1.2 How Markets Work LS7-11

Question 1

Whats the difference between deduction and induction?

The two approaches to a solution

Answer 1

Deduction is when you start with a hypothesis
Induction is when you collect evidence

Question 2

What does it mean when consumers are rational?

Answer 2

They buy products that maximise utility

Question 3

Whats utility?

Answer 3

The satisfaction or benefit derived from consuming a good

Question 4

Whats utility for firms?

Answer 4

Maximising profit

Question 5

How do firms maximise profit?

Answer 5

• Producing as efficiently as possible
• Making things that consumers both want and can afford

Question 6

What three things do economic agents need to make rational decisions?

Answer 6

• Time
• Information
• Ability to process information

Question 7

Deductive or inductive?

What approach does behavioural economics take?

Answer 7

Inductive (collect evidence) as its based on evidence and observations

Question 8

Whats bounded rationality?

Answer 8

When individuals wish to maximise utility but are unable to do so due to a lack of time, information and ability to process information

Question 9

What human behaviours can prevent rational decision making?

Answer 9

• Habitual behaviour
• Consumer inertia (fear of changing)
• The influence of others
• Consumer weakness of computation

Question 10

Demand definition

Answer 10

The quantity of a good or service purchased at a given price of a given time period

Question 11

State the law of demand

Answer 11

Ceteris paribus, as the price of a good increases, quantity demanded decreases

As the price of a good decreases, quantity demanded increases

Question 12

How is a decrease in price shown on a demand diagram?

Answer 12

Decrease in price = extension/expansion in demand

Shown by a movement along a demand curve
—>

Question 13

How is an increase in price shown on a demand diagram?

Answer 13

Increase in price = contraction in demand

Shown by a movement along a demand curve <—

Question 14

Substitute goods?

Answer 14

Two alternative products that could be used for the same thing
i.e. Xbox and playstation

Question 15

Complementary goods?

Answer 15

Products that are used together
i.e. tea and sugar

Question 16

What factors can affect demand?

Answer 16

• A change in the age structure of the population
• Changes in incomes
• Advertising (successful or unsuccessful)
• Changes in consumer tastes/preferences

Question 17

Revenue definition?

Answer 17

The income that a government or company receives

Question 18

Total revenue definition?

Answer 18

Price x quantity

Question 19

Who supplies goods and services in a market?

Answer 19

Firms

Question 20

Supply definition?

Answer 20

The quantity of a good or service that firms are willing to sell at a given price over a given time period

Question 21

State the law of supply

Answer 21

Ceteris paribus, as the price of a good increases, quantity supplied increases (as producers want to maximise profit).

As the price of a good decreases, quantity supplied decreases.

Question 22

How is an increase in price shown on a supply diagram?

Answer 22

Increase in price = extension/expansion in supply

Shown by a movement along the supply curve

Question 23

How is a decrease in price shown on a supply diagram?

Answer 23

Decrease in price = contraction in supply

Shown by a movement along the supply curve

Question 24

What two things does a supply diagram assume?

Answer 24

• Firms are motivated to produce by profit
• The cost of producing a unit increases as ouput increases

Question 25

Excess demand?

Answer 25

When demand exceeds supply at a given price in a given time period

Question 26

Excess supply?

Answer 26

When supply exceeds demand at a given price over a given time period

Question 27

Equilibrium price?

Answer 27

When supply meets demand

Question 28

Direct tax definition?

Answer 28

A tax levied directly on an individual or organisation

eg. income tax/corporation tax

Question 29

Indirect tax definition?

Answer 29

A tax levied on a good or service

e.g. VAT

Question 30

Specific tax?

Answer 30

• Causes a parallel shift in the supply curve
• Tax is same fixed amount at all prices

Question 31

Ad Valorem tax?

Answer 31

• Causes a non-parallel shift in supply curve
• Tax increases as amount sold rises (income tax)

Question 32

Why do governments impose taxes?

Answer 32

• In order to raise government revenue and/or
• To discourage certain economic activities

Question 33

Subsidy definition and why do governments give these to firms?

Answer 33

• Money given by the government to encourage production which is not paid back