Competitive markets

Question 1

Income effect

Answer 1

as price falls, the amount that consumers can buy with their income increases therefore demand increases

Question 2

Substitution affect

Answer 2

Fall in price of one good means consumers will increase demand for cheaper good and reduce demand for more expensive good

Question 3

Factors that cause shift in demand curve

Answer 3

• changes in taste and fashion
• changes to people’s real income (the amount of goods/services that a consumer can afford to purchase with their real income)

Question 4

How changes in real income affect different types of goods

Answer 4

Normal goods - those which people demand more if their real income rises. YED>0
Inferior goods - those which people demand less of if their real income rises. YED<0
Luxury goods - more equal distribution causes demand for luxury goods to decrease - less rich people

Question 5

Substitute goods

Answer 5

An increase in the price of one good will increase the demand for its substitutes. XED>0

Question 6

Complementary goods

Answer 6

Often used together, in joint demand. If the price of one good increases, the demand for both goods decreases. XED<0

Question 7

Derived demand

Answer 7

The demand for a good or a factor of production used in making another good or service

Question 8

Composite demand

Answer 8

Some goods have more than one use e.g. oil can be used to make plastics or for fuel. This means changes in demand for fuel will lead to changes in demand curve for plastics

Question 9

PED equation

Answer 9

%change in quantity demanded / %change in price

Question 10

Elastic demand

Answer 10

PED > 1

Perfect elastic demand has PED +/- infinity; any increase in price means demand will fall to zero

Question 11

Inelastic demand

Answer 11

0

Question 12

Unit Elasticity of demand

Answer 12

PED = +/- 1

Good has unit elasticity if %change in price = % change in quantity demanded

Question 13

Income elasticity of demand

Answer 13

YED = % change in quantity demanded of a good / % change in real income

Question 14

Cross elasticity of demand

Answer 14

XED = % change in quantity demanded of good A / % change in price of good B
If two goods are substitutes, XED = Positive
If two goods are complementary, XED = Negative

Question 15

Factors influencing price elasticity of demand

Answer 15

1) Substitutes - the more substitutes, the more elastic. Number of substitutes depends on how closely it’s defined
2) Type of good (or service) - essentials = inelastic. Non essentials = elastic
- Demands for goods that are habit forming are inelastic
- Demand for purchases that can’t be postponed are inelastic (e.g. emergency plumbing to fix a broken pipe)
- Demand for products with several uses (water) are inelastic
3) % of income spent on good - If high % of income, more elastic
4) Time - in LR, demand more elastic - easier to find alternatives

Question 16

Factors that cause shift in supply curve

Answer 16

• changes to costs of production (e.g. raw materials, wages etc.)
• improvements in tech -> reduce costs of production -> increase supply
• increased productivity of a factor of production -> more output from a unit of the factor
• indirect taxes and subsidies -> taxes increase costs for producer
• > subsidies reduce cost
• changes to price of other goods
• number of suppliers

Question 17

Price elasticity of supply

Answer 17

PES = % change in quantity supplied / % change in price
Elastic supply PES>1
Inelastic supply 0

Question 18

Why is high PES important to firms?

Answer 18

Firms aim to respond quickly to changes in supply and demanded therefore need to make supply elastic
Measures to improve elasticity of supply: flexible working patterns, using new tech, having spare production capacity

Question 19

Short run

Answer 19

time period when a firm’s capacity is fixed, and at least one factor of production is fixed

Question 20

Long run

Answer 20

All factors of production are variable -> firm can increase capacity

Question 21

Supply in SR and LR

Answer 21

SR: hard to switch between production of goods in short time therefore inelastic
LR: firms have longer to react to changes in supply and demand therefore more elastic

Question 22

Factors that affect PES

Answer 22

• during periods of unemployment -> easier to attract new workers therefore elastic
• perishable goods (fruit and veg) can’t be stored for long therefore inelastic
• firms with high stock levels are able to increase supply quickly if they want therefore elastic
• industries with more mobile factors of production tend to be more elastic

Question 23

Functions of the price mechanism

Answer 23

1) Acts as incentive to firms
2) Acts as signalling device e.g. change in price
3) Acts to ration scarce resources

Question 24

Advantages of price mechanism

Answer 24

• resources allocated efficiently to satisfy consumers’ needs and wants
• can operate without cost of employing people to regulate
• consumers decide what is and isn’t produced by producers
• prices kept to min as resources used efficiently

Question 25

Disadvantages of price mechanism

Answer 25

• inequality in wealth and income is likely
• underproduction of merit goods and over production of demerit goods as not all socially optimum level
• low skilled people will suffer unemployment or low wages
• public goods not produced

Question 26

Consumer surplus

Answer 26

• the difference between the price that a consumer is willing to pay for a good or service and the price they actually pay
• the area below the demand curve and above the equilibrium point

Question 27

Producer surplus

Answer 27

the difference between the price that a producer is willing to supply a good or service at and the price they actually receive for it
- the area above the supply curve and below the equilibrium price line