Theme 1 - Introduction to markets and market failure

Question 1

Define market failure

Answer 1

When the free market’s price mechanism leads to a misallocation of scarce resources at the socially optimum level, leading to a Net welfare loss

Question 2

Name the 3 types of market failure

Answer 2

• Externalities
• Under-provision of public goods
• Information gaps

Question 3

What are public goods and explain the market failure of the under provision of them

Answer 3

• Non-exlcudable
• Non-rivalry
• MF : under provided by private sector due to free rider problem
• provided by government and financed through taxation

Question 4

What is one example of public goods?

Answer 4

Street lights

Question 5

Are public goods provided by the free market?

Answer 5

No, they are provided by the government and financed through taxation

Question 6

Define demand

Answer 6

When you’re willing and able to buy a good or service at a given price and at a given time

Question 7

Why does the demand curve slope downwards?

Answer 7

There is an inverse relationship between the price of a good or service and the quantity demanded of that good or service

Question 8

Difference between when we say quantity demand has decreased and increased, OR, contraction, extension?

Answer 8

movement along demand curve - contraction or extension caused by change in price

shift in demand curve (new demand curve outwards or inwards) - decrease or increase caused by conditions of demand

Question 9

Define PED and give its formula

Answer 9

Measures the responsiveness of demand to a change in the price of a good

%change in QD / %change in P

Question 10

ALL PED formulas

Answer 10

relativley elastic PED -

Question 11

YED

Answer 11

YED is income elasticity of demand - measures the responsivness of quanity demanded to a change in income

Formula - %change in QD/ %change in Y(income)

(remember you q before you p)

YED always positive sign - normal good = positive relationship with QD, as Y increases, QD increases

YED always negative sign- inferior good = inverse relationship with QD, as Y increases, QD decreases

YED>1 = income elastic
YED<1 = income inelastic

Normal goods either normal necessity - YED>1, or normal necessity, YED<1 = normal luxury

Question 12

What are the types of indirect tax?

Answer 12

• Plastic bag charge (to address issue of environmental damage
• Fuel duties
• Alcohol duties
• Sugar tax
• Tobacco tax

Question 13

What is an indirect tax?

What is an ad valorem tax?

Answer 13

IT - Taxes on consumption imposed by the government which increases the cost of production for producers

AT - tax imposed as a percentage of the unit cost of the item, tax paid proportional to value of item

Question 14

When is all of the tax paid for by consumer?

Answer 14

• Perfectly elastic supply
• Perfectly inelastic demand

Question 15

Two types of ad valorem tax

Answer 15

• VAT (current UK rate is 20%)
• Insurance Premium Tax (applies to travel, car, and appliance assurance)

Question 16

Define market supply and how do you calculate it?

Answer 16

The total supply brought by producers into the market at every given price level

Calculate - Add up all individual supply schedules

Question 17

Define joint supply

Answer 17

When an increase or decrease in the supply of one product, leads to an increase or decrease in the supply of a bi-product (associated e.g. remote and batteries)