Topic 2 - Microeconomics

Question 1

What is a market?

Answer 1

A market is where a buyer and seller come together to carry out an economic transaction

Question 2

What are the non-price determinants of demand?

Answer 2

• Income
• Price of substitutes
• Price of complementary goods
• Tastes and preferences
• Future price expectations
• Number of consumers

Question 3

What is price elasticity of demand?

Answer 3

A measure of the sensitivity of quantity demanded to changes in price of a good or service

Question 4

Formula for PED

Answer 4

(Percentage change in quantity demanded)/(Percentage change in price)

Question 5

What are the determinants of PED?

Answer 5

• The number and closeness of substitutes
• Necessity of the product (width of definition)
• Proportion of income spent on the good
• Time period considered

Question 6

What is income elasticity of demand (YED)?

Answer 6

A measure of how the demand for a product changes when income changes

Question 7

Formula for YED

Answer 7

(Percentage change in quantity demanded)/(Percentage change in income)

Question 8

What are the non-price determinants of supply?

Answer 8

• Cost of factors of production
• Price of related goods
• Taxes and subsidies
• Expectation of future prices
• Changes in technology
• Weather or natural disasters

Question 9

What are the determinants of PES?

Answer 9

• How much costs rise as output is increased
• Time period considered (more elastic over time)
• The ability to store stock

Question 10

What is consumer surplus?

Answer 10

The extra utility gained by consumers from paying a price that is lower than that which they are prepared to pay

Question 11

What is producer surplus?

Answer 11

The actual earnings that a producer makes from a given quantity of output, over and above the amount the producer would be prepared to accept for that output

Question 12

What is community surplus?

Answer 12

Producer surplus + consumer surplus - the total benefit to society when a market is in equilibrium

Question 13

What is indirect tax?

Answer 13

A tax imposed on expenditure on goods and services

Question 14

Advantages of indirect tax

Answer 14

• Increased government revenue

- Limits consumption of demerit goods

Question 15

Disadvantages of indirect tax

Answer 15

• Lower consumer disposable income

- Little effect on PED inelastic goods

Question 16

Indirect Tax diagram

Answer 16

Textbook pg. 110

Question 17

Who pays what share of indirect tax?

Answer 17

If PED is elastic: producers pay more

If PED is inelastic: consumers pay more

Question 18

What is a subsidy?

Answer 18

An amount of money paid by the government to a firm, per unit of output

Question 19

Advantages of a subsidy

Answer 19

• Lowers price of goods (more disposable income)
• Guarantees supply of necessary products
• Improves employment
• Enable competition with foreign producers

Question 20

Disadvantages of a subsidy

Answer 20

• Government expenditure
• Little effect on PED inelastic goods
• Firms don’t have an incentive to improve efficiency
• Requirement of taxes to fund subsidy
• Foreign producers unable to compete - dumping

Question 21

What are price ceilings?

Answer 21

Price ceilings are maximum prices set by the government below the equilibrium price for a certain set of goods

Question 22

Price ceiling diagram

Answer 22

Textbook pg. 120

Question 23

Subsidy diagram

Answer 23

Texbook pg. 116

Question 24

Advantages of a price ceiling

Answer 24

• Decreased price (higher disposable incomes)

- Promotes consumption of merit goods

Question 25

Disadvantages of a price ceiling

Answer 25

- Shortage (Demand > Supply) - Possible emergence of Black Market - Unemployment due to reduced revenue

Question 26

What are price floors?

Answer 26

Minimum prices set by the government above the equilibrium price for a certain set of goods and services

Question 27

Advantages of price floors

Answer 27

- Raise incomes for producers - Protects workers - Reduces consumption of demerit goods

Question 28

Disadvantages of price floors

Answer 28

- Surplus (Supply > Demand) | - High prices lead to lower disposable incomes

Question 29

Why do governments intervene in markets?

Answer 29

- More merit goods, less demerit goods - Promote sustainability - Promote equity and economic well-being

Question 30

What is an externality?

Answer 30

An externality occurs when the production or consumption of a good or service has a spillover effect upon a third party

Question 31

What causes a negative externality of production?

Answer 31

MSC > MPC

Question 32

What causes a negative externality of consumption?

Answer 32

MPB > MSB

Question 33

What causes a positive externality of consumption?

Answer 33

MSB > MPB

Question 34

What causes a positive externality of production?

Answer 34

MPC > MSC

Question 35

How can a government fix a positive externality of consumption?

Answer 35

- Subsidies - Public awareness campaigns - Legislation (vaccines)

Question 36

How can a government fix a positive externality of production?

Answer 36

- Subsidies | - Direct provision (government becomes producer)

Question 37

How can a government fix a negative externality of consumption?

Answer 37

- Indirect taxes - Legislation/regulation - Education/raising awareness

Question 38

What are common pool resources?

Answer 38

Natural resources, such as fishing grounds, forests, and pastures, which are non-excludable, but rivalrous. In the absence of management, common pool resources are inevitably downgraded

Question 39

What is the Tragedy of the Commons?

Answer 39

The cumulative effect of all rational producers acting in their own self-interest, and degrading common pool resources

Question 40

What is the free-rider problem?

Answer 40

Those who do not change their behavior to account for the Tragedy of the Commons benefit from those who do

Question 41

How can the Tragedy of the Commons be reduced?

Answer 41

- International Agreements - Tradeable permits - Carbon tax - Legislation - Subsidies (increase use of renewable, decrease the use of fossil fuel) - Collective self-governance (working together)

Question 42

Why must governments provide public goods?

Answer 42

Public goods are non-excludable and non-rivalrous, meaning that private producers have no incentive to provide them. Hence, governments must do it themselves.