Theme 1.2 How Markets Work

Question 1

What is utility?

Answer 1

How useful something is

Question 2

What assumption do we need to make when regarding consumers?

Answer 2

That all consumers behave rationally and will aim to maximise their utility they derive from purchasing goods or services

Question 3

What assumption do we need to make when regarding firms?

Answer 3

The aim to maximise their utility by selling goods and services for the maximum possible profit

Question 4

What is irrational behaviour?

Answer 4

Where consumers decisions which don’t maximise utility by not taking the cheapest alternative but can cause a loss of economic welfare

Question 5

What is bounded rationality?

Answer 5

When you would always look for the cheapest option

Question 6

Explain why an economic agent might behave irrationally?

Answer 6

Brand loyalty
Not looking for cheapest price
Drawn in by advertisement/branding

Question 7

What does a demand curve show?

Answer 7

The relationship between price and quantity demanded. It slopes downwards from left to right because, as price falls, people are more willing to buy a good

Question 8

What is a contraction of demand?

Answer 8

When the price rises and quantity demanded falls - a movement on the demand curve left

Question 9

What is an expansion of demand?

Answer 9

When the price decreases and quantity demanded increases - a movement on the demand curve right

Question 10

What factors cause a shift in the demand curve?

Answer 10

Changes in real incomes
Changes in tastes and fashions
Advertising and branding
Changes in the price of substitutes and complimentary goods
Changes in size and age distribution of the population
Weather

Question 11

Define demand

Answer 11

The quantity of a product consumers are WILLING and ABLE to buy at different prices in a specified time period

Question 12

What is latent demand?

Answer 12

When a consumer is just willing to buy and product and not able to

Question 13

What is effective demand?

Answer 13

When a consumer is is both willing and able to buy the product

Question 14

What are the 7 conditions of demand?

Answer 14

P - population
A - advertising
S - substitute price 
I - income
F - fashion/tastes
I - interest rates 
C - compliment price

Question 15

What is diminishing marginal utility?

Answer 15

The additional utility, or amount of satisfaction, gained from each additional unit of consumption. Marginal utility will usually decrease with each additional increase on the consumption of a good

Question 16

What does price elasticity of demand (PED) measure?

Answer 16

The responsiveness of quantity demand to a change in price

Question 17

What does income elasticity of demand (YED) measure?

Answer 17

The responsiveness of quantity demanded to a change in income

Question 18

What does cross (price) elasticity of demand (XED) measure?

Answer 18

The responsiveness of quantity demanded for one good to a change in the price of another good

Question 19

How do you calculate PED?

Answer 19

% change in QD / % change in price

Question 20

How do you calculate YED?

Answer 20

% change in QD / % change in income

Question 20

How do you calculate XED?

Answer 20

% change in QD of good X / % change in price of good Y

Question 22

With regards to PED what is perfectly/relatively inelastic and unitary/relatively and perfectly elastic?

Answer 22

Perfectly elastic - 0
Relatively inelastic - 0 to -1
Unitary elastic - -1
Relatively elastic - -1 to infinity 
Perfectly elastic - infinity

Question 23

What regards to YED what is inferior and normal good?

Answer 23

<0 (negative) = inferior good - as income rises the demand for the product will fall
0 to 1+ = normal good - income inelastic demand
+1 to infinity = normal good - income elastic demand

Question 24

What factors influence PED?

Answer 24

The availability of substitutes
The addictive ness of the product
Time
The price of the product as a proportion of income

Question 25

Why do governments need to known the various elasticities of demand for various products?

Answer 25

To know if they should tax the product or use a subsidy for the product

Question 26

What is supply?

Answer 26

Supply refers to the amount that producers are willing and able to sell at any given price at any given period of time

Question 27

Why does the supply curve slope upwards?

Answer 27

Because as price rises rational profit maximising producers will supply more because profits should rise

Question 28

What is an extension of supply?

Answer 28

When the price increases the quantity supplied increases - and shift along the supply curve

Question 29

What is a contraction of supply?

Answer 29

Moving downwards on the supply curve - there is less quantity supplied and a lowered price

Question 30

What factors could cause a shift in the supply curve?

Answer 30

Changes in the cost of production 
The introduction of new technology
Indirect taxes (specific and ad valorem)
Subsidies
Changes and changes in the number of firms in an industry

Question 31

What are the conditions of supply?

Answer 31

P - productivity
I - indirect tax
N - number of firms in market 
T - technology 
S - subsidies 
W - weather
C - other costs

Question 32

What is equilibrium?

Answer 32

Where demand and supply intersect and equal each other

Question 33

What does it mean if the price is above equilibrium point?

Answer 33

Supply is greater than demand and there is excess supply (a surplus or glut)

Question 34

What does it mean if the price is below the equilibrium price?

Answer 34

Demand is greater than supply causing excess demand or a shortage

Question 35

What happens if there is an excess in supply?

Answer 35

Market forces will result in a contraction in supply and an extension in demand, so cause a fall in price to market equilibrium

Question 36

What happens if there is an excess in demand?

Answer 36

Market forces will result in an extension in supply and a contraction in demand, causing a rise in price to market equilibrium

Question 37

What cause price rises?

Answer 37

Increasing demand (shifting to the right) or decreased supply (shifting to the left)

Question 38

What causes price falls?

Answer 38

Decreasing demand (shifting to the left) or increased supply (shifting to the right)