The allocation of resources

Question 1

Market equilibrium

Answer 1

Occurs in a market when consumer demand for the product is exactly equal to the amount producers are willing and able to supply each period.

Question 2

3 Key Economic Questions

Answer 2

1. What goods and services to make?
2. How to produce these goods and services?
3. How to distribute these goods and services?

Question 3

Microeconomics

Answer 3

The study of economic decisions and actions of individual consumers, producers and households and how they interact to determine different market outcomes.

Question 4

Market disequilibrium

Answer 4

The state of a market when the quantity of producers are willing and able to supply each period differs from the quantity consumers are willing and able to buy.

Question 5

Macroeconomics

Answer 5

The study of major economics issues and conditions that affect a national economy.

Question 6

Mixed economic system

Answer 6

An economic system that combines free markets with government planning to allocate scarce resources and distribute goods and services. Some resources are owned and controlled by private individuals and firms while others are owned and controlled by the government. The government intervenes to produce public goods which are not produced by the private sector.

Question 7

Market economic system

Answer 7

An economic system that relies on the market forces of demand and supply to allocate resources with little or no government intervention.

Question 8

Planned economic system

Answer 8

An economic system that relies on the government planning to allocate scarce resources. It is often associated with a communist political system that strives for social equality.

Question 9

Demand

Answer 9

The willingness and the ability of consumers to pay a given price to buy a good or service. The Law of Demand states that the higher the price of a product, the lower the quantity demanded for the product.

Question 10

Shortage or Excess demand

Answer 10

Occurs when the quantity demanded for a product exceeds the quantity supplied of the product. This happens when the price is set below the equilibrium price.

Question 11

Movement

Answer 11

A movement along the existing demand or supply occurs when there is a change in the price of the good sold in the market.

Question 12

Shift

Answer 12

A shift in the demand or supply curve to the left or right occurs when there is a change in any determinant of demand or supply other than price and quantity.

Question 13

Supply

Answer 13

The willingness and the ability of firms to produce a good or service at given prices. The Law of Supply states the the higher the price of a product, the higher the quantity supplied of the product.

Question 14

Surplus or Excess supply

Answer 14

Occurs when the quantity supplied for a product exceeds the quantity demanded of the product. This happens when the price is set above the equilibrium price.

Question 15

Complements

Answer 15

Products that are jointly demanded for use together. For example, cinema and popcorn or cars and fuel.

Question 16

Substitutes

Answer 16

Products that are in competitive demand as they can be used in place of each other. For example, coffee and tea.

Question 17

Price elasticity of demand (PED)

Answer 17

A measure of the responsiveness of quantity demanded for a product following a change in its price. It is computed as the percentage change in quantity demanded divided by the percentage change in price. The PED is always negative due to the Law of Demand.

Question 18

Price elastic demand

Answer 18

PED is more than 1. Buyers are highly sensitive to changes in price. There is a large decrease in quantity demanded when there is a small increase in price. The demand curve is flat.

Question 19

Price inelastic demand

Answer 19

PED is less than 1. Buyers are not sensitive to changes in price. There is little change in quantity demanded when there is a small increase in price. The demand curve is steep.

Question 20

Price elasticity of Supply (PES)

Answer 20

A measure of the responsiveness of the quantity supplied of a product following a change in price. It is computed as the percentage change in quantity supplied divided by the percentage change in price.

Question 21

price elastic supply

Answer 21

PES is more than 1. Producers are highly sensitive to changes in price. There is a large increase in quantity supplied when there is a small increase in price. The supply curve is flat.

Question 22

price inelastic supply

Answer 22

PES is less than 1. Producers are not sensitive to changes in price. There is little change in quantity supplied when there is a small increase in price. The supply curve is steep.

Question 23

Market failure

Answer 23

Occurs when the market forces of demand and supply fail to allocate resources efficiently.

Question 24

Merit goods

Answer 24

Goods and services that have positive externalities and are usually under-consumed in a market economy. For example, education, healthcare.

Question 25

Demerit goods

Answer 25

Goods and services that have negative externalities and are usually over-consumed in a market economy. For example, cigarettes, driving a car, gambling

Question 26

Public goods

Answer 26

Goods and services that are not produced by the private sector due to the lack of a profit motive and has to be provided by the government. For example, street lighting, national defense.

Question 27

Private costs

Answer 27

The actual costs of a firm, individual or government incurred in the production or consumption of a good or service.

Question 28

External costs

Answer 28

The negative side-effects of production or consumption incurred by third parties, for which no compensation is paid. For example, air pollution caused by a driver driving a car.

Question 29

Social costs

Answer 29

Social costs = private costs + external costs

Question 30

Private benefit

Answer 30

The actual benefit accrued to a firm, individual or government due to the production or consumption of a good or service.

