How markets work

Question 1

What is rational decision making for a consumer and producer?

Answer 1

A rational consumer will try maximise their utility or satisfaction with the goods and services they buy. A rational producer will use their resources to try maximise profits.

Question 2

What is Utility?

Answer 2

Utility is the total satisfaction or benefit derived from consuming a good or service.

Question 3

What causes movements up and down the demand/supply, curve/line?

Answer 3

A price change

Question 4

What does the acronym PASIFIC stand for which shifts demand.

Answer 4

Population, Advertisements, Substitutes, Income taxes, Fashion and trends, Interest rates, Complements.

Question 5

What does the acronym PINTSWC stand for which shifts supply.

Answer 5

Productivity, Indirect Tax, No of firms, Technology, Subsidies, Weather, Cost of production.

Question 6

What is the formula for Price elasticity of demand (PED)?

Answer 6

% Change in quantity demanded / % Change in price

Question 7

If PED (elastic) price increases, what happens to Total revenue?

Answer 7

Decreases

Question 8

If PED (Inelastic) price increases, what happens to total revenue?

Answer 8

Increases

Question 9

What factors influence PED?

Answer 9

Cost of switching suppliers, availability of close substitutes, brand loyalty… etc

Question 10

What is the formula for Income elasticity of demand (YED)

Answer 10

% Change in quantity demanded / % Change in income

Question 11

What type of good is YED positive and why?

Answer 11

Normal good, (when income rises, the Quantity demanded increases). If it’s between 0 and 1 it indicates the good is a necessity, if it’s between 1 and infinity it indicates a luxury good.

Question 12

What type of good is YED negative and why?

Answer 12

Inferior good, (when income rises, quantity demanded decreases) . -for example including lower quality or generic foods, used or older cars etc. - people would buy less of these goods and may shift to higher-quality alternatives.

Question 13

What is the formula for Cross elasticity of demand (XED)?

Answer 13

% Change in demand for good A / % change in price of good B

Question 14

What does XED positive mean?

Answer 14

It is a substitute, and a close substitute has a strong elasticity of supply. (e.g. small change in relative to price).

Question 15

What does XED negative mean?

Answer 15

It is a complement. A high complement would be considered as a high negative number.

Question 16

What does XED 0 mean?

Answer 16

Unrelated product

Question 17

What is the formula for Price elasticity of supply (PES)?

Answer 17

% Change in quantity supplied / % Change in Price

Question 18

What does PES 0 mean?

Answer 18

Perfectly inelastic supply - supply does not change when price does.

Question 19

What does PES 0-1 mean?

Answer 19

Inelastic supply - % change in supply is smaller than %
change in price.

Question 20

What does PES 1 or more?

Answer 20

Elastic supply - % change in supply (responds more) to a % change in price.

Question 21

What does PES = ∞ mean?

Answer 21

Perfectly elastic supply - There is only one price consumers are willing to pay.

Question 22

What is price determination?

Answer 22

Price determination is the process of how the forces of demand for goods and services and the supply of goods and services in a market interact to determine the price.

Question 23

What are the functions of the price mechanism?

Answer 23

Signalling - signals prices through shifts in the market

Incentive - e.g When prices rise, producers are incentivized to increase production, while consumers are incentivized to reduce their consumption.

Rationing - When the supply of a good is limited, its price increases, which can help to reduce demand and allocate the available quantity to those who are willing and able to pay the higher price.

Allocating resources - Prices adjust accordingly, and resources are allocated to where they are most valued. (sorted through signalling)

Question 24

What is the difference between the consumer and producer surplus?

Answer 24

When the supply of a good is limited, its price increases, which can help to reduce demand and allocate the available quantity to those who are willing and able to pay the higher price.

Question 25

List alternative views of consumer behaviour

Answer 25

1. Influence of Other People’s Behaviour |herd-like mentality|- following the behaviour of one another
2. Importance of |Habitual Behaviour | - is a routine followed. examples: coffee, vaping, smoking, alcohol

3.Consumer Weakness at Computation - consumers find it difficult to calculate the probability of something happening when they make purchasing decisions. For example, people may underestimate the long-term health consequences of eating processed meats or relying heavily on prescription painkillers.