Markets in action

Question 1

Price elasticy of demand

Answer 1

The responsiveness of quantity demanded to a change in price

Question 2

Elastic demand

Answer 2

Where quantity demanded changes by a larger percentage than price. Ignoring the negative sign, it will be a value greater than 1

Question 3

Inelastic demand

Answer 3

Where quantity demanded changes by a smaller percentage than the price. Ignoring the negatice sign, it will be a value less than 1

Question 4

Unit elastic demand

Answer 4

Where quantity demanded changes by the same percentage as price. Ignoring the negatice sign, it will be a value equal to 1

Question 5

Total revenue (TR) (per period)

Answer 5

The total amount received by firms from the sale of a product, before the deduction of taxes or any other costs. The price multiplied by the quantity sold: TR= P*Q

Question 6

Price elasticity of supply

Answer 6

The responsiveness of quantity supplied to a change in price

Question 7

Formula for price elasticity of demand

Answer 7

The percentage(or proportionate) change in quantity demanded divided by the percentage(or proportionate) change in price: %ΔQd÷ %ΔP

Question 8

Total consumer expenditure on a product(TE) (per period of time)

Answer 8

The price of product multiplied by the quantity purchased: TE= P*Q

Question 9

Formula for price elasticity of supply (arc method)

Answer 9

ΔQs/(average Qs)÷ ΔP/(average P)

Question 10

Income elasticity of demand

Answer 10

The responsiveness of demand to a change in consumer incomes

Question 11

Normal goods

Answer 11

Goods whose demand increases as consumer incomes increase. They have a positive income elasticity of demand. Luxury goods will have a higher income elasticity of demand than more basic goods.

Question 12

Inferior goods

Answer 12

Goods whose demand decreases as consumer incomes increase. Such goods have a negative income elasticity of demand.

Question 13

Speculation

Answer 13

Where people make buying or selling decisions based on their anticipations of future prices.

Question 14

Self-fulfilling speculation

Answer 14

The actions of speculators tend to cause the very effect that they had anticipated

Question 15

Stabilising speculation

Answer 15

Where the actions of speculators tend to reduce price fluctuations

Question 16

Destabilising speculation

Answer 16

where the actions of speculators tend to make price movements larger

Question 17

Short selling (or shorting)

Answer 17

Where investors borrow an asset, such as shares of foreign currency; sell the asset, hoping the price will soon fall; then buy it back later and return it to the lender. Assuming the price has fallen, the short seller will; make a profit of the difference (minus any fees)

Question 18

Risk

Answer 18

When an outcome may or may not occur, but its probability of occurring is known. It is a measure of the variability of that outcome.

Question 19

Uncertainty

Answer 19

When an outcome may or may not occur and its probability of occurring is not known

Question 20

Expected value

Answer 20

The predicted of average value of an outcome over a number of occurrences, calculated by taking each of the possible outcomes and multiplying it by its probability of occurrence and then adding each of these values

Question 21

Risk neutral

Answer 21

When a person is indifferent between a certain outcome and a gamble with the same expected value

Question 22

Risk averse

Answer 22

Where you would require a gamble to have a higher expected value than a certain outcome before being willing to take the gamble. The more risk averse you are, the higher the expected value you would require(i.e. the better would have to be the odds).

Question 23

Risk loving

Answer 23

Where you would be willing to take a gamble even if its expected value was lower than that of certain outcomes. The more risk-loving you are, the lower the expected value you would be prepared to accept(i.e. the worse the odds would need to be)

Question 24

Diminishing marginal utility of income

Answer 24

Where each additional unit of income earned yields less additional utility than the previous unit.

Question 25

Future price

Answer 25

A price agreed today at which an item(e.g. commodities) will be exchanged at some set date in the future

Question 26

Spot price

Answer 26

The current market price

Question 27

Adverse selection

Answer 27

The tendency of those at greatest risk to take out insurance

Question 28

Moral hazard

Answer 28

The temptation to take more risk when you know that other people(e.g. insurers) will cover the risk.

Question 29

Asymmetric information

Answer 29

Where one party in an economic relationship has more or better information than another

Question 30

Pooling risk(for an insurance company)

Answer 30

The more policies an insurance issues and the more independent the risk from these policies are, the more predictable will be the number of claims

Question 31

Ław of large numbers

Answer 31

The larger the number of events of a particular type, the more predictable will be their average outcome

Question 32

Independent risks

Answer 32

Where two risky events are unconnected. The occurrence of one will not affect the occurrence of the other

Question 33

Minimum price

Answer 33

A price floor set by the government or some other agency. The price is not allowed to fall below this level(although it is allowed to rise above it)

Question 34

Maximum price

Answer 34

A price ceiling set by the government or some other agency. The price is not allowed to rise above this level(although it is allowed to fall below it)

Question 35

Rationing

Answer 35

Where the government restricts the amount of a good that people are allowed to buy.

