Theme 1 - Introduction to markets and market failure

Question 1

what is the basic economic problem

Answer 1

there are unlimited wants and limited resources. this leads to scarcity

Question 2

define scarcity

Answer 2

a situation that arises when people have unlimited wants in the face of limited resources

Question 3

define opportunity cost

Answer 3

the benefits of the next best alternative forgone as a result of a particular choice

Question 4

what are the 4 factors of production

Answer 4

land (-rent)
labour (-wages)
capital (-interest)
enterprise (-profit)

Question 5

what does the PPF (productivity possibility frontier) show

Answer 5

the maximum possible output combinations an economy can produce with a given set of resources (FoPs)

Question 6

define specialisation

Answer 6

occurs when societies engage in trade, and thus do not have to produce all the goods and services they need

Question 7

define division of labour

Answer 7

the delegation of tasks to individuals

Question 8

what causes the PPF to shift

Answer 8

a change in the quality or quantity of the factors of production

Question 9

define demand

Answer 9

the amount of a good or service that consumers are willing and able to purchase at any given price

Question 10

what causes a movement along the demand curve

Answer 10

change in price

Question 11

what causes a shift of the demand curve

Answer 11

non-price factors such as change in taste/preferences, income of consumers, price of substitutes/complements, population.

Question 12

define supply

Answer 12

the quantity of goods or services that suppliers are willing to sell at any given price

Question 13

what causes a movement along the supply curve

Answer 13

change in price

Question 14

what causes a shift of the supply curve

Answer 14

change in cost of production

Question 15

define market

Answer 15

a place where buyers and sellers exchange goods or services

Question 16

what are the three functions of price

Answer 16

1. rationing - consumers and firms will only be wiling and able to buy the gods they can afford. the price therefore limits demand for both consumers and producer goods, eliminating excess demand.
2. incentive - low prices give buyers an incentive to purchase a good, high prices give sellers an incentive to make goods available. this interaction of different incentives lead to equilibrium, where the price matches demand with supply.
3. signaling - the price of a good is an important piece of information for both buyers and sellers; they reflect market conditions and changes in these conditions and the decisions of all agents will depend on the signals sent and received.

Question 17

explain the rationing function of price

Answer 17

consumers and firms will only be wiling and able to buy the gods they can afford. the price therefore limits demand for both consumers and producer goods, eliminating excess demand.

Question 18

explain the incentive function of price

Answer 18

low prices give buyers an incentive to purchase a good, high prices give sellers an incentive to make goods available. this interaction of different incentives lead to equilibrium, where the price matches demand with supply.

Question 19

explain the signaling function of price

Answer 19

the price of a good is an important piece of information for both buyers and sellers; they reflect market conditions and changes in these conditions and the decisions of all agents will depend on the signals sent and received.

Question 20

what are the five types of interrelationships between markets

Answer 20

1. complements - goods that are consumed together, e.g. bread and butter.
2. substitutes - goods that are consumed instead of each other, e.g. cows milk or oat milk.
3. derived demand - refers to the situation where a good is demanded not for its own intrinsic characteristics, but because it allows the consumption of another good, e.g. a chef and sandwich - you don’t demand the chef for its own intrinsic value, but you do demand the chef because he can make a tasty sandwich.
4. composite demand - occurs when a good is demanded for more than one use, e.g. a vacant plot of land may be used for residential or commercial development. the two goods would be indirectly proportional.
5. joint supply - occurs when a good is supplied for more than one use (or by-products are present), e.g. a sheep can be used for meat and material for a fashion coat. the two goods would be directly proportional.

Question 21

explain the complements type of interrelationships between markets

Answer 21

goods that are consumed together, e.g. bread and butter.

Question 22

explain the substitutes type of interrelationships between markets

Answer 22

goods that are consumed instead of each other, e.g. cows milk or oat milk.

Question 23

explain the derived demand type of interrelationships between markets

Answer 23

refers to the situation where a good is demanded not for its own intrinsic characteristics, but because it allows the consumption of another good, e.g. a chef and sandwich - you don’t demand the chef for its own intrinsic value, but you do demand the chef because he can make a tasty sandwich.

Question 24

explain the composite demand type of interrelationships between markets

Answer 24

occurs when a good is demanded for more than one use, e.g. a vacant plot of land may be used for residential or commercial development. the two goods would be indirectly proportional.

Question 25

explain the joint supply type of interrelationships between markets

Answer 25

occurs when a good is supplied for more than one use (or by-products are present), e.g. a sheep can be used for meat and material for a fashion coat. the two goods would be directly proportional.

Question 26

define consumer surplus

Answer 26

the difference between the amount consumers are willing to pay, and the amount they actually pay for a good or service.

Question 27

define producer surplus

Answer 27

the difference between the amount producers are willing to sell the food for, and the actual price they receive (market price)

Question 28

what is the equation for price elasticity of demand

Answer 28

PED = % change in quantity demanded / % change in price

Question 29

define price elasticity of demand

Answer 29

the responsiveness of demand to a change in price