Question 31

External benefit

Answer 31

The positive side-effects of production or consumption incurred by third parties, for which no money is paid by the beneficiary. For example, clean air from a neighbour’s garden.

Question 32

Social benefit

Answer 32

Social benefit = private benefit + external benefit

Question 33

Subsidy

Answer 33

A sum of money given by the government to a producer to reduce the costs of production or to a consumer to reduce the price of consumption. It is used to increase the quantity supplied or quantity demanded of a good.

Question 34

Tax

Answer 34

A compulsory contribution to the government added to the cost of goods and services to discourage the production or consumption of these goods.

Question 35

Regulation

Answer 35

Rules imposed by the government to solve market failure.

Question 36

Privatisation

Answer 36

The transfer of a business, industry, or service from public to private ownership and control.

Question 37

Nationalisation

Answer 37

The transfer of a business, industry, or service from private to public ownership and control.

Question 38

Causes of market failure

Answer 38

This may be caused by

1) Underproduction or underconsumption of merit goods - The production or consumption of a good or service has positive externality for a third party not involved in the economic activity.
2) Overproduction or overconsumption of demerit goods - The production or consumption of a good or service has negative externality on a third party not involved in the economic activity.
3) Non-production of public goods - The failure of the private sector to provide some goods and services due to the lack of a profit motive.
4) Abuse of monopoly power - The existence of a firm in a monopoly market that does not act in the interest of the public by charging prices that are too high or engages in anti-competitive behaviour.
5) Factor immobility - factors of production that are difficult to move result in shortages or surplus

Question 39

Direct provision of goods

Answer 39

The government engages in the provision of a good directly. For example, the Singapore government provides face masks directly in times of severe haze.

Question 40

Maximum price

Answer 40

Also known as price ceiling. A regulation imposed by the government that limits the maximum price a seller can charge for a good or service.

Question 41

Minimum price

Answer 41

Also known as a price floor. A regulation imposed by the government that imposes a minimum price a seller can charge for a good or service.

Question 42

Factors that cause a shift in demand

Answer 42

1) An increase in income increases the demand for normal goods and decreases the demand for inferior goods
2) An increase in the price of another good - an increase in the price of a substitute increases the demand for a good, an increase in the price of a complement decreases the demand for a good
3) A change in consumer taste and preferences through trends, advertising, new product

Question 43

Factors that cause a shift in supply

Answer 43

1) An increase in the cost of production will decrease supply and vice versa
2) Improvements in technology increase supply
3) Increase in productivity of factors of production increases supply
4) An increase in the number of sellers increases supply
5) A tax imposed by the government increases the cost of production and decreases supply
6) A subsidy given by the government lowers the cost of production and increases supply.
7) An increase in the price and profitability of other products supplied by the same producer decreases the supply of the good.

Question 44

Uses of price elasticity of demand

Answer 44

1. Help firms to decide on their pricing strategy - increase or decrease price, price discrimination
2. Predict the impact of changes in price
3. Decide on how much tax can be passed on to consumers

Question 45

Determinants of price elasticity of demand

Answer 45

1) A good is more price elastic if many substitutes are available.
2) A good is more price elastic if a large proportion of household income is spent on it.
3) A good is more price elastic if it is not a necessity (a want or luxury item).
4) A good is more price elastic if its consumption does not cause habits to form. (E.g. addictive goods such as cigarettes, alcohol, drugs, coffee tend to be price inelastic).
5) A good is more price elastic if it does not have strong advertising or brand loyalty.
6) Demand for a good tends to be more price elastic in the long-run
7) A good is more price elastic if it is durable and non-perishable.
8) A good is more price elastic if there is little or no cost of switching to another product.

Question 46

The relationship between PED and total revenue

Answer 46

Elastic demand 
Price increase --> Revenue falls
Price decrease --> Revenue increases
Inelastic demand 
Price increase --> Revenue increases
Price decrease --> Revenue decreases

Question 47

Determinants of price elasticity of supply

Answer 47

1) Supply is more price elastic if a firm has plenty of spare capacity and can increase supply easily.
2) Supply is more price elastic if a firm has unused inventory that is readily available for use.
3) Supply is more price elastic if there are many sellers in the market.
4) Supply is more price elastic in the long run when there are no fixed costs.
5) Supply is more price elastic if factors of production are mobile or can be easily substituted

Question 48

Price mechanism

Answer 48

In a market economy, the price mechanism is used to decide how to allocate scarce resources.

High or rising market prices provide sellers with signals about what products consumers want and what they are willing to pay. These price signals help firms identify products that will be profitable to make and sell.

If the market price falls and profitability of the product falls because consumer demand for it is decreasing, it will act as a signal for firms to move their resources to the production of more profitable products.