How Markets Work

Question 1

What do markets have in common

Answer 1

One thing markets have in common is that buyers and sellers come into contact for the purpose of exchange. A price is agreed for exchange to take place. By price we mean the exchange value of a good or service.

Question 2

What do buyers represent in markets

Answer 2

Buyers or consumers represent the demand side of the market

Question 3

What do sellers represent in the market

Answer 3

Sellers or producers represent the supply side of the market.

Question 4

What is a market

Answer 4

Where consumers and producers come into contact with each other to exchange goods and services.

Question 5

What do we assume consumers to be

Answer 5

Consumers are assumed to make rational decisions. This means consumers will allocate their income to maximise their utility or satisfaction from the goods and services they purchase.

Question 6

What is utility

Answer 6

Utility refers to the amount of satisfaction obtained from consuming a good or service. Economists often make the assumption that utility can be measured.

Question 7

Define utility

Answer 7

The amount of satisfaction obtained from consuming a good or service.

Question 8

How is a consumer rational

Answer 8

A rational consumer will allocate his or her spending to maximise utility from the goods and services purchased. This requires the individual to equate the utility gained per £ spent on the last unit of each good or service. Eg. If a consumer has an extra £100 to spend then it could be used to buy a £20 T shirt and an £80 pair of shoes. We assume the t shirt would provide 40 units of extra utility (or marginal utility) and the pair of shoes 160 units of extra (or marginal) utility. In this way, the utility gained from the last unit of each good is equated (2 units of utility per £1 spent) maximising consumer utility is shown by the following formula:

Marginal utility of T shirt / price of T shirt = marginal utility of pair of shoes / price of pair of shoes.

Question 9

What do we assume producers to do

Answer 9

Producers are assumed to make rational decisions. This means firms will use their resources to maximise profits from the goods and services produced. This involves producing at a level of output where total revenue exceeds total cost by the largest amount.

Question 10

What is rational decision making

Answer 10

Where consumers allocate their expenditure on goods and services to maximise utility, and producers allocate their resources to maximise profits.

Question 11

What is demand

Answer 11

The buyers of consumers in a market are said to demand goods or services. Demand refers to the quantity of a good or service purchased at a given price over a given time period.

Demand is different from just wanting a good or service, it is a want backed up by the ability to PAY, which is also known as EFFECTIVE DEMAND

Question 12

Define demand

Answer 12

The quantity of a good of service purchased at a given price over a given time period.

Question 13

What does a demand curve show

Answer 13

A demand curve shows the quantity of a good or service that would be bought over a range of different price levels ins given period of time.

Question 14

What is the demand curve like

Answer 14

The demand curve for a good slopes downwards from left to right because, as price falls, the good becomes cheaper compared to substitute goods and also more can be purchased with a given level of income.

Question 15

Define the demand curve

Answer 15

Shows the quantity of a good or service that would be bought over a range of different price levels in a given period of time.

Question 16

What’s the market demand curve

Answer 16

The market demand curve is the horizontal summation of each individual demand curve for a particular good or service in the market.

Question 17

Where is there a movement along the demand curve

Answer 17

There is a movement along a demand curve for a good ONLY when there is a change in its price. A fall in price causes an extension in demand, and a rise in price causes a contraction in demand.

Eg. If demand curve like this \ , a rise in price causes a contraction in demand towards the top left.

Question 18

How can the downward sloping demand curve be explained by a concept involving marginal utility

Answer 18

The concept of diminishing marginal utility explains this. As one consumes more of a good, the utility or satisfaction gained from each extra unit will tend to fall or diminish.

Note that total utility from the good will increase as more is consumed, but this occurs at a diminishing rate.

As marginal utility falls from each extra good consumed, it means consumers will only buy more of it if the price falls - hence the downward sloping demand curve.

Question 19

Define marginal utility

Answer 19

The utility or satisfaction obtained from consuming one extra unit of a good or service.

Question 20

Define diminishing marginal utility

Answer 20

As successive units of a good are consumed, the utility gained from each extra unit will fall.

Question 21

What does a change in demand refer to

Answer 21

An increase in demand refers to the whole demand curve shifting outwards to the right at every price level. A decease in demand refers to the whole demand curve shifting inwards to the left at every price level.

Question 22

List 8 factors which can shift the demand curve for a good

Answer 22

A fall in the price of complimentary goods
A rise in the price of substitute goods
A change in fashion and tastes
Increased advertising
An increase in real incomes
A decrease in income tax, leads to an increase in disposable income.
An increase in the population or a change in the age structure of the population so they may like different products.
An increase in credit facilities, makes it easier to obtain funds for goods.

Question 23

What will a change in price level lead to with the demand curve

Answer 23

A change in price of a good will lead to a movement along the demand curve for that particular good; it will not shift the demand curve.

Question 24

What is price elasticity of demand

Answer 24

PED is the responsiveness in the demand for a good due to a change in its price.

Question 25

What’s the formula for PED

Answer 25

PED = %change in quantity demanded of good A / %change in price of good A

= %change D / %change P

In most circumstances, a minus answer is obtained, indicating that the two variables of price and demand move in opposite directions. There is a negative gradient.

