Theme 1 - Introduction to Markets and Market Failure (1.2 - How Markets Work)

Question 1

Describe the Neo-Classical theory [1]

Ref - 1.2.1 - Rational Decision Making

Answer 1

The assumption that all economic agents will act rationally to maximise their benefits or utility. [1]

Question 2

What is meant by consumer utility? [1]

Ref - 1.2.1 - Rational Decision Making

Answer 2

The satisfaction derived from consuming specific goods. [1]

Question 3

Which 4 groups of economic agents can the theory of maximisation be applied to? [4]

Ref - 1.2.1 - Rational Decision Making

Answer 3

Consumers [1]
Firms [1]
Workers [1]
Governments [1]

Question 4

Describe 2 examples in which economic agents agree with the theory of Maximisation [4]

Ref - 1.2.1 - Rational Decision Making

Answer 4

Consumers are assumed to maximise their consumer utility [1], so they must compare the utility gained from consuming a unit to it’s opportunity cost. [1]

Workers are assumed to maximise their welfare at work [1], so they must consider factors such as pay and job security. [1]

Question 5

What is meant by “the margin”? [1]

Ref - 1.2.1 - Rational Decision Making

Answer 5

A decision made by an economic agent is made in isolation, without other influencing factors. [1]

Question 6

Define demand [1]

Ref - 1.2.2 - Demand

Answer 6

Quantity of G+S that consumers are able and willing to pay at a given price. [1]

Question 7

Explain 2 conditions of demand which changes the level of demand [4]

Ref - 1.2.2 - Demand

Answer 7

Income - A rise in income will lead to a rise in demand [1] as consumers have more disposable income to use to buy G+S. [1]

Demand for complements - As demand for one good rises (e.g. washing machines) [1], demand for another good will rise (e.g. washing powder) [1]

Question 8

State the Law of Diminishing Marginal Utility. [1]

Ref - 1.2.2 - Demand

Answer 8

The utility gained from consuming a specific good falls the greater the number consumed [1]

Question 9

Describe how the Law of Diminishing Marginal Utility works in real life [2]

Ref - 1.2.2 - Demand

Answer 9

The more avaliable a good, the less marginal utility is provides [1], as consumers are likely to have consumed the same good already [1]. (e.g. chocolate)

Question 10

Explain how other consumer’s behaviours may influence consumer behaviour [3]

Ref - 1.2.10 - Alternative Views of Consumer Behavior

Answer 10

Consumer may adhere to social normalities in order to “fit in” [1], therefore they are more likely to act irrationally in consumption [1], which can cause herding behaviour over time, as more consumers want to “fit in” [1]

Question 11

Explain how habitual behaviour can influence consumer behaviour [3]

Ref - 1.2.10 - Alternative Views of Consumer Behavior

Answer 11

Many consumer may be addicted to substances such as alcohol [1], therefore they may act irrationally and buy more alcohol instead [1], therefore alcohol is price inelastic. [1]

Question 12

State and define the 3 other types of demand. [3]

Ref - 1.2.2 - Demand

Answer 12

Joint Demand - An increase in demand for one good, rises demand for another good. [1]

Competitive Demand - When demand increases for one good, demand decreases for another. [1]

Derived demand - Goods demanded only for production of other goods. [1]

Question 13

State what is meant by supply. [1]

Ref - 1.2.4 - Supply

Answer 13

The amount of goods firms are willing and able to sell at a given price. [1]

Question 14

Explain 2 reasons why the supply curve may shift. [4]

Ref - 1.2.4 - Supply

Answer 14

Higher costs of production decrease supply, [1] as there is less incentive to supply in a market with low profits. [1]

Better technology can improve productivity by improving capital [1], therefore reduce production costs and increase supply. [1]

Question 15

State and describe the 2 types of supply. [2]

Ref - 1.2.4 - Supply

Answer 15

Joint supply - When supply of one good increases, supply of another good also increases. [1]

Competitive supply - When P of (X) increases, so supply of good (Y) falls, so firms switch to producing good (X) [1]

Question 16

Describe how excess supply is reached in an economy. [2]

