1.2 How Markets Work

Question 1

Rational decision making

Answer 1

When making economic decisions, consumers aim to maximise their utility and firms aim to maximise profits

Question 2

Consumer utility

Answer 2

consumer’s utility is the total satisfaction received from consuming a good or service.

Question 3

Price elasticity of demand

Answer 3

responsiveness of a change in demand to a change in price

Question 4

PED formula

Answer 4

PED = change in quantity demand
——————————————
Change In quantity price

Question 5

Price elastic

Answer 5

change in price leads to an even bigger change in demand. The numerical value for PED is >1.

Question 6

Price inelastic

Answer 6

Change in price leads to a smaller change in demand

PED is <1.

Question 7

Unitary elastic good

Answer 7

change in demand which is equal to the change in

price. PED = 1.

Question 8

perfectly inelastic good

Answer 8

A perfectly inelastic good has a demand which does not change when price changes. PED = 0.

Question 9

Perfectly elastic good

Answer 9

perfectly elastic good has a demand which falls to zero when price changes. PED = infinity

Question 10

Factors affecting PED

Answer 10

• necessity
• substitutes
• addictivenes
• proportion of income
• time

Question 11

Income elasticity of demand

Answer 11

Income elasticity of demand is the responsiveness of a change in demand to a change in income.

Question 12

Inferior good

Answer 12

Inferior goods are those which see a fall in demand as income increases

YED < 0.

Question 13

Luxury good

Answer 13

increase in income causes an even bigger increase in demand. YED > 1

Question 14

Cross elasticity of demand

Answer 14

Cross elasticity of demand is the responsiveness of a change in demand of one good, X, to a change in price of another good, Y

Question 15

Formula of cross elasticity of demand

Answer 15

Change In quantity of demand of X
————————————————-
Change in quantity of price of Y

Question 16

Complementary goods

Answer 16

Complementary goods have a negative XED. If one good becomes more expensive, the quantity demanded for both goods will fall.

Question 17

Substitutes

Answer 17

Substitutes can replace another good, so the XED is positive

Question 18

Unrelated goods

Answer 18

Unrelated goods have a XED equal to zero.

Question 19

price elasticity of supply

Answer 19

The price elasticity of supply is the responsiveness of a change in supply to a change in price

Question 20

Formula of price elasticity of supply

Answer 20

Change in quantity of supply
—————————————-
Change in price

Question 21

Elastic supply

Answer 21

Change in price leads to a bigger change in supply

PES is >1

Question 22

Supply inelastic

Answer 22

Change in price leads to a smaller change in supply

PES is <1

Question 23

perfectly inelastic supply

Answer 23

perfectly inelastic supply has PES = 0. Supply is fixed, so if there is a change in demand, it cannot be met easily.

Question 24

Supply perfectly elastic

Answer 24

Supply is perfectly elastic when PES = infinity. Any quantity demanded can be met without changing price.

Question 25

Factors influencing PES

Answer 25

Time
Spare capacity
Number of stocks
Perishability

Question 26

Price determination

Answer 26

This is when supply meets demand. On the diagram, this is shown by P1 and Q1. At market equilibrium, price has no tendency to change, and it is known as the
market clearing price.

Question 27

Excess demand

Answer 27

Demand is now greater than supply

This is a shortage in the market. This pushes prices up and causes firms to supply more. Since prices increase, demand will contract.

Question 28

Excess supply

Answer 28

• when price is above P1.