Question 26

Define price elasticity of demand

Answer 26

The responsiveness of demand for a good or service to a change in its price.

Question 27

What does it mean if PED is greater than 1

Answer 27

The good is relatively price elastic, percentage change in demand is greater than the percentage change in price.

Question 28

What does it mean if PED is less than 1

Answer 28

The good is relatively price inelastic, the percentage change in demand is less than the percentage change in price.

Question 29

What does it mean if PED is equal to 1

Answer 29

The good has unit elasticity, percentage change in demand is the same as the percentage change in price.

Question 30

What does it mean if PED is equal to zero

Answer 30

The good is perfectly inelastic, change in price has no effect on quantity demanded. Demand curve is vertical

Question 31

What does it mean if PED is infinite

Answer 31

The good is perfectly elastic, a rise in price causes demand to fall to zero. Demand curve is horizontal.

Question 32

What does PED look like on a graph when it’s unitary elastic

Answer 32

A curve, like a the first half of a u

Question 33

What does a minus sign answer for PED mean

Answer 33

A fall in price leads to increase of demand

If PED is greater than 1, we also include number with minus eg. -2 and count it as included in this category, the minus sign just tells us the relationship.

Question 34

What happens with PED and demand curves

Answer 34

Don’t confuse elasticity with the gradient of a demand curve. Straight line demand curves have constant gradients but different elasticities along them.

Question 35

Tell me about the relationship between price elasticity of demand and total revenue.

Answer 35

Elasticity varies along a straight line demand curve. Elasticity falls as you move a long the curve from top left (elastic demand) to the bottom right (inelastic demand ) and equilibrium position (unit elasticity)

Total revenue forms an n shape curve with the max point/ max total revenue at the equilibrium position of the demand curve.

Question 36

What is total revenue

Answer 36

Total revenue refers to the total payments a firm receives from selling a given quantity of goods or services. It is the price per unit of a good multiplied by the quantity sold. The total revenue a firm receives from selling a good will be equal to the total spending by consumers on that good.

Question 37

Define total revenue

Answer 37

The price per unit of a good multiplied by the quantity sold

Question 38

When will a firms total revenue increase

Answer 38

A firms total revenue will increase as long as price is moving towards the mid position of the demand curve (unit elasticity).

Question 39

Why is it important for firms to know the PED of their output

Answer 39

It is important to know when making pricing decisions, because this affects revenue and profitability.

Question 40

What happens to revenue when demand is elastic

Answer 40

If demand is elastic, then a cut in price increases total consumer spending and hence revenue to the firm. On the other hand, a rise in price causes total consumer spending to fall and so firms lose revenue.

Question 41

What happens to revenue when demand is inelastic

Answer 41

If demand is inelastic, then an increase in price increases total consumer spending and hence revenue to the firm. On the other hand, a fall in price causes total consumer spending to fall and so firms to lose revenue.

Question 42

What happens to revenue when demand is unit elastic

Answer 42

Once unit price elasticity has been reached, the firm is maximising its total revenue.

Note the relationship between PED and marginal revenue, which falls during a move down the demand curve. As long as marginal revenue is positive, demand is price elastic. When marginal revenue is 0, demand is unit elastic, when marginal revenue is negative, demand is inelastic.

Question 43

List the determinants of price elasticity of demand

Answer 43

Availability of substitutes

Luxury and necessity goods

Proportion of income spent on the good

Addictive and habit forming goods

The time period

Brand image

Question 44

Tell me how availability of substitutes is a determinant if PED

Answer 44

The more narrowly a good is defined, the more substitutes it tends to have and so its demand is elastic. For example, cod, a type of fish, has many substitutes such as plaice, rock, salmon and haddock.

However, the more broadly a good is defined, the fewer substitutes it tends to have and so it’s demand is less elastic. For example, there are few close substitutes for fish as a whole and so demand tends to be relatively less elastic.

Question 45

Tell me how luxury and necessity goods are a determinant of PED

Answer 45

Luxury goods, such as racing cars and caviar, tend to have an elastic demand, whereas necessity goods, like bread and underwear, tend to have an inelastic demand.

Question 46

Tell me how the proportion of income spent on the good is a determinant of PED

Answer 46

If a high percentage of income is spent on the good, as with a new car or boat, demand tends to be price elastic. However, for goods that take up a small percentage of income, such as newspapers and tomato sauce, demand will tend to be price inelastic.

Question 47

Tell me how addictive and habit forming goods are a determinant of PED

Answer 47

Tobacco, alcohol, and coffee are types of goods that tend to be price inelastic in demand

Question 48

Tell me how the time period is a determinant of PED

Answer 48

For most goods, demand is less elastic in the short term than the long term. For example, a rise in the price of household electricity is likely to have only a minor effect on consumption in the short run. In the long run, households can cut back on consumption by switching to gas for their cooking and heating. This means demand eventually becomes more responsive to changes in price .