Ref - 1.2.6 - Price Determination

Answer 16

When the price level is above equilibrium [1]
So consumers are deincentivised to consume, so excess supply is formed. [1]

Question 17

Describe how excess supply is eliminated [2]

Ref - 1.2.6 - Price Determination

Answer 17

Prices would need to contract [1] making products cheaper which raises demand, until a new equilibrium is reached. [1]

Question 18

Describe how excess demand is reached in an economy. [2]

Ref - 1.2.6 - Price Determination

Answer 18

Price would be below equilibrium [1].
So too many consumers would demand the cheaper goods, so excess demand is created. [1]

Question 19

Describe how excess demand is eliminated [2]

Ref - 1.2.6 - Price Determination

Answer 19

Prices would need to expand [1] allowing demand to fall slowly, until equilibrium is reached. [1]

Question 20

What is meant by the price mechanism? [1]

Ref - 1.2.7 - Price Mechanism

Answer 20

Free markets allocating resources through interaction of demand and supply. [1]

Question 21

State the 3 functions of the price mechanism. [3] (HINT - SIR)

Ref - 1.2.7 - Price Mechanism

Answer 21

Signalling [1]
Incentive [1]
Rationing [1]

Question 22

Describe the signalling function in a price mechanism. [1]

Ref - 1.2.7 - Price Mechanism

Answer 22

The prices provide info to consumers/firms to aid rational decision making. [1]

Question 23

Describe the incentive function in a price mechanism. [1]

Ref - 1.2.7 - Price Mechanism

Answer 23

Prices incentivise changing of behaviour of consumers+firms, to max welfare/profit [1]

Question 24

Describe the rationing function in a price mechanism. [1]

Ref - 1.2.7 - Price Mechanism

Answer 24

The price determines who can afford the good, therefore who is supplied the good. [1]

Question 25

State 2 other functions of the price mechanism. [2] | Ref - 1.2.7 - Price Mechanism

Answer 25

Entry and exit of firms. [1] Eliminating excess demand and supply. [1]

Question 26

Describe the function of the price mechanism in the entry and exit of firms. [3] | Ref - 1.2.7 - Price Mechanism

Answer 26

If demand of a good increases, [1] this signals to a producer that that market is more profitable, [1] incentivising producers to expand supply to that market to maximise profits. [1]

Question 27

What is consumer surplus? [1] | Ref - 1.2.8 - Consumer and Producer Surplus

Answer 27

What consumers are willing to pay for a good, and what they actually pay. [1]

Question 28

What is producer surplus? [1] | Ref - 1.2.8 - Consumer and Producer Surplus

Answer 28

What firms are willing and able to supply, and the profits they receive. [1]

Question 29

How is consumer and producer surplus represented on a diagram? [2] | Ref - 1.2.8 - Consumer and Producer Surplus

Answer 29

At equilibrium, consumer surplus is above the price level [1], and producer surplus is below the price level. [1]

Question 30

What is indirect taxation? [1] | Ref - 1.2.9 - Indirect Taxation and Subsidies

Answer 30

Taxes on good and services. [1]

Question 31

What are the 2 types of indirect tax? [2] | Ref - 1.2.9 - Indirect Taxation and Subsidies

Answer 31

Unit tax [1] Ad Valorem tax [1]

Question 32

What is Ad Valorem tax? [1] Give an example of Ad Valorem tax? [1] | Ref - 1.2.9 - Indirect Taxation and Subsidies

Answer 32

A tax on a good/service set as a % of a price. [1] (e.g. VAT) [1]

Question 33

What is unit tax? [1] | Ref - 1.2.9 - Indirect Taxation and Subsidies

Answer 33

A tax on a good/service which is set at a constant rate per item. [1]

Question 34

On a S+D diagram, where a tax has been added (S+tax), state where government revenue is found. [1] | Ref - 1.2.9 - Indirect taxation and subsidies

Answer 34

Box [abce] [1] | Reference - https://www.youtube.com/watch?v=uKemzVqloYg

Question 35

On a S+D diagram, where a tax has been added (S+tax), state where tax per unit is found. [1] | Ref - 1.2.9 - Indirect taxation and subsidies

Answer 35

Difference between S+tax and S [1] | Reference - https://www.youtube.com/watch?v=uKemzVqloYg

