Basic Economic Problem & Opportunity Cost

Question 1

What is the basic economic problem?

Answer 1

There are infinite wants and finite resources. Resources are scare in relation to wants.

Question 2

Opportunity Cost

Answer 2

The value of the next best alternative foregone (given up) when a choice is made.

Question 3

Resources are used in the production process

Answer 3

Land- natural physical resources
Labour- human input
Capital- man-made resources, eg machinery
Enterprise/Entrepreneurship- the ability and willingness to organise, coordinate and take risks in the production process

Question 4

Microeconomics v Macroeconomics

Answer 4

Microeconomics studies the behaviour of individuals and firms in the market.
Macroeconomics considers the economy as a whole.

Question 5

Rewards to factors of Production

Answer 5

Land= rent
Labour= wages
Capital= interest
Enterprise= profit

Question 6

Positive Statements v normative statements

Answer 6

Positive statements describe the world as it is, without making any value judgements. Based on objective facts, can be proven or disproven. Example: A rise in the ,minimum wage decreases employment.
Normative statements express an opinion about what ought to be. They are subjective statements, they carry judgements, bias. Example: The government should increase spending on healthcare.

Question 7

Division Labour

Answer 7

Involves specialisation of individual tasks in a production process.
It can lead to higher output per person/hour worked, improved productivity.

Question 8

Economies of Scale

Answer 8

Specialisation and the resulting efficiency in production often lead to economies of scale. Production quantities increase, average cost tend to decrease.

Question 9

Negatives of division labour

Answer 9

Repetitive strain injuries at work.
Reduced job satisfaction = workplace absenteeism.
Workers take less pride = work quality goes down

Question 10

Specialisation

Answer 10

Process by which individual, firms concentrate their effort on producing a narrow range of goods and services.

Question 11

Extension in demand

Answer 11

Quantity of a good rises due to fall in price.

Question 12

Contraction in demand

Answer 12

Quantity of a good falls due to a rise in price.

Question 13

Ceteris paribus

Answer 13

All other influencing actors are held constant.

Question 14

Total utility

Answer 14

Total satisfaction the consumer gets for purchasing units of a good.

Question 15

Marginal utility

Answer 15

The change in total utility from consuming an extra unit of a product.

Question 16

Law of diminishing Marginal Utility

Answer 16

More units consumed = extra satisfaction gain diminishes.
Higher quantities = less willing to buy at a higher price.

Question 17

Factors causing a shift in Demand

Answer 17

-Change in tastes/preferences
-Change in incomes
-Change in population size/structure
-Changes in interest rates.

Question 18

Why the demand curve slopes downward:

Answer 18

Substitution effect: consumes substitute in favour of the good that become relatively cheap.
Real income effect: change in demand caused by an increase or decrease in a consumers purchasing power or real income. Income increase=demand increase

Question 19

Factors influencing PED

Answer 19

-Availability of close substitutes
-Cost of switching supplies
-Breadth of product definition
-Habitual demand
-Brand loyalty

Question 20

Price inelastic demand

Answer 20

A rise in price = increased revenue why government increases
Examples, life saving medication, drugs, alcohol

Question 21

Price elastic demand

Answer 21

Decrease in price = more revenue

Question 22

PED calculations

Answer 22

PED = %change in quantity demand/%change in price Fv-Iv/Ivx100=change%

Question 23

When PED is elastic:

Answer 23

A rise in P leads to more than proportionate fall in Qd, a fall in P leads to a more than proportionate fall in Qd so TR falls. Inferior goods won’t be as demanded, there are substitutes. As price rises for low-end products, people simply won’t purchase, TR falls. Lowering prices benefits TR, more people buy.

Question 24

Low Elasticity Values

Answer 24

Percentage change in Qd is < the percentage change in P. Value between 0 and -1. Perfectly inelastic PED=0

Question 24

When PED is inelastic:

Answer 24

A rise in P leads to a less than proportionate fall in Qd, so TR rises, a fall in P leads to a less than proportionate rise in Qd so TR falls. Normal goods like cigarettes will be bought regardless of price therefore rising prices is more beneficial for TR, why governments tax these goods.

