1.1 The Market System

Question 1

What are finite resources?

Answer 1

Ones that have an end or a limit

Question 2

What are needs?

Answer 2

Basic requirements for human survival

i.e. shelter, food, water

Question 3

What are wants?

Answer 3

People’s desires for goods and services

i.e. new golf clubs, better education, improved healthcare

Question 4

What is a basic economic problem?

Answer 4

Resources are scarce and people’s wants are infinite, so governments have to make decisions about how to allocate their resources i.e. what to produce, how to produce and for whom to produce

Question 5

What is an opportunity cost

Answer 5

It’s a cost of the next best alternative given up after making a choice

Question 6

What are capital goods?

Answer 6

Those purchased by firms to produce other goods

i.e. machinery, tools, equipment

Question 7

What are consumer goods?

Answer 7

Those purchased by households

i.e. food, confectionery, cars

Question 8

What are PPCs and what do they show?

Answer 8

They are Production Possibility Curves (Frontiers)
They show the different combinations of two goods that can be produced if all resources in a country are fully used up (the maximum quantities of goods that can be produced)

Question 9

What if a point is inside/outside of a PPC? In what scenario does the whole curve shift outward/inward?

Answer 9

If it’s inside the curve, there are unemployed resources
A point outside of a PPC describes the impossible scenario, because a country doesn’t have enough resources to make it true
A curve shifts outwards if a country produces more
A curve shifts inwards if a country produces less due to: resource exhaust, unfavourable weather patterns, emigration or armed conflicts

Question 10

What is economic growth?

Answer 10

Increase in the output level of a nation

Question 11

Name and define the causes of economic growth

Answer 11

New Technology - productive potential is increased because new technology is faster and more reliable
Improved Efficiency - new more efficient productive methods are developed
Education and training - proportion of educated workers who carry out the tasks more efficiently increases
New resources - allow a nation to produce more output

Question 12

What are the two main assumptions in economics?

Answer 12

Consumers aim to maximise their benefit
Businesses aim to maximise their profit
*that is if they all are rational in making decisions and it is assumed that they are

Question 13

Why consumers may not always maximise their benefit?

Answer 13

Difficulty in calculating the benefits from consuming a product - satisfaction gained is hard to calculate
Buying habits - consumers develop loyalty to a particular brand
Influenced by other people i.e. by parents buying a particular brand or by peers
Lack of information i.e. a consumer doesn’t know where to buy at cheaper prices

Question 14

Why producers may not always maximise their profit?

Answer 14

Other people in a company may not aim to maximise the profit i.e. managers maximise sales
Producers may have different business objectives i.e. focusing on customer care
Some enterprises are charities
Some businesses are social enterprises - main aim is to maximise improvements in human/environmental well-being
Lack of information i.e. a producer doesn’t know where to buy at cheaper prices

Question 15

How do you define demand?

Answer 15

Amount of a good that will be bought at given prices over a period of time

Question 16

How do you define effective demand?

Answer 16

Amount of a good people are willing to buy at given prices over a given period of time supported by the ability to pay

Question 17

How do we know whether there will be a movement along a demand curve or it will shift entirely?

Answer 17

Demand curve shifts due to any factor affecting demand but price
Changes in price will contribute to the movement along the curve (straight line)

Question 18

Why is it more common to use straight lines rather than actual curves?

Answer 18

To simplify the drawing

To make it easier to understand diagrams

Question 19

What are some of the factors that may shift the demand curve?

Answer 19

Advertising - intense advertisement (both positive and negative) is likely to change respectively the quantity demanded
Income - if disposable income rises, so does demand (opposite effect for inferior goods)
Fashion and tastes - demand patterns change because consumer tastes change
Price of substitutes - if there are many cheap analogies of a good, demand for that product will fall
Price of complements - if a complementary good becomes more expensive, demand for a complemented good will fall
Demographic changes - demand rises gradually as the population grows; geographical, age, gender and ethnic distribution affects the demand for certain goods

Question 20

What are inferior goods?

