Preliminary Exam Topic 3

Question 1

Define ‘PRODUCT MARKET’

Answer 1

The interaction of demand for and supply of the outputs of production.

Question 2

Define ‘FACTOR MARKET’

Answer 2

A market for any input into the production process - trading of the inputs of production.

Question 3

Define ‘ALLOCATIVE EFFICIENCY’

Answer 3

Refers to the economy’s ability to allocate resources to satisfy consumer wants.

It is also said that the market mechanism ensures allocative efficiency.

Competition among producers also ensures they are responsive to consumer demand and thus utilise the most efficient and cost-effective production methods.

Question 4

In general why do governments intervene in the market place

Answer 4

Although markets can be effective at resolving basic issues of what and how much to produce, the market can still create unsatisfactory outcomes.

The market price or equilibrium quantity that results from the free interplay of demand and supply may be considered too high or too low.

When markets do not produce the desired outcome it is called market failure - When this occurs, governments may intervene in the market.

Question 5

What are two ways in which the government can intervene in the market?

Answer 5

1. Price intervention
2. Quantity intervention

Question 6

What is Gov price intervention?

Answer 6

When the market-determined price for commodities is too high or too low - They may intervene to impose price ceilings ( Maximum Market Price ) or price floors ( Minimum Market Price ).

The main reason for influencing prices in this way is to affect the distribution of income.

Price ceilings (sydney water) will redistribute money from sellers to buyers while price floors will do the opposite.

Question 7

What is Gov quantity intervention?

Answer 7

The quantity of some G&S provided by the market may be too high or too low.

This occurs because individual business firms and consumers often do not consider social costs and benefits of the production and consumption of certain goods. Externalities.

The government can artificially restrict production levels through laws - can also impose taxes on businesses, which increase their production costs and reduce production levels.

Consumers do not consider the social benefits ( Positive Externalities ) that accompany their consumption of some G&S.

The government may intervene in order to encourage the provision of these merit goods and services that have positive externalities.

They do this through subsidies to consumers to lower prices and increase consumption.

Question 8

Define ‘MERIT GOODS’

Answer 8

Merit Goods = Goods not produced in sufficient quantity by the private sector because private individuals do not place sufficient value on those goods.

For this reason, the government intervenes to supply these items and finances them with its tax revenue.

Public education

Question 9

How are PUBLIC GOODS and MERIT GOODS different?

Answer 9

Public goods such as street lights are defined as goods which are non-excludable and non-rivalrous in consumption.

Merit goods such as education are goods deemed socially desirable by the government.

Street lights are non-excludable in consumption while education is excludable in consumption.

Question 10

Define ‘PUBLIC GOODS’

Answer 10

Public Goods = Goods that private firms are unwilling to supply as they are not able to restrict usage and benefits to those willing to pay.

Non-rivalrous and Non-excludable

E.g street lights and national defence

Question 11

Go look at chapter 3 table above ceteris paribus

Answer 11

NOW

Question 12

Define ‘DEMAND’

Answer 12

Demand: can be defined as the quantity of a particular good or service that consumers are willing and able to purchase at various price levels at a given time.

Question 13

Define ‘INDIVIDUAL DEMAND’

Answer 13

Individual Demand = The demand of each individual consumer for a particular good or service.

Question 14

Define ‘MARKET DEMAND’

Answer 14

Market Demand = The demand by all consumers for a particular good or service.

Question 15

What is the law of demand?

Answer 15

The Law of Demand: As prices increase, the quantity demanded decreases.

Thus, price and quantity has an inverse relationship

Question 16

If you are drawing a demand curve, what units are on the Y and X axis.

And what direction is the slope

Answer 16

y axis = price ($)
x axis = quantity (units)

The line, which has a negative slope, does not touch either axis.

Question 17

Any movement along the demand curve is referred to as…

Answer 17

An expansion or contraction: This represents the changes in quantity demanded as price changes.

Question 18

DEMAND
Movement up =
Movement down =

Answer 18

Movement up = Contraction
Movement down = Expansion

Question 19

What is a shift in the demand curve?

Answer 19

A change in any one of the other factors that influence demand will lead to a shift in the demand curve.
AKA NOT A CHANGE IN PRICE…

It is where the entire line moves parallel to the left or to the right

Question 20

DEMAND
Shift Left =
Shift Right =

Answer 20

Shift Left = Decrease in demand

A decrease in demand means that consumers are willing and able to buy less of the product at each possible price than before.
A decrease in demand also means that consumers are willing and able to buy a given quantity at a lower price than before.