Question 49

How is brand image a determinant of PED

Answer 49

Some goods have a strong brand image, eg Levi jeans and Coca Cola. Demand for these goods is typically price inelastic as consumers are often willing to pay a premium price for them.

Question 50

Define income elasticity of demand

Answer 50

The responsiveness of demand for a good or service to a change in income

Question 51

What is YED

Answer 51

Income elasticity of demand, is the responsiveness of demand for a good or service to a change in real income.

Question 52

What is real income

Answer 52

Real income refers to the spending power of money income - the amount of goods and services which can be purchased with ones nominal income.

Question 53

What’s the formula for YED

Answer 53

YED = percentage change in demand for a good / percentage change in real income

YED = %change In D/ %change in Y

Question 54

What does it mean when YED is positive

Answer 54

In most circumstances, YED is positive, which means the two variables of income and demand move in the same direction. In other words, a rise in income causes a rise in quantity demanded.

This is a NORMAL GOOD

Note that some economists identify goods which have a YED above +1 as a LUXURY GOOD, but these are STILL a type of normal good.

Question 55

A good with YED less than 1 means ….

Answer 55

The good is relatively income inelastic

Question 56

A good with YED above 1 is…

Answer 56

A good that is relatively income elastic in demand

Question 57

A good with YED equal to 1 means…

Answer 57

The good has unitary elasticity

Question 58

Define normal good

Answer 58

A good with a positive income elasticity of demand. As income rises, so too does demand for the good.

Question 59

Describe an inferior good

Answer 59

Occasionally, YED is negative which means the two variables of income and demand move in opposite directions. This is because people tend to demand higher quality goods as their income rises, substituting them for lower quality products.

Examples include minced meat and supermarkets own value brands of food eg Waitrose essential 🤮🤮🤮

Question 60

Define inferior good

Answer 60

A good with a negative income elasticity of demand. As income rises, demand for the good falls.

Question 61

Compare the demand curves for a normal vs inferior good

Answer 61

On a graph of income (y) and quantity demanded (x),

A normal good has a positive gradient demand curve

An inferior good has a negative gradient demand curve. (As income rises QD falls)

Question 62

What does XED stand for

Answer 62

Cross elasticity of demand

Question 63

What is cross elasticity of demand

Answer 63

it is the responsiveness of demand for good B to a change in price of good A.

Question 64

What’s the formula for XED

Answer 64

XED = percentage change in demand for good B/ percentage change in price for good A

XED = %change in D for good B/ %change in P for good A

Question 65

Define cross elasticity of demand

Answer 65

The responsiveness of demand for good B to a change in price of good A

Question 66

What’s a common error with XED

Answer 66

Students compare change in demand for one good to change in demand for another - THIS IS WRONG NO !

Question 67

What is XED used for

Answer 67

It is used to determine whether goods are complements or substitutes for each other.

Question 68

What are substitute goods

Answer 68

Substitute goods are in competitive demand. For example, a rise in the price of coffee may cause an increase in demand for tea. XED is positive for substitute goods, as the two variable of price and demand move in the same direction. There is a positive gradient.

Question 69

What are complementary goods

Answer 69

Complementary goods are in joint demand. They tend to be consumed together. For example, a fall in the price of tennis rackets may cause an increase in demand for tennis balls. XED is negative for complementary goods, as the two variables of price and demand move in opposite directions. There is a negative gradient

Question 70

What are unrelated goods

Answer 70

Unrelated goods have a XED value of zero, for example, an increase in the price of cars will have no effect upon the demand for potatoes.

Question 71

What do the demand curve on graphs of XED for substitute and complementary goods look like

Answer 71

On a graph of price of a good A (y) and quantity demanded of good B (x)

Substitute goods have a positive gradient, as a price of good A increase demand for good B increase

Complementary goods have a negative gradient demand curve

Question 72

What does a cross elasticity of zero mean

Answer 72

There is no relationship between the goods, such as a chocolate bar and beef

Question 73

What is supply

Answer 73

The sellers or producers in a market are said to supply goods and services.

Supply refers to the quantity of a good or service that firms are willing to sell at a given price and over a given period of time.

Question 74

Define supply

Answer 74

The quantity of a good or service that firms are willing to sell at a given price and over a given period of time.

Question 75

What is the supply curve

Answer 75

A supply curve is the quantity of a good or service that firms are willing to sell to a market over a range of different price levels in a given period of time.

Question 76

Which way does the supply curve slope

Answer 76

It slopes upwards

Question 77

Why does the supply curve slope upwards

Answer 77

It slopes upwards from left to right since: as firms raise output in the short term, they face rising production costs and so pass these costs onto consumers by charging higher prices. Furthermore, as price rises, it encourages firms to supply more of a good to increase profits. indeed, higher prices may encourage firms to enter a market and so raise supply.

Question 78

What’s is the market supply curve

Answer 78

The market supply curve is the horizontal summation of individual firms supply curves for a particular good or service.

