How Markets Work - T1

Question 1

What does rational decision making rely on

Answer 1

Perfect information
Judgement skills
Interdependent from others decisions
Sufficient time to make decision

Question 2

Why is the demand curve downwards sloping

Answer 2

As marginal utility decrease, consumers will only buy more of a good if the price decreases

Question 3

Factors shifting demand

Answer 3

Price of substitutes/complimentary goods 
Income tax 
Advertisement 
Fashion 
Income rises

Question 4

What is PED

Answer 4

Price elasticity of demand- the responsiveness of demand to a price change
%change in demand / % change in price

Question 5

Values of PED and that effects elasticity

Answer 5

If PED>1 - elastic 
If PED<1 - inelastic 
If PED = 1 - unitary elasticity 
If PED=0 - inelastic (drugs)
If PED  = Infinite - elastic

Question 6

How will firms total revenue change depending on elasticity of good

Answer 6

Firms total revenue will increase as price level moves towards midpoint
If good is elastic a decrease in price will lead to higher revenue
If good is inelastic and increase in price will lead to higher revenue

Question 7

What determines price elasticity of demand

Answer 7

Availability of substitutes- more = more elastic
Luxury: elastic
Necessity : inelastic
%of income spent on good, if high % elastic
Addictive- inelastic
Time Period- less elastic in short run
Branding- Inelastic

Question 8

Income elasticity

Answer 8

Responsiveness of demand for a good or service to a change on real income
%Change in demand / %change in income

Question 9

Income elasticity of different types of goods

Answer 9

Normal: +YED, YED>1 luxury good elastic , YED<1 inelastic

Inferior goods: negative YED, people buy higher quality of goods as income increase so inferior goods are bought less

Question 10

Cross elasticity

Answer 10

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

Question 11

How does the price of other goods effect the demand of good B (XED)

Answer 11

Substitutes goods are in competitive demand:
If price of coffee increase so will demand for tea
XED is positive
Complementary goods:
XED is negative
Price of tennis rackets goes up,demand for balls goes down
XED=0 if goods are unrelated

Question 12

Supply

Answer 12

Quantity of goods that firms are willing to sell

Question 13

What will shift the supply curve

Answer 13

• improvements in technology
• reduction in labour/ transport/ capital costs
• discovery of new oil, reduction of oil prices
• decrease in external market influence

Question 14

PES

Answer 14

The responsiveness of supply to a change in price

%change in supply / % change in price

Question 15

What do the PES values means

Answer 15

PES >1 elastic 
PES<1 inelastic 
PES = 1 unitary elasticity 
PES =0 perfectly Inelastic 
PES = infinite

Question 16

What determines PES

Answer 16

Level of spare capacity, high spare capacity = elastic
State of economy, in recession spare capacity is high
Level of finished stock, high = elastic
Perishability of product, cannot be stocked piled = inelastic
High barriers to entry= inelastic
Time period, inelastic in short run

Question 17

Equilibrium price

Answer 17

When quantity demanded = quantity supplied

Question 18

Function of price mechanism

Answer 18

Resources allocated to those willing to pay the most

Rise in price = incentive for firms to supply more/ new firms to enter the market since profit is higher

Question 19

Consumer surplus

Answer 19

The amount of money a consumer is willing to pay above the amount they actually paid for a good

Question 20

Producer surplus

Answer 20

Extra amount of money paid to producers above what they would of accepted

Question 21

What shifts in demand or supply would change consumer/producer surplus

Answer 21

Increase in demand will increase both

Decrease in supply will reduce both

Question 22

Indirect taxes

Answer 22

Specific taxes - set amount added to price e.g £1

Ad valorem tax - % of goods price added on top e.g 20%

Question 23

Who does the burden of tax fall onto

Answer 23

Consumers usually

Unless PED is elastic and PES is inelastic

Question 24

Problems with Economists assumptions of consumer activity

Answer 24

People do not buy to maximise utility
Economic models are created on how consumers should behave
Consumers are influenced by each other “herd mentality”
Habitatal behaviour
Consumers: stick to what they know, think short term, have imperfect knowledge, do not know what they want