Theme 1 - Introduction to Markets and Market Failure (1.2 - How Markets Work) Flashcards

1
Q

Describe the Neo-Classical theory [1]

Ref - 1.2.1 - Rational Decision Making

A

The assumption that all economic agents will act rationally to maximise their benefits or utility. [1]

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2
Q

What is meant by consumer utility? [1]

Ref - 1.2.1 - Rational Decision Making

A

The satisfaction derived from consuming specific goods. [1]

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3
Q

What is the theory of Maximisation? [1]

Ref - 1.2.1 - Rational Decision Making

A

When economic agents act in a way to increase their net benefits. [1]

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4
Q

Describe 2 examples in which economic agents agree with the theory of Maximisation [4]

Ref - 1.2.1 - Rational Decision Making

A

Consumers are assumed to maximise their consumer utility [1], so they must compare the utility gained from consuming a unit to it’s opportunity cost. [1]

Workers are assumed to maximise their welfare at work [1], so they must consider factors such as pay and job security. [1]

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5
Q

What is meant by “the margin”? [1]

Ref - 1.2.1 - Rational Decision Making

A

The assumption that a decision made by an economic agent is made in isolation, without other influencing factors. [1]

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6
Q

Define demand [1]

Ref - 1.2.2 - Demand

A

The quantity of goods and services that is bought at a given price over a period of time. [1]

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7
Q

Explain 2 conditions of demand which changes the level of demand [4]

Ref - 1.2.2 - Demand

A

Income - A rise in income will lead to a rise in demand [1] as consumer have more disposable income to use for consumption. [1]

Price of goods - If the prices of goods increase, demand decreases [1] as less consumers are willing to buy the good at the given price. [1]

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8
Q

State the Law of Diminishing Marginal Utility. [1]

Ref - 1.2.2 - Demand

A

The utility gained from consuming a specific good falls the greater the number consumed [1]

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9
Q

Describe how the Law of Diminishing Marginal Utility works in real life [2]

Ref - 1.2.2 - Demand

A

The more avaliable a good, the less marginal utility is provides [1], as consumers are likely to have consumed the same good already [1]. (e.g. chocolate)

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10
Q

Explain how other consumer’s behaviours may influence consumer behaviour [2]

Ref - 1.2.10 - Alternative Views of Consumer Behavior

A

Consumer may adhere to social normalities in order to “fit in” [1], therefore they are more likely to act irrationally in consumption. [1]

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11
Q

Explain how habitual behaviour can influence consumer behaviour [3]

Ref - 1.2.10 - Alternative Views of Consumer Behavior

A

Many consumer may be addicted to substances such as alcohol [1], therefore they may act irrationally and buy more alcohol instead [1], therefore alcohol is price inelastic. [1]

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12
Q

State and define the 2 other types of demand. [2]

Ref - 1.2.2 - Demand

A

Joint Demand - An increase in demand for one good, rises demand for another good. [1]

Competitive Demand - When demand increases for one good, demand decreases for another. [1]

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13
Q

State what is meant by supply. [1]

Ref - 1.2.4 - Supply

A

The amount of goods firms are willing and able to sell at a given price. [1]

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14
Q

Explain 2 reasons why the supply curve may shift. [4]

Ref - 1.2.4 - Supply

A

Higher costs of production decrease supply, [1] as there is less incentive to supply in a market with low profits. [1]

Better technology can improve productivity by improving capital [1], therefore reduce production costs and increase supply. [1]

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15
Q

State and describe the 2 types of supply. [2]

Ref - 1.2.4 - Supply

A

Joint supply - When supply of one good increases, supply of another good also increases. [1]

Competitive supply - When the supply of one good increases, supply of another good will decreases. [1]

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16
Q

Describe how excess supply is reached in an economy. [2]

Ref - 1.2.6 - Price Determination

A

When the price level is above equilibrium [1]
Demand would therefore expand and supply would contract until a new equilibrium is reached. [1]

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17
Q

Describe how excess demand is reached in an economy. [2]

Ref - 1.2.6 - Price Determination

A

Price level would be below equilibrium [1].
Supply would therefore expand and demand would contract until a new equilibrium is reached. [1]

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18
Q

What is meant by the price mechanism? [1]

Ref - 1.2.7 - Price Mechanism

A

Free markets allocating resources through interaction of demand and supply. [1]

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19
Q

State the 3 functions of the price mechanism. [3]