Question 79

When is there a movement along a supply curve

Answer 79

There is movement along a supply curve for a good ONLY when there is a change in price. A rise in price causes an extension in supply, and a fall in price causes a contraction in supply

Question 80

What does an increase in supply refer to

Answer 80

An increase in supply refers to the whole supply curve shifting outwards to the right at every price level. A decrease in supply refers to the whole supply curve shifting inwards to the left at every price level

Question 81

List factors that can cause the supply curve to shift.

Answer 81

Improvements in technology
A reduction in labour costs
A reduction in capital costs
A reduction in transport costs
Discovery of new oil fields
An increase in the number of firms in the market/industry
A decrease in market influences, eg firms can now produce more than quotas previously set by theses market influencers
Good weather/climatic conditions to produce
A reduction in indirect taxation
An increase in government subsidies

Question 82

What does PES stand for

Answer 82

Price elasticity of supply

Question 83

What is price elasticity of supply

Answer 83

PES is the responsiveness of the supply of a good to a change in its price.

Question 84

What’s the formula for PES

Answer 84

PES = percentage change in supply of a good / percentage change in price of a good

PES = %change in S /% change in P

Question 85

Define price elasticity of supply

Answer 85

The responsiveness of the supply of a good or service to a change in its price.

Question 86

What does it mean if PES is positive

Answer 86

In most cases, a positive answer is obtained, indicating that the two variables of price and quantity move in the same direction, there is a positive gradient.

Question 87

If PES is greater than one…

Answer 87

The good is relatively price elastic: that is, the percentage change in supply is greater than the percentage change in price of the good.

Question 88

If PES is less than one…

Answer 88

The good is relatively price inelastic, that is, the percentage change in supply is less than the percentage in price of the good.

Question 89

If PES is equal to one…

Answer 89

The good is unit elastic, that is, the percentage change in supply is the same as the percentage change in price of the good

Question 90

If PES is equal to zero…

Answer 90

The good is perfectly inelastic: that is, a change in price has no effect on quantity supplied. The supply curve is vertical.

Question 91

If PES is infinite…

Answer 91

The good is perfectly elastic. The supply curve is horizontal.

Question 92

What happens to the supply curve the more elastic it is

Answer 92

It becomes more horizontal, gradient gets lower.

Unit elasticity is a gradient of 1 and price and quantity are directly proportional

Question 93

List the determinants of price elasticity of supply

Answer 93

Level of spare capacity

State of the economy

Level of stocks of finished goods in a firm

Perishability of the product

Ease of entry to an industry

Time period under consideration

Question 94

For price elasticity of supply, how is level of spare capacity a determinant

Answer 94

A high level of spare capacity in a firm means that it can raise production quickly, so supply tends to be elastic. A firm or industry operating at full capacity is unable to raise output quickly and so its supply tends to be inelastic

Question 95

For price elasticity of supply, how is the state of the economy a determinant

Answer 95

In a recession there are many unemployed resources and so there is a high level of spare capacity. Firms find it relatively easy to raise supply if needed.

Question 96

For price elasticity of supply, how is level of stocks of finished goods in a firm a determinant

Answer 96

A high level of stocks means that the firm can increase supply quickly, so supply is elastic. Alternatively, a firm or industry operating with low stocks is unable to raise output quickly and so supply tends to be inelastic.

Question 97

For price elasticity of supply, how is perishability of the product a determinant

Answer 97

Some goods cannot be stockpiled, eg, some agricultural goods such as fresh fruit, vegetables and flowers are highly perishable. These goods are typically inelastic in supply. On the other hand, manufactured goods tend to be non perishable and so can be stockpiled by firms in order to meet anticipated increases in demand. Eg. Fridges, freezers and washing machines

Question 98

For price elasticity of supply, how is ease of entry to an industry a determinant

Answer 98

If there are high entry barriers to an industry then it will be difficult for new firms to enter, even with the attraction of high prices and profits. Sometimes existing producers deliberately create entry barriers, so supply may be restricted and inelastic.

Question 99

For price elasticity of supply, how is time period under consideration a determinant

Answer 99

This is perhaps the most important determinant of elasticity of supply. The short run is the period of time In which a firm is able to increase supply with its existing capacity. At least one factor input is likely to be fixed In quantity in the short run, which makes it difficult for a firm to raise production. Supply tends to be relatively inelastic. The long run is the period of time In which a firm is able to increase supply by adding to its production capacity. All factor inputs are variable in the long run, making it easier for a firm to raise production. Supply tends to be relatively elastic.

Question 100

Why, for many agricultural products, is supply inelastic in the short run

Answer 100

Because the output from the summer and autumn harvests depends on the amount of seed planted at the start of the year. It takes an even longer period of time to raise the supply of products from livestock, such as milk and beef, because these depend on the nurturing of animals over several years .

Question 101

Why might the supply of minerals be inelastic in the short run

Answer 101

Due to the length of time required to explore and discover new deposits and then extract them. The costs and technical complexities involved could be phenomenal. Eg. Developing a new iron ore mine will require heavy machinery and the construction of new rail and road links.

Question 102

DONT CONFUSE DETERMINANTS OF PES WITH DETERMINANTS OF PED!!!!

