topics 1-3: Central Economic Problem, DD and SS, Elasticity

Question 1

Productive Efficiency

Answer 1

Economy produces maximum output for given amount of inputs. All goods and services produced should use the least cost combination of all available resources
- all points on PPC is productively efficient

Question 2

Allocative efficiency

Answer 2

Society produces and consumes optimal mix of goods and services that maximizes it welfare
- only one combination of goods and services on PPC that is allocative efficient.

Question 3

Decision-making process

Answer 3

1. decision
2. objective
3. constraint
4. MPB, MPC
5. weigh MB with MC
6. Review decision (intended/unintended consequences, internal/external changes)

Question 4

Demand factors

Answer 4

EGYPT

1. expectations of consumers
2. government policies (direct taxes, direct subsidy)
3. income/interest rates
4. population/ prices of related goods [change in price of substitutes/ complements/final goods in the mkt for FOP)
5. taste and preferences

Question 5

Supply factors

Answer 5

WETPIGS

1. Weather/season
2. Expectations of producers
3. Technology
4. Prices of related goods (competitive/ joint supply)
5. Input prices
6. Government Policies (indirect tax, indirect subsidy)

Question 6

Price Adjustment Process

Answer 6

Surplus:
At original price Po, quantity supplied Qs is more than quantity demanded Qd. The surplus exerts an downward pressure on price as producers seek to lower prices to clear inventories. With a lower price, consumers are more willing and able to consume and increase quantity demanded while profit-maximising producers reduce quantity supplied. Prices continue to drop until surplus QdQs is eliminated and equilibrium is reached again at E1

shortage: ^vice versa

Question 7

Simultaneous shift in DD and SS

Answer 7

• use PAP
• concurrent increase in demand and supply will reinforce increase in equilibrium quantity but effect on eqm prices is indeterminate. depends on extent of increase in DD relative to SS (draw graph)

Question 8

YED

Answer 8

degree of responsiveness of demand for good to given change in income of consumers.

• inferior YED<0
• necessity 0 1 (income elastic): increase in income leads to MTP increase in demand for good

Question 9

PED

Answer 9

degree of responsiveness to qty demanded of a good to change in price of good itself

• PED>1 (demand in price elastic): increase in price of goods leads to MTP fall in qty demanded
• |PED|<1 (demand is price inelastic)

Question 10

determinants of YED

Answer 10

degree of necessity

consumers income level

Question 11

determinants of PED

Answer 11

TINS

1. time period (more, more price elastic)
2. proportion of household income spent on good (more, more price elastic)
3. degree of necessity (more, more price inelastic)
4. availability of close substitutes (the more substitutes, the more price elastic)
5. broadness of definition

Question 12

application of PED to producers

Answer 12

price inelastic demand: producers can increase price to raise total revenue - LTP fall in qty demanded. (gain in revenue - draw graph, fall in SS)

price elastic demand: producers can decrease price to raise total revenue - MTP increase in qty DD [but mot possible to continue reducing price as price should be above AC)

Question 13

application of XED to producers

Answer 13

reduce substitutability of goods thru real/ perceived product differentiation

Question 14

PES

Answer 14

degree of responsiveness of qty supplied of a good to given change in price of good itself

• supply is price elastic PES>1
• supply price inelastic 0

Question 15

determinants of PES

Answer 15

MINTS

1. factor mobility of FOP (more mobile, more elastic)
2. level of stocks/ inventories + ease of keep stocks (highly perishable/long shelf life) (more, more elastic)
3. nature of good (long gestation period VS manufactured that can be produced quickly)
4. Time period (long run, more elastic) as FOP is variable (vs. fixed in supply)
5. availability of spare capacity (more, more elastic) - utilise spare capacity

Question 16

XED

Answer 16

degree of responsiveness of demand for good given change in price of related good (start point)
1. substitutes XED>0 (increase in P of one goods leads to increase in DD for other good)
strong sub XED>1: MTP increase in DD
2. complements XED<0 (^fall in DD for other good)
strong complement XED

Question 17

XED application

Answer 17

producers: joint promotion/ match price cut
govt: import tariffs

Question 18

change in demand/ supply: which elasticity concept to use

Answer 18

change in DD:
due to...
1. income -> YED
2. price of sub/complement -> XED
3. other DD factors -> PES

change in SS -> PED

Question 19

shift in supply with diff PED values

Answer 19

fall in SS

dd is price inelastic: large rise in price, smaller fall in qty to eliminate shortage

Question 20

shift in DD with diff PES values

Answer 20

fall in DD

supply is price inelastic: larger fall in price, smaller fall in qty