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 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

• When the price of a product decreases, people’s real income effectively increases, allowing them to buy more of the product
• Conversely, if the price of a product rises, people’s real disposable income decreases, leading to a reduced quantity demanded

Question 6

Substitution Effect (HL)

Answer 6

When the price of a product falls, it becomes more attractive compared to products with unchanged prices, leading consumers to buy more of the cheaper product and substitute it for more expensive ones

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 - Cost of factors of production
• 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

Assumption underlying the law of supply (HL)

Answer 13

• the law of diminishing marginal returns
• increasing marginal costs

Question 14

The law of diminishing marginal returns (HL)

Answer 14

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

Question 15

Increasing marginal costs (HL)

Answer 15

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

Question 16

Equilibrium

Answer 16

Is where the supply and demand intersect

Question 17

Allocative efficiency

Answer 17

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

Question 18

Consumer surplus

Answer 18

Consumer surplus - when consumers buy a product at a price lower than they were willing to pay

Question 19

Producer surplus

Answer 19

Producer surplus - when producers sell a product at a price higher than they were willing to sell it for

Question 20

HL ONLY - Rational consumer choice

Answer 20

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

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

Question 21

Biases 1 - Rule of thumb

Answer 21

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 22

Biases 2 - Anchoring

Answer 22

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 23

Biases 3 - Framing

Answer 23

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 24

Bias 4 - Availability

Answer 24

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

Question 25

Bounded rationality

Answer 25

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 26

Bounded self-control

Answer 26

People conform to social norms and group preferences (which may not be their own preferences). People exercise self-control only within limits.

Question 27

Bounded selfishness

Answer 27

while rational consumers are assumed to prioritize their own well-being, they sometimes act reciprocally or altruistically, sacrificing personal welfare for the public good. Such unselfish behavior is oftne seen as less rational.

Question 28

Imperfect information

Answer 28

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

Question 29

Choice architecture

Answer 29

• Choice architecture is the deliberate design of different ways of presenting choices to members of society.
• Choice architects help to deal with the problem of choice overload. Effective choice architecture helps people avoid making poor choices or irrational decisions.

Question 30

Default choices

Answer 30

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 31

Mandated choices

Answer 31

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 32

Nudge theory

Answer 32

Nudges are created by choice architects using small prompts or tweaks to alter social and economic behaviour, but without taking away the power for people to choose

Question 33

Nudge Theory - When does it work best?

Answer 33

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 34

HL ONLY - Business objectives

Answer 34

profit maximisation (MR = MC)

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

Question 35

Alternative business objectives

Answer 35

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

Question 36

Market Share

Answer 36

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

Question 37

Corporate social responsibility (CSR)

Answer 37

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

Question 38

Satisficing

Answer 38

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

Question 39

Growth

Answer 39

Increasing the size and scale of the firm

Question 40

Status quo/inertia bias

Answer 40

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

Question 41

Hyperbolic discounting

Answer 41

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

Question 42

Movements along demand curve

Answer 42

Question 43

Movements along supply curve

Answer 43

Question 44

Consumer and Producer Surplus

Answer 44

Question 45

Shift in Demand

Question 46

Shift in Supply

Question 47

Explaining a diagram

Answer 47

1. Interpret the question and state assumptions and which determinant is occuring.
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, ad the quantity to increase from Q to Q1. This leads to an extension along the supply curve.