1.2 How markets work (1.2.1-1.2.2)

Question 1

What does it mean to maximize utility?

Answer 1

to seek to attain the highest level of satisfaction from their economic decisions

Question 2

What is the objective of consumers?

Answer 2

Consumers aim to maximise utility

Question 3

What is the objective of firms?

Answer 3

To maximize profits

Question 4

What are reasons for firms wanting to maximize profits? (2)

Answer 4

• to reinvest profits
• to offer managers and staff members better rewards

Question 5

How can the government try to maximise overall welfare? (2)

Answer 5

• reducing inflation
• reducing or eliminating unemployment

Question 6

What is utility?

Answer 6

the amount of satisfaction gained from consuming a good or service

Question 7

What is total utility?

Answer 7

the total satisfaction a consumer gets from the consumption of all units of a good consumed within a given period of time

Question 8

What is marginal utility?

Answer 8

the additional utility or satisfaction gained from each additional unit of consumption

Question 9

What are the three types of economic agents?

Answer 9

• producers
• consumers
• governments

Question 10

What is quantity demanded?

Answer 10

the total number of units purchased at that price

Question 11

What is the law of demand?

Answer 11

that there is an inverse relationship between price and quantity demanded

Question 12

Why is the demand curve downwards sloping?

Answer 12

As it shows the relationship between price and quantity, the higher the price is, the lower demand is

Question 13

What is demand?

Answer 13

the amount that consumers are willing and able to buy at a given price

Question 14

What is meant by ‘willingness to pay’?

Answer 14

desire to pay based on tastes and preferences

Question 15

What is meant by ‘ability to pay’?

Answer 15

factors in a person’s income, and whether they can afford the good or service or not

Question 16

What will an increase in price of one good cause on another good in substitute goods?

Answer 16

an increase in the price of one good will increase the quantity demanded of the other good

Question 17

What will an increase in price of one good cause on another good in complement goods?

Answer 17

an increase in the price of one good will cause a decrease in the quantity demanded of the other good

Question 18

State the two theories that explain the relationship between price and quantity?

Answer 18

• Income effect
• Substitution effect

Question 19

What is the income effect?

Answer 19

when prices fall, consumers can afford a greater quantity of goods and services (assuming income is fixed), so demand for these goods and services increases

Question 20

What is the substitution effect?

Answer 20

when the price of one good falls, consumers will buy more of the cheaper good or service and less of the more costly good or service. So demand for the cheaper good increases; demand for the costlier good decreases

Question 21

When will the demand curve shift right?

Answer 21

when there is an increase in demand for a good at each price level

Question 22

When will the demand curve shift left?

Answer 22

when there is a decrease in the demand for a good at each price level

Question 23

What does a effect on the demand curve, due to a change in income depend on?

Answer 23

the type of good, whether it is a normal or inferior good

Question 24

What is the effect of an increase in income on a normal good?

Answer 24

increased income will lead to an increase in quantity demanded

Question 25

What is the effect of an increase in income on an inferior good?

Answer 25

increased income may lead to a reduction in quantity demanded

Question 26

What will a rise in price cause on the demand curve?

Answer 26

A demand contraction (when demand decreases)

Question 27

What will a fall in price cause on the demand curve?

Answer 27

A demand extension (when demand increases)

Question 28

What is the concept of diminishing marginal utility/returns?

Answer 28

the concept that the more of something you add, the lower the impact of each additional unit, assuming all else is fixed

Question 29

What does the law of diminishing marginal utility state?

Answer 29

the more that an individual consumes (ceteris paribus) the utility of the good/service decreases with every additional unit consumed

Question 30

Give an example of diminishing marginal utility

Answer 30

The first slice of dominos pizza is very satisfying, but the 100th may not be quite as enjoyable. Eventually, the marginal utility of another slice can be negative