Answer 102

😳😟

Question 103

The larger the gradient of a supply curve….

Answer 103

The more inelastic it is

Question 104

What do economists assume about consumers and producers

Answer 104

Economists assume that consumers and producers make rational decisions: this means consumers spend their income to maximise utility and producers allocate their resources to maximise profits.

Question 105

Tell me about shifts and moves along the demand curve

Answer 105

A movement along the demand curve is caused by a change in the price of the good, whereas a shift in the demand curve is caused by changes in real income, tastes, and the price of substitutes and complementary goods

Question 106

Why is the demand curve downward sloping

Answer 106

It can be explained by diminishing marginal utility. As an additional unit of a good is consumed, marginal utility falls, so consumers will only buy more of a product as its price falls.

Question 107

A change in the price of a good towards unitary elasticity of demand will lead to…..

Answer 107

An increase in total revenue

Question 108

What are the determinants of PED for a good

Answer 108

They include, the availability of substitutes, the proportion of income spent on it, the time period and whether its addictive

Question 109

What are the YEDs for normal and inferior goods

Answer 109

Normal goods have a positive and inferior goods have a negative income elasticity of demand

Question 110

What XEDs do substitute and complementary goods have

Answer 110

Substitute goods have a positive and complementary goods have a negative cross elasticity of demand

Question 111

What are movements along the supply curve and shifts of the supply curve caused by

Answer 111

A movement along a supply curve is caused by a change in the price of the good, whereas shifts in a supply curve are caused by other factors: for example, changes in the costs of production, technology, the ability of firms to enter and exit an industry, indirect taxes and government subsidies

Question 112

What are the determinants of PES of a good

Answer 112

Levels of spare capacity, state of the economy, level of stocks, perishability, ease of entry and exit to an industry, and time period under consideration.

Question 113

What does a vertical supply curve indicate

Answer 113

Indicates that the supply of a good is perfectly price inelastic. Eg, the capacity of the Wembley stadium is 90,000 seats.

Question 114

How is price determined

Answer 114

Price is determined through the interaction of demand and supply in a competitive market.

Question 115

What is an equilibrium price and quantity

Answer 115

An equilibrium price and quantity occurs when there is a balance in the market.

There is no tendency for price or quantity to change. The equilibrium price and quantity of a good are obtained from the point of intersection between the demand and supply curves

Question 116

Define equilibrium price

Answer 116

The price where the quantity demanded equals the quantity supplied for a good or service in a market.

Question 117

In a free market what happens if price is above or below equilibrium

Answer 117

In a free market, price cannot remain above or below the equilibrium position for long.

Question 118

What happens when there’s excess supply in a free market

Answer 118

In order to sell the surplus, producers tend to reduce price and thus encourages consumers to buy more, demand extends and supply contracts until the equilibrium price is reached

Question 119

Define excess supply

Answer 119

Wheee the quantity supplied exceeds the quantity demanded for a good at the current market price.

Question 120

What happens when there is excess demand in a free market

Answer 120

Consumers tend to bid up the price in order to obtain the good and this encourages producers to supply more. Supply extends and demand contracts until the equilibrium price is reached.

Question 121

What does the price mechanism do with excess demand or excess supply

Answer 121

The price mechanism automatically eliminates surpluses and shortages of a good - something that the economist Adam Smith referred to as the invisible hand

Question 122

Who referred to the price mechanism as an invisible hand

Answer 122

Adam Smith

Question 123

Define excess demand

Answer 123

Where the quantity demand exceeds the quantity supply for a good at the current market price

Question 124

What is the price mechanism

Answer 124

Refers to the way price responds to changes in demand or supply for a product or factor input, so that a new equilibrium position is reached in the market. It is the principal method of allocating resources in a market economy. It has several functions

Question 125

What is price

Answer 125

Price is the exchange value of a good or service

Question 126

Define price mechanism

Answer 126

The use of market forces to allocate resources in order to solve the economic problem of what, how and for whom to produce

Question 127

List the 3 functions of the price mechanism

Answer 127

Rationing device

Incentive device

Signalling device

Question 128

What is the rationing device function of the price mechanism

Answer 128

Resources are scarce, which means that the goods and services produced from them are limited in supply. The price mechanism allocates these goods and services to those who are prepared to pay the most for them. In effect, price will rise or fall until equilibrium is reached between the quantity demanded and the quantity supplied.

Question 129

What is the incentive device function of the price mechanism

Answer 129

Rising prices tend to act as an incentive to firms to produce more of a good or service, since higher profits can be earned. Rising prices also mean firms are able to cover the extra costs involved with increasing output.

Question 130

What is the signalling device of the price mechanism

Answer 130

The price mechanism indicates changes in the conditions of demand or supply. For example, an increase in demand for a good or service raises its price and encourages firms to expand their supply, while a decrease in demand lowers the price and causes firms to contract their supply. Consequently, more or fewer resources are allocated to the production of a particular good or service.

Question 131

Any of the factors which may shift demand or supply curves will lead to a change in…..