Ref - 1.2.7 - Price Mechanism

A

Signalling [1]
Incentive [1]
Rationing [1]

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20
Q

Describe the signalling function in a price mechanism. [1]

Ref - 1.2.7 - Price Mechanism

A

The prices in a market provides information to consumers/producers to aid rational decision making. [1]

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21
Q

Describe the incentive function in a price mechanism. [1]

Ref - 1.2.7 - Price Mechanism

A

Prices in a market can encourage consumers to maximise utility, and producers to maximise profits. [1]

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22
Q

Describe the rationing function in a price mechanism. [1]

Ref - 1.2.7 - Price Mechanism

A

The price in a market determines who can afford the good or service. [1]

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23
Q

State 2 other functions of the price mechanism. [2]

Ref - 1.2.7 - Price Mechanism

A

Entry and exit of firms. [1]
Eliminating excess demand and supply. [1]

24
Q

Describe the function of the price mechanism in the entry and exit of firms. [3]

Ref - 1.2.7 - Price Mechanism

A

If the demand of a specific good increases, [1] this signals to a producer that that market is more profitable, [1] therefore incentivising producers to expand supply to maximise profits. [1]

25
Q

What is consumer surplus? [1]

Ref - 1.2.8 - Consumer and Producer Surplus

A

What consumers are willing to pay for a good, and what they actually pay. [1]

26
Q

What is producer surplus? [1]

Ref - 1.2.8 - Consumer and Producer Surplus

A

What firms are willing and able to supply, and the profits they receive. [1]

27
Q

How is consumer and producer surplus represented on a diagram? [2]

Ref - 1.2.8 - Consumer and Producer Surplus

A

At equilibrium, consumer surplus is above the price level [1], and producer surplus is below the price level. [1]

28
Q

What is indirect taxation? [1]

Ref - 1.2.9 - Indirect Taxation and Subsidies

A

Taxes on good and services. [1]

29
Q

What are the 2 types of indirect tax? [2]

Ref - 1.2.9 - Indirect Taxation and Subsidies

A

Unit tax [1]
Ad Valorem tax [1]

30
Q

What is unit tax? [1]

Ref - 1.2.9 - Indirect Taxation and Subsidies

A

A tax on a good/service which is set at a constant rate per item. [1]

31
Q

What is Ad Valorem tax? [1]

Give an example of Ad Valorem tax? [1]

Ref - 1.2.9 - Indirect Taxation and Subsidies

A

A tax on a good/service set as a % of a price. [1] (e.g. VAT) [1]

32
Q

What is a subsidy? [2]

Ref - 1.2.9 - Indirect Taxation and Subsidies

A

Money from the government to a producer, [1] to encourage production and reduce price. [1]

33
Q

Explain one reason why providing subsidies to firms can have a negative impact on a market. [3]

Ref - 1.2.9 - Indirect Taxation and Subsidies

A

The firm receiving a subsidy may become complacent as a result. [1] This could cause a loss in production and efficiency [1], therefore reducing supply to the economy. [1]

34
Q

What is the concept of elasticity? [2]

Ref - 1.2.3 - Price Elasticity of Demand

A

Elasticity measures the extent to which demand or supply will react to a change in the price level [1] or demand for other goods (XED) [1]

35
Q

How do you calculate percentage change? [1]

Ref - 1.2.3 - Price Elasticity of Demand

A

(New value - Original value) / (Original value) x 100 [1]

36
Q

What are the 4 types of elasticity? [4]

Ref - 1.2.3 - Price Elasticity of Demand

A

Price elasticity of demand [1] (PED)
Price elasticity of supply [1] (PES)
Income elasticity of demand [1] (YED)
Cross elasticity of demand [1] (XED)

37
Q

Define PED [1]

Ref - 1.2.3 - Price Elasticity of Demand

A

The responsiveness of demand to changes in the price level. [1]

38
Q

What is the formula used to calculate PED? [1]

Ref - 1.2.3 - Price Elasticity of Demand

A

% Change in quantity demanded / % Change in price level [1]

39
Q

State the value of PED which represents a price elastic and price inelastic demand. [2]

Ref - 1.2.3 - Price Elasticity of Demand

A

Price elastic - Less than -1 [1]
Price inelastic - Between 0 and -1 [1]

40
Q

State the 3 other types of price elasticity of demand, and state the values at which they occur. [3]

