The Allocation of Resources

Question 1

What is the Market System?

Answer 1

The Markey system is the way in which an economy is structured & organised.

A Market can lean towards two sides, one being the free market in which the market forces of supply and demand allocate goods & services. It operates through the privately owned firms and individuals, also known as the private sector. There is less government intervention.

On the other hand is a planned economy, which relies on direct involvement from the government to allocate goods & services

Question 2

What is the Price Mechanism?

Answer 2

The price mechanism is the interaction of demand and supply in a free market. When scarcity of a good increases, the price mechanism essentially means price will go up, which will cause less people to be able to buy it and scarcity will decrease again.

Question 3

What is Demand & Quantity Demanded

Answer 3

Demand is the amount of a good or service bought at given prices over a period of time.

Quantity Demanded is the amount of good or service brought at a specific price over a period of time.

Question 4

What are the Laws of Demand

Answer 4

The Income Effect: If price goes up, less people can afford it or want to pay the price. (Price has an inverse relationship with demand.)

The Substitution Effect: A substitute is a good or service that satisfies the same need or wants as another good. There are also weaker substitutes and stronger substitutes.

Question 5

What is Market Equilibrium & Disequilibrium

Answer 5

Equilibrium: When Quantity Demanded = Quantity Supplied

Disequilibrium: When Quantity Demanded doesn’t equal Quantity supplied

In the short run it is not uncommon to have disequilibrium but in the long run it should reach market equilibrium. When it is in equilibrium, stock should run out, if price is too high, then there will be excess supply or surplus. if the price is too low, there will be excess demand or shortages.

Excess Supply leads to producers cutting price to clear (downbidding). Excess demand leads to upbidding by consumers to buy it.

Question 6

What are the non-price Determinants of Demand

Answer 6

Changes in Real Income
Changes in Fashion/Taste/Trends
Changes in Population
Changes in the Price of Substitutes
Changes in the Complementary Goods

Question 7

What is the definition of Supply

Answer 7

Supply is the amount of a good or service supplied at given prices over a period of time.

Quantity Supplied is the amount of good or service supplied at a specific price over a period of time.

Question 8

What are the Laws of Supply

Answer 8

The Incentive Effect: Firms have an incentive to produce more of a good at higher prices sop they can make more profit.

Question 9

What are the non-price Determinants of Supply

Answer 9

Cost of Raw Materials
Cost of Wages
Cost of Rent
Tax & Subsidies
New Technology
Price of Related Goods (Complementary & Substitute)

Question 10

What is Price Elasticity of Demand

Answer 10

Demand Elasticity is the responsiveness of Quantity Demanded to a change in price. The gradient of the demand curve is the elasticity. High demand elasticity means changing the price causes big changes in demand. Low demand elasticity is the opposite

Elasticity = %ΔQD / %ΔP

Question 11

What are the Factors Affecting PED

Answer 11

Availability of Substitutes.

Price as Proportion of Income. The higher the price the higher the elasticity. E.g If a yacht changes from 2mil to 3 mil, big changes will happen. But if a eraser gets ten cent more expensive, minimal change.

Time. The longer time period given to react, the more elastic the response. When buying a car, if the price of gas doubles while you’re in need for fuel, you’ll probably fuel up anyways. But the next day, you might use more public transport to save.

Question 12

How to Maximise revenue using PED

Answer 12

The total revenue rule states that in order to maximise revenue, firms should increase the price of products that are inelastic in demand & decrease prices on products that are elastic in demand.

Question 13

What is Perfectly Inelastic & Perfectly Elastic Demand

Answer 13

Perfectly Inelastic Demand means that the people will buy the good at any price, so price has no effect on quantity demanded. This is theoretical so the closest you can get is air.

Perfectly Elastic means people will buy your good only at a certain price. Under that, everyone wants it, over it no one wants it.This requires homogeneous goods, no branding and perfect knowledge, so is theoretical.

Question 14

What is Price Elasticity of Supply

Answer 14

It is the measure of the responsiveness of quantity supplied for a change in price. it is the firms ability to change supply when the price changes.

PES = %ΔQS / %ΔP

Question 15

What are the Factors affecting PES

Answer 15

The first factor is time. It takes time to produce or obtain it, so supply won’t be able to change in a given moment. In the short run, supply can be increased, but only through more labour.

The second factor is the availability of resources. A firm needs more land, labour, capital and enterprise to be able to produce more. If an economy maxed out these CELLs, then supply is inelastic.

The third factor is stock levels, how much you got in storage.

The fourth factor is the mobility of factors of production.

Also, PES increases as you move away from the forms of production. Primary is the lowest with raw material extraction while tertiary has the highest PES.

