How markets work

Question 1

What is demand

Answer 1

Demand is the quanitity of a good or service that consumers are able and willing to buy at the given price

Question 2

What factors shift the demand curve

Answer 2

PIRATES
- Population: The larger the population the higher the demand
- Income: If consumers dispoable income is higher there will be more consumer spending
- Related goods: Substitute and complimentary goods, If price for substitute falls the demand for original good will fall as spending will switch to the cheaper. If price of a complimentary good increases then demand for the original good will decrease.
- Advertsing: This increases consumer loyalty to the good and increases demand
- Taste and fashion: The demand curve will also shift if consumer tastes change
- Expectations: If speculators predict price of shares increases in the future demand in the present will increase
- Seasons: Demand changes based on what time of year it is

Question 3

Name the types of demand

Answer 3

Derived demand - This is when the demand for one good is linked to the demand for a related good
Composite demand - This is when the good demanded has more than once use
Joint demanded - This is when goods are bought together, such as a camera and a memory card

Question 4

Explain diminishing marginal utility

Answer 4

The law of diminishing marginal utility states that as an extra unit of the good is consumed the benefit derived from consuming the good falls. Therefore consumers are willing to pay less for the good

Question 5

Define price elasticity of demand

Answer 5

The price elasticity of demand is the responsiveness of a change in demand to a change in price
PED = %∆QD/%∆P

Question 6

State the numerical values for each elasticities

Answer 6

Elastic: PED > 1
Inelastic: PED < 1
Perfect Elastic: PED = ∞
Perfect Inelastic = 0

Question 7

Factors influencing PED

Answer 7

Necessity - Bread will have consistent inelasticity
Substitutes - If a product has a substitute then demand is more price elastic
Addictiveness - The demand will be inelastic as the consumer is addicted
Peak and off-peak demand - during peak times consumers will be more price inelastic

Question 8

Define income elasticity of demand

Answer 8

Income elasticity of demand is the responsiveness of a change in demand to a change to a change in income
YED = %∆QD / %∆Y

Question 9

Name the types of goods in relation to income elasticity

Answer 9

Inferior, normal and luxury goods

Question 10

Describe the relation between the different types of goods and income elasticity of demand

Answer 10

• Inferior goods are those which see a fall in demand as income increases YED < 0
• Normal goods, demand increases as income increases YED > 0
• Luxury goods, an increase in income causes an even bigger increase in demand YED> 1

Question 11

Define cross elasticity of demand

Answer 11

Cross elasticity is the responsiveness of a change in demand of good X to a change in price of good Y
XED = %∆QD of X / %∆P of Y

Question 12

State the types of goods in relation to cross elasticity

Answer 12

Compliments, substitutes and unrelated goods

Question 13

Describe the relation to these goods and cross elasticity

Answer 13

• Complimentary goods have negative XED. If one good becomes more expensive, the quantity demanded for both goods will fall (weak = inelastic, strong = elastic)
• Substitues have positive XED so if one good becomes cheaper demand for the other will fall (close = elastic, weak = inelastic)
• Unrelated goods have XED equal to 0

Question 14

What is supply

Answer 14

Supply is the quantity of a good or service that a producer is able and willing to supply at given price

Question 15

What factors shift a supply curve

Answer 15

PINTSWC
- Productivity: if productivity increase costs will fall
- Indirect taxes: Inward shift in supply
- Number of firms: More firms = larger supply
- Technology: More advanced tech leads to outward shift
- Subsidies: Cause outward shift in supply
- Weather: Agricultural produce can be effected either way
- Costs of production: if costs fall then. supply is more affordable, vice versa

Question 16

Explain joint supply

Answer 16

Increasing the supply of one good causes an increase or decrease in supply of another good

Question 17

What is price elasticity of supply

Answer 17

Price elasticity of supply is the responsiveness of a change in supply to a change in price
PES = %∆QS / %∆P

Question 18

Describe the numerical values of supply elasticity

Answer 18

If supply is elastic PES is > 1
If supply is inelastic PES is < 1
A perfectly inelastic supply has PES = 0
Supply is perfectly elastic when PES = infinity

Question 19

What factors influence PES

Answer 19

• Time scale: In SR supply is price inelastic as producers cannot quickly increase supply, LR supply becomes more price elastic
• Spare capacity: If the firm is operating at the full capacity there is no space left to increase supply
• Level of stocks: If goods can be stored firms can increase supply easily
• Barriers to entry to the market: Higher barriers to entry means supply is more price inelastic
• How substitutable factors are: If labour and capital are mobile , supply is more price elastic as resources can be allocated to where extra supply is needed

Question 20

What does the price mechanism do

Answer 20

Determines market price, invisible hand of the market

Question 21

What three main functions does the price mechanism use

Answer 21

• Rationing: When there are scarce resources, price increases due to the excess of demand. This decreases demand and consequently rations resources
• Incentive: This encourages a change in behaviour of a consumer or producer, a high price would encourage firms to supply more to the market to maximise profit
• Signalling: The price acts as a signal to consumers and new firms entering the market, the price chnages to show where resources are needed in the market.

Question 22

Describe how to increase and decrease consumer surplus

Answer 22

Increase - Shift demand curve outward
Decrease - Shift supply curve inward

Question 23

Describe how to increase and decrease producer surplus

Answer 23

Increase - Shift supply curve outward
Decrease - Shift demand curve inward

Question 24

What is economic welfare

Answer 24

The total benefit society receives from an economic transaction, the sum of the area of the consumer and producer surplus

Question 25

What are indirect taxes and its effects

Answer 25

Taxes imposed by the government which increase production costs for producers. Therefore producers supply less which increase market price

Question 26

What is a subsidy

Answer 26

A subsidy is a payment from the government to a producer to lower their cost of production and encourage them to produce more

Question 27

What are some effects of a subsidy

Answer 27

• Subsidies increase output and lower prices for consumers
• They reduce inequality in society
• Subsidies could help control inflation by keeping costs of production low
• There could be government failure if the government provides an inefficient subsidy or if the subsidy distorts the market price

Question 28

What are the reasons for irrational consumer behaviour

Answer 28

• The influence of others behaviour
• The importance of habitual behaviour
• Consumer weakness at computation