Price Mechanism and Applications

Question 1

Define demand

Answer 1

The quantity of a good that a consumer is both willing and able to buy at each possible price during a given period of time, ceteris paribus

Question 2

Define quantity demanded

Answer 2

The amount of a good a consumer is willing and able to buy at a given price over a given period of time

Question 3

What are the determinants of demand

Answer 3

• Price of good itself
• Expectation of future prices
• Government policies
• Level & distribution of income
• Price and availability of related goods
• Taste and Preference
• Demography of population
  (EGIPT - D)

Question 4

What is the Law of Demand

Answer 4

States that in a given period of time, quantity of a good demanded is inversely related to its price, ceteris paribus.

Question 5

What are three assumptions for demand/supply curve

Answer 5

A specific time period is involved
‘Ceteris Paribus’ –> everything else remains unchanged
Consumers/Producers expected to behave rationally

Question 6

How does level and distribution of income affect demand of goods

Answer 6

Normal good demand rises as income rises, but inferior good demand falls as income rises

Question 7

Why would there be an upward shift in demand curve

Answer 7

Willingness and ability to pay higher prices for the same quantity

Question 8

Why would there be a rightward shift in demand curve

Answer 8

Increase in quantity demanded at every price

Question 9

Define substitutes

Answer 9

Pair of goods considered by consumers to be alternatives to each other with the level of utility derived from consuming either good to be relatively similar

Question 10

Describe competitive, joint, derived and composite demand

Answer 10

Competitive –> qdd rises/falls as rational consumers aim to maximise utility within given income, switch away from one good to other
Joint –> pair of goods consumed together to satisfy the same want (same consumer)
Derived –> Demand for one good results in demand for another (different consumers)
Composite –> Demand for good w different uses

Question 11

Describe taste and preference in affecting demand

Answer 11

More desirable consumers find a good, the more of it they will demand at any given price to maximise utility

Question 12

Describe expectation of future prices affecting demand

Answer 12

If price is anticipated to increase, current demand for good will increase to maximise utility within given budget, avoiding paying higher price in future (only for non-perishables)

Question 13

Describe different types of government policies

Answer 13

command-and-control –> directly increase/restrict access to specific types of good
measures to adjust credit conditions –> directly affecting purchasing power and ability to buy

Question 14

Define supply

Answer 14

The quantity of a good or service a producer is both willing and able to sell at each possible price during a given period of time, ceteris paribus

Question 15

What are determinants of supply

Answer 15

• Price of good
• Marginal cost of production (technology, price of factor inputs)
• Government policies
• Price of related goods
• Expectation of future prices
• Number of sellers in market
• Unpredicted events

Question 16

Explain rightward and downward shift in supply curve

Answer 16

Rightward–> positive marginal profits, incentivising them to increase production to capture additional profits
Downward –>more w/a to accept lower price to supply each additional unit of good

Question 17

What affects marginal cost

Answer 17

Price of factor inputs –> marginal cost of producing additional unit of good falls relative to marginal revenue, increase supply to capture marginal profit
Technology –> Productivity increases, reduces input required for each add. unit of output, lowers marginal cost… (same as earlier)

Question 18

Types of tax and effect on supply

Answer 18

Specific: Fixed rate per physical unit (parallel upward shift in supply curve)
Ad-valorem: Tax levied as percentage of price (pivotal shift in supply curve)
Rational and profit-maximising producers w/a supply same units of output at higher prices

Question 19

Subsidies and effect on supply

Answer 19

Provision of money and other resources by government to support a person or bzness activity
Specific (parallel shift) and ad-valorem (pivotal shift)

Question 20

Describe prices of related goods affecting supply

Answer 20

Joint supply: Higher production of one good increases for other (normally from same source)
Competitive supply: Production of one good decreases other (diverting from same source to other output)

Question 21

Describe expectation of future prices effect on supply

Answer 21

Producers may temporarily hold back amount of goods they release into market, likely to build up stocks to sell at higher price

Question 22

Describe number of sellers in market affecting supply

Answer 22

Increased number of sellers (e.g. due to lower barriers to enter industry) results in more producers more w/a to enter market, market supply increases

Question 23

Describe equilibrium after MAP

Answer 23

In perfectly competitive markets, prices adjust until point where quantity demanded by buyers exactly equals quantity supplied by sellers, no pressure on price and quantity to adjust, equilibrium reached

Question 24

(Essay skill) Describe how increase in demand affects market price and quantity

Answer 24

(explain increase in demand)
Buyers bid up prices –> utility-maxing csrs constrained by budget, reduce qdd
–>o/p higher marginal cost more profitable at higher prices, profit-max firms increase qss
upward pressure as csrs more w/a after increasing price to bid
market adjusts to point where_

