

Goods that are used in conjunction with others. They have negative XED

Question 12

Substitutes

Answer 12

Goods that compete for the same market. They have positive XED

Question 13

Price mechanism

Answer 13

The price mechanism is the method through which the market allocates scarce resources by responding to changes in the conditions of supply and demand. Prices create signals and incentives to determine what is produced, how it’s produced and who receives the product

Question 14

Consumer surplus

Answer 14

The difference between what a person would be willing to pay and what they actually pay to buy a certain quantity of a good. This represents the extra utility that a consumer gains above the price that they pay for it. It is the area below the demand curve and above the price level.

Question 15

Producer surplus

Answer 15

The difference between what a producer is paid for a quantity of a good and the lowest price the producer requires in order to supply that quantity. It is the area above the supply curve and below the price level

Question 16

Direct tax

Answer 16

This is collected directly by government from the individuals or companies on whom it is levied. Examples include income tax and corporate taxes. Direct taxes are more likely to influence the demand curve because they influence the disposable income of consumers

Question 17

Indirect tax

Answer 17

A tax on the producer or sale of a good or service. Indirect taxes are included in the price paid for the good or service by its final purchases e.g. VAT, beer duty. The introduction or increase of an indirect tax causes a negative shift in the supply curve

Question 18

Unit/Specific tax

Answer 18

A tax based on the volume of the product sold e.g. tax of £1 per bottle of whisky or 50p per litre of petrol. The supply curve shifts parallel to itself

Question 19

Ad valorem tax

Answer 19

Means according to value, a method of taxation using the value of the product taxed to determine the amount of tax. VAT is an example of an ad valorem tax because it is charged at 20% of the value of product or service being sold. The supply curve shift is nonparallel.

Question 20

Incidence of tax

Answer 20

The way in which the burden of tax eventually falls on the consumer and producer

Question 21

Subsidy

Answer 21

A grant given that lowers the price of a good, usually designed to encourage production or consumption of a good and causes a positive shift in the supply curve

Question 22

Behavioural economics

Answer 22

A method of economic analysis that applies psychological insights into human behaviour to explain economic decision-making

Question 23

Commodity

Answer 23

Any product of agriculture, fishing or mining that is produced to be traded or sold such as cash crops. It can be a food, a fibre such as cotton, or tobacco, gold and copper

Question 24

Exchange rate

Answer 24

The price of one country’s currency expressed in terms of another country’s currency