Theme 1 - Introduction to Markets and Market Failure (1.2 - How Markets Work) Flashcards
Describe the Neo-Classical theory [1]
Ref - 1.2.1 - Rational Decision Making
The assumption that all economic agents will act rationally to maximise their benefits or utility. [1]
What is meant by consumer utility? [1]
Ref - 1.2.1 - Rational Decision Making
The satisfaction derived from consuming specific goods. [1]
Which 4 groups of economic agents can the theory of maximisation be applied to? [4]
Ref - 1.2.1 - Rational Decision Making
Consumers [1]
Firms [1]
Workers [1]
Governments [1]
Describe 2 examples in which economic agents agree with the theory of Maximisation [4]
Ref - 1.2.1 - Rational Decision Making
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]
What is meant by “the margin”? [1]
Ref - 1.2.1 - Rational Decision Making
A decision made by an economic agent is made in isolation, without other influencing factors. [1]
Define demand [1]
Ref - 1.2.2 - Demand
Quantity of G+S that consumers are able and willing to pay at a given price. [1]
Explain 2 conditions of demand which changes the level of demand [4]
Ref - 1.2.2 - Demand
Income - A rise in income will lead to a rise in demand [1] as consumers have more disposable income to use to buy G+S. [1]
Demand for complements - As demand for one good rises (e.g. washing machines) [1], demand for another good will rise (e.g. washing powder) [1]
State the Law of Diminishing Marginal Utility. [1]
Ref - 1.2.2 - Demand
The utility gained from consuming a specific good falls the greater the number consumed [1]
Describe how the Law of Diminishing Marginal Utility works in real life [2]
Ref - 1.2.2 - Demand
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)
Explain how other consumer’s behaviours may influence consumer behaviour [3]
Ref - 1.2.10 - Alternative Views of Consumer Behavior
Consumer may adhere to social normalities in order to “fit in” [1], therefore they are more likely to act irrationally in consumption [1], which can cause herding behaviour over time, as more consumers want to “fit in” [1]
Explain how habitual behaviour can influence consumer behaviour [3]
Ref - 1.2.10 - Alternative Views of Consumer Behavior
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]
State and define the 3 other types of demand. [3]
Ref - 1.2.2 - Demand
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]
Derived demand - Goods demanded only for production of other goods. [1]
State what is meant by supply. [1]
Ref - 1.2.4 - Supply
The amount of goods firms are willing and able to sell at a given price. [1]
Explain 2 reasons why the supply curve may shift. [4]
Ref - 1.2.4 - Supply
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]
State and describe the 2 types of supply. [2]
Ref - 1.2.4 - Supply
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]
Describe how excess supply is reached in an economy. [2]
Ref - 1.2.6 - Price Determination
When the price level is above equilibrium [1]
So consumers are deincentivised to consume, so excess supply is formed. [1]
Describe how excess supply is eliminated [2]
Ref - 1.2.6 - Price Determination
Demand would shift outwards [1] and supply would shift inwards until a new equilibrium is reached. [1]
Describe how excess demand is reached in an economy. [2]
Ref - 1.2.6 - Price Determination
Price level would be below equilibrium [1].
So too many consumers would demand the cheaper goods, so excess demand is created. [1]
Describe how excess demand is eliminated [2]
Ref - 1.2.6 - Price Determination
Demand would shift inwards [1] and supply would shift outwards to make a new equilibrium at Pe1. [1]
What is meant by the price mechanism? [1]
Ref - 1.2.7 - Price Mechanism
Free markets allocating resources through interaction of demand and supply. [1]
State the 3 functions of the price mechanism. [3]
Ref - 1.2.7 - Price Mechanism
Signalling [1]
Incentive [1]
Rationing [1]
Describe the signalling function in a price mechanism. [1]
Ref - 1.2.7 - Price Mechanism
The prices in a market provides information to consumers/producers to aid rational decision making. [1]
Describe the incentive function in a price mechanism. [1]
Ref - 1.2.7 - Price Mechanism
Prices in a market can encourage consumers to maximise utility, and producers to maximise profits. [1]
