some exam help

Question 1

What is the definition of Price Elasticity of Demand (PED)?

Answer 1

PED measures the responsiveness of quantity demanded to a change in the price of a good or service.

Question 2

What is the formula for calculating Price Elasticity of Demand?

Answer 2

PED=
%changeinprice
%changeinquantitydemanded
​

Question 3

How do you interpret a PED of 2?

Answer 3

If PED = 2, demand is elastic, meaning quantity demanded is highly responsive to price changes (a 1% price change leads to a 2% change in quantity).

Question 4

What does a positive cross-price elasticity indicate about two goods?

Answer 4

A positive cross-price elasticity indicates the goods are substitutes (if the price of one increases, demand for the other increases).

Question 5

What does a negative cross-price elasticity indicate about two goods?

Answer 5

A negative cross-price elasticity indicates the goods are complements (if the price of one increases, demand for the other decreases).

Question 6

What does positive income elasticity of demand mean?

Answer 6

A positive income elasticity means the good is a normal good (demand increases as income rises).

Question 7

What does negative income elasticity of demand mean?

Answer 7

A negative income elasticity means the good is an inferior good (demand decreases as income rises).

Question 8

If the supply of a good decreases, what happens to its price?

Answer 8

The price of the good will rise due to the reduced availability.

Question 9

If demand for a good increases, what happens to its price?

Answer 9

The price of the good will rise due to increased competition for the good.

Question 10

If both supply decreases and demand increases for a good, what happens to its price and quantity exchanged?

Answer 10

Price will rise, but the effect on quantity exchanged is uncertain without knowing the size of the shifts in supply and demand.

Question 11

Flashcard 11: Example of Complementary Goods

If the price of coffee increases, what happens to the demand for milk?

Answer 11

A: The demand for milk will decrease because coffee and milk are complementary goods (used together).

Question 12

Flashcard 12: Example of Substitute Goods

If the price of tea rises, what happens to the demand for coffee?

Answer 12

The demand for coffee will increase because tea and coffee are substitute goods (if the price of one goes up, people switch to the other).

Question 13

What is equilibrium?

Answer 13

The point where supply equals demand, determining the price and quantity.

Question 14

How do you find the equilibrium price and why do we set the supply equation equal to the demand equation?

Answer 14

To find the equilibrium price, we set the supply equation equal to the demand equation because equilibrium occurs when the quantity supplied equals the quantity demanded at a specific price.
Example:

Supply: P = 3 + 2Q
Demand: P = 15 - Q

Set the equations equal: P = 3 + 2Q = 15 - Q

Solve for Q:
3 + 2Q + Q = 15
3 + 3Q = 15
3Q = 12
Q = 4

Substitute Q = 4 into either equation to find P:
Using the supply equation:
P = 3 + 2(4)
P = 3 + 8 = 11

So, the equilibrium price is 11, and the equilibrium quantity is 4.

Question 15

What is consumer surplus?

Answer 15

The difference between what consumers are willing to pay and what they actually pay.

Question 16

How do you calculate consumer surplus?

Answer 16

1/2 X Base X Height

Question 17

What is the base of the triangle?

Answer 17

The equilibrium quantity

Question 18

How do you work out the height?

Answer 18

The height of the triangle is the difference between the maximum price consumers are willing to pay (where the demand curve intersects the price axis) and the equilibrium price.

The maximum price consumers are willing to pay is found by setting the quantity demanded to zero in the demand equation (Q = 0). This gives us the intercept price on the vertical axis, which is the highest price consumers are willing to pay.

Height = Maximum price consumers are willing to pay - Equilibrium price.

Demand equation: P = 20 - 2Q

Find the maximum price consumers are willing to pay:
Set Q = 0 in the demand equation:
P = 20 - 2(0) = 20
So, the maximum price consumers are willing to pay is 20.

Find the equilibrium price (from a previous question, for example):
Let’s say the equilibrium price is 8.

Calculate the height of the triangle:
Height = Maximum price consumers are willing to pay - Equilibrium price
Height = 20 - 8 = 12

Question 19

What happens when demand shifts?

Answer 19

Right shift = higher price & quantity, left shift = lower price & quantity.

Question 20

What happens when supply shifts?

Answer 20

Right shift = lower price & higher quantity, left shift = higher price & lower quantity.

Question 21

Why substitute equilibrium quantity into equations?

Answer 21

To find the specific price and quantity at equilibrium.

Question 22

What is the Marginal Rate of Substitution (MRS) and how do you calculate it?

Answer 22

MRS is the rate at which a person is willing to trade one good for another while keeping their satisfaction constant.

To calculate MRS, divide the amount of one good the person is willing to give up by the amount of the other good they are willing to take in exchange.
MRS = Amount of Good 2 given up / Amount of Good 1 gained.

Example:
If Roy is willing to trade 4 pizzas for 7 soft drinks, the MRS = 7 / 4 = 1.75.
This means for every pizza he gives up, he needs 1.75 soft drinks in return.

Question 23

How do you use the MRS to find the price ratio between two goods?

Answer 23

If you know the MRS, it tells you how the prices of the two goods should relate when utility is maximized.

Use the formula:
MRS = Price of Good 2 / Price of Good 1.

Rearrange to find the price of Good 1 in terms of Good 2, or vice versa.
For example, if MRS = 7/4, the price of Good 1 is 7/4 times the price of Good 2.

Example:
If MRS = 7/4, and the price of a soft drink is £1, then the price of a pizza is 7/4 = £1.75.

Question 24

What should you do if the problem asks about the price relationship based on MRS?

Answer 24

Use the MRS value to determine the price ratio.

If the MRS = 7/4, then the price of 1 pizza is 7/4 times the price of 1 soft drink.

If asked to compare, find the appropriate price ratio that reflects the MRS and match it to the available options.

Example:
If the MRS is 7/4, then the price of 1 pizza should be 7/4 times the price of 1 soft drink.
If the price of a soft drink is £1, then the price of 1 pizza would be (7/4) * 1 = £1.75.

Question 25

What happens when the price of an inferior good falls?

Answer 25

Substitution effect: Buy more (good is cheaper). Income effect: Buy less (you feel richer, so you avoid inferior goods). Example: Ramen (inferior good) price drops → Substitution = buy more, Income = buy less.

Question 26

How do you decide whether to take another action under uncertainty (e.g., visiting another flat)?

Answer 26

Compare the expected gain from acting to the opportunity cost. Proceed if expected benefit > cost. Example: Flat value: £600 high quality (25%), £500 low quality (75%). Expected value = 0.25×600 + 0.75×500 = £525. Visit again if opportunity cost < £25.

Question 27

How do you calculate opportunity cost in decision problems?

Answer 27

Opportunity cost = Value of the next best alternative you give up. In probability decisions: Opportunity cost = (Probability × Value of best outcome) + (Probability × Value of worse outcome) - Current known value. Simple Rule: Opportunity cost is what you sacrifice by taking another action. Example: Current flat: £500. New expected flat value = 0.25×600 + 0.75×500 = £525. Opportunity cost = Difference = £25. Visit if cost of searching is less than £25.