Pack 2 Micro Demand and Supply Model

Question 1

What does rational decision making mean?

Answer 1

• where economic agents make decisions to maximize their own benefit

Question 2

How do consumers act rationally?

Answer 2

• by maximizing their utility

Question 3

How do producers act rationally?

Answer 3

By selling goods/services in a way that maximizes their profits

Question 4

How do workers act rationally?

Answer 4

By balancing welfare at work with consideration of both pay and benefits

Question 5

How does the government act rationally?

Answer 5

By placing the interests of the people they serve first in order to maximize their welfare

Question 6

What is utility maximisation?

Answer 6

Where consumers make decisions to gain as much satisfaction as possible

Question 7

What is profit maximisation?

Answer 7

Where firms make decisions to ensure the largest difference between total revenue and total cost

Question 8

How are consumers influenced by other people’s behavior?

Answer 8

• peer pressure often prompts consumers to make purchasing decisions that may go against a computation of net benefits
• producers influence consumer choices - advertising, (influencer culture)

Question 9

How does consumer weakness and computation affect consumers decision making?

Answer 9

• wider range of choice, harder it is for a consumer to gather information and compute which one offers the highest net benefits
• consumers often lack time or ability to consider relative prices of different products and sellers frequently make it difficult for them to do so

Question 10

How does habitual behavior influence consumers?

Answer 10

• consumers make so many purchasing decisions that they often rely on habits to speed up the process
• using rule of thumb refers to a short cut that makes a quick estimation of benefits without gathering too much info
• may decide to carry on consuming same food even when switching improves their welfare due to loss averse and not wanting to risk making themselves worse off
• consumers may be addicted to the product e.g tobacco so won’t stop consuming even if there are negative implications for their own welfare

Question 11

What is the nudge theory?

Answer 11

• consumer behavior can be influenced by small suggestions and positive reinforcements

Question 12

What is demand?

Answer 12

• amount of a good/service that consumers are willing and able to buy at a given price
  Individual demand = demand of one person
  Market demand = everyone in a particular market

Inverse relationship between price and quantity

Question 13

What is marginal utility and diminishing marginal utility?

Answer 13

Marginal utility = change in satisfaction from consuming an extra unit of a good or service
Diminishing marginal utility = a situation where an individual gains less additional utility from consuming a product, the more is consumed (eg chocolate bars)

Question 14

What causes shifts in the demand curve?

Answer 14

• disposable incomes
• demand for substitutes
• demand for complements: if buying more of a complementary product may want more ( joint demand of tea and milk)
• derived demand (good demanded because they are need for the production of other goods) e.g bricks for houses
• fashion and changes in consumer tastes
• changes in legislation
• advertising
• changes in population

Question 15

What is supply?

Answer 15

How many goods firms are willing and able to put on the market at any given price
- positive relationship between price and quantity supplied
- because when market prices increase, incentive for rational businesses to increase output in order to maximize profits

Question 16

What causes movements in supply and demand curve?

Answer 16

Price

Question 17

What causes shifts in the supply curve?

Answer 17

• cost of production
• indirect taxes and subsidies
• technology and productivity
• competitive supply (producers better off to supply another product)
• joint supply (e.g higher supply of beef =higher supply of leather)
• weather (crops)
• entry or exit of new firms into and out of the market (supply increase when firms enter)
• producer cartels (group of firms operate together to decide how much to supply, and so the price)

Question 18

What is markers equilibrium?

Answer 18

Price and quantity When demand equals supply

Question 19

Why will prices fall to eliminate excess supply?

Answer 19

• if producer has large surplus of stock that is not selling
• they will lower their price to encourage consumers to buy it (expanding demand) and producers may decide to reduce their production as it is now less profitable (contraction in supply)

Question 20

Why will prices rise to eliminate excess demand?

Answer 20

• produce has very popular products
• most likely increase their price due to its popularity and try to gain as much profit as possible
• less consumers willing and able to buy at the higher price (contracting demand) and producers may decide to increase their production as it is now more profitable (expanding supply)

Question 21

What is the price mechanism and what are the functions of it?

Answer 21

• free markets allocate resources through the interaction of demand and supply

Signalling: where price in a market provides info to consumers and producers to abide their rational decision making

Incentive: price in market encourages change in behavior by consumers to maximize utility and producers to maximize profits

Rationing:where price in a market determines who can afford the good or service and therefore who is provided with the service

Question 22

What is the function of the price mechanism when there is an increase in demand?

Answer 22

• increase in demand will signal that the market is profitable due to rise in price
• will provide an incentive for produce to expand supply whilst also rationing demand

Question 23

What is the function of the price mechanism when there is a decrease in supply?

Answer 23

• decrease in supply will signal that the market is profitable due to rise in price
• will provide an incentive for producers to expand supply whilst also rationing demand

Question 24

What is the function of the price mechanism for the entry of firms?

Answer 24

ENTRY OF FIRMS:
- if there is an increase in demand for say copper, it will signal to producers that copper is profitable
- gives an incentive to expand supply to maximize profits in the short run and in the long run more producers may enter the industry to take advantage of the extra profit, leading to an increase in supply therefore decreasing copper price in future

Question 25

What is the function of the price mechanism for the exit of firms?

Answer 25

• if there was a decrease in demand for copper, then this will signal a less profitable copper
• incentive to contract supply to maximize profits
• in the long run producers will leave the market as they are making losses, leading to a decrease in supply and therefore increasing the price of copper

Question 26

How does the price mechanism eliminate surpluses and eliminate shortages?

Answer 26

Eliminating surpluses:
- if there is excess supply then the price will fall
- lead to a contraction in supply (as less profitable) and an expansion in demand(as now cheaper to buy the goods**

Eliminating shortages:
- if there is excess demand the price will rise
- lead to a contraction in demand and an expansion in supply

Question 27

What is consumer surplus?

Answer 27

difference between what consumers are willing and able to pay for a good and what they actually pay

Question 28

What is producer surplus?

Answer 28

Difference between the market price which firms receive and the price at which they are willing able to supply

Question 29

What is indirect taxation?

Answer 29

A charge levied on goods or services by the government which increases the producers’ costs and shifts supply to the left

Question 30

What is a specific tax?

Answer 30

A levy set by the government on goods or services set at a constant amount per item

Question 31

What is an Ad Valorem tax?

Answer 31

A levy set by the government on goods or service set at a % of a price

Question 32

What is a subsidy?

Answer 32

Sum of money paid by the governments to the producer in order to encourage production and reduce price

Question 33

How will subsidies affect the supply curve?

Answer 33

• shift supply curve to the right as it reduces costs of production for the producer

Question 34

What ar the limitations of using subsidies?

Answer 34

• Financial cost of the subsidy: need to be financed through taxation or borrowing, issue for UK considering high levels of debt already
• Opportunity cost of the subsidy: this money could be used to finance other areas of the economy
• Issues of inefficiency: could cause the industry to become over-reliant on subsidy