Pack 2: The Demand and Supply Model

Question 1

What is rational decision making?

Answer 1

Economic agents making decisions to maximise their benefit

Question 2

What is utility maximisation?

Answer 2

Consumers making decisions to gain as much satisfaction as possible

Question 3

What is profit?

Answer 3

Total revenue minus total cost

Question 4

What is profit maximisation?

Answer 4

Firms making decisions to ensure largest difference between total revenue and cost

Question 5

Why might consumers not behave rationally?

Answer 5

~Herding behaviour
~Consumer weakness at computation
~Habitual behaviour
~Nudge theory - can be used to reduce market failure (positive)

Question 6

What is demand?

Answer 6

The amount of good or services consumers willing to buy at a given price

Question 7

What is marginal utility?

Answer 7

Change in satisfaction from consuming extra unit of good/service

Question 8

What is diminishing marginal utility?

Answer 8

Individual gaining less additional utility from consuming more of a product

Question 9

What is supply?

Answer 9

Amount of goods firms willing to put on the market at a given price

Question 10

What is market equilibrium?

Answer 10

Price and quantity where demand equals supply

Question 11

What is the price mechanism?

Answer 11

Free market allocating resources through interaction of demand/supply

Question 12

What are the 3 functions of the price mechanism?

Answer 12

~Signalling
~Incentives
~Rationing

Question 13

What is signalling?

Answer 13

Price provides information to consumers + producers to aid rational decision making

Question 14

What are incentives?

Answer 14

Price in market encourages change in behaviour, consumers to maximise utility, producers to maximise profit

Question 15

What is rationing?

Answer 15

Price in market determines who can afford the good/service and thus who is provided with it

Question 16

What are the other functions of the price mechanism?

Answer 16

~Controls entry/exit of firms
~Eliminates surpluses and shortages

Question 17

What is a consumer surplus?

Answer 17

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

Question 18

What is a producer surplus?

Answer 18

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

Question 19

What is indirect taxation?

Answer 19

Charge levied on goods/services by government, increase producer costs, shifts supply to the left

Question 20

What is specific/unit tax?

Answer 20

Levy set by government on goods/services at a constant amount per item

Question 21

What is ad valorem tax?

Answer 21

Levy set by government on goods/services as % of a price

Question 22

What is a subsidy?

Answer 22

Sum of money paid by government to producer to encourage production and reduce price

Question 23

What are the limitations of subsidies?

Answer 23

~Financial cost
~Opportunity cost
~Efficiency issues