How Markets Work 1.2

Question 1

What are the 3 assumptions of rational economic decision making?

Answer 1

• Consumers aim to maximize utility
• Producers aim to maximize profit
• Government aims to maximize satisfaction

Question 2

What is Demand?

Answer 2

The ability and willingness to buy a particular good at a given price

Question 3

What are the 7 Conditions of Demand? mnemonic

Answer 3

PIRATES
- Population
- Income
- Related Goods
- Advertisement
- Tastes
- Expectations
- Seasons

Question 4

What is Diminishing Marginal Utility?
- What does it explain?

Answer 4

The satisfaction gained from the consumption of an additional unit of a good decreases as more of it is consumed
- Explains why the Demand Curve slopes downwards

Question 5

What does PED stand for and what is it?

Answer 5

Price Elasticity of Demand
- The responsiveness to change in demand with an increase in price

Question 6

What factors affect PED?

Answer 6

• Time (i.e. if they don’t need it right away)
• Substitutes
• Necessity
• Addictiveness
• % of total Expenditure

TANES

Question 7

What is the significance of PED?
- Explain in terms of elastic and inelastic Demand Curves

Answer 7

Determines the effectiveness of the imposition of indirect taxes and subsidies
- I.e. more elastic Demand curve means lower incidence of tax for consumer
- more inelastic, consumers pay more, however less effective at reducing output (cus consumers still want it), and Government revenue increases

Question 8

What is YED?

Answer 8

Income Elasticity of Demand
- The responsiveness to change in Demand with Change in income

Question 9

What is the significance of YED?

Answer 9

• Lets firms know how sales are affected by Change in income
• Allows firms to know what goods to produce and how much

*obviously because if the population have more money, they more shit to spend it on init

Question 10

What is XED?

Answer 10

Cross Price Elasticity of Demand
The responsiveness of Demand for Good A with change in price of Good B

Question 11

What is the Significance of XED?

Answer 11

• Lets firms know how prices of goods from other firms will affect them (competition init)

Question 12

What is Supply?

Answer 12

The ability and willingness to provide goods and services at a given price

Question 13

What are the Conditions of Supply? (movement)

Answer 13

PINTSWC
- Productivity
- Indirect Taxes
- Number of Firms
- Technology
- Subsidies
- Weather
- Cost of production

Question 14

What does PED stand for and what does it mean?

Answer 14

Price Elasticity of Supply
- The responsiveness of supply with change in price

Question 15

What factors affect PES?

Answer 15

TWEASA
- Time
- Working below full capacity
- Ease of entry into the market
- Availability of the factors of production
- Stocks
- Availability of Substitutes

Question 16

How is excess demand caused?

Answer 16

When the price is set lower than the equilibrium point

Question 17

How is Excess Supply caused?

Answer 17

When the price is set higher than the equilibrium point

Question 18

What are the 3 functions of the Price Mechanism? Explain them.

Answer 18

• Rationing Function: Only those who can afford the good can buy them
• Signalling function: The price Mechanism acts as a signal for where resources should be allocated (e.g., if price increases for a product, so does quantity)
• Incentive Function: Incentive for people to earn more so they can buy more; suppliers supply more to earn more

Question 19

What is consumer and producer surplus?

Answer 19

• Consumer surplus: The difference between the price consumers are willing to pay and how much they actually pay
• Producer Surplus: The difference between the price suppliers are willing to supply at and the price they actually supply at

Question 20

What is Indirect Taxes? What are the 2 types and explain them

Answer 20

Indirect Taxes: Tax on expenditure
- Ad Valorem: Tax proportional to the value of a good (percentage tax, e.g, VAT)
- Specific Tax: Specific cost added (e.g., 10p per litre)

Question 21

What is the general impact of Indirect taxes?

Answer 21

• Supply falls and prices rise

Question 22

What is a subsidy?

Answer 22

Subsidies: Grants by the government

Question 23

What are the 3 Irrational Consumer Behaviours? Explain them.

Answer 23

• Influence of others: Herd behavior or following trends of other people to ‘fit in’
• Influence of Habitual Behaviour: Habits that dont change because it saves time and effort
• Consumer weakness at computation: Consumers who are not willing or able to make comparisons between goods/ services