May Micro

Question 1

What is unitary PES?
What is elastic PES?
What is perfectly elastic PES?

Answer 1

Unitary PES = 1. Change in supply is proportional to change in demand.
Elastic PES : A change in price leads to a proportional greater change in quantity supplied.
Perfectly elastic supply: Any change in price will lead to an infinite change in quantity supplied.

Question 2

What is inelastic PES?

What is perfectly inelastic PES?

Answer 2

A change in price leads to a proportionately smaller change in quantity supplied. PES < 1.
Perfectly inelastic. PES = 0

Question 3

What determines PES?

Answer 3

Time: the shorter time period the harder it is for firms to increase production in response to higher prices. E.g. agriculture is inelastic in the short term.

• Ability to build and release stocks.
• Mobility of factors of production. Can a firm’s technology be used to produce different products.
• Legal constraints may stop firms from expanding or other firms entering the market.
• Spare capacity: both in the industry, and in the macroeconomy - unemployment means businesses can hire workers more easily.

Question 4

What is price elasticity of supply?

Answer 4

A numerical measure of the responsiveness of quantity supplied to a change in price.
PED = %△Qs / %△P
Usually, more is supplied when prices rises their is incentive for firms to produce more for higher profit and more firms are attracted to the industry.

Question 5

Why is knowledge of XED useful for firms?

Answer 5

• Firms can estimate the implications of price changes from competitors, and suppliers of complements. They can plan to respond with perhaps changing their own prices, or adjusting production.
• Firms often produce complements and substitutes to their own products. Apple Pens. Coca-cola, Sprite, Fanta.

Question 6

Why is XED not equal to 1 for perfect substitutes?

Answer 6

A minute change in price will cause a huge change in Qd, when can consumers can switch to a perfect substitute.

Question 7

Why is YED useful to firms?

Answer 7

• Production planning: if economic growth is forecast, and the firm produces luxury goods it can plan to increase production.
• Product portfolio planning: knowledge of YEDs can help a firm plan their range of product - inventing Lexus, or iPhone SE.

Question 8

What is income inelastic demand?

Answer 8

When a change in income will result in a proportionately smaller change in quantity demanded. Quantity demanded is said to be unrelatively unresponsive to a change in income when the absolute 0 < YED < 1. YED less than 0 is an inferior good

Question 9

Why is PED important to businesses and governments?

Answer 9

• For businesses, pricing strategies to increase total revenue.
• For governments understanding the incidence of taxes and subsidies on consumers and producers. The more price inelastic the good, the greater proportion of the tax is on consumers. For subsidies, the more price inelastic demand, greater the gain for consumers

Question 10

What would happen to a product with inelastic demand when price increases or decreases?

Answer 10

Revenue would increase when price increases, and revenue would decrease as price decreases.

Question 11

What would happen to a product with elastic demand when price increases or decreases?

Answer 11

Revenue would decrease when price increases, and revenue would increase as price decreases.

Question 12

What affects PED?

Answer 12

• The availability and closeness of substitutes : consumers cannot switch from oil when price rises.
• Brand loyalty.
• Percentage of total expenditure.
• Addictiveness
• Durability : it takes time for consumers to change behavior, and so in the non durable products become more price elastic over time.
• Necessity or luxury? People have to buy even if price goes up - linked to addictiveness.

Question 13

What is unitary price elasticity of demand?

Answer 13

When a change in quantity demanded is exactly proportional to the change in price. PED = -1

Question 14

What is price inelastic demand?

Answer 14

When a change in price will result in a proportionately smaller change in quantity demanded. Quantity demanded is said to be unrelatively responsive to a change in price when the absolute PED <1. Perfectly inelastic PED = 0.

Question 15

What is price elastic demand?

Answer 15

When a change in price will result in a proportionately greater change in quantity demanded. Quantity demanded is said to be relatively responsive to a change in price when the absolute PED > 1. Perfectly elastic PED = ∞.

Question 16

What is cross elasticity of demand?
What is the formula?
What types of goods have what XEDs?
What does the XED say about the relationship of two goods?

Answer 16

A numerical measure of the responsiveness of quantity demanded to a change in price of another product.
PED = %△Qdx / %△Py
Substitute goods have a positive XED, complement goods negative. Unrelated goods gave 0 XED.
The higher the absolute value of XED, the closer their relationship (complement or substitute).

Question 17

What is income elasticity of demand?
What is the formula?
What types of goods have what YEDs?

Answer 17

A numerical measure of the responsiveness of quantity demanded to a change in income.
PED = %△Qd / %△Y
Inferior goods have a negative YED, normal goods positive.

Question 18

Why might consumers not maximize utility

Answer 18

• the influence of other people’s behaviour (herding)
• habitual behaviour
• inertia
• poor computational skills
• the need to feel valued
• framing and bias.

Question 19

Explain the meaning of rival, excludable, and moral hazard.

Answer 19

Rivalrous means that consumption by one party reduces the ability of another party to consume it.
Excludability is the degree to which a firm can prevent “free” consumption of a good.
Moral hazard is when an entity has incentive to increase exposure to risk because it does not bear the full cost of those risks.

Question 20

How might market bubbles arise?

Why might it pop?

Answer 20

• ## A rapid increase in market value may occur due to a speculative frenzy and “spontaneous optimism” what Keynes named “animal spirits”. Keynes argues out that “fears of loss may have a basis no more reasonable than hopes of profit had before”. Austrians would blame interest rates.

Question 21

List methods of government intervention.

Answer 21

• indirect taxation (ad valorem and specific)
• subsidies
• maximum and minimum (guaranteed) prices.
• tradeable pollution permits
• extension of property rights
• state provision
• regulation
• provision of information.

Question 22

What are the roles of financial markets

Answer 22

• to facilitate saving
• to make funds available to businesses and individuals
• to facilitate the exchange of goods and services
• to provide forward markets in commodities and currencies
• to provide a market for equities.

Question 23

Can PED the same along the demand curve?

Answer 23

Elasticity can only be measured at a unique price on a straight line demand curve, as price elasticity increases lower down the demand curve - except perfectly inelastic and elastic curves.

Question 24

What is a forward market?

Answer 24

• Futures contract : obligation to buy or sell in the future for a price set today. This might be in a commodity or a currency.

Question 25

What is government failure?

Answer 25

• Where the government intervenes, ad there is a net welfare loss.
• This could be from an information gap, the government taking on risk and creating moral hazard, excessive administration costs or unintended consequence and distorted incentives.