1.2 How Markets Work

Question 1

What is Rational Decision Making for Consumers, Firms and Government

Answer 1

Consumers- Maximise utility
Firms- Maximise profits
Government- Maximise social welfare

Question 2

Demand?

Answer 2

The willingness and ability to buy a g/s at a given price at a given time

Question 3

Factors causing demand to shift

Answer 3

Population, Income, No. of substitutes, Advertising, Taste/Trends

Question 4

Law of diminishing returns?

Answer 4

The satisfaction derived from consuming and additional unit will decrease as more is consumed

Question 5

PED definition and equation

Answer 5

The responsiveness of demand after a change in price
%change in Qd / %change in P

Question 6

What does PED=1, >1, <1, 0 show

Answer 6

1= unitary elastic (qty changes by exactly price change)
>1= elastic
<1= inelastic
0= perfectly inelastic (price has no effect on qty

Question 7

Factors influencing PED (SPLAT)

Answer 7

Subsititutes
Proportionof income
luxury/necessity
Addictiveness
Time period

Question 8

PED effects on tax incidence

Answer 8

higher elasticity means lower incidence of tax on consumer vice versa

Question 9

YED definition and equation

Answer 9

responsiveness of demand after a change in income
%change in qty / %change in income

Question 10

YED >0, <0 , 1 meanings

Answer 10

> 0= normal good - rise in income leads to a rise in demand
<0= inferior good - rise in income leads to a fall in demand 1= luxury good - is a normal good

Question 11

XED definition and equation

Answer 11

Responsiveness of demand of good A in response to a change in price of good B
%change in Qty A / %change in P B

Question 12

XED >0, <0, 1, 0 meanings

Answer 12

> 0- Substitute
<0- Complementary
0= unrelated

Question 13

Supply?

Answer 13

willingness and ability to provide a g/s at a given price at a given time

Question 14

Factors influencing supply 4

Answer 14

Cost of production
Price of another good
Technology
Taxes , subsidiesP

Question 15

PES definition and equation

Answer 15

responsiveness of supply after a change in price
%change Qty supplied / %change in price

Question 16

PES 1, >1, <1, 0, 1

Answer 16

1= unitary elastic
>1= elastic
<1= inelastic
0= perfectly inelastic

Question 17

Factors effecting PES

Answer 17

Time
Stocks
Capacity
Substitutes available

Question 18

Price Mechanism- Rationing Function

Answer 18

When resources become scarcer the price will rise further. Only those who can afford to pay for them will receive them

Question 19

Price Mechanism- Signalling Function

Answer 19

Prices provide info to producers and consumers about where resources should be allocated

Question 20

Price Mechanism- Incentive Function

Answer 20

Prices act as incentives for people to work hard and for suppliers to supply more to make more profits

Question 21

Consumer and producer surplus definitions

Answer 21

C- the difference between what consumers are willing and able to pay and what they actually pay
P-the difference between the price suppliers are willing to produce at and what they actually produce at

Question 22

What can cause surplus to shift

Answer 22

Decrease in demand -> less output and lower price-> lower C and P surplus
Decrease in supply->less output-> lower C and P surplus

Question 23

Indirect tax

Answer 23

A tax on expenditure where the person paying doesn’t pay it straight to govtt

Question 24

Two types of Indirect Tax with explanations

Answer 24

Ad Valorem Tax- The amount of the tax increases in proportion to the price of product
Specific Tax- A fixed tax per unit of output

Question 25

Impact of taxes (COA)

Answer 25

Increased cost of production-> inwards supply shift->Price increase
Govt also gain tax revenue

Question 26

Subsidy

Answer 26

A grant given to firms by the government to encourage consumption/production of a g/s

Question 27

Subsidy effect

Answer 27

Lower production costs-> increased supply-> rise in output->fall in price