1.2 - introduction to markets and market failure

Question 1

assumptions of rational decision making

Answer 1

• consumers aim to maximise utility
• firms aim to maximise profits
• government aims to maximise welfare

Question 2

government rules in a mixed economy

Answer 2

• create framework of rules
• supplements and modifies the price system
• redistributes income
• stabilises the economy

Question 3

conditions of demand

Answer 3

population - how much they demand
income - how willing and able consumers are to spend
related goods - complements and substitutes
advertising
taste and fashion
expectations - expectation of what will happen in future
seasons - demand for some goods change with weather

Question 4

what is diminishing marginal utility

Answer 4

the inverse relationship between price and quantity
- satisfaction decreases the more you use/ purchase a product (explains why demand curve slopes down)

Question 5

PED

Answer 5

change in demand in response to change in price
- PED > 1 relatively elastic (shallow D curve)
- PED < 1 relatively inelastic (steep D curve)
- PED =1 unitary elastic (same % change for S and D)
- PED = ∞ perfectly elastic (horizontal line)
- PED = 0 perfectly inelastic (vertical line)

Question 6

factors influencing PED

Answer 6

availability of substitutes = elastic PED
necessity = if something is needed, inelastic
% of total spending = if good takes up small %, inelastic
addictive product = inelastic

Question 7

YED

Answer 7

change in demand in response to change in income
- YED <0, income up = demand for inferior goods fall
- YED >0, income up = demand for normal good up
- YED >1, income up = demand for luxury good up

Question 8

XED

Answer 8

change in demand of one product in response to change in price of another
- XED>0, substitutes, price up for A = demand up for B
- XED<0, complements, price up for A = demand down B
- XED=0, unrelated

Question 9

conditions of supply

Answer 9

productivity - if higher = outward shift
indirect taxes - inward shift in supply
number of firms - more = larger supply
technology - more advanced = outward shift
subsidies - outward supply shift
weather - (agricultural)
costs of production - if high, inward shift

Question 10

joint supply

Answer 10

increasing supply of one good causes a change in supply of another good
- (eg. more lamb = more wool)

Question 11

PES

Answer 11

change in supply in response to change in price

Question 12

factors affecting PES

Answer 12

time scale - SR supply = more inelastic
spare capacity - if spare resources = supply increased quickly
level of stock - if perishable, inelastic
substitutable factors
barriers to entry - high means inelastic

Question 13

how does the price mechanism set prices

Answer 13

rationing - scarce resources = price increase
- discourages demand = rations resources
incentive - encourages change in consumer or producer behaviour
signalling - price acts as signal to consumers and new firms
- high price = enter market bc profitable, consumers reduce demand

Question 14

consumer surplus

Answer 14

difference between price consumers are willing and able to pay vs price they actually pay
- above p and below D curve, top triangle

Question 15

producer surplus

Answer 15

difference between price producer is willing to charge and price they actually charge
- below p and above S curve, (bottom triangle)

Question 16

economic welfare

Answer 16

total benefit society receives from an economic transaction
- producer + consumer surplus

Question 17

indirect taxes

Answer 17

increases cost of production
- as a result producers produce less
- increases market price, demand contracts

Question 18

types of indirect tax

Answer 18

ad valorem
- are a percentage of the unit price (eg. VAT)
specific
- a set tax per unit (eg. 58p/ litre of petrol)

Question 19

burden of tax with diff PED

Answer 19

• if elastic, tax falls mainly on supplier
• if inelastic, tax falls mainly on consumer

Question 20

ad valorem taxes

Answer 20

• if inelastic, gov rev from tax is higher than if elastic, bc demand only falls slightly w tax
• some taxes could be regressive, impact those on low and fixed incomes
• taxes could be inflationary

Question 21

effects of subsidies

Answer 21

• increased output and lower prices
• increase employment (apprenticeship)
• help control inflation, production costs low
• boost demand and consumption
• could be gov failure, if inefficient subsidies