Question 25

High Elasticity Values

Answer 25

Percentage change in Qd is more than the percentage change in P value between -1 and infinity. Perfectly elastic=-infinity

Question 26

Factors Influencing PED

Answer 26

Availability of close substitutes, time frame, cost of switching supplies, breadth of product definition, degree of necessity, brand loyalty, %income spent, habitual demand.

Question 27

Uses of PED

Answer 27

Determination of pricing policy/impact on revenue, indication of competition faced, price setting in price discrimination, government decision on which goods to tax indirectly.

Question 28

Supply

Answer 28

The quantity of a good or service that producers are willing and able to supply at a given price.

Question 29

Law of Supply

Answer 29

As the price of a product rises, so businesses expand supply. Higher prices provide a profit incentive for firms to expand production.

Question 30

Profit Motive

Answer 30

The driving force behind most private sector businesses engaging in different marks and industries.

Question 31

Standard Theory

Answer 31

Rational firms choose an output and price that aims to maximise profits.

Question 32

Shifts in Supply

Answer 32

Fall in the price of factors of production, increase in productivity, more suppliers entering the market.

Question 33

Market Supply

Answer 33

The total supply brought to the market by producers at each price.

Question 34

Causes of Shifts in market supply curve

Answer 34

Changes in the unit costs of production, lower unit costs mean a business can supply more at each price, higher unit costs cause an inward shift of supply perhaps due to a rise in wage rates or increase in prices of raw materials, a fall in the exchange rate causes an increase in the price of improved components and raw materials, favourable weather conditions, taxes, subsides and government regulations: indirect taxes (inward), subsides (outward), regulations usually increase cost.

Question 35

Excess Supply

Answer 35

When QS exceeds demand.

Question 36

Excess Demand

Answer 36

When QD exceeds supply.

Question 37

Rationing Function

Answer 37

Price acts as a rationing mechanism to allocate scarce resources among competing uses. When demand exceeds supply, price rises, discouraging some consumers from buying, and ensuring that goods are allocated to those willing to pay the highest prices.

Question 38

Incentive Function

Answer 38

Higher prices indicate increased demand, motivating producers to produce more. Lower prices signal decreased demand, encouraging producers to relocate resources to more profitable uses.

Question 39

Signalling Function

Answer 39

Rising prices=potential shortages, prompting consumers to conserve and producers to increase supply. Falling prices=oversupply, prompting consumers to buy more and producers to cut back on producers.

Question 40

Local Markets

Answer 40

Prices are determined by supply and demand conditions within a specific geographic area. Example, weather or local preferences.

Question 41

National Markets

Answer 41

Cover an entire country and consider supply and demand at a broader scale. National policies and regulations, such as taxes and trade polices can affect prices. Example, government polices related to interest rates.

Question 42

If an indirect tax is Imposed on a product with Inelastic demand curve then?

Answer 42

The producer is able to pass on most of the tax to the consumer through a higher price.
All of the tax must be paid for by the consumer.

Question 42

Global Markets

Answer 42

International trade, can be influenced by factors like currency, exchange rates, global supply chains and geographical events. Example, price of oil in global markets affects fuel prices globally.

Question 43

If an Indirect tax is imposed?

Answer 43

The size of the tax per unit is measured by the vertical distance between the new equilibrium and the original supply curve.

Question 44

The Tax on Cigarettes is?

Answer 44

Regressive because lower income individuals pay a larger proportion of their income in taxes compared to higher income individuals.
Is paid more by the consumer than the producer because consumers reduce their consumption only slightly when price increases in tax.

Question 45

What is a Specific Tax?

Answer 45

A fixed amount of tax applied per unit of a good.

Question 46

What is a Subsidy and how does it effect the Supply Curve?

Answer 46

A payment made by the government to produces to reduce their production costs, shifts the supply curve to the right.

Question 47

The Incidence of an indirect tax is determined by?

Answer 47

Incidence- who bears the burden of the tax.
Determined by the elasticity of supply and demand. Demand more inelastic than supply = consumers bear a larger share of the tax burden and vice versa.

Question 48

A subsidy is the most effective at increasing output when?

Answer 48

Both supply and demand are elastic. Supply is elastic = producers can increase output. Demand is elastic = consumers will increase their quantity demanded.

Question 49

The Deadweight loss from a tax is greatest when?

