1.2. How markets work

Question 1

What assumptions are made about the objectives of consumers and producers

Answer 1

That consumers and businesses will act rationally
Consumers aim to maximise utility
Producers aim to maximise profit

Question 2

Explain how herd mentality may prevent consumers from acting rationally

Answer 2

If a consumer sees another consumer acting irrationally they are likely to also react irrationally as to not miss out

Question 3

Explain how habitual behaviour may prevent consumers from acting rationally

Answer 3

A consumer prefers to do what they have always done as it takes less effort to decide to do something else

Question 4

Explain how computational weakness may prevent a consumer from acting rationally

Answer 4

Consumers are not always capable of comparing prices and offers of products
Prices and offers are often presented in difficult ways

Question 5

Explain diminishing marginal utility

Answer 5

Satisfaction diminishes with the consumption of an additional good or service.

Question 6

Explain why a demand curve is downward sloping

Answer 6

As prices rise fewer consumers are inclined to or can afford to buy a good or a service

Question 7

Explain the factors that cause a demand curve to shift

to the right

Answer 7

Population - more people, more demand
Advertising - influence people into buying
Substitutes - price increase, demand decrease
Income - more disposable income, more consumption
Fashion and Taste - herd mentality and trends
Interest Rate - low interest rates, higher demand
Compliments - decreased price, more demand

Question 8

Explain why the supply curve is upward sloping

Answer 8

The profit motive - higher prices create higher profit
Increased supply leads to higher costs which need to be covered by higher prices
Higher prices attract new firms into the market

Question 9

Explain the factors that cause a supply curve to shift

to the right

Answer 9

Productivity - higher productivity, more supply
Indirect taxes - lower taxes, increased supply
Number of Firms - more producers, more supply
Technologies - better technologies, higher supply
Subsidies - more money to invest, increased supply

Question 10

Explain, using an example, the meaning of joint supply

Answer 10

When two products are in joint supply, an increase in the suoplu of one will lead toan increase in the supply of the other.
For example: sheep and wool - wool is a by-product

Question 11

Explain the meaning of a consumer surplus

Answer 11

The difference between how much a consumer is willing to pay and how much they actually pay

Question 12

Explain the meaning of a producer surplus

Answer 12

The difference between the price at which a firm is willing to sell for and how much they actually sell for

Question 13

Define “price elasticity of demand”

Answer 13

the responsiveness of quantity demanded to a change in price

Question 14

What is the formula for price elasticity of demand

Answer 14

PED = % change in QD / % change in price

Question 15

Explain the significance of a PED of 0

Answer 15

Perfectly inelastic

Question 16

Explain the significance PED between 0 and -1

Answer 16

Inelastic

Question 17

Explain the significance of a PED of -1

Answer 17

Unitary elasticity

Question 18

Explain the significance of a PED between -1 and infinity

Answer 18

Elastic

Question 19

Explain the significance of a PED of infinity

Answer 19

Perfectly Elastic

Question 20

List the factors that influence PED

Answer 20

Proportion of Income
Luxury
Addictiveness
Necessity
Time between purchase
Substitutes

Question 21

Define “price elasticity of supply”

Answer 21

The responsiveness of quantity supplied to a change in price

Question 22

What is the formula for price elasticity of supply

Answer 22

PES = % change in QS / % change in price

Question 23

Explain the significance of a PES of 0

Answer 23

Perfectly Inelastic

Question 24

Explain the significance of a PES between 0 and 1

Answer 24

Inelastic

Question 25

Explain the significance of a PES of 1

Answer 25

Unitary elasticity

Question 26

Explain the significance of a PES between 1 and infinity

Answer 26

Elastic

Question 27

Explain the significance of a PES of infinity

Answer 27

Perfectly elastic

Question 28

List the factors that influence PES

Answer 28

``` Barriers to entry Resources Inventory Times Spare capacity ```

Question 29

Define "income elasticity of demand"

Answer 29

The responsiveness of demand to a change in income

Question 30

What is the formula for income elasticity of demand

Answer 30

YED = % change in QD / % change in Y

Question 31

What YED would you expect from a normal good

Answer 31

Positive values - when income rises, demand rises

Question 32

What YED would you expect from an inferior good

Answer 32

Negative values - when income rises, demand falls

Question 33

What YED would you expect from an luxury good

Answer 33

Value > 1 - more elastic

Question 34

What YED would you expect from a necessity good

Answer 34

Value between 0 and 1 - more inelastic

Question 35

Define "cross elasticity of demand"

Answer 35

The responsiveness of demand for one product to a change in price of another product

Question 36

What is the formula for cross elasticity of demand

Answer 36

XED = % change in QD for A / % change in P for B

Question 37

What XED values would you expect from a substitute good

Answer 37

Positive - price of A increase, demand of B increase

Question 38

What XED would you expect from a complementary goods

Answer 38

negative - price of A increases, demand of B decreases

Question 39

What XED would you expect from an unrelated good

Answer 39

0 - price of A increases, demand of B is unaffected

Question 40

Explain rationing

Answer 40

Prices ration scarce resources | When there is a shortage, prices increase, only those with the willingness to pay will purchase the product

Question 41

Explain incentive

Answer 41

Higher prices created by shortages are an incentive for producers to increase supply Producers are motivated by profit If there is a surplus, prices will be lower, this acts as an incentive to reduce supply

Question 42

Explain signalling

Answer 42

Prices adjust to demonstrate where resources are required and where they aren't Prices rises and fall to reflect scarcities and surpluses e.g. if prices rise due to high demand, suppliers are signalled to expand to production to meet the demand

Question 43

Explain, with examples, what a direct tax is

Answer 43

A tax levied on income, wealth, profits of the person who pays it e.g. income tax

Question 44

Explain, with examples, what an indirect tax is

Answer 44

A tax levied on goods or services | e.g. VAT

Question 45

Explain, with examples, what an ad valorem tax is

Answer 45

Tax based on the value of a transaction or of property | e.g. VAT

Question 46

Explain, with examples, what a specific tax is

Answer 46

A tax that is a fixed amount for each unit of a good sold | Excise duty

Question 47

Explain the meaning of consumer incidence

Answer 47

How much of the tax the consumer pays

Question 48

Explain the meaning of producer incidence

Answer 48

How much of the tax the producer pays

Question 49

Define "subsidy"

Answer 49

A grant from the government to firms, designed to lower the price of a good and encourage production, lowers the cost of production for firms

Question 50

Explain the meaning of "consumer gain" from a subsidy

Answer 50

The amount of money that the product has been lowered by andthe consumer no longer has to spend

Question 51

Explain the meaning of "producer gain" from a subsidy

Answer 51

The reduction in the cost to produce the product