Micro Ls16-20

Question 1

What does the price mechanism do?
What is it determined by?

Answer 1

• allocates resources by setting prices
• determined by interaction of demand and supply
• e.g. price rises when buyers want more than is being supplied, suppliers encouraged to sell more to increase profit,

Question 2

State the three functions of the price mechanism

Answer 2

The rationing function
The signalling functions
The incentive function

Question 3

Describe/explain the rationing function

Answer 3

• rations goods
• as the price increases some people may not be able to afford the product whilst others may no longer desire it
• hence the limited resources are rationed by being allocated to only those who can afford it or to those who value it very highly and are willing to pay the higher price

Question 4

Describe/explain the signalling function

Answer 4

• acts as a signal where resources should be used
• when prices rise manufacturers direct resources towards the manufacture of that product
• changes in price indicate to suppliers/consumers that market conditions have changed
• this will cause them to change the quantity bought and sold
• when piece equilibrium moves output equilibrium moves with it

Question 5

Describe/explain the incentive function

Answer 5

• incentivises people to work hard
• buyers realise the more money they have the more products they can purchase
• suppliers realise that the more products they product the more money they make
• low prices can also incentivise consumers to buy more of a good
• high prices act as an incentive for suppliers to sell more of a good
• price mechanism encourages consumers/suppliers to behave in certain ways

Question 6

What would happen if the demand for fur coats falls (because of social change)?
(Talk about price mechanism)

Answer 6

• demand curve shifts to the left
• more is supplied than is demanded so there is excess supply
• equilibrium price will then decrease
• low price signals to manufacturers the market is worse and incentive has decreased
• low prices indicate that profits will decrease
• hence they will make less coats and supply shifts down

Question 7

What would happen if supply for a product falls? (talk about price mechanism)

Answer 7

• supply falls
• supply curve shifts left
• at old equilibrium price there is excess demand
• equilibrium price will increase as less of the reduction is supplied and demanded
• the higher price medicates to buyers and sellers that market has changed
• higher price rations the product
• this is shown by a movement up the demand curve
• consumers will be priced out whilst others will cut back on consumption

Question 8

Assume demand is price elastic. What would be the change in revenue caused by a:
- increase in price
- decrease in price

Answer 8

Increased price = fall in total revenue
As quantity demanded decreases
Decreased price = a rise in total revenue
As quantity demanded increases

Question 9

Assume demand is price inelastic. What would be the change in revenue caused by a:
- increase in price
- decrease in price

Answer 9

Increased price = a small rise in total revenue
As quantity demanded does not decrease very much
Decreased price = a small fall in total revenue
As quantity demanded does not increase enough

Question 10

Define market failure
How is market failure caused?

Answer 10

Market failure is when too much or too little of a good is produced and/or consumed compared with the socially optimal level of output, or when the price mechanism leads to an inefficient allocation of resources

• The private (or internal) benefits that the market confers on individuals or businesses carrying out a particular activity diverge from the benefit to society
• When private costs diverge from social costs in the case of negative externalities
• An inequitable allocation of resources/unequal factor, incomes arising from the free market mechanism is regarded by many (but not all economists) as a key cause of market failure

Question 11

State and briefly define the types of market failure

Answer 11

• externalities: consumption/production of some goods/services can impact third parties unintentionally
• Public goods: some goods would be underprovided if left to the private sector as they are non-excludable and non-rivalrous
• Information gaps: buyers or sellers may not have enough information to produce or consume at the socially optimum level for example, cigarettes were marketed as a health product in the 30-50s whilst nowadays producers and consumers have enough information to realise that it is actually very unhealthy

Question 12

Define negative externalities

Answer 12

Also known as external costs: a cost to a third-party that is not involved in the matter, making/buying/selling/consumption of a specific good or service

Social benefits < social costs

Question 13

Define positive externalities

Answer 13

Also known as external benefits: a benefit to a third-party that is not involved in the making/buying/selling/consumption of a specific good or service

Social benefits > social costs

Question 14

What is a non-rival good?

Answer 14

The consumption of this product does not prevent another person from also consuming the product. For example, a radio program is a non-rivalrous good. The radio however, is a rival good

Question 15

What is a non-excludable?

Answer 15

This means that once a good is provided, it is impossible to stop people from using it for example, once of lighthouses provided, then ships at sea can’t be prevented from benefiting from it. However, if a car manufacturer produces a new model of car, people can be excluded if they cannot afford one.

