Demand, Supply and Equilibrium

Question 1

Demand

Answer 1

The willingness and the ability to purchase a particular good at a given price and time, ceteris paribus.

Question 2

The Law of Demand

Answer 2

• Price increase, quantity demanded decrease
• Price decrease, quantity demanded increase

Question 3

Non-price Determinants for Shifts in Demand Curve

Answer 3

PEPSIC

Preference
Expectations
Population
Substitutes
Income
Complementary

Question 4

Assumptions of the Law of Demand (HL)

Answer 4

• The income effect
• The substitution effect
• The law of diminishing marginal utility

Question 5

Income Effect (HL)

Answer 5

• A price drop increases real income, boosting quantity demand.
• A price rise reduces real income, reducing quantity demanded.

Question 6

Substitution Effect (HL)

Answer 6

When a product’s price falls, it becomes more attractive, leading consumers to substitute it for pricier options.

Question 7

The law of diminishing marginal utility (HL)

Answer 7

As consumption increases, the additional satisfaction from each unit decreases, so consumers buy more only at lower prices.

Eventually, marginal utility reaches zero, and they stop wanting more.

Question 8

Supply

Answer 8

The willingness and ability to produce a particular good at a given price and time, ceteris paribus.

Question 9

The Law of Supply

Answer 9

Price increase, quantity supplied increase
Price decrease, quantity supplied decrease

Question 10

Shifts in the Supply Curve (non-price determinants)

Answer 10

• Input costs
• Price of other goods the supplier could make (sometimes called a “supplier substitute”)
• Weather
• Technology
• Expectations
• Government intervention

Question 11

Indirect tax/Expenditure

Answer 11

A tax on goods and services

Question 12

Subsidy

Answer 12

A payment by the government to a producer per unit of output to increase the supply of a good or to lower production costs.

Question 13

Assumptions underlying the law of supply (HL)

Answer 13

• The law of diminishing marginal returns
• Increasing marginal costs

Question 13

The law of diminishing marginal returns (HL)

Answer 13

After reaching an optimal production level, adding more of a production factor results in smaller output increases

Question 14

Increasing marginal costs (HL)

Answer 14

Marginal cost is the increase in cost caused by producing one more unit of the good

Question 15

Equilibrium

Answer 15

Is where the supply and demand intersect

Question 16

Allocative efficiency

Answer 16

Resources are allocated into their best possible use (the most efficient way from society’s point of view)

Question 17

Consumer surplus

Answer 17

When consumers buy a product at a price lower than they were willing to pay

Question 17

Producer surplus

Answer 17

When producers sell a product at a price higher than they were willing to sell it for

Question 18

HL ONLY - Rational consumer choice

Answer 18

Rational choice theory states that individuals make logical decisions to maximize their self-interest:

• consumers aim to maximize utility
• producers aim to maximize profit

Question 19

Biases 1 - Rule of thumb

Answer 19

Making decisions in a practical way without having to be exact; judging a situation by experience and sticking to a default choice.

E.g. Children choosing the same food at McDonalds
E.g. When we assume that discounted prices are cheaper than the average price
E.g. Drivers in autopilot mode when choosing route home

Question 20

Biases 2 - Anchoring

Answer 20

People understand the unfamiliar by comparing it to something familiar and often make decisions based on the first piece of information they encounter, even if it’s irrelevant

Question 21

Biases 3 - Framing

Answer 21

Presenting information in such a way that it creates a bias in favour of a particular decision

E.g. Yogurt is sold as 90% fat free it would be more successful than if labelled 10% fat

Question 22

Bias 4 - Availability

Answer 22

People tend to overestimate the likelihood of an event occurring due to recent similar occurrences or emotional associations with similar events.

Question 23

Bounded rationality

Answer 23

People often make decisions without access to all relevant information or the ability to process it all due to limited capacity

Decisions are often based on incomplete information because rationality is bounded by:

• people’s thinking capacity
• the availability of information
• time

E.g. When ordering at a restaurant, customers will make suboptimal decisions because they feel rushed by the waiter

Question 24

Bounded self-control

Answer 24

People conform to social norms and group preferences (which may not be their own preferences).

People exercise self-control only within limits.

Question 25

Bounded selfishness

Answer 25

Rational consumers may act selflessly, sacrificing personal gain for the public good.

Question 26

Imperfect information

Answer 26

Imperfect information is when people have inaccurate, incomplete or unreliable information, so decision making is not optimal.

Question 27

Choice architecture

Answer 27

Choice architecture designs how choices are presented, guiding people to avoid poor or irrational decisions.

Question 28

Default choices

Answer 28

• When a person is automatically signed up into a system, or it is the given decision if no action is taken

E.g. employees enrolled in a pension scheme
E.g. restaurants default side option is a salad

Question 29

Mandated choices

Answer 29

When people are required to make an advanced decision and declare whether/how they wish to participate in a particular activity.

E.g. applying for a new driving license, we are asked whether we wish to donate organs in the event of death

E.g. Governments ask individuals to declare how they will vote (by post or in a polling station).

Question 30

Nudge theory

Answer 30

Nudges are small prompts by choice architects to subtly influence behavior without removing choice.

Question 31

Nudge Theory - When does it work best?

Answer 31

E - Easy (removing friction and simplifying things in order to influence people)

A - Attractive (break through attention)

S - Social (humans are influenced by what others do)

T - Timely (determining when people are most responsive)

Question 32

HL ONLY - Business objectives

Answer 32

profit maximisation (MR = MC)

• profit increase if MR > MC
• profit decrease if MC > MR

Question 33

Alternative business objectives

Answer 33

• Corporate social responsibility (CSR)
• Market share
• Satisficing
• Growth

Question 34

Market Share

Answer 34

A firm’s portion of total value of sales in a particular industry

Question 35

Corporate social responsibility (CSR)

Answer 35

Firms aim for ethical objectives rather than aiming solely or primarily for profit

Question 36

Satisficing

Answer 36

Aiming for a satisfactory or adequate level of profit rather than the maximum profit

Question 37

Growth

Answer 37

Increasing the size and scale of the firm

Question 38

Status quo/inertia bias

Answer 38

When confronted with numerous choices, consumers prefer to maintain status quo and do nothing

Question 39

Hyperbolic discounting

Answer 39

Tendency for humans to prefer smaller short term rewards over larger later rewards

Question 40

Movement along demand curve

Answer 40

Question 41

Movement along supply curve

Answer 41

Question 42

Consumer and Producer Surplus

Answer 42

Question 43

Shift in Demand

Answer 43

Question 44

Shift in Supply

Answer 44

Question 45

Explaining a diagram

Answer 45

1. Interpret the question and state assumptions and which determinant is occurring.
2. Curve shift.
3. Effect on price and quantity.
4. Effect on the other curve (extension or contraction).

E.g.

Assuming that jam and marmalade are substitutes (one can be used in place of the other), which is a determinant of demand, if the price of marmalade increases then consumers will buy more jam. This shifts the demand curve for jam outwards, increasing demand, from D to D1, which will cause the price to increase from P to P1, and the quantity to increase from Q to Q1. This leads to an extension along the supply curve.