chapter 4 - the market economy

Question 1

the price mechanism - 1. price signalling

Answer 1

prices serve as signals of the relative scarcity of goods and services in the market. When demand for a good or service increases relative to its supply, its price rises, indicating its scarcity. conversely, when demand decreases or supply increases, prices fall signalling a surplus

Question 2

the price mechanism - incentive function

Answer 2

through their choices consumers send information to producers about their changing nature of needs and wants. one important feature of a free–market system is that decision making is decentralised, i.e there is no single body responsible for deciding what to produce and in what quantities. there is no single body responsible for deciding what to produce and in what quantities. there is in contrast to planned(state controlled) economic system where there is significant intervention in market prices and state ownership of key industries. Ireland has a mixed economy, so has elements of both.

Question 3

the price mechanism - rationing function

Answer 3

prices ration scarce resources when demanding outstrips supply. when there is a shortage, prices is bid up - leaving only those with willingness and ability to pay to buy

Question 4

what is the law of demand

Answer 4

the law of demand states that as prices rise the quantity demanded will fall and vice versa, cereris paribus ( all other things being equal )
we illustrate the law of demand using a downward sloping line from left to right. there is an inverse or negative relationship between the price of a good and the quantity demanded of that good
eg if price of a bar of chocolate increased by 5c per bar then the quantity demanded or purchased would fall

Question 5

what is a complementary good / joint demand

Answer 5

goods which are consumed together/ are used in conjunction with one another/ a rise in the price of one good will lead to a decrease in the demand for another good.
eg computer consoles and software games or monitors / cars and petrol

Question 6

what is effective demand

Answer 6

effective demand is demand supported by the necessary purchasing power

Question 7

what is derived demand

Answer 7

where a factor of production is not demanded for its own sake but rather for its contribution to the production process. the demand for land will decrease if there is a decrease in the demand for housing

Question 8

explain the difference between a normal good and a inferior good

Answer 8

normal good - a good that when peoples incomes go up (increase ) they demand more of them
eg branded jaffa cakes - McVitie’s , branded pasta

inferior good - a good that when people’s incomes go up, they demand less of them. they are usually cheaper versions of a good with different alternatives
eg tesco own brand jaffa cakes , tesco value brand pasta

Question 9

what is the relationship between individual demand and market demand

Answer 9

individual demand - the quality of a good an individual consumer demands at different prices

market demand - the total quantity of a good that all consumers demand at different prices

Question 10

what is the difference between movement and a shift of a demand curve

Answer 10

movement along a demand curve- caused by a change in the selling price of the good itself, all other things being equal

shift in a demand curve- if any of the factors other than the price of the good itself change, this will result in a shift in the demand curve

Question 11

factors that cause a shift of a demand curve (YSCTEUG)

Answer 11

income levels - if income rises than the demand for concert tickets will increase, assuming concert tickets is a normal good

change in price of a subsite good - if the price of tickets for an alternative concert increased then demand for tickets for this concert tickets may increase

change in price of a complementary good- if the price of a hotel accommodation near the concert venue decreased then the demand for the concert tickets may increase

taste/ preference - if the consumer preference for the artist/ event becomes stronger than the demand for concert tickets will increase

expectations about the future- if the consumers expect the performance to not be repeated they may increase their demand. if they expect ticket prices to rise in the future they may buy the ticket now and demand will increase

unplanned events - factors such as the weather may influence the current demand for tickets
eg good weather may increase demand for an outdoor event

government policies- advertising or awareness campaigns used to promote or show the effects of purchasing different goods/ services

Question 12

possible exceptions to the law of demand

Answer 12

1.status symbol/ snob items/ ostentatious goods- a rise in prices makes these goods more exclusive, and therefore more attractive to those who have the incomes to purchase them. a fall in price may lead to a fall in quantity demanded as there may no longer appear as exclusive to the rich and are still outside the price ranges of the poor

2. speculative goods - if the prospective consumers think that prices are likely to be even higher in the future, the current level of demand may not fall even if the prices increase. if a perso is considering buying a house the possibility that prices are likely to be even higher in the future will probability stimulate demand at current prices
3. goods of addiction - consumer become so addicted to a drug that in order to get the same “buzz” from the consumption of the drug, demand for the commodity may increase, even when the price of the commodity increases
4. giffen goods - as the prices falls, real incomes increase and consumers buy less of those goods and purchase more of better quality goods. as the prices rises consumers have less income to spend on other types of goods so they tend to devote more of their incomes to these goods

Question 13

what is a giffen good ?

