The invisible hand

Question 1

Why do we need to make economic choices

Answer 1

There are scarce resources

Question 2

What are the 3 main economic choices

Answer 2

What
How
To whom

Question 3

Why do we need an economic system e.g. free market

Answer 3

To help make economic choices

Question 4

How do we judge how effective an economic system is

Answer 4

1) efficiency (productive and allocative)
2) Equity

allocative efficiency is the (what?)
Productive efficiency is the (how?)
Equity is the (to whom?)

Question 5

When does allocative efficiency occur

Answer 5

When the marginal utility of the consumer is equal to the marginal costs of production for all units of production

Question 6

How is allocative efficiency shown on a market diagram

Answer 6

Market equilibrium (demand equals supply so utility = costs)

Question 7

What are the 2 types of disequilibrium

Answer 7

Excess demand
Excess supply

Question 8

How is allocative efficiency restored to bring back market equilibrium

Answer 8

Through the price mechanisms:
Rationing
Signaling
Incentive
Allocative efficiency

Question 9

How do more competitive markets impact allocative efficiency

Answer 9

They help allocative efficiency happen by improving utility through higher quality products

Question 10

What are ways of increasing productive efficiency

Answer 10

Improved technology
Economies of scale
Lowered factor prices

(reduce costs of production)

Question 11

How does the free market promote productive efficiency

Answer 11

• Firms have an incentive to lower prices
• Competition will eliminate firms that charge too high of a price
• this encourages firms to lower costs of production in order to maintain profit margins

Question 12

Why does the free market produce a distribution of income

Answer 12

• Ability/skill increases income generally
• There is a very unequal distribution of skills
• There is therefore a distribution of income

Question 13

What is the relationship between efficiency and equity

Answer 13

Inverse, there is a trade off associated

e.g. adding more disabled parking spots causes unused spots

Question 14

What is market failure

Answer 14

Any situation where the free market fails to achieve efficiency or equity

Question 15

What are the 8 key types of market failure

Answer 15

• Externalities
• Merit/demerit goods
• Equilibrium price is too high/low
• Lack of competition between firms
• Market not producing public goods
• Inequality
• Information failure
• Rationality

Question 16

What is government failure

Answer 16

• Market failure is solved by government intervention
• Government failure is where the government fails to correct market failure