Theme 1 - How markets work 1.2

Question 1

Why does maximisation occur?

Answer 1

This is when an economic agent tries to obtain the most from the economic activity that they undertake.

Question 2

What does it mean when someone is being ‘rational’.

Answer 2

Making decisions in order to maximise personal satisfaction

Question 3

How might economic agents be questioned upon their rational decision making?

Answer 3

Firms are not provided enough information to behave ‘rationally’ and consumers do not always make calculated decisions

Question 4

What is the definition for demand?

Answer 4

The amount an individual is willing and able to buy at any given price.

Question 5

Give 3 reasons why the demand curve slopes downwards.

Answer 5

1) Income effect (as the price level increases, sales fall)
2) Substitution effect ( higher the price, consumers find cheaper options
3) Diminishing marginal utility (the satisfaction gained decreases as an extra unit of good or service is consumed.

Question 6

What is meant by marginal utility?

Answer 6

The extra satisfaction gained after every extra unit.

Question 7

What does a contraction and an extension mean on a demand curve?

Answer 7

A contraction is caused when there is an increase in price and so demand levels decrease. An extension is shown as a decrease in price which increases demand.

Question 8

What are 7 factors that cause a shift on the demand curve?

Answer 8

Income, Complements, substitutes, tastes and preferences, population, advertisement, legislation.

Question 9

Definition of supply

Answer 9

Supply is the amount a business is willing and able to sell.

Question 10

Describe the relationship between quantity and price on a supply curve.

Answer 10

Price is directly proportional to the quantity supplied.

Question 11

Give 2 reasons to why the supply curve is upward sloping

Answer 11

1) profit motive - supply increases when price increases due to firms taking advantage of the higher price.
2) Maximising profit - a business will decrease their cost in production when price increases in order to maximise profits.

Question 12

5 factors that may shift the supply curve

Answer 12

Changes in the units in cost of production, a fall in exchange rate, advances in production technologies, new entry of producers and indirect taxes.

Question 13

What is meant by the acronym SPICED

Answer 13

S - strong, P - pound, I - imports, C - cheaper, E - exports, D - dearer.

Question 14

What is market equillibirum?

Answer 14

When supply and demand in an economy at equal.

Question 15

What happens in an economy when there is excess supply?

Answer 15

If the price was to increase, quantity demanded will decrease however, this will incentivise firms to increase supply as it is more profitable. This will lead to excess stock.

Question 16

What happens in an economy when there is excess demand?

Answer 16

When prices decrease, demand will increase but, firms are going to supply less because it is less profitable. This therefore means that there is excess demand.

Question 17

What happens when there is a shift in the demand curve?

Answer 17

An increase in demand is shown by a shift upwards and to the right. This means that there is an increase in price and an increase in quantity demanded.

Question 18

What happens when there is a shift on the supply curve?

Answer 18

An increase in supply is shown by a shift to the right. This will cause a decrease in price and an increase in quantity supplied

Question 19

What are market forces?

Answer 19

Market forces are pressure that are constantly pushing the market back into equilibrium when in disequilibrium.

Question 20

Factors impacting shifts on a demand curve.

Answer 20

Consumer income, taste and fashion and advertising

Question 21

Factors impacting shifts on a supply curve.

Answer 21

Cost of production, technological changes, taxations and subsidies.

Question 22

What is the price mechanism?

Answer 22

Price mechanism is the method of which prices of goods and services are achieved

Question 23

What is the rationing function?

Answer 23

Excess demand will cause an increase in prices due to the scarcity of the product but an increase in prices will decrease demand therefore leaving a rationing of the product

Question 24

What is the signalling function?

Answer 24

The signalling function is the function where higher prices signals firms to increase supply and signals consumers to decrease demand.

Question 25

What is the incentive function?

Answer 25

This function states that when there is an increase in prices, this will incentivise firms to supply more to maximise profits. This is because of the greater contribution per unit.

Question 26

The 3 types of efficiencies in allocating resources

Answer 26

Allocative = customer satisfaction is maximised in production of g + s
Productive = no additional output can be produced from the factor inputs available at the lowest average unit cost.
Economic = occurs when we have productive and allocative at the same time.

Question 27

What is consumer surplus?