Answer 131

Price of a good or service

Question 132

What is consumer surplus

Answer 132

Consumer surplus is the extra amount of money consumers are prepared to pay for a good or service above what they actually pay. It is the utility or satisfaction gained from a good or service in excess of the amount paid for it.

Question 133

What is producer surplus

Answer 133

Producer surplus is the extra amount of money paid to producers above what they are willing to accept to supply a good or service. It is the extra earnings obtained by a producer above the minimum required for them to supply the good or service.

Question 134

What does the area of consumer surplus look like

Answer 134

Consumer surplus is the area above the equilibrium price but below the demand curve.

Draw a line for equilibrium price to y axis, the area above this line up to the demand curve is consumer surplus

It’s a triangle shape

Question 135

What does the area for producer surplus look like

Answer 135

Producer surplus is the area below the equilibrium price and above the supply curve

If you draw a line form equilibrium price to y axis, the area below this line up to the supply curve is producer surplus, triangle shape

Question 136

Is consumer surplus above or below producers surplus

Answer 136

Consumer surplus is ABOVE producer surplus

Use conduce to remember (consume + produce)

Question 137

What’s the impact of an increase in demand on producer surplus

Answer 137

An increase in demand for a good is likely to raise producer surplus

Draw a diagram if you don’t believe me ☹️

Question 138

What’s the impact of increase demand on consumer surplus

Answer 138

It’s likely to raise consumer surplus (as will producer surplus)

Assuming all other things remain equal

Question 139

Tip: don’t always assume a fall in price of a good will increase consumer surplus, it depends on the reason for the fall, eg a decrease in demand for the good will lead to a lower price and lower consumer surplus

Answer 139

Yeah 🤔🤔

Question 140

What’s the impact of a decrease in supply on consumer surplus

Answer 140

It is likely to reduce consumer surplus

Question 141

What’s the impact of a decrease in supply on producer surplus

Answer 141

It will likely decrease

Question 142

What is a tax

Answer 142

A tax is a compulsory charge made by the government, on goods, services, incomes, or capital.

Question 143

What is the purpose of taxes

Answer 143

The purpose is to raise funds to pay for government spending programmes.

Question 144

What are the two types of tax

Answer 144

Direct and indirect

Question 145

What’s a direct tax

Answer 145

A direct tax is levied directly on an individual or organisation. Direct taxes are generally paid on incomes: for example, personal income tax and corporation tax (on company profits)

Question 146

What’s an indirect tax

Answer 146

An indirect tax is usually levied on the purchase of goods and services. It represents a tax on expenditure. There are two types of indirect tax: specific and ad valorem

Question 147

What are the two types of indirect tax

Answer 147

Specific and ad valorem

Question 148

What’s a specific tax

Answer 148

A type of indirect tax, it’s charged as a fixed amount per unit of a good. An excise tax is a good example.

Question 149

What’s an ad valorem tax

Answer 149

An ad valorem tax is charged as a percentage of the price of a good. For example, VAT of 20% is added on to restaurant meals.

Question 150

Define indirect tax

Answer 150

A tax imposed on goods or services supplied by businesses. It includes both specific and ad valorem taxes.

Question 151

What does the imposition of an indirect tax do to price and what does it do to the supply curve generally

Answer 151

It raises the price of a good or service. The tax is added to the supply price, effectively causing the supply curve to shift vertically upwards and to the left ( a decrease in supply)

Question 152

What does a specific tax do to the supply curve

Answer 152

A specific tax causes a parallel shift of the supply curve to the left.

Question 153

What does an ad valorem tax do to the supply curve

Answer 153

It causes a pivotal rotation of the supply curve to the left, as supply increases, the gap between the original supply curve and new one becomes larger/distance between them increases.

Question 154

Define incidence of tax

Answer 154

The distribution of the tax paid between consumers and producers

Question 155

Where does the incidence of a tax usually fall

Answer 155

It usually falls partly on consumers and partly on producers, depending on the relative elasticities of demand and supply for a good or service. A combination of price inelastic demand and price elastic supply tends to place most of the tax burden on consumers: addictive goods such as tobacco and alcohol tend to be price inelastic in demand. This means firms are able to pass most of the burden of tax on to consumers via higher prices.

Question 156

What would a combo of price elastic demand and price inelastic supply do to incidence of tax

Answer 156

Tends to place most of the tax burden on the producers. It may also lead to a significant reduction in output and employment. Consequently, a government may be reluctant to place high indirect taxes on these types of goods.

Question 157

How is the incidence of tax paid by consumers

Answer 157

It is shown by the actual rise in market price.

Question 158

How can we show an indirect tax on a diagram

Answer 158

Always start from the new equilibrium price position and then draw a vertical line down to the original supply curve, this is the whole tax area

It’s a rectangle shaped area

Question 159

What is subsidy

Answer 159

A subsidy is a grant, usually provided by the government, to encourage suppliers to increase production of a good or service, leading to a fall in its price. Bus and train companies are often given subsidies in order to increase the number of bus and train services, which benefits both the firms and consumers.

Question 160

Define subsidy

Answer 160

A government grant to firms, which reduces production costs and encourages an increase in output.

