micro - how competitve markets work

Question 1

what is resource allocation?

Answer 1

the means by which scarce resources are chosen to produce particular goods or services.

Question 2

what is the coordination problem?

Answer 2

How can all the decisions made by economic agents be coordinated to ensure that society’s scarce resources are allocated in the most efficient way?

Question 3

how are are resources allocated in a free market economy?

Answer 3

the market decides on how resources should be allocated, by using the economic forces of supply (which shows the willingness of producers to supply goods and services) and demand (representing the wants of consumers.) - equilibrium that maximises economic welfare.

Question 4

what are advantages of a free market economy?

Answer 4

the market gives incentives to suppliers to produce what customers want, leading to a wide range of choices for consumers.

the market mechanism encourages the most efficient use of the factors of production, increasing the products available and lowering the costs.

the market mechanism automatically reacts to changes in demand and supply, to ensure that economic welfare is achieved.

Question 5

what are the disadvantages of a free market economy?

Answer 5

inequality of income and wealth occurs

there may instability in prices, growth and unemployment.

it may result in monopoly, leading to restricted supply and high prices, giving high profits to suppliers but not meeting consumer’s needs.

Question 6

how are are resources allocated in a command/ centrally planned economy?

Answer 6

the government decides on what to produce, and how resources should be allocated among the population.

Question 7

what are the advantages of a command/centrally planned economy?

Answer 7

allocation can be based on wants rather than income, and the misallocation of resources arising from inequality can be overcome.

public goods will be supplied by the government and resources diverted from demerit (“unhealthy”) goods to merit (e.g. education) goods.

governments can intervene to ensure that externalities are considered and monopoly power is controlled.

Question 8

what are the disadvantages of a command/centrally planned economy?

Answer 8

government ownership reduces competition and thus the incentive to produce efficiently.

government intervention is based on values that may not represent everyone’s viewpoint.

administrative costs represent an inefficient use of resources.

Question 9

how are are resources allocated in a mixed economy?

Answer 9

the market decides on how resources should be allocated, except where governments choose to intervene.

Question 10

what are the advantages of a mixed economy?

Answer 10

more freedom than command economy

enables economy to benefit from the strengths of a free market economy, while using a command economy in areas where the market economy is causing market failure.

Question 11

what is the disadvantage of a mixed economy?

Answer 11

tend to lean more towards government control and less towards the people.

Question 12

what is demand?

Answer 12

it is the amount of good or service that consumers in a market are willing and able to buy at any given price over a period of time (ceteris paribus).

Question 13

what is market demand?

Answer 13

the sum of the demand by every consumer in a market?

Question 14

what is notional demand?

Answer 14

reflects a consumer’s wants, which are theoretically limited.

Question 15

what is effective demand?

Answer 15

when a consumer’s desire to buy a product is backed up by their ability to pay for it.

Question 16

what does the demand curve show?

Answer 16

the relationship between the quantity demanded, and the price of the product.

Question 17

what is a demand schedule?

Answer 17

the data that is used to draw the demand curve for a product.

Question 18

what is the law of demand?

Answer 18

there is an inverse relationship between price and quantity demanded. The lower the price, the greater the demand.

Question 19

movement along the a demand curve occurs…

Answer 19

when the only variable to change is price. For goods, an increase in price causes a contraction, and a decrease causes an expansion.

Question 20

what is derived demand?

Answer 20

where the demand for a good or service is determined by the demand for another good or service. For example: the demand for tyres derive from demand for cars.

Question 21

what is joint demand?

Answer 21

when two or more goods are used together. For example: toothbrush and toothpaste are jointly demanded.

Question 22

what is composite demand?

Answer 22

where goods are demanded for different purposes. For example: milk can be demanded in order to provide milk, yogurt or cheese.

Question 23

what is competitive demand?

Answer 23

where a good is purchased as an alternative to another good (substitute good). For example beef and pork.

Question 24

what is the ‘snob effect’?

Answer 24

as the price increases, the demand for a product increases e.g. popular brand.

Question 25

what is a normal good?

Answer 25

goods for which an increase in income leads to an increase in demand.

Question 26

what is a inferior good?

Answer 26

goods for which an increase in income leads to a fall in demand.

Question 27

what are substitute goods?

Answer 27

goods that compete with one another. Therefore, If the price of a good increases, then the demand for a substitute good increases vice versa.

Question 28

what are complimentary goods?

Answer 28

goods that are used together. Therefore, if the price of a good increases, then the demand of a complimentary good is likely to fall vice versa - inverse relationship.

Question 29

for a consumer to make a rational decision…

Answer 29

they must be fully aware of market prices.

Question 30

what does ‘ceteris paribus’ mean?

Answer 30

‘other things being equal’. All other influencing factors are held constant so we can focus on the effects of a change in one variable e.g. price.

Question 31

what are the 4 determinants of demand?

Answer 31

price (a movement up or down the demand curve).
income (a shift - increase or decrease in demand)
price of other goods (substitutes and compliments - a shift)
consumer preferences (trends) and other influences - shift.

Question 32

what is disposal income?

Answer 32

income after taxes on income have been deducted and state benefits have been added.

Question 33

what is real disposal income?

Answer 33

income after taxes on income have been deducted and state benefits have been added, however changes in price (inflation) have been taken into account.

Question 34

what is consumer surplus?

Answer 34

the extra amount that a consumer is willing to pay for a product above the price that is actually paid.

Question 35

what is supply?

Answer 35

the amount of good or service that firms in a market, are prepared to offer for sale at any given price over a period of time (ceteris paribus).

Question 36

what is individual supply?

Answer 36

the amount of a good or service that an individual firm (supplier) is prepared to offer for sale at any given price over a period of time.

Question 37

what is market supply?

Answer 37

the amount of a good or service that all firms in a market are prepared to offer for sale at any given price over a period of time.