Answer 20

Those for which demand falls as disposable income rises (normal good is the opposite)
i.e. supermarket “own-label”, public transport

Question 21

What are complementary goods?

Answer 21

Those purchased and therefore used together

i.e. milk and cornflakes

Question 22

What are substitute goods?

Answer 22

Those purchased as an alternative to another product but perform the same function
i.e. Coca - Cola and Pepsi

Question 23

How do you define supply?

Answer 23

Amount of a good that sellers offer at any given price over a period of time

Question 24

What is the relationship between the price and supply?

Answer 24

As the price increases, supply increases - businesses are motivated to supply more goods if they are sold at higher prices (works the other way around too)

Question 25

What is similar in the way demand and supply curves react to a change in other factors (not price)

Answer 25

In both of them there won’t be any movement along the curve - they would shift entirely

Question 26

What are the factors that may shift the supply curve?

Answer 26

Production costs - if increased, supply falls because profits will be reduced (assuming that price is fixed)
New technology and techniques - production is more efficient thus costs are reduced and more is offered
Indirect taxes - represent a cost to firms so supply falls
Subsidies - help to reduce production costs so supply is increased
Natural factors - different factors like unfavourable weather patterns, natural disasters, pests or diseases decrease the supply of most industries

Question 27

Why supply is sometimes fixed? How does such curve look like?

Answer 27

It’s fixed if it is impossible to increase even at higher prices i.e. sport stadium
The curve will be vertical (supply doesn’t change at any price)

Question 28

What is an equilibrium price?

Answer 28

At which consumers’ wishes are matched exactly with those of producers; supply and demand are equal at that point
A.k.a. market clearing price

Question 29

What is total revenue? Show the formula

Answer 29

Amount of money generated from sale of output

TR = Q x P (quantity x price)

Question 30

What is excess demand? Why it happens?

Answer 30

Demand is greater than supply so there is shortage in a market
Because the price set is below the equilibrium price

Question 31

What is excess supply? Why it happens?

Answer 31

Supply is greater than demand so goods are unsold in a market
Because the price set is above the equilibrium price

Question 32

What is price elasticity of demand?

Answer 32

It shows how much demand changes when there is change in price (shows its responsiveness)

Question 33

What if demand is inelastic?;elastic?

Answer 33

When price changes, demand change is insignificant

For elastic, demand change is greater than the change in price

Question 34

How to calculate Price Elasticity of Demand (PED)? How do we use results to find out whether it is inelastic or elastic?

Answer 34

PED is always negative
Percentage change in quantity demanded (supplied for PES) / Percentage change in price (income for YED)
PED < 1 => demand is inelastic
PED > 1 => elastic
PED = 0 => demand is perfectly inelastic (change in price has no effect on demand)
PED = ∞ => perfectly elastic (increase in price results in zero demand)
PED = -1 (1 for PES) => demand is unitary elastic (change in price is proportionate to the change in demand)

Question 35

What are some factors that affect PED?

Answer 35

Availability of substitutes - if a product has a lot of substitutes demand is elastic because consumers can easily switch
Degree of necessity - if a product is essential, its demand is inelastic because if the price rises people will still have to buy it
Proportion of income spent on a product - demand is more elastic if a product has a high value
Time - if people have time, they can find substitutes/are more prepared to switch so demand is price elastic; if not then the opposite because they don’t have time to find substitutes because the change in price will have no significant effect on demand

Question 36

What are some factors that affect PES?

Answer 36

Factors of production - supply will be elastic if producers have easy access to factors of production so can boost the supply / if factors are mobile (can be switched to other uses)
Availability of stocks - can respond quickly to price change
Spare capacity - if firms run at full capacity, they cannot produce more if needed
Time - the more time, the more elastic because producers have time to react

Question 37

Describe the Income Elasticity of Demand for luxury, normal, inferior goods and necessities

Answer 37

Necessities - income inelastic because consumers always require them
Luxury - income elastic because they are optional
Normal - income elasticity is positive
Inferior - income elasticity is negative

Question 38

How can businesses respond to predicted changes in incomes (YED)?

