Classical Economics

Question 1

What is a market?

Answer 1

A structure that allows buyers and sellers to exchange goods or services

Question 2

Draw the market demand graph

Answer 2

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Question 3

Draw the market supply graph

Answer 3

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Question 4

Draw the competition pricing graph, showing consumer surplus and producer surplus

Answer 4

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Question 5

Where on the competition pricing graph is the market equilibrium price p*?

Answer 5

Where the supply and demand curves cross

Question 6

What is the meaning of market equilibrium price p*?

Answer 6

– Supply has exhausted all the demand willing to pay up to p* and demand has exhausted all supply willing to offer for at least p*
– The demand curve faced by each firm is zero at any price above p, but the firm would face all the demand for any price below p

Question 7

What is market demand?

Answer 7

The willingness and ability of customers in a market to purchase a given good. Sum of demand over consumers

Question 8

What is marginal cost?

Answer 8

The change in total cost that arises from producing one additional item

Question 9

What is market supply?

Answer 9

The total amount of an item producers are willing and able to sell

Question 10

What is consumer surplus?

Answer 10

The total amount people saved on their reservation price

Question 11

What is a reservation price?

Answer 11

The highest price a buyer is willing to pay

Question 12

What is producer surplus?

Answer 12

Total amount firms saved on their marginal costs

Question 13

What is a monopoly?

Answer 13

Where one seller or producer of a particular good or service dominates and controls the entire supply. They make decisions based on marginal revenue

Question 14

What power does a monopolist have?

Answer 14

Significant market power and the power to set prices

Question 15

What is marginal revenue?

Answer 15

The additional profit the seller can make for every additional item sold

Question 16

Draw the monopoly pricing graph (add marginal revenue to the competition pricing graph). What monopolist behaviour might this suggest?

Answer 16

That monopolists might restrict supply - selling less goods at a higher price can make them more revenue than more goods at a lower price

Question 17

Add the consumer surplus, producer surplus and deadweight loss to the monopoly pricing graph

Answer 17

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Question 18

What does the sum of consumer and producer surplus represent, and when might this be diminished?

Answer 18

Social welfare. This is diminished when a monopolist restricts supply in order to get increase their marginal revenue

Question 19

What is a Pareto improvement?

Answer 19

A way to make some people better off without making anyone worse off

Question 20

What is a Pareto efficient allocation?

Answer 20

An allocation such that no Pareto improvement is possible

Question 21

What is a Pareto efficient allocation for a monopolist?

Answer 21

Charge everyone their reservation price

Question 22

How does a monopolist charging everyone their reservation price impact producer surplus? Show this on the competition pricing graph

Answer 22

Producer surplus is maximised. The monopolist captures all the consumer surplus

Question 23

What is utility?

Answer 23

How much consumers value a good/service. Can be used to measure overall satisfaction from consuming multiple goods

Question 24

What is marginal utility?

Answer 24

The additional satisfaction or value that an individual derives from consuming an additional unit of good/service

Question 25

State the Law of Diminishing Marginal Utility

Answer 25

As an individual consumes more of a particular good, the additional satisfaction from each successive unit tends to decrease

Question 26

What is market price?

Answer 26

The amount of money a good/service can be sold for in a market

Question 27

Draw the supply graph

Answer 27

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Question 28

Explain the supply graph

Answer 28

-- Firms have fixed costs and variable costs, so the average cost of goods initially falls with output. -- The variable costs rise at some point and eventually rise sharply due to capacity constraints

Question 29

Give two examples of a fixed cost

Answer 29

1. Rent 2. Utility bills

Question 30

Give two examples of a variable cost

Answer 30

1. Raw materials 2. Labour costs

Question 31

Draw the cost evolution graph

Answer 31

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Question 32

Explain the cost evolution graph

Answer 32

-- In the long run, firms can fix capacity constraints by building more factories. -- This gives nearly constant fixed costs and so constant returns to scale as the firm expands

Question 33

How does a firm maximise its profit?

Answer 33

By setting output so that its marginal cost equals equilibrium price p*

Question 34

What is partial equilibrium analysis?

Answer 34

Studying supply and demand for one good

Question 35

What is general equilibrium analysis?

Answer 35

Studying supply and demand for multiple goods including other factors such as labour/leisure, capital etc.

Question 36

State the First Theorem of Welfare Economics

Answer 36

Market equilibrium is Pareto optimal

Question 37

State the Second Theorem of Welfare Economics

Answer 37

Any Pareto optimal allocation can be achieved by market forces provided preferences are convex

Question 38

Give 4 technical conditions for these welfare theorems

Answer 38

1. Rational actors 2. Complete information 3. No transaction costs 4. No externalities

Question 39

Give 3 violations of these welfare theorems

Answer 39

1. Monopoly can set prices 2. Production can lead to negative externalities eg. environmental pollution 3. Behavioural economics: people often make mistakes, or are not just selfishly profit-maximising, so may not be acting rationally

Question 40

Why do some sectors have large companies and others small ones?

Answer 40

Large companies because external transaction costs are higher than internal ones

Question 41

Give 3 examples of transaction costs

Answer 41

1. Time 2. Effort 3. Policing

Question 42

What is utilitarian welfare?

Answer 42

W = sum(Ui) (Ui is utility of individual i) ie. the welfare of a society is the sum of the utilities of all citizens

Question 43

Does Pareto efficiency imply justice?

Answer 43

No. Giving all the money to the king is Pareto efficient

Question 44

What is Rawlsian welfare?

Answer 44

W = min Ui (Ui is utility of individual i) ie. the welfare of a society is the utility of the most miserable citizen

Question 45

What did Pigou say?

Answer 45

Diminishing marginal utility of money means that transferring £1 from a rich man to a poor one will generally increase welfare