Unit 1.C - Microeconomics: Markets

Question 1

What are the assumptions of perfect competition?

Answer 1

• Lots of buyers and sellers
• Lots of similar (homogenous) products
• No externalities
• No barriers to entry
• Perfect knowledge

Question 2

What is the goal of a subsidy?

Answer 2

Usually the goal of a subsidy is to increase consumption.

Question 3

What is the law of supply?

Answer 3

The law of supply is that there’s a direct relationship between price and quantity supplied

E.g. if price in the market for candles increases, the quantity supplied will also increase.

Question 4

What is the law of demand?

Answer 4

There is an inverse relationship between price and quantity demanded.

E.g. in market for candles if price increases quantity demanded will decrease

Question 5

How do movements in supply and/or demand occur?

Answer 5

• As the result of price factors leading to a movement (expansion or contraction) ALONG the curve.
• As the result of non-price factors leading to a movement (increase or decrease) OF the curve.

Question 6

What are the non-price factors influencing supply?

Answer 6

• Change in natural conditions/resource availability
• Change in state of technology
• Change in price of other goods firm could be producing
• Change in costs of production

Question 7

What are the non-price factors influencing demand?

Answer 7

• Change in populations
• Change in incomes
• Change in consumer tastes and preferences
• Expectations of future price changes
• Change in the price of complementary goods
• Change in price of substitute goods

Question 8

Increase vs expansion of supply?

Answer 8

Increase: a greater quantity can be supplied with no change in price.

Expansion: a greater quantity can be supplied as a result of an increase in price

Question 9

What is market clearing?

Answer 9

The process of a market returning to equilibrium price and quantity following a period of disequilibrium.

Question 10

What is market equilibrium?

Answer 10

Market equilibrium occurs when Qs = Qd

At this point there is no oversupply or undersupply: anyone who is willing and able to demand or supply may do so. Market is stable with no tendency to change.

Disequilibrium occurs if:
Price too high: Qs>Qd
Price too low: Qs

Question 11

What’s the price mechanism?

Answer 11

The price mechanism is the interaction of supply and demand as seen on a market diagram, and is the process used to determine the quantity of goods/services produced and consumed in a free market economy. It used prices to determine quantity given that the supply and demand curves represent willingness and ability to supply and demand at a range of prices.

Question 12

Things to remember when answering market clearing questions?

Answer 12

• Link to willingness and ability ALWAYS
• State whether oversupply or undersupply results
• State the change in equilibrium price and qty
• State when disequilibrium occurs and in what way.
• State that at equilibrium market is stable with no tendency to change, and all who are willing and able to demand or supply may do so.

Question 13

Cost vs value vs price:

Answer 13

Value: the amount you are prepared to pay
Cost: the amount paid in production
Price: what is decided you should pay.

Question 14

Product vs factor markets?

Answer 14

Both are markets in which an equilibrium price and quantity is reached by supply and demand according to the price mechanism:

In a factor market the factors of production are bought by firms from households e.g. the labour market, and in a product market consumer goods are sold by firms to households e.g. market for highlighters.

Question 15

What is the price elasticity of demand?

Answer 15

The price elasticity of demand measures the responsiveness of quantity demanded following a change in price.

If a good is elastic there will be a more than proportionate change in quantity demanded following a change in price. Using the total revenue method, an elastic good is marked by the inverse relationship of price and total revenue, e.g. if the price of mars bars increases, the total revenue decreases.

If a good is inelastic there is a less than proportionate change in qty demanded following a change in price. Using the total revenue method, an inelastic good is marked by the direct relationship of price and total revenue: e.g. if the price of petroleum increases, the total revenue also increases.

Question 16

How do product markets solve the economic problem?

Answer 16

If the demand curve represents the possible wants to be satisfied, and the supply curve production using limited resources, equilibrium represents the fraction of those wants that may actually be satisfied given the finite level of resources: interaction of supply and demand eventually establish a price and quantity that best satisfies individual wants using limited resources, thus addressing if not solving the economic problem.