Shift Right = Increase in demand

An increase in demand means that consumers are willing and able to buy more of the product at each possible price than before.
An increase in demand also means that consumers are willing and able to buy a given quantity at a higher price than before.

Question 21

List five factors that cause a SHIFT in the demand curve

Answer 21

Prices of Other Goods and Services ( Substitute + Complimentary Goods )
The Size and Age Distribution of the Population
Consumer Tastes and Preferences
Expected Future Prices
Consumer Incom

Question 22

What are the six main factors affecting market demand

Answer 22

1. The price of goods and services (what they are trying to buy)
2. The price of other goods and services (complementary/substitute)
3. Expected future prices
4. Changes in consumer tastes and preferences
5. Level of income
6. Size and age of population

Question 23

Go read through the factors that effect demand

Answer 23

Thank you

Question 24

Define ‘SUPPLY’

Answer 24

Supply: refers to the total quantity of a good or service that producers are willing and able to sell at various prices within a certain time period.

Question 25

Define the ‘LAW OF SUPPLY’

Answer 25

The law of supply states that as the price of a certain product rises, the quantity supplied by producers will rise.
- This occurs because it becomes more profitable for firms already in the industry to increase production.
- This also occurs because the higher price and the potential of profitability attract new firms to the industry.

Question 26

What causes a shift in the supply curve

Answer 26

A change in any one of the other factors that influence supply will lead to a shift in the supply curve.
(not price)

Question 27

What does it mean if there is movement ALONG the supply curve

Answer 27

Any change in the price of a good is going to cause a change in the quantity supplied in the same direction as the price change.

A contraction in supply occurs when a decrease in the price of a good or service causes a decrease in the quantity supplied = downward movement on the supply curve.

An expansion of supply occurs when an increase in the price of a good or service causes an increase in the quantity supplied = upward movement along the demand curve.

Question 28

SUPPLY
A shift in the supply curve to the right =
A shift in the supply curve to the left =

Answer 28

A shift in the supply curve to the right = increase in supply.

An increase in supply means that firms are willing and able to supply more of a product at each price level than before.
An increase in supply also means that firms are willing and able to supply a given quantity at a lower price than before.

A shift in the supply curve to the left = decrease in supply

A decrease in supply means that firms are willing and able to supply less of a good at each price level than before.
A decrease in supply also means that firms are only willing and able to supply a given quantity at a higher price than before

Question 29

List five factors that could cause a shift in a SUPPLY graph

Answer 29

Prices of Other Goods and Services
The Costs of Factors of Production
The Quantity of the Good Available
Climatic and Seasonal Influence
The State of Technology

Question 30

What are the 6 factors affecting market supply

Answer 30

The Price of Goods and Services:
The market price of a G&S will influence the producer’s ability and willingness to supply it. Expectations about the future prices also influence supply; an expected rise in demand will increase supply.

The Price of Other Goods and Services:
The quantity of a G&S supplied is influenced by the prices of other G&S. More likely to supply the goods which are most profitable; dependent on their price in relation to other goods and services.

The State of Technology:
Improvements in technology lower production costs and allow more firms to supply more goods at a given price. Allow firms to adjust production runs to quickly accommodate changing demand.

Changes in the Cost of Factors of Production:
Among the most important influences on supply. Any fall in the cost of factors of production allows firms to supply more of a particular good, VICE VERSA

The Quantity of the Good Available:
Quantity of the goods available is a limiting factor that affects supply. In many industries, the number of suppliers also affects the quantity of the G&S available; more suppliers means more supply.

Climatic and Seasonal Influence:
Changes in climatic conditions will obviously affect agricultural production.

Question 31

Define ‘PRICE MECHANISM’

Answer 31

The interaction of the forces of supply and demand which determines the prices at which commodities will be bought and sold in the market.

Question 32

Define ‘MARKET EQUILIBRIUM’

Answer 32

Market equilibrium = is a situation where, at a certain price level, the quantity supplied and the quantity demanded of a particular commodity are equal.

This means that the market clears and there is no tendency for change in price or quantity.

Equilibrium is achieved in an individual market when all consumers willing to pay the market price for a good are satisfied and producers offering G&S at market price can sell their product.

Market equilibrium occurs where the demand and supply curves intersect; the point at which quantity demanded is equal to quantity supplied.

Question 33

What is an excess in demand? What happens?