Answer 13

a giffen god is a necessity that has very few substitutes that represent a large proportion of the expenditure of low income families. giffen goods react abnormally to changes in real income caused by a price change as such break the law of demand

Question 14

what is a substitute effect of a good ?

Answer 14

when the price of a good rises customers may shift to cheaper substitutes to maximise utility

Question 15

what is the income effect on a good ?

Answer 15

when the price of a good falls it means the consumers real income will rise

Question 16

what is the law of supply ?

Answer 16

the law of supply states that as prices the quantity supplied will rise and vice versa ceteris paribus ( all other things being equal ). we illustrate the supply curve using an upward sloping line for left to right

Question 17

describe the difference between a movement and a shift of a supply curve

Answer 17

a change in the selling price of the good itself will cause a movement along the supply curve and we term this change in the quantity supplied

a change in any of the factors other than price will cause the supply curve to shift to the right( an increase in supply ) or to the left ( a fall in supply). in this case we say that there has been a change in supply at any given price

Question 18

factors that cause a shift in supply ( ACTUNG)

Answer 18

price of an alternative good - if a firm can produce 2 gods (A&B) and sell them at a certain price. if the price a firm can sell B increases, the firm would want to increase their supply of B as they will earn more revenue. the firm would switch resources away from A to make more of B- so supply of A would fall , causing a leftward shift to the supply curve( even though A’s price is the same)

input costs - these are the costs of the firm to both labour and raw materials. if either of these inputs increase in costs and the firms cost of production will have risen causing an inward shift in the supply curve. conversely if input costs fall it will result in an outward shift in the supply curve

the firms technology - if there is a breakthrough in technology the supply curve will have an outward shift. conversely if there is a breakdown in technology an inward shift will occur

unplanned factors -eg adverse weather conditions leading to a bad harvest would result in an inverse shift in the supply curve. conversely a bump in harvest would be an example of a factor causing an outward shift

number of sellers - if the number of firms in a market increases, supply will rise, causing a rightward shift of the supply curve. if fewer firms are in the market, supply will fall, causing a leftward shift of the supply curve

government taxation/ subsidies - increases in government taxation on a product itself would result in an inward shift in the supply curve, while a reduction in taxation on a product would cause an outward shift in the supply curve. if a subsidy is granted in the raw materials or on the labour employed by the firm, this has the effect of reducing costs and thereby resulting in an outward shift in the supply curve

Question 19

what is the difference between individual and market supply

Answer 19

individual supply - the quantity of a good an individual firm is willing to supply at different prices

market supply - the total quantity of a good that all firms are willing to supply at different prices

Question 20

what is the market equilibrium ?

Answer 20

market equilibrium arises at the price and quantity where the quantity demanded equals the quantity supplied and there is no tendency for price to change

Question 21

what excess demand ?

Answer 21

if the price on the market is below the equilibrium price, a situation of excess demand will occur. excess demand will drive up the price of a product. eventually as the price begins to rise demand will decrease and supply will increase. price will continue to rise until equilibrium is restored at the equilibrium price

Question 22

what is excess supply ?

Answer 22

if the price on the market is above the equilibrium price, a situation of excess supply will occur as buyers are not willing to pay the high price. there will be a downward pressure on price. quantity supplied will exceed quantity demanded and firms will lower price to sell the surplus items. firms will reduce stock levels by reducing price. the lower prices will encourage an increase in demand. price will continue to fall until equilibrium is restored at the equilibrium price

Question 23

what is a consumer surplus and a producer surplus

Answer 23

consumer surplus - this is the difference between what the consumer actually pay and what he would have be willing to pay

producer surplus - this is the difference between the actual price a firm receives for selling something and the price it would have being willing to sell it at