Question 25

(Essay skill) Describe how increase in supply affects market price and quantity

Answer 25

(explain increase in supply) To remove surplus, firms cut prices, as prices falls: - qdd ^ as utility-max csrs, constrained by budget, more WAB larger quantities - Units of output only be produced at higher MC become unprofitable, profit-maximising firms cut back output to avoid marginal losses, reducing qss market adjusts to point where_

Question 26

What are functions of price mechanism

Answer 26

Signalling function (what) - prices adjust to show where resources are required Incentive function (how much) - incentivise/disincentivise production based on csrs needs & price Rationing function (for whom) - ration & distributes good to WAP csrs

Question 27

Describe signalling function

Answer 27

Market prices will adjust to demonstrate where resources are required, rise to reflect shortages and fall to reflect surpluses

Question 28

Describe incentive function

Answer 28

Consumers send important info to producers about changing nature of needs and wants through expression of preferences. Demand high and strong, incentive to raise output, supplier stands to make higher profit. Attract FOP away from industries w slower growth. Resources move out of industries into more profitable one, price of good fall, disincentivising production when MR falls below marginal cost

Question 29

Describe rationing function

Answer 29

Rations out goods produced according to the willingness and ability to pay. Buyers who desire the good and can afford to pay price will obtain the item, and those who can't go without

Question 30

How is question of "how to produce" answered in price mechanism functions

Answer 30

Look at factor market: price mech signals relative abundance of certain FOP and incentivises firms to employ abundant FOP and economise on use of less abundant FOP

Question 31

Formal explanation of economic efficiency

Answer 31

An allocatively efficient level of production of a commodity as that level for which the total net social benefits is maximised

Question 32

What is consumer sovereignty (not v impt)

Answer 32

Consumers ultimately determine what goods and services are produced and how the economy's limited resources are used based on the purchases they make.

Question 33

Define consumer surplus

Answer 33

The difference between what consumers are willing and able to pay for each unit of good and actual price of the good

Question 34

Define producer surplus

Answer 34

The difference between the actual price received by firms and minimum price they are willing and able to accept for each successive unit of the good supplied, which is the MC

Question 35

Define price elasticity of demand

Answer 35

Measure of degree of responsiveness of the quantity demanded for a good to change in price of good itself

Question 36

Why is sign of PED negative

Answer 36

Law of Demand states qdd is inversely related to price. An increase in price of good will lead to decrease in quantity demanded, cp

Question 37

Define price elastic/inelastic demand

Answer 37

Demand is said to be price elastic/inelastic when given change in price of good results in more/less than proportionate change in quantity demanded in opposite direction, cp

Question 38

What are determinants of PED

Answer 38

ADAPT: Availability and closeness of substitutes Addiction Degree of necessity Proportion of income spent Time Period

Question 39

How does availability and closeness of substitutes affect PED

Answer 39

Greater availability & closeness -> more price elastic Consumers can readily switch to other products that satisfy same want

Question 40

How does proportion of income spent on good affect PED

Answer 40

Greater proportion of person's income spent on good, more price elastic the demand will be, cp For given price increase, utility-max consumers experience more significant reduction in PP due to higher cost, forcing cutback of qdd

Question 41

How does degree of necessity affect PED

Answer 41

Demand for necessities is more price inelastic. Necessities are goods considered to be essential in our lives, have to be consumed despite price changes Non-necessities: can switch to alternatives or forgo the want

Question 42

How does addiction affect PED

Answer 42

Greater the degree of addiction, the more price inelastic the demand, cp Will perceive it as having few substitutes

Question 43

How does time period affect PED

Answer 43

The longer time period in which a consumer makes purchasing decision, the more price elastic the demand. Consumers have opportunity to get info on availability of substitutes, compare prices and adapt tastes and preferences

Question 44

Define cross price elasticity of demand

Answer 44

Measure of responsiveness of demand for one good to change in price of another good, cp

Question 45

Sign of XED for substitutes/complements and why

Answer 45

Substitutes: Positive Rational consumers aim to max utility with given income will switch given price change Complement: Negative Rational csrs aim to max utility will buy more of one good, increase demand for _ as accompaniment to original good

Question 46

When is XED zero

Answer 46

If two goods are unrelated or independent of each other, where change in price of one has no impact on demand for the other

Question 47

What does magnitude of XED show

Answer 47

How closely related 2 goods are, larger magnitude = more closely related

Question 48

Define income elasticity of demand

Answer 48

Measure of responsiveness demand to changes in income, cp

Question 49

Why is YED of inferior goods negative

Answer 49

Demand changes in opposite direction as change in income, cp. Rising incomes give them greater purchasing power, consumers' willingness to purchase inferior goods falls as can switch to goods that yield higher levels of utility