Answer 33

Competition among buyers for limited goods causes suppliers to start bidding up the price → Supply Expansion + Demand Contraction

This will continue to occur as long as there is excess in demand until we reach the intersection of supply and demand.

This is the price mechanism in action; the market forces of supply and demand interact to bring about equilibrium and eliminate excess.
It is said that the market mechanism achieves consistency between the plans and outcomes for consumers and producers without explicit coordination.

Question 34

What is an excess in supply? What happens?

Answer 34

In order to remove the excess supply, sellers will offer to sell at a lower price. → Demand Expansion + Supply Contraction
This will continue to occur as long as there is excess in supply until we reach the intersection of supply and demand.

This is the price mechanism in action; the market forces of supply and demand interact to bring about equilibrium and eliminate excess.
It is said that the market mechanism achieves consistency between the plans and outcomes for consumers and producers without explicit coordination.

Question 35

GO READ CHANGES IN EQUILIBRIUM

Answer 35

YAY

Question 36

What is the degree of industry in a market usually determined by?

Answer 36

The degree of competition in an industry is primarily determined by market structure; the number and size of the firms within the industry.
It is also determined by the nature of the product being sold and the ease with which new firms can enter into that industry.

Question 37

Define ‘PURE COMPETITION’ and elaborate

Answer 37

A theoretical model of perfect competition - many small buyers. None sufficiently large enough to affect the market price.

The products sold by all firms are homogeneous; buyers and sellers know that the product is the same and are aware of all the prices at which the products are being offered for sale.

There are no barriers to new firms entering or exiting firms leaving the market.

Under these market conditions, firms are price takers; they must simply accept the market price - If they try to sell above it, no one will buy their product - Advertising is ineffective.

(Fruits and vegetables)

Question 38

Define MONOPOLY and elaborate

Answer 38

A monopoly = opposite of pure competition.

There is only one firm selling the product; no market competition.

There are significant barriers to entry and this effectively prevents any potential competitors from entering the market.

The product sold has no close substitutes.

Under these conditions, the monopolist has great control over the market price; they are the price setter and can set the price in order to maximise profit.

(Water supply - sydney water)

Question 39

Define MONOPOLISTIC COMPETITION and elaborate

Answer 39

There are many small firms in the industry.

The products sold in the market are similar, but not identical; the firms engage in product differentiation through advertising.

There are some small barriers to entry for new firms entering the market, including the fact that existing firms have loyal customers ( Brand Loyalty ).

Through product differentiation, the firms operating under conditions of monopolistic competition have some control over the price of their product.

( Motels + Restaurants )

Question 40

Define OLIGOPOLY and elborate

Answer 40

Most common market structure in Australia’s large industries.

There are only a few relatively large firms, each of which has a significant share of the market.

There are significant barriers to entry and this generally accounts for the fact that there are only a few firms in the industry.

They sell similar but differentiated products - advertising is better than price cutting for promoting products

It must consider very carefully the reactions of its competitors whenever it decides to change its pricing or output policies.

( Supermarkets + Banks + Oil Companies + Airlines )

Question 41

Define ‘PRICE ELASTICITY OF DEMAND’

Answer 41

Measures the responsiveness or sensitivity of the quantity demanded of a particular product to changes in its price.

As a figure, the price elasticity of demand shows the percentage change in the quantity of a good demand resulting from a 1% increase in its price.

Question 42

GO READ PRICE ELASTICITY OF DEMAND

Answer 42

YAYYAYAYYAY

Question 43

Define ‘ELASTIC DEMAND’

Answer 43

Elastic Demand = A strong response to a change in price.

Question 44

Define ‘INELASTIC DEMAND’

Answer 44

Inelastic Demand = A weak response to a price change.

Question 45

Define ‘UNIT ELASTIC DEMAND’

Answer 45

Unit Elastic Demand = A proportional response to a price change; the total amount spent by consumers remains unchanged.

For example

3 customers buy a sock for $2 (total amount spend = 6 dollars)

The price goes up to $3 per sock (Um the heck u think your doing)

Now only 2 customers want to buy it (total amount spent still $6)

Question 46

What is the significance of price elasticity of demand for both business and governments

Answer 46

A knowledge of price elasticity of demand is important to business firms and to the government - firms need to understand price elasticity of demand for the goods they sell to decide on optimal pricing.

If demand was relatively elastic, the firm would know that lowering the price would greatly expand sales and increase revenue.

If demand was relatively inelastic, the firm could increase the price which would also lead to an increase in revenue as the reduction in sales would be less than the price increase.

