Unit 1 - Markets in Action

Question 1

What is the economic problem?

Answer 1

The economic problem is there are scarce resources in relation to unlimited wants.

Question 2

What are the 4 factors of production?

Answer 2

Land, labour, capital and enterprise.

Question 3

How can specialization address the problem of scarcity?

Answer 3

Specialisation can be used to address the problem of scarcity in the sense; as regions specialise, more output can be produced, meeting more wants. Surpluses can be traded (creating dependency).

Question 4

What is opportunity cost?

Answer 4

Opportunity cost is the cost of the next best alternative forgone

Question 5

What is the PPC?

Answer 5

The PPC/PPF/PTC shows the maximum combination of 2 goods (given current resources, current technology and assuming that all resources are fully utilised). As you produce more of one good, the opportunity cost is the other good. Convex shape. Economic growth will shift curve outwards.

Question 6

Competitive market

Answer 6

A competitive market is a market that operates through the laws of supply & demand.

Question 7

Consumer surplus

Answer 7

The difference between the price that customers are willing to pay, & the price that they actually pay.

Question 8

Producer surplus

Answer 8

The difference between the price that suppliers are willing to sell at, & the price actually charged.

Question 9

What are the factors affecting demand?

Answer 9

Price,

Price of substitutes & compliments,

Income,

Advertising,

Tastes/trends,

Addictiveness

Question 10

What do movements on the supply curve represent?

Answer 10

Movement up the curve [expansion of supply] means a higher price, movement down the curve [contraction of supply] means lower price.

Question 11

What factors affect supply?

Answer 11

Changes in cost

Legislation

Question 12

Price elasticity of demand (PED)

Answer 12

How responsive demand is to a change in price.

%ΔQD/%ΔP

Question 13

Price elasticity of supply (PES)

Answer 13

How responsive supply is to a change in price.

%ΔQS/%ΔP

Question 14

Income elasticity of demand (YED)

Answer 14

How responsive demand is to a change in income.

%ΔQD/%ΔY

Question 15

Cross elasticity of demand (XED)

Answer 15

How responsive demand for one product is to a change in price of another.

%ΔQD of GOOD A/%ΔP of GOOD B

Question 16

Cross elasticity of demand is positive for…

Answer 16

Substitutes

Question 17

Cross elasticity of demand is negative for…

Answer 17

Compliments

Question 18

What factors affect PED?

Answer 18

Addictiveness,

Proportion of real/disposable income,

Availability of substitutes

Question 19

Business relevance of elasticity

Answer 19

Set a price, ways to increase revenue (inelastic – lower price and vice versa), luxury/normal good/inferior good (-YED)/necessity, as income rises demand for normal goods increase, set pricing structures (bundling), however only estimates (inaccurate data leads to inaccurate elasticity co-efficient)

Question 20

Market equilibrium

Answer 20

Market equilibrium occurs where demand meets supply

Question 21

Market failure

Answer 21

Market failure occurs when the price mechanism fails to allocate resources efficiently all the time.

Free market forces fail to produce the products that people want, in the quantities they desire and at prices that reflect consumer satisfaction.

Question 22

Externalities

Answer 22

Costs/benefits imposed upon a third party who aren’t directly involved in a decision making process.

Question 23

Internalising the externality

Answer 23

Making the externality part of the price.

Eg. Externalising the externality of petrol.. tax the good (to the level of welfare loss), this will successfully internalise the externality.

Question 24

Social costs/benefits

Answer 24

The total cost/benefit arising from a particular decision.

Question 25

Private costs/benefits

Answer 25

The costs/benefits that accrue to an individual/firm

Question 26

External costs/benefits

Answer 26

Social costs/benefits exceed private costs/benefits.

Costs/benefits upon the third party.

Question 27

Information failure

Answer 27

Lack of how good/bad a product or service is for you, hence insufficient demand will be registered in the free market. Demand is below optimum level – the market has failed.

When information is lacking, missacurate, unprocessable and out of date leading to consumers and producers making decisions that do not maximise welfare.

Question 28

Merit good

Answer 28

Positive externalities.

People do not perceive the full benefits. Under-consumed. Eg. Education.

Question 29

Demerit good

Answer 29

Negative externalities.

People do not perceive the full costs. Over-consumed. Eg. Cigs.