Answer 49

Both supply and demand are elastic = both consumers and producers are highly responsive to price changes.

Question 50

An Ad Valorem Tax

Answer 50

Increases with the price of the good. Price increases = tax increases proportionally.

Question 51

A Pigovian tax is used correct?

Answer 51

Designed to correct the market failure that arise from negative externalities.

Question 52

Deadweight Loss

Answer 52

The lost welfare to society when markets are not at equilibrium. Loss of economic efficiency that occurs when the equilibrium for a good/service is not achieved or achievable.

Question 53

Overconsumption

Answer 53

Refers to consumers, such as those drinking sugary beverages, consuming more than is socially optimal. While they balance their personal benefits with personal costs, they ignore societal costs like increased healthcare burden (e.g., more doctor visits funded by taxpayers). The result is a welfare loss because social costs exceed social benefits at the private consumption level, causing market failure.

Question 54

Overproduction

Answer 54

Occurs when producers, like car factories, produce more than socially optimal levels, leading to pollution that negatively affects third parties, such as worsening asthma. As producers prioritize their private costs and benefits, they ignore the environmental and health damages caused by pollution. Without government intervention, overproduction continues, leading to market failure.

Question 55

Underconsumption

Answer 55

Happens when goods with positive externalities, such as fruit, are consumed below the socially optimal level. While consuming fruit can reduce healthcare costs by improving health, consumers fail to account for these broader social benefits. This results in underconsumption and a social welfare loss as the full potential benefits to society go unrealized.

Question 56

Underproduction

Answer 56

Involves goods with societal benefits, like green technology (e.g., solar panels), being produced below the socially optimal level. Although the production of solar panels has environmental advantages, producers only focus on their private benefits and costs, leading to a shortfall in production and missed societal benefits, resulting in a welfare loss.

Question 57

Under-provision of public goods

Answer 57

Public goods are goods/services that are often provided by the government with an intention to fill a missing market that private firms will not operate in. Public goods are often non-profit making e.g. a lighthouse. The main two characteristics of a public good are:
Non rival: this means that the consumption of a good/service by another individual does not reduce the amount of benefit derived from that good/service to other people. For example a person that is standing by a streetlight does not lose benefit from that street light if another person stands in the light also.
Non excludable: the benefit derived from the good/service is unable to be excluded from certain individuals. For example, a person that does not pay taxes will still benefit from the armed services who protect their country. The armed services cannot refuse to protect certain individuals who do not pay their taxes.

Question 58

Asymmetric information

Answer 58

Occurs when one party (either the consumer or producer) has more information than the other, leading to imbalanced decision-making. In the insurance market, consumers may withhold or understate information, causing companies to offer lower prices than they would with full information. Conversely, in the car market, dealers may know more about the car’s flaws but only disclose positive details, leading consumers to overvalue the car.

Question 59

Symmetric information

Answer 59

Occurs when both parties have equal information, often leading to better decision-making and efficient resource allocation. The rise of the internet and product reviews has increased transparency in markets like online shopping, reducing information gaps and improving resource allocation.

Question 60

Government Intervention of Maximum Prices

Answer 60

When the government sets a maximum price, it aims to make that product more affordable so that more people can buy it. However, since the price is lower, producers may not want to produce as much. Leading to a decrease in supply.

Question 61

Government Intervention of Minimum Prices

Answer 61

A minimum price is set by the government to make a product more expensive, often when the product causes negative externalities like alcohol. When the minimum price is higher than the original price, consumers have to buy it at the higher price. Supply increases because the product is profitable.

Question 62

The Tragedy of the Commons

Answer 62

The tragedy of the commons refers to a situation where individuals, acting in their own self-interest, overuse and deplete a shared resource, leading to its degradation or depletion. This happens because the resource is available to everyone (common access), but no one has an incentive to conserve it since they do not bear the full cost of overuse. Examples include overfishing, deforestation, or the overuse of public pastures.

Question 63

Property Rights

Answer 63

When property rights are clearly defined, individuals or businesses have a direct incentive to manage and protect their resources, reducing the likelihood of externalities. For instance, if someone owns a piece of land, they are more likely to prevent pollution or overuse of that land because they bear the direct consequences. This can help internalize external costs or benefits, leading to more efficient resource use and reducing negative externalities.