Chapter 7: Prices, resource allocation and concept of the margin

Question 1

Define the marginal principle

Answer 1

The idea that economic agents may take decisions by considering the effect of small changes from the existing situation

Question 2

Define rational decision making

Answer 2

A decision that allows an economic agent to maximize their objective, by setting the marginal benefit of action equal to its marginal cost

Question 3

What’s an important element in making choices

Answer 3

Opportunity cost

Question 4

How are decisions often taken?

Answer 4

By considering small changes to existing behavior

Question 5

What does the marginal principle underpin?

Answer 5

The notion of rational decision making

Question 6

What does the assumption of rationality enable?

Answer 6

Economists to model the behaviour of economic agents

Question 7

What type of circumstances may occur?

Answer 7

Circumstances in which decisions do not reflect this rational approach

Question 8

Define utility

Answer 8

The satisfaction received from consuming a good or service

Question 9

Define marginal utility

Answer 9

The additional utility gained from consuming an extra unit of a good or service

Question 10

Define the law of diminishing marginal utility

Answer 10

States that the more units of a good that are consumed, the lower the utility from consuming those additional units

Question 11

Name one way of interpreting the marginal utility that you receive from consuming a good

Answer 11

It informs your willingness to pay for it

Question 12

What will the decision to consume more of one good effect?

Answer 12

The consumption of complementary and substitute goods

Question 13

What does marginal utiltiy theory rest on?

Answer 13

The crucial assumption that consumers act rationally in taking decisions about their spending and consumption by setting out to maximize their utility

Question 14

Define price signal

Answer 14

Where the price of a good carries information to producers or consumers that guide the market towards equilibrium and assists in resource allocation

Question 15

What may happen in the long run if firms in a market are seen to be enjoying producer surplus?

Answer 15

This may attract other firms to enter the market which would be seen as an increase in supply at the market level, so that price would fall until there was no further incentive for firms to join the market

Question 16

If market forces are to allocate resources effectively, what do consumers need to do?

Answer 16

To be able to express their preferences for goods and services in such a way that producers can respond

Question 17

Why do consumers express their preferences through prices?

Answer 17

Prices will adjust to equilibrium levels following a change in consumer demand

Question 18

Producers have an incentive to respond to changes in prices. How does this occur in the short run?

Answer 18

Output adjustments of existing firms (movements along the supply curve)

Question 19

Producers have an incentive to respond to changes in prices. How does this occur in the long run?

Answer 19

Firms will enter the market (or exit from it) until there are no further incentives for entry or exit

Question 20

Illustrate productive efficiency on a PPF

Answer 20

Figure 7.5

Question 21

Define allocative efficiency

Answer 21

Achieved when society is producing the appropriate bundle of goods and services relative to consumer preferences - this occurs when price equals marginal cost

Question 22

Define economic efficiency

Answer 22

A situation in which both productive efficiency and allocative efficiency have been reached

Question 23

Evaluation points of economic efficiency and society (3)

Answer 23

1. Would the position of economic efficiency, would that always be the ideal position?
2. There may be issues surrounding equity
3. Economic efficiency is not the only objective of the society

Question 24

What’s the government’s role in a free economy?

Answer 24

A basic framework of property rights is essential, together with a basic legal framework

Question 25

What assures the incentives for the owners of capital?

Answer 25

Secure property rights

Question 26

Name 2 factors that Adam Smith felt interfered with the free market system

Answer 26

1. Over protectionism

2. Restrictions on trade

Question 27

What does an individual market exhibit aspects of?

Answer 27

Allocative efficiency when the marginal benefit received by society from consuming a good or service matches the marginal cost of producing it - when the price is equal to marginal cost

Question 28

What may a society also need to consider?

Answer 28

The distribution of resources in society, balancing equity with efficiency