The government needs to understand price elasticity of demand when pricing the goods and services that it provides for the community.

It needs to be able to predict the effects of changes in the level of any indirect taxes, such as sales taxes, excise duties and special levies that it imposes on goods such as alcohol.

These taxes raise the price of the goods affected, and the government needs to be able to gauge the responsiveness of demand to accurately estimate the amount of revenue they will raise.

This relationship explains why governments tend to charge indirect taxes, such as excise duties, on those goods that have a relatively inelastic demand, including alcohol.

Question 47

How do you measure price elasticity of demand?

Answer 47

A simple way of measuring the price elasticity is to look at the effect of changes in price on the total revenue earned by the producer - This is known as the total outlay method.

Total Outlay = Price x Quantity Demanded ( At that price… )

Price ↑ + Revenue ↑ = Inelastic
Price ↑ + Revenue ↓ = Elastic
Price ↑ + Revenue - = Unit Elastic

Question 48

What is the relationship between the slope of demand and demand elasticity

Answer 48

The slope of the demand curve is not a measure of the price elasticity of demand - Even with a linear curve, the price elasticity of demand will vary.

Question 49

Explain perfectly elastic demand

Answer 49

no such situation exists in reality.
When demand is perfectly elastic, the demand curve is a horizontal straight line.
When demand is perfectly elastic, consumers will demand an infinite quantity at a certain price, but nothing at all at a price above this.
No individual seller would be able to charge a higher price, since they would lose all customers to the others selling identical products.
E.G If an apple grower sells apples along with other apple growers, they can sell the entire load at the going market price.
If the grower tries to sell at a price above the competition, they won’t make a sale.

Question 50

What does the graph look like for perfectly elastic demand

Answer 50

horizontal line

Question 51

Explain perfectly inelastic demand

Answer 51

When demand is perfectly inelastic, the demand curve is a vertical straight line.
Consumers are willing to pay any price to obtain a given quantity of a good - governments should regulate such markets to prevent exploitation of vulnerable consumers.
e.g. A person with a life-threatening disease that can only be treated with a particular drug would be willing to pay almost any price. SYDNEY WATER

Question 52

What is the graph for perfectly inelastic demand?

Answer 52

vertical line

Question 53

What are the factors effecting the elasticity of demand? (5)

Answer 53

Whether the good is a luxury or a necessity
Necessities = Inelastic
Luxury Goods = Elastic

Whether the good has any close substitutes
GS with close substitutes tend to have a highly elastic demand - Easy to switch to different brands.
GS without substitutes have an inelastic demand - cannot change where product is supplied.

The expenditure on the product as a proportion of income
GS that account for lower percentage of total income = lower price elasticity.
GS that account for a greater proportion of total income = high elasticity.

The length of time subsequent to a price change
As the price of products increases, consumers take time to become aware and adjust to the price change - The same with decreases. ST = I LG = E

After an initial price change, durable goods tend to have a more elastic demand than non-durable goods.

Whether a good is habit-forming (addictive) or not
Goods that tend to be habit-forming, tend to have an inelastic demand - willing to pay most prices.

Question 54

Define the ‘ELASTICITY OF SUPPLY’

Answer 54

The price elasticity of supply: measures the responsiveness of the quantity supplied of a product to changes in price; the percentage change in the quantity supplied caused by a 1% change in price.

For most goods, a rise in price will cause an expansion in supply, which means that for most goods the price elasticity of supply is positive.

If the rise in quantity supplied is proportionately greater than the increase in price, then that supply is very responsive to a price change and thus relatively elastic.

The opposite situation, a less-than-proportionate change in quantity supplied, would indicate relatively inelastic supply.

If quantity supplied rises by the same proportion as the price increase, supply is unit elastic.

Question 55

What is perfectly elastic supply?

Answer 55

When supply is perfectly elastic, the supply curve is a horizontal line.
At price OP, suppliers would supply an infinite quantity of the good.
Below that price, they would not be willing to supply any.
This is an unlikely situation.

Question 56

What is perfectly inelastic supply?

Answer 56

When supply is perfectly inelastic, the supply curve is a vertical straight line.
The quantity supplied is fixed at 0Q regardless of the price.
The supply of a unique piece of art may be perfectly inelastic.
If one exists, then the supply is fixed regardless of the price.

Question 57

Factors effecting the elasticity of supply (3)

Answer 57

GO READ THE PAGE FOR MORE DETAILS NOW

1. Time lags after a price change
2. The ability to hold and store stock
3. Excess capacity