Question 36

On a S+D diagram, where a tax has been added (S+tax), state where consumer and producer incidence is found. [2] | Ref - 1.2.9 - Indirect taxation and subsidies

Answer 36

Consumer incidence - Difference in price [1] Producer incidence - (Goverment revenue area - Consumer burden area) [1] | Reference - https://www.youtube.com/watch?v=uKemzVqloYg

Question 37

What is a subsidy? [2] | Ref - 1.2.9 - Indirect Taxation and Subsidies

Answer 37

Money from the government to a producer, [1] to encourage production and reduce price. [1]

Question 38

On a diagram, show where the subsidy applied per unit is found. [1] | 1.2.9 - Indirect tax and subsidies

Answer 38

Difference between S(1) and S(1) + Tax [1] | Ref - https://www.youtube.com/watch?v=41p5WFd-y5A

Question 39

On a diagram, show where the government cost and producer revenue is found. [2] | 1.2.9 - Indirect tax and subsidies

Answer 39

Box P(2)BCD [1] | Ref - https://www.youtube.com/watch?v=41p5WFd-y5A

Question 40

On a diagram, show where the consumer savings are found [1] | 1.2.9 - Indirect tax and subsidies

Answer 40

Difference between P(1) and P(2) [1] | Ref - https://www.youtube.com/watch?v=41p5WFd-y5A

Question 41

Explain one reason why providing subsidies to firms can have a negative impact on a market. [3] | Ref - 1.2.9 - Indirect Taxation and Subsidies

Answer 41

The firm receiving a subsidy may become complacent as a result. [1] This could cause a loss in production and efficiency [1], therefore reducing supply to the economy. [1]

Question 42

What is the concept of elasticity? [2] | Ref - 1.2.3 - Price Elasticity of Demand

Answer 42

Elasticity measures the extent to which demand or supply will react to a change in the price level [1] or demand for other goods (XED) [1]

Question 43

How do you calculate percentage change? [1] | Ref - 1.2.3 - Price Elasticity of Demand

Answer 43

(New value - Original value) / (Original value) x 100 [1]

Question 44

What are the 4 types of elasticity? [4] | Ref - 1.2.3 - Price Elasticity of Demand

Answer 44

Price elasticity of demand [1] (PED) Price elasticity of supply [1] (PES) Income elasticity of demand [1] (YED) Cross elasticity of demand [1] (XED)

Question 45

Define PED [1] | Ref - 1.2.3 - Price Elasticity of Demand

Answer 45

The responsiveness of demand to changes in the price level. [1]

Question 46

What is the formula used to calculate PED? [1] | Ref - 1.2.3 - Price Elasticity of Demand

Answer 46

% Change in quantity demanded / % Change in price level [1]

Question 47

State the value of PED which represents a price elastic and price inelastic demand. [2] | Ref - 1.2.3 - Price Elasticity of Demand

Answer 47

Price elastic - Less than -1 [1] Price inelastic - Between 0 and -1 [1]

Question 48

State the 3 other types of price elasticity of demand, and state the values at which they occur. [3] | Ref - 1.2.3 - Price Elasticity of Demand

Answer 48

Perfectly Price Inelastic - (PED = 0) [1] Perfectly Price Elastic - (PED = ∞) [1] Unitary Elastic - (PED = -1) [1]

Question 49

State and explain 2 factors which influence PED [6] | Ref - 1.2.3 - Price Elasticity of Demand

Answer 49

Number of substitutes [1]. The more available substitutes, the more elastic a good/service is, [1] as consumers can buy substitute goods if another goods prices rise. [1] Addiction. [1] People who are addicted to substances will continue to buy the substance even if prices rise, [1] therefore the substance becomes more price inelastic. [1]

Question 50

State the shape of the graph of a price elastic and price inelastic good. [2] | Ref - 1.2.3 - Price Elasticity of Demand

Answer 50

Price elastic - Shallow curve [1] Price inelastic - Steep curve [1]

Question 51

How can businesses utilize PED to maximise profits? [2] | Ref - 1.2.3 - Price Elasticity of Demand

Answer 51

When demand is elastic, lowering prices increases revenue [1]. When demand is inelastic, increasing prices will increase revenue [1].

