1.2 How do markets work Flashcards
Define rational behaviour
When economic agents maximise their own self interest and are able to assess economic costs and benefits to themselves of making alternative choices
Why is switching from tobacco to e-cigarettes rational behaviour
Reasons rational
Smokers computationally aware of financial gains of switching
Smokers informed of private health gains
Reducing health external costs e.g. passive smoking
Smokers aware that regulations will increasingly make it difficult for them to gain utility of nicotine consumption through tobacco smoking
3 marks
Why is switching from tobacco to e-cigarettes irrational behaviour
Reasons against being rational
-Smokers lack information and computational skills to accurately assess full costs and benefits of switching. May underestimate long-term gains of switching (bounded rationality)
-Information overload
-Both products contain nicotine which is addictive and habit forming.
-Switch may be only short-term (impulse buying)
-E-cigarettes complements tobacco smoking resulting in an overall increase in nicotine consumption
-PED for tobacco remains lower than e-cigarettes so a price rise in the latter may result in a switch
back
3 marks
Explain how Bitcoin fulfils one function of money, apart from as a medium of exchange.
- A measure of value (1) e.g. prices can be measured in satoshis (1) people can compare prices of goods and
services (1) - A store of value (1) when an individual saves bitcoin (1) they are confident they will receive the equivalent value back (1)
- A standard of deferred payment (1) when an individual loans another person bitcoin (1) they are confident they will receive the equivalent value back (1)
Define demand
The quantity of a good or service that consumers are able and willing to. buy at a given price during a given period of time.
Define law of diminishing marginal utility
As each additional unit of a product is consumed, the marginal benefit to the consumer from each additional unit falls.
Satisfaction decreases and consumers are less likely to pay at a higher price
In the UK, as seen from the extract, the PES for housing is less than 0.5.
What is the disadvantge of this
This means supply is inelastic, and therefore, prices have to increase severely in order to encourage a significant boost to housing supply.
With a growing population, this presents a problem. Over time, people will find it more and more difficult to get on the housing ladder, unless incomes increase dramatically so people can afford the high deposits necessary.
Define price elasticity of demand
The responsivness of a change in quantity demanded given a change in price
2 marks
The price elasticity of demand for petrol is -0.2. Explain the change to the total revenue of petrol stations as a result of cutting their prices.
Total revenue is the revenue recieved from the sale of a given level of output.
The % rise in QD is lower than % fall in price as demand is price inelastic
YED
Define income elasticity of demand
The responsivness of a change in quantity demanded given a change in income
3 marks
Explain one reason why income elasticity of demand is significant to the producer of Freddos if YED= -2.5%.
YED= responsiveness to a change in quantity demanded given a change in income
YED is negative= inferior good= inelastic
Sales revenues fall as incomes rise
Define cross elasticity of demand
Measures the responsivness of quantity demanded of good X given a change in price of good Y
Define substitutes
A substitute good is one which has rivals in consumption / A good that can be replaced by another to satisfy a want
E.g. Iphone and android
Define complementary goods
A complementary good is one which is consumed with another G/S
A good where the demand increase of one good causes an increase in demand of a related G/S
Define price elasticity of supply
The responsivness of a change in quantity supplied given a change in price
If theres a 100% increase in P of coffee in Uganda which leads to 33% increase in QS. What does this suggest about supply of coffee in Uganda.
PES= %∆ in QS/ %∆ in P
PES= 33/100= 0.33
Coffee is price inelastic since the answer is less than 1
It may be price inelastic supply as it takes a long time to grow
3 marks
The world’s largest producer of natural gas is the USA. In 2021 production fell even though the price increased.
Explain one likely factor that may influence the price elasticity of supply of gas.
- Supply of gas is price inelastic
- One factor - lack of stockpiles
- Gas prices have risen and supply of gas has fallen since 2021
- Less availability means gas suppliers are unable to respond to changes in the market price
- In the long run, firms can respond (all FoP are variable)
What is SIRA
Prices perform a signalling function – they adjust to demonstrate where resources are required.
Prices act as an incentive function – for consumers and/or suppliers
Prices perform a rationing function.
This leads to allocative effiency where a new market clearing equilibrium is reached
SIRA
Discuss the functions of the price mechanism with a rightward shift in demand
S) D↑ as P1= excess demand
I)↑P1-P2 = eraadicated excess demand
R) Contraction along D as P↑= impacts utility
Extension along S = profit maximisers
A) Allocate scarce resources
* New market clearing equilibrium has been reached (S=D) P2Q2
Define Producer surplus
The difference between the price a supplier is willing to produce a good at and the price they actually produce at, set my the price mechanism
Define consumer surplus
The difference between the price a consumer is willing to pay for a good at and the price they actually pay, set my the price mechanism
How will PED affect incidence of tax
- Price inelastic- Greater tax revenue, producers pass on much higher propotion of tax to consumers and pay the rest themselves
- Price elastic- Producers pass on much smaller proportion of tax to consumers and pay the rest themselves
QD falls by a larger proption than increase in P
Example of price mechanism when there is low demand
- Low demand indicates to firms to produce less
- Therefore not waste scare resources
- Contraction along S curve
- New clearing market equilbrium
Purpose of market forces
- Ensures effiency due to competition and profit incentive
- Competition has a potential to drive up standards of provision and increase opportunity for consumer choice
- Inceased competition= firms are incentivised to produce at lowest average cost (productive effiency) so to compare with rest of market and not lose market share
Disadvantage of incentive funtion in SIRA
Incentives lack perfect information or exhibit
asymmetric information
Effect on consumer and producer surplus if theres an
* Increase in demand
* Decrease in demad
Increase in demand= CS↑ PS↑
Decrease in demand= CS↓ PS↓
Effect on conumser and producer surplus if theres an
* Increase in supply
* Decrease in supply
Increase in supply= CS↑ PS↓
Decrease in supply= CS↓ PS↓
Define supply
The quantity of a good or service that producers are willing and able to supply at a given price in each time period
Define specific tax
Specific tax is a set amount per unit of a product sold
Define indirect tax
- Imposed on producers by the government
- Tax on consumer expenditure
Incidence of tax effect
- PS and CS fall
- Increases CoP
- P increases, QD decreases
- Firms are less competitive on international markets- may relocate or leave market
- Tax improves govt finances- tax funds could be used to reduce external costs
- Tax internalise external CoP
- Eradicates deadweight loss = closer to social optimum P
Whats the effect in consumer difficulty in computation
Dont have full understanding in order to make a judgment on whether to change consumption in relation to a change in price
Consumers find considerable difficulty in calculating the profitability of something happening
Optimising our own self interest
Tragedy of the commons
The pursuit of individual self interest is often not good for social efficiency, which leads to long term depletion of resources
Why may consumers not switch to cheaper brands
- Computation issues eg. consumers do not understand their pricing structure
- Habitual behaviour/ brand loyalty- may have a tendency to purchase same G/S over time
- Consumers dont have time to shop around or look for better deals- want to avoid disruption of changing provided (inertia)
- Strong brand= inelastic demand