Question 16

What is the free-rider problem?

Answer 16

A type of market failure that occurs because everybody is able to benefit from a good. Three riders are problematic because they don’t pay for the good but continue to use/access. It lost a good is underprovided or not provided at all so it is a merit good.

Question 17

What is a social benefits and what is it comprised of

Answer 17

Social benefit = private benefits + external benefits

e.g. cycling to work has the social benefits of externally there being less pollution and privately having better health

Question 18

What is a social cost and what is it comprised of?

Answer 18

Social cost = private costs + external cost
An example would be what are the social costs of a coal power station ? The private costs are insurance or taxes and the external costs are air pollution etc.

Question 19

When does the social optimum level of output occur?

Answer 19

When all external benefits and external costs are accounted for (there are no welfare losses).

Question 20

What happens if there are external benefits/external costs present in a free-market?

Answer 20

• when the external benefits present, there will be under consumption/under production in free-market
• when external costs are present, there will be overproduction/overconsumption in free-market

Question 21

Define perfect information

Answer 21

This is when a buyer and/or seller has a complete understanding of the quality and nature of a good or service

Question 22

Define symmetric information

Answer 22

This is when buyers and sellers have equal amounts of knowledge, about a good or service

Question 23

Define imperfect information

Answer 23

This is when a buyer and/or seller lacks a complete understanding of the quality and nature of a good or service

Question 24

Define asymmetric information

Answer 24

When a buyer or seller has more information about a good or service than the other oarty

Question 25

What is an information gap

Answer 25

When either the buyer or seller does not have access to the information needed to make a fully informed decision. An information gap can cause market failure.

Question 26

In a free market economy why are public goods under provided

Answer 26

Due to the free rider problem

Question 27

Are merit goods rivalrous?

Answer 27

Yes so they must be provided by the government

Question 28

Where is maximum price set?

Answer 28

A price set below the market equilibrium price. Set by the government

Question 29

What is a minimum price

Answer 29

A price set above the market equilibrium price by the government

Question 30

When is it appropriate to set a min/max price and when is there no need for gov intervention?

Answer 30

• it is appropriate to set a minimum price for things like cleaners wages or farmers incomes. This is to prevent the producer from exploited
• it’s appropriate to set a maximum price for things like ceo pay, interest charged by lenders, rent. This is set to prevent the consumer from being exploited.
• there’s no need for gov intervention for things like music downloads, playstations or pizzas. These arent set because the goods are luxuries?

Question 31

1. What happens to consumer surplus if a minimum price is introduced to a market?
2. What happens to consumer surplus if a maximum price is introduced to a market?
3. What happens to producer surplus if a minimum price is introduced to a market?
4. What happens to producer surplus if a maximum price is introduced to a market?

Answer 31

1. Decreases
2. Increases
3. Increases
4. Decreases

Question 32

Why is healthcare not a public good?
But why is state provision used to supply it?

Answer 32

It is excludable and also a merit good
It yields external benefits meaning there will be underconsumption or underproduction of it. It also suffers the free rider problem so its not as profitable so private firms wouldn’t be as incentivised to supply healthcare

Question 33

What s a guaranteed minimum pricing scheme

Answer 33

A scheme in which excess supply is purchased by the government at the minimum price. The purpose of this is to protect producers incomes

Question 34

What’s the justification for using minimum pricing in some markets
What’s the problem this creates
How does the minimum pricing scheme help?

Answer 34

The prices for some goods are highly volatile so in order to protect producers incomes and prevent them from leaving the market the gov purchases any excess good at the minimum price. This prevents the supply for that good from being endangered
This means that there’s excess supply and the producers incomes will be reduced.
Minimum pricing guarantees there’s an income for the producers

Question 35

How does a subsidy increase the consumption of a good or service
Evaluate

Answer 35

Decreases the cost of reduction
Hence the price decreases so consumers more likely to buy the product or increase consumption

If subsidy too small the increase in consumption will negligible
If demand is inelastic then there wont be a large increase in consumption irregardless of price

Question 36

What kind of government intervention help to deal with externalities?

Answer 36

• Governments can implement taxes to internalise the cost of negative externalities in production or consumption. For example, the sugar attacks internalises the negative externalities of sugar consumption.
• Governments can provide subsidies or bursaries to encourage the consumption or production of good services which have positive externalities.
• Governments can implement regulations: emissions permits to internalise external costs, or safety regulations to promote external benefits
• Governments can also implement maximum or minimum prices