Theme 1 - The Nature Of Economics (Autumn Term 2 - Yr 12)

Question 1

What is meant by Price Elastic?

Answer 1

A measure of the effect of a price change or a change in the quantity supplied on demand for a product or service.

Question 2

Why do businesses need to be aware of how customer demand might respond to the price set?

Answer 2

The responsiveness of demand to changes in price can be described as price elasticity. It can help firms forecast effect on sales of planned price changes or strategies.

Question 3

Why does price inelasticity mean that demand does not change?

Answer 3

Inelastic demand is where people will buy about the same amount whether the price drops or not, likewise they will not buy more even if the price drops. An example is cigarettes.

Question 4

What is the equation of Price elasticity? + example

Answer 4

PED = % change in quantity demanded / % change in price
Quantity demanded: 20, 25
Price: £8, £7
((25-20)/20)100= (1/4)100= 25 ((7-8)/8)100=(-1/8)100=(-25/2)
PED: 25 / (-25/2) = -2% (inelastic)

Question 5

If the value in PED calculations is bigger than 1, is it elastic or inelastic? Similarly if the value is smaller than 1.

Answer 5

Bigger than 1 = elastic

Smaller than 1 = inelastic

Question 6

Why is petrol inelastic? (PED)

Answer 6

People still need to buy petrol for their vehicles, therefore they will continue to buy it.

Question 7

Why are holidays offered by a major tour operator elastic? (PED)

Answer 7

If the price of the holiday is too expensive, then people would prefer to save their money or take a domestic holiday, so fewer people will buy them.

Question 8

Why are Ford cars elastic? (PED)

Answer 8

They can be too expensive and there are cheaper substitutes so people will not buy it.

Question 9

What determines Price elasticity?

Answer 9

1) lots of substitutes
2) complementary goods
3) luxury/necessities- addictive drugs
4) price/expensiveness
5) time
6) Brand loyalty
7) switching costs

Question 10

What is total expenditure?

Answer 10

It is the amount that buyers spend on the product.

Question 11

What is meant by total revenue?

Answer 11

It is the amount that sellers receive from selling the product (assuming both are at the same amount).

Question 12

Why is PED useful for producers?

Answer 12

Can estimate:
1) the effect of a change in price on total revenue of sellers
2) ?
3) the effect of indirect tax (eg VAT) on price and QD and also whether the business is able to pass on some or all of the tax onto the customer.
4) price determination- where suppliers decide to charge different prices for the same product to differ segments of the market (rail travel peak times)
Usually done when PED is inelastic

Question 13

What are the limitations of PED?

Answer 13

1) Problems with inaccurate or incomplete data collection
2) PED varies by region/time
3) Not all businesses are profit maximisers
4) Varies within product ranges e.g. economy and premium products
5) Rivals will change their market strategies from time to time

Question 14

Define income elasticity of demand.

Answer 14

It is measure of the responsiveness of QD to a change in income.

Question 15

What is the formula for income elasticity of demand? + example

Answer 15

YED: % change in QD / % change in income
(Y/change in Y) * (change in QD/QD)
QD: 100, 120      Income: 10, 14
QD: ((120-100)*100)= 20        Income: ((14-10)*100)= 40
YED: 20/40= 0.5% - normal

Question 16

What are normal and inferior goods?

Answer 16

Normal goods: a good where demand increase when income increase (positive) - cars.
Inferior goods: a good where demand falls when income increases (negative) - if you have more money, it does not mean you will take the bus even if you can take it.

Question 17

Define Cross Price Elasticity (XED).

Answer 17

It is a measure of responsiveness of QD of one good to a change in price of another good.

Question 18

What is the formula for XED? + example

Answer 18

XED: % change in QD of good X / % change in price of good Y
QD: 100, 180 P: 5, 6
((180-100)/100)100=80% ((6-5)/5)100=20%
XED: 80/20=4% - substitute

Question 19

What are substitutes and how do they affect XED?

Answer 19

1) They are products that are in competitive demand.
2) An increase in the price of one good will lead to increase in demand for a rival product.
3) It is always positive.
Exs: if the price of PlayStations go up, the demand for x-boxes will increase.

Question 20

What are complements and how do they affect XED?

Answer 20

1) They are products in joint demand
2) A fall in the price of one product (may) causes an increase in demand for the complementary good. OR! And increase in the price of one product causes a decrease in demand for the complementary product.
3) It is always negative.
Exs: if the price of PlayStations go up, the demand for games will decrease.

Question 21

What is Gross income?