Question 16

What is Perfectly Inelastic & Perfectly Elastic Supply

Answer 16

Perfectly Inelastic supply means regardless of price, the supply won’t change. An example of this is sport stadiums. There are only so many seats to sell.

Perfectly Elastic supply means no matter the change in supply, the price will stay the same. This is impossible.

Question 17

Advantages & Disadvantages of a Free Market

Answer 17

ADVANTAGES:
- Choice, the private sectors want to please customers and fulfil their wants
- Efficiency, Competition & profits are prioritised which leads to improvements due to the price incentive
- Lower Taxation (in Theory), if the government isn’t funding it, they don’t need the money

DISADVANTAGES:
- Greater Wealth Inequality
- Competition is wasteful as advertising and marketing could be used for more productive purposes
- Pollution & other external costs, as profits are prioritised over external costs.

Question 18

What is Market Failure

Answer 18

This is when the market fails to allocate resources in the most sociably desirable way.

Question 18

Reasons for Market Failure

Answer 18

Consumers consume and Firms produce for private benefit, but they don’t take external costs into account which leads to this.

This can also be created due to monopolies exploiting customers and limit supply due to not having competition.

Another reason is that Public goods are hard to profit from, making them under-provided. Examples include libraries.

Lastly Factor immobility occurs when it is difficult for FoPs to move or switch, which results in inefficient allocation of resources.

Question 19

What is a Mixed Economic System

Answer 19

It is when the economy has both private and public sectors. These sort of government can intervene in the market via indirect taxation, subsidies, maximum & minimum price, regulation, nationalisation and privatisation.

Question 20

What is External Cost & Benefit

Answer 20

External cost is the cost of an economic activity on third parties and External benefits are the benefits of a economic activity to third parties.

Question 21

What is Social Cost & Benefit

Answer 21

Social cost is the cost of an economic activity on society, i.e those involved and those not involved. Social Benefit is the benefit of an economic activity on society.

Question 22

What is Private Cost & Benefit

Answer 22

Private Cost is the cost of an economic activity to those involved, and private benefit is the benefit of an economic activity to those involved.

Question 23

What would Ration Consumers & Producers do?

Answer 23

Rational Consumers would consume the quantity of a good where the private cost equals the private benefit. Rational producers will produce the quantity of a good where the private cost equals the private benefit.

Question 24

What are the three positions a market can be in?

Answer 24

Social Optimum, where Social Benefit equals Social Cost. There is no market failure.

Overconsumption/Overproduction, where Social Benefit is less than Social Cost

Under consumption/Underproduction, where Social Benefit exceeds Social Cost.

Question 25

What is a Demerit Good & a Merit Good

Answer 25

A Demerit good is a good that is overconsumed or overproduced past social optimum.

Merit goods are goods that are under consumed or underproduced relative to social optimum.

Question 26

Governments addressing Market Failure - Minimum Price

Answer 26

A price which a good cannot legally sold below. The government can declare a good cannot be sold under a certain price to decrease its consumption. This is only done on demerit goods.

Question 27

Governments addressing Market Failure - Maximum Price

Answer 27

A price which a good cannot legally sold above. The government can declare a good cannot be sold above a certain price to increase its consumption. However, Firms are less willing to supply, so this could cause shortages. This is only done on merit goods.

Question 28

Governments addressing Market Failure - Minimum Wage

Answer 28

If a minimum wages needs to be imposed, the market failed to find an equilibrium in a way that satisfies the government, whether for humanitarian reasons or the need for more workers.

The Qd for labour will fall due to income/substitution effect, meanwhile Qs will increase, due to the incentive effect as more people are willing to work. Fewer are hired overall due to surplus.

Question 29

Governments addressing Market Failure - Subsidies

Answer 29

Subsidies are a payment from the government to a firm to lower the cost of production. As cost of production is reduced, supply increases, causing a decrease in price and an increase in consumption.

Question 30

Governments addressing Market Failure - Indirect Taxation

Answer 30

Indirect Taxation is a tax that is taken through the consumption of goods & services. Taxes are another cost of production for suppliers which creates an inward shift in supply and an increase in price, decreasing consumption. This is done for demerit goods.

Question 31

Governments addressing Market Failure - Social Advertising

Answer 31

The goal of social advertising is to increase knowledge and to decrease asymmetrical information (consumers don’t have all the information that suppliers have) by promoting merit goods and discouraging demerit goods.

Question 32

Governments addressing Market Failure - Regulations

Answer 32

Regulations decrease private benefit gained by making the consumption of demerit goods more inconvenient which causes decrease in demand and therefore consumption. An example is banning indoors smoking.

Question 33

Consequences of Market Failure

Answer 33

Demerit goods are over-provided, which causes external costs, so Governments have to regulate this.

In the same way, Merit goods are under-provided which decreases the potential amount of social benefit.