1.2 - How Markets Work

Question 1

Consumers aim to maximise ______, firms aim to maximise ______, and the Government aims to maximise ______ ________.

Answer 1

• Utility
• Profits
• Social Welfare

Question 2

What is utility?

Answer 2

The satisfaction gained from consuming a good/ service.

Question 3

What is Demand?

Answer 3

The ability and willingness to buy a particular good at a given price and time.

Question 4

What causes a movement along the demand curve?

Answer 4

Caused by a change in the price of the good.

Question 5

What are the factors that cause Demand to shift?

Answer 5

• Population
• Income
• Related goods
• Advertising
• Tastes
• Expectations
• Seasons
  (PIRATES)

Question 6

What assumption is made to predict or explain how consumers will spend their money?

Answer 6

We have to assume consumers will behave rationally, and expect them to spend according to what gives them the greatest level of satisfaction (or welfare).

Question 7

What is Total Utility?

Answer 7

The satisfaction gained by consumers from overall consumption of a good.

Question 8

What is marginal Utility?

Answer 8

The change in satisfaction as a result of consuming another unit of good.

Question 9

What is the Law of Diminishing Utility?

Answer 9

The satisfaction derived from consuming another unit of a good will decrease as more of the good is consumed.

Question 10

What is Price Elasticity of Demand (PED)?

Answer 10

The responsiveness of demand to change in the price of the good.

Question 11

What are the 5 factors influencing PED?

Answer 11

• Availability of Substitutes
• Time
• Necessity
• How large of a % total expenditure (e.g. how much it makes up of someone’s total spending)
• Addictiveness

Question 12

If a Demand curve is more elastic, what will this mean for the consumer (in terms of the incidence of tax)?

Answer 12

The incidence of tax (for the consumer) will be lower, meaning tax will only lead to a small increase in price for consumer
(and the supplier covers a majority of the cost of the tax)

Question 13

Why would taxes be ineffective at reducing output if a good is inelastic?

Answer 13

Consumers are relatively unresponsive to the price of an inelastic good, therefore output would not fall too much.

Question 14

What causes an increase in revenue for an elastic demand curve?

Answer 14

A decrease in price.

Question 15

What is Income Elasticity of demand (YED)?

Answer 15

The responsiveness of demand to a change in income.

Question 16

What is Cross elasticity of Demand (XED)?

Answer 16

The responsiveness of demand for one product (A) to the change in price of another product (B).

Question 17

What is a complementary good? Give an example.

Answer 17

An increase in the price of good B will decrease the demand for good A. (XED > 0)
- e.g, DVD’s and DVD players

Question 18

What is supply?

Answer 18

The ability and willingness to provide goods/services at a given price and time.

Question 19

What are the factors that cause supply to shift?

Answer 19

• Productivity
• Indirect Tax
• Number of Firms
• Technology
• Subsidies
• Weather
• Cost of Production (most important)
  (PINTSWC)

Question 20

What is Price Elasticity of Supply (PES)?

Answer 20

The responsiveness of supply to a change in price of the good.

Question 21

what are the 6 factors that affect PES?

Answer 21

• Time
• Stocks
• working below full capacity
• Availability of factors of production
• Ease of entry into the market
• Availability of substitutes

Question 22

what is the rationing function of the price mechanism?

Answer 22

A way of rationing goods to where only the people who value them the highest can afford them

Question 23

what is the signalling function of the price mechanism?

Answer 23

The price mechanism acting as a signal for where resources should be used
- i.e. producers moving resources into the manufacture of a product that has had an increase in demand

Question 24

what is the incentive function of the price mechanism?

Answer 24

Price mechanism acts as an incentive for people to work hard
- because they know the more money they have, the more products they can afford; suppliers know if they cab produce more goods, the more money they can make…

Question 25

what is consumer surplus? what does it show?

Answer 25

The difference between the price the consumer is willing to pay and the price they actually pay
- Shows the welfaire gained by consumers (total satisfaction)

Question 26

what is producer surplus? what does it show?

Answer 26

The difference between the price the supplier is willing to produce their product at and the price they actually produce it at
- Shows economic gain for producers

Question 27

what is an indirect tax? what are the two types?

Answer 27

A tax on expenditure (goods/services)

• Specific tax: a fixed amount of tax placed on a particular good (or per-unit tax)
• Ad Valorem tax: and imposed tax on a good/service depending on its value (e.g. VAT)

Question 28

what is a subsidy?

Answer 28

A grant given by the government
(extra payment to firms to encourage/ increase production of good/service)

Question 29

what is influence of habitual behaviour? what limits can it have to consumer judgement?

Answer 29

Habits consumers have, which reduce time it takes so do something because their actions are subconsious
- Can prevent consumers from making beneficial decisions for themselves e.g., buying alcohol when trying to stop

Question 30

what is the influences of other people? what limits can it have to consumers judgement?

Answer 30

Individuals influenced by social norms to ‘fit-in’ (because everyone had or is doing something)
- Can prevent making individual decisions that benefits them (herd behaviour)