Question 36

Underground or shadow markets

Answer 36

Where people ignore the government’s price and/or quantity controls and sell illegally at whatever price equates illegal demand and supply

Question 37

Price elasticity of demand is a measure of

Answer 37

the responsiveness of demand to a change in price.

Question 38

It is defined as the proportionate (or percentage) change in

Answer 38

quantity demanded divided by the proportionate (or percentage) change in price. Given that demand curves are downward sloping, price elasticity of demand will have a negative value.

Question 39

If quantity changes proportionately more than price,

Answer 39

the figure for elasticity will be greater than 1 (ignoring the sign): demand is elastic. If the quantity changes proportionately less than price, the figure for elasticity will be less than 1 (again, ignoring the sign): demand is inelastic. If quantity and price change by the same proportion, the elasticity has a value of (minus) 1: demand is unit elastic.

Question 40

Demand will be more elastic the greater the number and closeness of

Answer 40

substitute goods, the higher the proportion of income spent on the good and the longer the time period that elapses after the change in price.

Question 41

Price elasticity of supply measures the responsiveness of

Answer 41

supply to a change in price. It has a positive value.

Question 42

Supply will be more elastic the less

Answer 42

costs per unit rise as output rises and the longer the time period.

Question 43

The total expenditure on a product is found by

Answer 43

multiplying the quantity sold by the price of the product.

Question 44

When demand is price elastic,

Answer 44

a rise in price will lead to a reduction in total expenditure on the good and hence a reduction in the total revenue of producers.

Question 45

When demand is price inelastic,

Answer 45

a rise in price will lead to an increase in total expenditure on the good and hence an increase in the total revenue of producers.

Question 46

Income elasticity of demand measures

Answer 46

the responsiveness of demand to a change in income. For normal goods it has a positive value; for inferior goods it has a negative value.

Question 47

Demand will be more income elastic the more

Answer 47

luxurious the good and the less rapidly demand is satisfied as consumption increases.

Question 48

Cross-price elasticity of demand measures the

Answer 48

responsiveness of demand for one good to a change in the price of another.
For substitute goods the value will be positive; for complements it will be negative.

Question 49

The cross-price elasticity will be more elastic the

Answer 49

closer the two goods are as substitutes or complements.

Question 50

A complete understanding of markets must take into account

Answer 50

the time dimension.

Question 51

Given that producers and consumers take a time to respond fully to price changes, we can identify different

Answer 51

equilibria after the lapse of different lengths of time. Generally, short-run supply and demand tend to be less price elastic than long-run supply and demand. As a result, any shifts in demand or supply curves tend to have a relatively bigger effect on price in the short run and a relatively bigger effect on quantity in the long run.

Question 52

People often anticipate price changes and this will affect

Answer 52

the amount they demand or supply. This speculation will tend to stabilise prices (i.e. reduce fluctuations) if people believe that the price changes are only temporary. However, speculation will tend to destabilise prices (i.e. make price changes larger) if people believe that prices are likely to continue to move in the same direction as at present - at least for some time.

Question 53

Many economic decisions are taken under conditions of

Answer 53

risk or uncertainty. If we know the probabilities, we are said to be operating under conditions of risk. If we do not know the probabilities, we are said to be operating under conditions of uncertainty.

Question 54

People can be divided into

Answer 54

risk lovers, risk averters and those who are risk neutral. Because of the diminishing marginal utility of income it is rational for people to be risk averters (unless gambling is itself pleasurable).

Question 55

Uncertainty over future prices can be tackled by

Answer 55

holding stocks or through transactions in futures markets. Consumers may hold a buffer stock of saving because of the uncertainty around future incomes.

Question 56

Insurance markets provide a way of

Answer 56

eliminating risk. If people are risk averse they are prepared to pay premiums to obtain insurance. Insurance companies are able to pool risk by selling a large number of policies, but require that the risks are independent.

Question 57

The government may fix

Answer 57

minimum or maximum prices. If a minimum price is set above the equilibrium price, a surplus will result. If a maximum price is set below the equilibrium price, a shortage will result.

Question 58

Minimum prices are set as a means of

Answer 58

protecting the incomes of suppliers or creating a surplus for storage in case of future reductions in supply. If the government is not deliberately trying to create a surplus, it must decide what to do with it.

Question 59

Maximum prices are set as a means of

Answer 59

keeping prices down for the consumer. The resulting shortage will cause queues, waiting lists or the restriction of sales by firms to favoured customers. Alternatively, the government could introduce a system of rationing. If it does, then underground markets are likely to arise. This is where goods are sold illegally above the maximum price.