Question 52

Define YED [1] | Ref - 1.2.3 - Income Elasticity of Demand

Answer 52

The responsiveness of demand to a change in real income [1]

Question 53

What is the formula used to calculate YED? [1] | Ref - 1.2.3 - Income Elasticity of Demand

Answer 53

% Change in Demand / % Change in Real Income [1]

Question 54

State the 3 types of goods used to interpret YED, and state the values at which they occur. [3] | Ref - 1.2.3 - Income Elasticity of Demand

Answer 54

Normal Goods - YED is 0-1 [1] Inferior Goods - YED is Negative [1] Luxury Goods - YED is above +1 [1]

Question 55

State what is shown when a good is luxury, neccessity, or inferior. [3] | 1.2.3 - Income Elasticity of Demand

Answer 55

Inferior - As incomes rise, demand falls more than proportionally. [1] Necessity - Demand is stable regardless of rise/falling incomes. [1] Luxury - As income rises, demand also rises more than proportionally. [1]

Question 56

State the values at which a good is income elastic and income inelastic [2] | Ref - 1.2.3 - Income Elasticity of Demand

Answer 56

Income Elastic - YED is above +1 or below -1 [1] Income Inelastic - YED is between +1 and -1 [1]

Question 57

State and explain 2 factors which may influence YED [4] | Ref - 1.2.3 - Income Elasticity of Demand

Answer 57

Type of good/service. [1] YED can change if the good is inferior or luxury. [1] Inflation [1] - An increase in inflation can reduce the real value of workers incomes. [1]

Question 58

How can a business use YED to maximise revenue? [1] | Ref - 1.2.3 - Income Elasticity of Demand

Answer 58

Businesses can use YED of certain goods to plan their production levels. [1]

Question 59

Define XED [1] | Ref - 1.2.3 - Cross Elasticity of Demand

Answer 59

The responsiveness or demand of good X to a change in the price level of Good Y [1]

Question 60

What is the formula used to calculate XED? [1] | Ref - 1.2.3 - Cross Elasticity of Demand

Answer 60

% Change in Demand (Good X) / % Change in Price (Good Y) [1]

Question 61

State the 3 types of goods used when interpreting XED figures, and state the values at which they occur. [3] | Ref - 1.2.3 - Cross Elasticity of Demand

Answer 61

Substitute Good - XED is Positive [1] Complementary Good - XED is Negative [1] Unrelated Good - XED = 0

Question 62

Explain what is shown by a substitute, non-related, and complement good. [3] | Ref - 1.2.3 - Cross Elasticity of Demand

Answer 62

Substitute - Can be replaced with another good (Since XED>0) [1] Non-related - Change in price of one good doesn't affect demand for another. [1] Complement - Increase in price of one good causes fall in demand for another (Printer and ink) [1]

Question 63

How can a business used XED to maximise revenue? [3] | Ref - 1.2.3 - Cross Elasticity of Demand

Answer 63

Businesses can determine the demand for a certain good, [1] therefore estimate revenue[1], which can help make production decisions to respond to change in demand. [1]

Question 64

Define PES [2] | Ref - 1.2.5 - Price Elasticity of Supply

Answer 64

The responsiveness of quantity supplied of a good [1] to changes in price. [1]

Question 65

What is the formula used to calculate PES? [2] | Ref - 1.2.5 - Price Elasticity of Supply

Answer 65

% Change in Quantity Supplied [1] / % Change in Price. [1]

Question 66

State the values at which PES is price inelastic and price elastic. [2] | Ref - 1.2.5 - Price Elasticity of Supply

Answer 66

Price Inelastic - (0-1) [1] Price Elastic - (>1) [1]

Question 67

Explain 2 factors which influence PES [6] | Ref - 1.2.5 - Price Elasticity of Supply

Answer 67

If a good is perishable, such as fresh vegetables, it cannot be stockpiled. [1] It is harder for supply to respond to a change in price, [1] so price is more inelastic. [1] If entry of firms into a market is easier, such as low start up costs [1], this means that there are more firms to supply more goods in reponse to price change, [1] so supply is more elastic. [1]