1.2 How Markets Work Flashcards

Question

What is the value of YED for a normal good?

Answer 1

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

Answer 2

Supply is the ability and the willingness to provide a good or service at a particular price at a given moment in time.

Answer 3

Joint supply is where the production of one good automatically causes the production of another goods ## Footnote e.g. the production of beef automatically produces leather

Answer 4

Competitive supply is where the production of one good prevents the supply of another ## Footnote e.g. if the farmer kills his cows, he can no longer produce the milk

Answer 5

PES is the responsiveness of supply to a change in price of the good.

Answer 6

PES = infinity

Answer 7

The price mechanism acts as a signal where resources should be used. When prices rise, producers move resources into the manufacture of that product ## Footnote The change in price indicates to suppliers and consumers that market conditions have changed so they should change the quantity bought and sold- when price equilibrium moves, output equilibrium moves with it.

Answer 8

The price system is a way of rationing goods because when price increases, some people will no longer be able to afford to buy the product and others may no longer have the desire the buy the good ## Footnote The limited resources can be rationed and allocated to the people who are able to afford them and those who value them most highly.

Answer 9

It acts as an incentive for people to work hard. Buyers realise that the more money they have, they are able to buy more products. Suppliers realise that if they produce more of the goods, they will make more money. ## Footnote Also, low prices act as an incentive for consumers to buy more of a good and high prices act as an incentive to suppliers to sell more of a good. The price mechanism encourages people to behave a certain way.

Answer 10

Consumer surplus is the difference between the price the consumer is willing to pay and the price they actually pay,

Answer 11

Producer surplus is the difference between the price the supplier is willing to produce their product at and the price they actually produce at, set by the price mechanism.

Answer 12

Consumer surplus

Answer 13

Producer surplus

Answer 14

Excess demand ## Footnote At the price P2, suppliers are willing to supply QS but consumers demand QD, meaning there is excess demand of the orange shaded area. As a result, there is a shortage in the market. Firms know they can charge higher prices and still sell their goods, so this will cause an extension in supply and they will now charge P1 for quantity Q1. This higher price will lead to a contraction in demand. The prices are now in equilibrium.

Answer 15

Excess supply ## Footnote At price P2, suppliers are willing to supply QS but consumers only demand QD, meaning there is excess supply of the orange shaded area. Prices would have to fall. As a result, firms have unsold goods. This will encourage them to put on sales to sell the excess goods, causing prices to fall and supply to contract to P1. As a result, demand will extend to P1. The market will now be in equilibrium.

Answer 16

● The consumer sees a small fall in price ● The producer gains a lot in extra revenue. ● There is a large change in output

Answer 17

● The more inelastic demand, the more the price falls ● The producer gains less in extra revenue compared to if the good was elastic ● There is little change in output

Answer 18

Subsidies on goods with inelastic demand are ineffective at increasing output ## Footnote (They are cheaper for the government to impose since output increases by less and so the government have to pay the subsidy on less goods)

Answer 19

S1 = unitary elastic supply curve S2 = relatively elastic supply curve S3 = relatively inelastic supply curve

Answer 20

The more inelastic demand, the higher consumer surplus is likely to be ## Footnote Perfectly elastic demand will mean that there is no consumer surplus, whilst perfectly inelastic demand will mean that consumer surplus is infinite

Answer 21

The more inelastic supply, the higher producer surplus is likely to be. ## Footnote When supply is perfectly elastic, producer surplus is 0 and when it is perfectly inelastic, producer surplus is infinite

Answer 22

A decrease in demand from D1 to D2 will lead to a fall in consumer and producer surplus ## Footnote As both price and output decrease

Answer 23

A decrease in supply from S1 to S2 will lead to a fall in consumer and producer surplus.

Answer 24

The total welfare to society is the community surplus: consumer surplus plus producer surplus

Answer 25

An indirect tax is a tax on expenditure ## Footnote Where the person who is ultimately charged the tax is not the person responsible for paying the sum to the government. The business is required to pay the tax but the customer is charged instead.

Answer 26

● Ad valorem tax ● Specific tax

Answer 27

Ad valorem tax is where the tax payable increases in proportion to the value of the good. The tax is a percentage of the cost of the good ## Footnote For example VAT - 20% (standard rate)

Answer 28

Specific tax is where an amount is added to the price. The tax increases with the amount bought rather than the value of goods. ## Footnote For example, excise duties on alcohol, tobacco and petrol are a specific amount (e.g. 10p a litre)

Answer 29

The consumer and producer burdens of an **ad valorem tax**

Answer 30

The tax burden on the taxpayer

Answer 31

The supplier will pay all the tax.

Answer 32

All the tax will be passed on to the consumer.

Answer 33

In general, the more elastic the demand curve, or the more inelastic the supply curve, the lower the incidence of tax on the consumer, meaning the supplier has to pay more.

Answer 34

The **more inelastic** the **demand curve**, the **higher the revenue of tax** for the government because quantity demanded falls less and the more goods that are bought, the higher the tax revenue.

Answer 35

A subsidy is a grant given by the government and is the opposite of a tax, an extra payment to encourage production/consumption of a good or service

Answer 36

Rationality assumes people act individually to maximise their own benefits but sometimes individuals are influenced by social norms, known as a bias. For example, someone may buy something to ‘fit-in’ or because everyone else has it. Consumers become unwilling to change the bias, even if doing so will benefit them, if it goes against the norms of society. ‘Herding behaviour’ occurs when an individual copies the actions of a large group ## Footnote One example is the stock market, and this causes huge market bubbles

Answer 37

Habits create a barrier to decision making since they limit or prevent consumers considering an alternative. Habitual behaviour includes addictions and so this influences people’s decisions, for example consumers will buy more drugs/alcohol even though they know they should give up ## Footnote Another habit many consumers have is buying their products at eye level so supermarkets tend to keep higher priced products near the top and lower priced products lower

Answer 38

Many consumers aren’t willing or able to make comparisons between prices and so they will buy more expensive goods than needed, for example many customers buy multipack goods because they assume they are cheaper but this is not always the case. Consumers are sometimes poor at self-control and so do things they know they shouldn’t. Similarly, consumers will make decisions without looking at the long term effects, and so make irrational decisions ## Footnote One example of this is consumers saving up for their pensions: many put off doing this because they fail to look long term.