Answer 38

Some may have flexible resources so they can switch to another product if demand for it will be income elastic i.e. plastics firm may switch from production of buckets to toys if they knew incomes and demand would rise
Producers of income elastic goods will expect demand to rise as incomes increase so they plan ahead to increase the capacity for their output

Question 39

How can businesses predict the effect of changing prices on total revenue (PED)?

Answer 39

If they know the value of PED for their product, they can tell if changing prices will benefit their revenue
i.e. if demand for a product is elastic, reducing the prices will raise TR

Question 40

How does government exploit PED? pg.67

Answer 40

By imposing indirect taxes and excise duty on products with inelastic demand (consumers will avoid heavily taxed products that have elastic demand), governments raise their revenue because the chosen goods often have very few substitutes and/or they are necessities i.e. petrol, cigarettes
By giving out subsidies to help producers increase supply of price inelastic goods (if it’s not inelastic, price will only reduce slightly) and thus decrease prices i.e. help the poor by lowering prices for agricultural goods

Question 41

What do different values of YED mean?

Answer 41

Values between -1 and 1 show that the good’s demand is income inelastic i.e. petrol, cigarettes (necessities have YED of between 0 and 1)
Values greater than 1 or less than -1 indicate that the good is income elastic i.e. cars, seafood

Negative correlation between income and demand, like in inferior goods, makes YED to be negative
Positive correlation, like in normal goods, makes YED to be positive

Question 42

What are sole traders, partnerships and companies?

Answer 42

Sole trader - business is owned and controlled by one person i.e. taxi drivers, plumbers
Partnership - owned and controlled by two or more people that specialise in each area (have professions)
Company - shareholders own the business and elect a board of directors who run the business for them

Question 43

What are the aims of private sector organisations?

Answer 43

Survival - takes time to establish a business and unexpected difficulties are encountered
Profit maximisation - shareholders benefit from high dividends that are linked to profits but it’s not always the case
Growth - reduced average costs through economies of scale; higher profits in the future and secure jobs
Social responsibility - companies want to please more stakeholders and due to pressure from the media, government and other people

Question 44

What are the aims of public sector organisations?

Answer 44

Improving the quality of services - performance indicators used to monitor quality i.e. feedback buttons in the hospitals
Minimising costs - wasted resources are minimised to be more efficient
Allow for social costs and benefits - they take into account the needs of a wide range of stakeholders
Profit - some countries have large businesses that make profits, but that’s not usually the priority

Question 45

Briefly describe market/free and command/planned economies

Answer 45

Market economy relies least on public sector, so mostly private sector provides goods and services; public sector’s role being a provider of a legal, monetary systems and key state systems (defense, ensuring there is competition)
Command economy fully relies on public sector to choose, produce and distribute goods. All resources belong to the state as it is responsible for planning, organising and coordinating production.
Mixed economy is the mixture of the two (majority of the countries)

Question 46

Expand on the basic economic questions in relation to the mixed economy

Answer 46

What to produce? - consumer goods are best maintained by the private sector because goods like food, clothes and entertainment are best chosen by consumers. Education, street lighting, roads are provided by the public sector to make sure there are sufficient quantities that private sectors may fail to provide due to market failure (market is inefficient)
How to produce? - private sector organisations that want to maximise profit also create competition and therefore choice for consumers and high quality goods. Some of these produce public goods and services and public sector may also ask a private sector organisation to carry out works
For whom to produce? - private sector goods are for everyone who can afford them, public sector goods are paid from taxes and are free

Question 47

Reasons for government intervention and market failure? pg.76

Answer 47

Externalities - not all costs of production were taken into account i.e. chemical pollution of production imposes an external cost on society => market system has resulted in chemical firm failing to meet any cost
Lack of competition - market fails when one firm dominates the market because it may exploit consumers by limiting the choice or raising prices
Missing markets - public goods like defense are not provided by the private sector; merit goods like education are underprovided because they are too expensive for people to afford them
Lack of information - market inefficiency due to wrong goods purchased/produced and wrong prices paid
Factor immobility - for market to be efficient, factors need to have different uses i.e. a laser cutter for glass is quite immobile because it won’t have any other use
Government intervenes to make sure that
-businesses that impose externalities are penalised
-businesses do not heavily dominate (legislation to prevent company mergers not in the interests of consumers)
-businesses provide enough information about the product (legislation to oblige businesses to provide info)
-there are significant goods and services available for everyone free of charge from public organisations