Answer 27

The difference between the price they are willing to pay and the price they actually pay

Question 28

What happens to consumer surplus if there is an decrease in price?

Answer 28

A decrease in price will increase consumer surplus and as quantity demanded increase. Consumer surplus is now the original areas plus the area above the new equilibrium.

Question 29

What happens to consumer surplus if there is a increase in price?

Answer 29

An increase in price will decrease consumer surplus as there is less quantity demanded. This means that the new are above the higher price level is the new consumer surplus.

Question 30

What is producer surplus?

Answer 30

The difference between the price the producer is willing to supply a product and the price actually received for the product.

Question 31

What happens to producer surplus if there is an increase in price?

Answer 31

This will increase quantity demanded and so producer surplus increases

Question 32

What happens to producer surplus if there is a decrease in price?

Answer 32

This will decrease quantity demanded and so producer surplus decreases.

Question 33

Changes in demand to consumer surplus

Answer 33

Increase = increase in consumer surplus
Decrease = decrease in consumer surplus

Question 34

Changes in supply to producer surplus

Answer 34

Increase = increase in producer surplus
decrease = decrease in producer surplus

Question 35

What is a free market economy? Relate this to a theorist

Answer 35

Free markets is where the forces of supply and demand work together to supply what is demanded by consumers and consumers demanding what is demanded by suppliers for cheap. The invisible hand by Adam Smith states that no government intervention is needed and market forces work together to maximise profits for firms and utility for consumers.

Question 36

Advantages of free markets

Answer 36

Consumer choice - Increase in demand, increase production, maximisation of profits and utility
Competition - Competing means higher quality and lower prices

Question 37

Disadvantages of free markets

Answer 37

Little government intervention - high prices from no government allocation of resources and low quality
Inequalities in wealth
Little control of negative externalities

Question 38

What is a command economy? Relate this to a theorist

Answer 38

Resources, not labour, are allocated by the government and not the price mechanism. Karl Marx believed that labour was exploited by capitalism because capitalists (people with high authority and own lots of capital goods) payed workers low wages to maximise profits despite the high levels of output

Question 39

Advantages of command economy

Answer 39

Higher social equality - governments increasing social welfare so allocating resources fairly and regulations

Question 40

Disadvantages of command economy is

Answer 40

Allocates resources based on that the government thinks the needs and wants of consumers is.

Question 41

What is a mixed economy?

Answer 41

Resources are allocated by the price mechanism and governments. The state provides public goods, controls macroeconomic variables, reduce consumer exploitation and create competition.

Question 42

Who has a higher gain for a subsidy when demand is inelastic?

Answer 42

Consumers because when prices fall, the demand doesn’t increase by a lot so, revenue will not increase by as much as price so consumers benefit more as they pay less.

Question 43

Who has a higher gain for a subsidy when demand is elastic?

Answer 43

Producers because when prices fall, demand increases by a larger proportion meaning revenues will increase and so producers benefit more as they gain higher profits

Question 44

Who has a higher burden for a tax when demand is inelastic?

Answer 44

Consumers because when prices increase, demand decrease by as much so consumers will pay the higher prices but it means they have to bear more of the tax

Question 45

Who has a higher burden for a tax when demand is elastic?

Answer 45

Producers because when prices rise, demand decreases by a larger proportion. This means that producers receive less revenue and so are left bearing majority of the tax

Question 46

What does behavioural economics look at?

Answer 46

Emotional, social and psychological factors

Question 47

What is asymmetric information and how does it impact rationality?

Answer 47

When one person knows more information than the other person in an economic transaction. This means consumers will make irrational decisions because they don’t know all the information to back up their decision.

Question 48

What is meant by bounded rationality?

Answer 48

This is when someone tends to make a decision that benefits them and not a rational one

Question 49

Three biases that impact rational decision making?

Answer 49

• Habitual behaviour means that consumers tend to make decisions that they usually do
• Availability means that consumers overestimate the probability of something occurring again based on how easy it is to remember it happening
• Social norms where a number of people influence someone decision making.

Question 50

3 ways in which businesses use behavioural economics to make policies

Answer 50

• Nudges is when someone options are made easier without removing the freedom of choice
• Framing is the way in which something is presented to make something look more appealing to consumers
• Default option is when options are made easier when something happens automatically.