Answer 21

It is the income before income tax, national insurance contributions and wealth of benefits have been taken into account.

Question 22

What is disposable income?

Answer 22

Disposable income = Gross income - (income tax + employees’ national insurance contributions + welfare benefits)

Question 23

What would you use if you wanted to measure economic performance on a macro level?

Answer 23

UK Economy - international trade, employment, growth + GDP, inflation.

Question 24

What is microeconomics and macroeconomics?

Answer 24

Micro: the study of the economy of an individual, household or a firm or industry.
Macro: the study of the economy on a bigger scale, eg a whole country or global trade.

Question 25

Explain the neo-classic theory vs the behaviour economics.

Answer 25

Neo-classic (Rationale): assumes that consumers act rationally and aim to maximise their own utility or economic welfare.
Behavioural economics: the economic agents do not act rationally. Choices can be manipulated.

Question 26

Why do consumers not act rationally?

Answer 26

1) Consideration of the influence of other people’s behaviour - social norms
2) The importance of habitual behaviour - ‘rule of thumb’. Consumers also do not gather all the information because they believe they can make a decision with a part of the information (supermarkets placing products on different rows). They also make people lack self-control = not maximising benefits (drugs).
3) Consumers weakness at computation - they are not will or able to make comparisons.

Question 27

What do markets do?

Answer 27

The role of markets is to allocate scarce resources. They can be efficient or they can fail.

Question 28

What is partial market failure?

Answer 28

There is overproduction or underproduction of goods.

Question 29

What is market failure?

Answer 29

Where resources are inefficiently allocated due to imperfections in the working of the market mechanism.

Question 30

Why do markets fail?

Answer 30

1) Externalities: market prices + profits can be misleading as they do not reflect true prices and profits to society of economic activities. Eg. There is commercial sense to cut down trees in the Amazon rainforest to make sense for cattle and meat for the west (short-term) but there are many environmental issues with it for the long-term.
- if markets put out the wrong signals, it can lead to a misallocation of resources.
2) Under-provision of public goods: it is relatively easy to gain benefits from the general or without having to pay for it, so there is a large incentive for individuals not to pay for it, in the hope that others will.
3) Information gap: Information can be imperfect so they cannot make good decisions. + asymmetric information - where one party knows more information than the other (‘lemon cars’)

Question 31

What is the current base rate and what is it’s significance?

Answer 31

0.75% (Bank of England)
The base rate indicate what amount of rate banks charge to the public so they can make a profit but if it is too much then the ‘bank of England’ shall have a word with them. It provides a guidance.

Question 32

What are interest rates?

Answer 32

The cost of borrowing and the reward of saving.

Question 33

What happens if interest rates go up?

Answer 33

1) Spending decreases because they have to pay more for:
2) an increase in cost of mortgages -> sack employees, save more, can lose business or their job.
3) Demand decreases since there is less disposable income mostly due to high mortgage rates
4) The value of the £ increase, therefore imports are cheaper, exports are inelastic but can be reduced
5) Fall in consumption and investment - confidence decreases
6) There is an increase in Govt interest payments = higher taxes

Question 34

What happens if interest rates go down?

Answer 34

1) People spend more, due to paying less for their mortgages, so they have a higher disposable income
2) Borrowing is cheaper, therefore it encourages people take our more loans
3) The value of the £ decreases - exports are cheaper, imports are more expensive, people will take more domestic holidays but there be an increase of people from abroad.

Question 35

Definition of the Exchange Rates.

Answer 35

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

It depends on the demand for a country’s which will determine its value.

Question 36

What happens if the £ is strong?

Answer 36

1) imports are cheaper so you can buy more stuff
2) travel abroad for a cheaper price
3) exports are inelastic

Question 37

What happens if the £ is weak?

Answer 37

1) imports are more expensive = buy less
2) fewer holidays
3) exports increase and are cheaper so foreigners buy more
4 ) more holidays in the UK

Question 38

What is inflation?

Answer 38

The rise of general prices and the reduction in the value of money.

Question 39

What is the ‘basket of goods’?

Answer 39

Refers to a fixed set of consumer products + services valued on an annual basis and used to track inflation in a specific market or country. They are often adjusted according to consumers habits.
Inflation is measured with RPI (Retail Price Index).

Question 40

What is Cost Push vs Demand Pull?

Answer 40

Cost Push: the rise is costs ‘pushes’ up the price of products. Eg. Raw materials, labour, fuel and energy cost.
Demand pull: high demand for products and services pulls up the prices price for these across the board.