Question 30

Public good

Answer 30

Non-excludable (cannot stop being provided to everyone). Non-rival (if one person consumes it, it doesn’t stop other people). Eg. Streetlighting.

Question 31

Quasi-public good

Answer 31

Kind of public, but not fully. Eg. Beach – can get crowded (rival).

Question 32

+/- Externalities

Answer 32

• Divergence between private/social costs/benefits
• Not reflected in price
• Over/under produced and consumed
• External costs = neg. externality & vice versa

Question 33

Merit/demerit goods

Answer 33

• Due to a lack of information
• People do not perceive full costs/benefits
• Over/under produced and consumed

Question 34

Why do governments intervene?

Answer 34

To achieve economic efficiency & to achieve a fair or equitable distribution of resources in the economy.

Question 35

Method of Intervention 1

Indirect taxation

Answer 35

Taxing firms who produce demerit goods. De-merit goods are overproduced (imperfect information) so production needs to decrease to social optimum.

Question 36

Advantages of indirect taxation

Answer 36

• Deter demand as price increases
• Firms are forced to reduce supply, solving over-production
• Costs of production are raised, shifting the supply curve
• Reduces firm’s profit margin – stop producing the good if it gets too low?
• Allocative efficiency
• Internalises the externality & thus correct the misallocation of resources

Question 37

Disadvantages of indirect taxation

Answer 37

• In order to prevent government failure, the tax must equal external cost
• Tax can be inflationary and reduce real GDP
• Restricts economics growth – unemployment
• Inelastic demand products can increase price to pass the cost onto customers (polluter doesn’t pay)
• Relocate abroad (tax-less)
• Taxes on necessities may be regressive

Question 38

Method of Intervention 2 - Subsidies

Answer 38

Subsidising production of merit goods. Payment to producers to decrease their costs & increase output.

Question 39

Advantages of subsidies

Answer 39

• Control inflation rates
• Boost living standards of some groups
• Encourage consumption of merit goods with positive externalities
• Increase social benefits
• Improve under-consumption of merit goods to create allocative efficiency
• Boost employment of LT unemployed

Question 40

Disadvantages of subsidies

Answer 40

• Opportunity cost of dishing out money to groups
• Which groups should receive the subsidy? – fairness + equity
• Alternatives – income support through tax system
• People may not benefit from subsidy – yield no satisfaction

Question 41

Advantages of regulation (method of intervention 3)

Answer 41

• Restrict amount of –ext produced
• Fine companies – lots of money

Question 42

Disadvantages of regulation (method of intervention 3)

Answer 42

• Not always enforceable
• Need evidence to prove breaking of law

Question 43

Advantages of polluter permits (method of intervention 4)

Answer 43

• Tradable between firms
• Encourages less pollution if firms have an incentive to make money
• Limits amount of neg ext (pollution)

Question 44

Disadvantages of polluter permits (method of intervention 4)

Answer 44

• Monopoly can buy them all out
• Encourage businesses to travel elsewhere

Question 45

Advantages of state provision of public goods (method of intervention 5)

Answer 45

• Ensures provision
• Meets demand

Question 46

Disadvantages of state provision of public goods (method of intervention 5)

Answer 46

• Expensive for govt
• No profit motive; not as efficient

Question 47

Advantages of provision of information (method of intervention 6)

Answer 47

• Corret level of demand would be registered

Question 48

Disadvantages of provision of information

Answer 48

• Must ensure information is correct/suitable/cheap or free

Question 49

Define allocative efficiency

Answer 49

Allocative efficiency is achieved when the value consumers place on a good or service (reflected in the price they are willing to pay) equals the cost of the resources used up in production.

Condition required is that price = marginal cost. When this condition is satisfied, total economic welfare is maximised. When you get goods that have negative externalities, the market price is not reflective of the true social costs. So if allocative efficiency was truly achieved, the price of the goods with negative externalities would be the private costs + the social costs (ie the damage caused to a third party, e.g. the environment). Things are being produced that people want.

Question 50

Define economies of scale

Answer 50

When costs fall in the long run due to an increased scale of operation. Examples included; bulk buying materials, division of labour, technological advancements

Question 51

Define pareto efficiency

Answer 51

Where it is not possible to make someone in society better off without making someone else worse off

Question 52

Define productive efficiency

Answer 52

Where production is at the possible cost. Using the least amount of scarce resources to produce a product.