Question 48

What are the two characteristics of public goods? pg.77

Answer 48

Non-excludability - once a good has been provided, any individual cannot be prevented or excluded from its consumption
Non-rivalry - consumption of a public good by one individual cannot reduce the amount available to others

Question 49

What is privatisation?

Answer 49

Process of transferring governments’ public sector resources to the private sector investors

Question 50

What are some forms of privatisation?

Answer 50

Sale of nationalised industries - private sector organisations that were transferred to public sector are sold back to private sector
Contracting out - government and local authority services are contracted out to private sector businesses
Sale of land and property - people are encouraged to buy council-owned property by lowering the price

Question 51

Why does privatisation take place?

Answer 51

To generate income - sale of state assets generates income for the government
Inefficiency of public sector organisations - lack of incentive to make profits, losses and bad quality of goods and services
To reduce political interference - organisations are free from political interference in private sector and they can make decisions by themselves

Question 52

What are the effects of privatisation? pg.84

Answer 52

For consumers - better quality products and price because businesses become more efficient and are under pressure to meet customer needs
Some costs for services have increased though
For workers - workers become redundant, forced into raising their productivity
For businesses - weakened due to loss of experienced staff (they are redundant) => harder and more expensive to scale up in the future; high competition; higher profits (objectives changed); higher investments; businesses merged and taken over
For governments - large amount of revenue generated, though money were spent of advertising at the taxpayers’ expense and some assets were sold too cheaply => revenue wasn’t maximised

Question 53

What is the difference between the external costs and external benefits?

Answer 53

Negative effects of consumption or production that affect other people; Positive effects of consumption or production that affect other people

Question 54

What are some examples of external costs/benefits?

Answer 54

Costs - Noise, air, water pollution, overcrowding, traffic congestion and resource depletion
Benefits are
Education - better jobs with more income will bring higher standard of living; educated people get socially useful jobs which improve productivity of the society; lower unemployment, improved household mobility and rates of political participation
Health care - feel less pain and can return to work => enjoy life more; healthy people work more effectively so they contribute to economic output and taxes better which benefits the society
Vaccinations - society, as individuals themselves, benefit from it because the likelihood of spreading a disease lowers

Question 55

What is social cost? Explain what does it include

Answer 55

It’s a cost of an economic activity to society as well as the individual or firm
Social cost = Private cost + External cost
Private costs are met by the consumers and producers of a good i.e. a smoker pays $100 for their cigarettes every month
External cost in this example will be the discomfort and health risk that a third party is exposed to

Question 56

What is social benefit? Explain what does it include

Answer 56

It’s a benefit of an economic activity to society as well as to the individual or firm
Social benefit = Private benefit + External benefit
Private benefits are enjoyed by the consumers and producers of a good i.e. putting the lights on your christmas tree pleases you when they are switched on
External benefit in this example will be the enjoyment of other people who come to see the tree (they didn’t pay for it but they are able to enjoy it when they come over as guests)

Question 57

How do governments deal with negative externalities?

Answer 57

Taxation - tax increases the production costs => firm charges higher prices that lower the demand and thus supply falls and the pollution level drops
Subsidies - offer money as an incentive to reduce external costs i.e. building a plastics recycling plant; subsidies to students encourage more people into higher education
However, this money could be spent on something else (opportunity cost)
Fines - discourages economic activity that imposes external costs
Regulation - governments stricten legislation due to societal pressure about global warming; but governments may lack commitment or may not have enough resources for enforcement
Pollution permits - since these are sellable, it encourages companies to find a way of reducing their polluting levels so that they can sell permits to another companies i.e. find a new technology; but governments may issue to many or too little because pollution is hard to measure