Question 161

How do you work out the incidence of taxation on consumers and producers on a diagram

Answer 161

At the original equilibrium, the consumer tax is the area from this line up to the point where the demand curve meets the new supply curve and then to y axis. So it’s rectangular in shape.

Question 162

How do you work out the incidence of taxation on the producer on a diagram

Answer 162

Draw a line from the original equilibrium, then where the new supply meets the demand, draw a line down to the original supply, the area under the original equilibrium is the producer tax.

Question 163

What’s the exam tip to show a subsidy on a diagram

Answer 163

To show a subsidy on a diagram, always start from the new equilibrium price position and then draw a vertical line up to the original supply curve.

Many students make the mistake of starting from the original equilibrium price position and end up with wrong area

Question 164

Who is the subsidy often paid to

Answer 164

Often paid directly to producer.

Question 165

Why do consumers gain from a subsidy

Answer 165

A subsidy is often paid directly to producers, but as they respond by increasing output, the market price falls and this indirectly passes on some of the gain to consumers.

Question 166

How does the amount of consumer gain for a subsidy change

Answer 166

If demand is price inelastic, then the market price falls by a relatively large amount, increasing the benefits to consumers.

If demand is price elastic, then market price falls by a relatively small amount and so there is less gain for consumers.

Question 167

What is the amount of subsidy that consumers gain area

Answer 167

It is shown by the actual fall in market price from the original equilibrium to the new one. They gain by paying a lower price for the good.

The area is under the producer subsidy (unlike tax areas)

If you go from new equilibrium and draw up to original supply curve and across both to the y axis, and then go to original equilibrium and draw to y axis, the area under the original equilibrium (rectangle) is consumer subsidy.

Question 168

What’s the area for the producer subsidy

Answer 168

If you go from new equilibrium and draw up to original supply curve and across both to the y axis, and then go to original equilibrium and draw to y axis, the area above the original equilibrium is the producer subsidy

Rectangle shape

Question 169

Do consumers always act rationally

Answer 169

No, we can take an inductive approach by investigating how consumers actually behave and then develops models from the results.

Indeed consumers may be considered irrational in seeking a satisfactory level of utility rather than maximising utility. There are several factors that help explain this behaviour.

Question 170

List factors why consumers may not act rationally

Answer 170

The influence of other peoples behaviour

The importance of habitual behaviour

Consumer weakness at computation

Question 171

Explain how the influence of other people’s behaviour can make consumers act irrationally

Answer 171

Consumers are influenced by the behaviour of others; for example, if some people start buying a share in a particular company, others may follow, despite thus causing the price to rise and making the share less of a bargain. This ‘herd’ like mentality is often displayed in various markets where it has become clear that consumers who come late to the market receive little benefit.

Question 172

Explain how the importance of habitual behaviour causes humans to act irrationally

Answer 172

Consumers are creatures of habit and prefer what they know and have, rather than risking something new where there is more uncertainty. There may be difficulties involved with changing a bank or energy supplier etc, using considerable time.

Consumers are often unrealistic about their future behaviour, eg. Many adults are overweight and yet continue habit of eating too much.

Question 173

How is consumer weakness at computation a reason for irrational consumer behaviour

Answer 173

Many consumers have difficult in calculating best buys, eg knowing that multipacks are often cheaper than individual units, consumers may simply lack skills required to calculate Best Buy.

Imperfect market knowledges underlies the weakness that some consumers display in computation. It is impossible for consumers to have full market knowledge in which to base their decisions.

Question 174

In a competitive market, what is equilibrium price and quantity of a good determined by

Answer 174

It is determined by the interaction of demand and supply

Question 175

What is the price mechanism - summary point

Answer 175

The price mechanism is the use of market forces to allocate resources in order to solve the economic problem of what, how and for whom to produce. It’s three functions are to operate as a rationing, incentive and signalling device in the market.

Question 176

What is consumer surplus

Answer 176

Consumer surplus is the utility or satisfaction gained from a good or service in excess of the price paid for it.

Question 177

What is producer surplus

Answer 177

Producer surplus is the extra earnings obtained by a producer above the minimum required for them to supply the good or service.

Question 178

What will excess demand for a good cause

Answer 178

It will cause price to rise until equilibrium is reached, an excess supply of a good will cause price to fall until a new equilibrium is reached

Question 179

What is an indirect tax

Answer 179

An indirect tax on a good will cause an inward shift in the supply curve, leading to a fall in output and a rise in price.

Question 180

What will a unit subsidy on a good cause

Answer 180

It will cause an outward shift in the supply curve, leading to a rise in output and a fall in price.

Question 181

What are some of the alternative views of consumer behaviour

Answer 181

Alternative views of consumer behaviour are based on real world investigations of how consumers actually behave. This indicates that consumers may not aim to maximise total utility, or they may be confused over the behaviour required to do this.

Question 182

Why does the demand curve slope downwards from left to right

Answer 182

As the price of a good falls, it becomes more affordable for consumers to buy with their income. Also it becomes relatively cheaper than substitute goods and so some consumers will switch to buying it.