Ref - 1.2.3 - Price Elasticity of Demand

A

Perfectly Price Inelastic - (PED = 0) [1]
Perfectly Price Elastic - (PED = ∞) [1]
Unitary Elastic - (PED = -1) [1]

41
Q

State and explain 2 factors which influence PED [6]

Ref - 1.2.3 - Price Elasticity of Demand

A

Number of substitutes [1]. The more available substitutes, the more elastic a good/service is, [1] as consumers can buy substitute goods if another goods prices rise. [1]

Addiction. [1] People who are addicted to substances will continue to buy the substance even if prices rise, [1] therefore the substance becomes more price inelastic. [1]

42
Q

State the shape of the graph of a price elastic and price inelastic good. [2]

Ref - 1.2.3 - Price Elasticity of Demand

A

Price elastic - Shallow curve [1]
Price inelastic - Steep curve [1]

43
Q

How can businesses utilize PED to maximise profits? [2]

Ref - 1.2.3 - Price Elasticity of Demand

A

When demand is elastic, lowering prices increases revenue [1]. When demand is inelastic, increasing prices will increase revenue [1].

44
Q

Define YED [1]

Ref - 1.2.3 - Income Elasticity of Demand

A

The responsiveness of demand to a change in real income [1]

45
Q

What is the formula used to calculate YED? [1]

Ref - 1.2.3 - Income Elasticity of Demand

A

% Change in Demand / % Change in Real Income [1]

46
Q

State the 3 types of goods used to interpret YED, and state the values at which they occur. [3]

Ref - 1.2.3 - Income Elasticity of Demand

A

Normal Goods - YED is Positive [1]
Inferior Goods - YED is Negative [1]
Luxury Goods - YED is above +1 [1]

47
Q

State the values at which a good is income elastic and income inelastic [2]

Ref - 1.2.3 - Income Elasticity of Demand

A

Income Elastic - YED is above +1 or below -1 [1]
Income Inelastic - YED is between +1 and -1 [1]

48
Q

State and explain 2 factors which may influence YED [4]

Ref - 1.2.3 - Income Elasticity of Demand

A

Type of good/service. [1] YED can change if the good is inferior or luxury. [1]

Inflation [1] - An increase in inflation can reduce the real value of workers incomes. [1]

49
Q

How can a business use YED to maximise revenue? [1]

Ref - 1.2.3 - Income Elasticity of Demand

A

Businesses can use YED of certain goods to plan their production levels. [1]

50
Q

Define XED [1]

Ref - 1.2.3 - Cross Elasticity of Demand

A

The responsiveness or demand of good X to a change in the price level of Good Y [1]

51
Q

What is the formula used to calculate XED? [1]

Ref - 1.2.3 - Cross Elasticity of Demand

A

% Change in Demand (Good X) / % Change in Price (Good Y) [1]

52
Q

State the 3 types of goods used when interpreting XED figures, and state the values at which they occur. [3]

Ref - 1.2.3 - Cross Elasticity of Demand

A

Substitute Good - XED is Positive [1]
Complementary Good - XED is Negative [1]
Unrelated Good - XED = 0

53
Q

How can a business used XED to maximise revenue? [3]

Ref - 1.2.3 - Cross Elasticity of Demand

A

Businesses can determine the demand for a certain good, [1] therefore estimate revenue[1], which can help make production decisions to respond to change in demand. [1]

54
Q

Define PES [2]

Ref - 1.2.5 - Price Elasticity of Supply

A

The responsiveness of quantity supplied of a good [1] to changes in price. [1]

55
Q

What is the formula used to calculate PES? [2]

Ref - 1.2.5 - Price Elasticity of Supply

A

% Change in Quantity Supplied [1] / % Change in Price. [1]

56
Q

State the values at which PES is price inelastic and price elastic. [2]

Ref - 1.2.5 - Price Elasticity of Supply

A

Price Inelastic - (0 to -1) [1]
Price Elastic - (>1) [1]

57
Q

Explain 2 factors which influence PES [6]

Ref - 1.2.5 - Price Elasticity of Supply

A

If a good is perishable, such as fresh vegetables [1], it cannot be stockpiled. It is harder for supply to respond to a change in price, [1] so price is more inelastic. [1]

If entry of firms into a market is easier, such as low start up costs [1], this means that there are more firms to supply more goods in reponse to price change, [1] so supply is more elastic. [1]