Question 183

What causes a movement along a demand curve for a good

Answer 183

A change in the price of the good in question. A rise in price will lead to a contraction in demand and a fall in price will lead to an extension of demand.

Question 184

What causes a shift in the demand curve for a good

Answer 184

The main factors include a change in price of substitute or complementary goods and a change in incomes or tastes. Note that changes in the price of the good will not shift the demand curve.

Question 185

What does the minus sign mean in price elasticity of demand answers

Answer 185

The minus sign means there is an inverse relationship between the change in price and the change in demand. Thus, a rise in price will cause a fall in quantity demanded. The demand curve has a negative gradient.

Question 186

What does the actual figure represent in price elasticity of demand answers

Answer 186

The answer indicates how much a 1% change in price cause demand to change by. For example, an answer of 3 means that a 1% change in price will lead to a 3% change in demand for the good.

Question 187

Why might price elasticity of demand be useful to firms

Answer 187

If a firm knows the price elasticity of demand for the good it produces then it may be able to increase total revenue by changing the price. If demand is inelastic, a rise in price will increase total revenue; if demand is elastic, a fall in price will increase total revenue.

Question 188

Why might price elasticity of demand be useful to the government

Answer 188

If the government knows the price elasticity of demand for a particular good then it will have an idea of the impact that an indirect tax will have on it. For example, a tax placed on a good with inelastic demand should lead to a high tax yield and have relatively little impact on demand.

Question 189

Distinguish between normal and inferior goods

Answer 189

Normal goods have a positive income elasticity of demand; as real income rises, demand for the good also rises. Inferior goods have a negative income elasticity of demand; as real income rises, demand for the good falls.

Question 190

Distinguish between complementary and substitute goods

Answer 190

Complementary goods have a negative cross elasticity of demand: for example, a fall in price of computer games consoles will cause an increase in demand for computer games software. Substitute goods have a positive cross elasticity of demand: for example, a rise in price of beef may cause an increase in demand for lamb.

Question 191

Why does the supply curve slope upwards from left to right

Answer 191

As the price of a good rises, there is an incentive to supply more since the firm might achieve higher profits. It is also able to cover the extra costs involved in producing more of a good.

Question 192

What causes a movement along a supply curve for a good

Answer 192

A change in the price of the good in question. A rise in price will lead to an extension in supply and a fall in price will lead to a contraction in supply.

Question 193

What causes a shift in the supply curve for a good

Answer 193

The main factors include a change in costs of production, technology, the ability of firms to enter and exit an industry, indirect taxes and government subsidies. Note that changes in the price of the good will not shift the supply curve.

Question 194

What does a positive figure mean in price elasticity of supply answers

Answer 194

A positive number means there is a direct relationship between the change in price and the change in quantity supplied. Thus, a rise in price will cause a rise in the quantity supplied. The supply curve has a positive gradient.

Question 195

What does the number represent in price elasticity of supply answers

Answer 195

The figure indicates by how much a 1% change in price causes quantity supplied to change. For example an answer of two means that a 1% change in price will lead to a 2% change in quantity supplied of the good.

Question 196

How might the price elasticity of supply for a good change over time

Answer 196

For most goods, supply tends to be relatively price inelastic in the short run as some factor inputs are fixed in quantity, but becomes relatively price elastic in the long run when all factor inputs are variable.

Question 197

What is likely to happen to price of a good if supply exceeds demand in a free market

Answer 197

If supply exceeds demand, price will fall, leading to an extension in demand and a contraction in supply. Eventually, equilibrium position is reached.

Question 198

What is likely to happen to the price of a good if demand exceeds supply in a free market

Answer 198

If demand exceeds supply, price will rise, leading to an extension in supply and contraction in demand. Eventually, a equilibrium position is reached.

Question 199

Briefly explain how a decrease in demand for a good affects producer surplus and consumer surplus

Answer 199

A decrease in demand for a good will cause its price to fall and so lead to a decrease in producer surplus and consumer surplus.

Question 200

Briefly explain how a decrease in supply of a good affects consumer surplus and producer surplus

Answer 200

A decrease in supply of a good will cause price to rise but a fall in both consumer surplus and producer surplus.

Question 201

Distinguish between a specific tax and an ad valorem tax

Answer 201

A specific tax is placed as a fixed amount per unit of good and causes an inward parallel shift in the supply curve. An ad valorem tax is placed as a percentage of the price of a good and causes an inward pivotal shift in the supply curve.

Question 202

How does a unit subsidy affect the market price and output for a good

Answer 202

A unit subsidy will shift the supply curve outwards (an increase in supply) and reduce the equilibrium price.

Question 203

What is meant by alternative views of consumer behaviour

Answer 203

Alternative views of consumer behaviour are those which assume consumers do not always aim or behave in a way that maximises total utility from their expenditure.

Question 204

Outline three reasons why consumers may not maximise total utility

Answer 204

Consumers may not maximise total utility due to: copying other consumers rather than thinking for themselves, keeping with their habits rather than making changes, difficulties in computation.