Unit 2A: Microeconomics - do markets provide what we need?

Question 1

1. A shift in demand can only be caused by……….
2. A rightward shift indicates a _______ in demand.
3. A leftward shift indicates a _______ in demand.

Answer 1

1. one of the non-price determinants of demand
2. increase
3. decrease

Question 2

Define a movement on a demand graph

Answer 2

When price changes cause demand to either extend or contract along one demand curve.

• A change between points on a graph
• lower price = more demand = extension
• Higher price = less demand = contraction

Question 3

Define demand

Answer 3

The willingness and capability of consumers to purchase goods and services at certain prices

Question 4

Define a shift of a demand curve

Answer 4

Non-price factors either increase or decrease demand shown by a shift/change from one demand curve to a new second curve on a quantity demanded vs price graph

Question 5

Define microeconomics

Answer 5

Study/analysis of or focus on individual markets / economic agents e.g. individuals, households, and firms (2). Study of economics on a small scale, e.g. demand for cars (1). Demand and supply for individual products/markets (1)

Question 6

Define macroeconomics

Answer 6

The study of the whole economy (2). Example of a macroeconomic topic e.g. unemployment/study of economics on a large scale (1).

The study of aggregate economic activity. It investigates how the economy as a whole works.

• e.g. prolonged recession will cause unemployment in many industries resulting in negative economic growth for the economy as a whole
• places greater emphasis on empirical data as evidence to explain changes in the economy, such as booms and recessions

Question 7

Define stocks

Answer 7

These are the raw materials, components, and finished goods (ready for sale) used in the production process - sometimes referred to as inventory.

Question 8

Examples of topics involved in microeconomics:

Answer 8

Look at pg 21-22 of text book

• factors of production
• demand
• supply
• price elasticity of demand and supply
• market failure
• economies and diseconomies of scale
• firms costs, revenues and objectives
• market structure
• An entrepreneur deciding what business to start
• A household considering the costs of raising a child
• You deciding how to spend your pocket money/allowance
• Basically everything you learnt up till unit 3B

Question 9

Examples of topics involved in macroeconomics

Answer 9

Look at pg 22 of textbook

• the role of the government
• the redistribution of income
• fiscal policy
• monetary policy
• supply-side policies
• economic growth
• employment and unemployment
• inflation and deflation
• governments choosing which policy tool to use to create economic growth or raise levels of employment
• Governments setting different rates of income tax
• Governments setting new policies on immigration and employment law

Question 10

What is the law of demand?

Answer 10

There is an inverse relationship between the price of a good/service and the quantity demanded.

There are 2 reasons for this relationship:

• As the price of a good/service falls the consumers purchasing power rises since their real income increases when there is deflation- that is, with the same amount of income, the customer is able to buy more products at a lower price
• As the price of a product falls, a higher number consumers are able to pay, so they are more likely to buy the product

Question 11

What are the non-price factors which affect demand?

Answer 11

• Habits, fashion, and tastes
• Changes in the weather
• Income (changes in this could occur as a result of income taxes)
• substitutes and compliments
• advertisements
• Government policies
• State of the economy (recession or boom)
• Size and composition of population (age, gender, ethnicity, and religious beliefs)

Question 12

Define substitutes

Answer 12

Goods or services which can be used instead of each other e.g. tea or coffee

Question 13

Define compliments

Answer 13

Goods which are in joint demand e.g. tennis balls and tennis raquets

Question 14

Individual demand/supply vs market demand/supply

Answer 14

• aggregation(sum) of all individual demand/supply for a particular product at each price level
• the horizontal sum of the individual demand/supply curves for a product of all the producers/consumers in a market

Question 15

Explain the difference between changes in demand, and changes in quantity demanded

Answer 15

• changes in demand = shift of demand curve
• changes in quantity demanded = movement along demand curve

Question 16

Define supply

Answer 16

The willingness and ability of firms to provide goods and services at given price levels.

Question 17

What is the law of supply?

Answer 17

There is a positive relationship between the price of a good/service and its supply.

There are 2 reasons for this:

• existing firms can earn higher profits if they supply more
• New firms are able to join the market if the higher price allows them to cover production costs

Question 18

What are all the non-price factors of supply?

Answer 18

• Changes in the price of other goods
  In a free market, resources are allocated to
  those goods and services that make the most
  profit
  If a product is making a profit, entrepreneurs
  will gather more of a resource and production
  facilities to produce that product.
  Rising prices (of products) are an indicator of
  profitable activities.
• Changes in the costs of the factors of production/production costs
  Rising costs erode profit
• Technical progress/innovations
  Improvements in the performance of
  machines, labour, production methods, quality,
  etc.
• Other factors/random shocks (e.g. natural disasters)
  The weather can affect the supply of natural
  products
• Govt influences supply by using taxes or
  subsidies
• Weather

Question 19

Define the market system/price mechanism

Answer 19

The method of allocating scarce resources through the market forces of demand and supply. Markets consist of buyers (who have demand for a particular good or service) and sellers (suppliers of a particular good or service).

Question 20

Define market equilibrium

Answer 20

Exists when the demand of a good/service matches the supply, so there is no excess demand [shortage], or excess supply [surplus].

Question 21

Define market disequilibrium

Answer 21

Where the quantity demanded does not equal the quantity supplied. It exists of the price is too high [resulting in excess supply, or a surplus] or too low [resulting in excess demand, or shortage]. The forces of demand and supply cause the price to change until the market reaches equilibrium.

Question 22

Define sales revenue

Answer 22

Sum of money received from a sale of a good/service. Calculated by PxQ

Question 23

Define profit

Answer 23

Money that remains in the business after all costs have been deducted

Question 24

What are the key economic questions?

Answer 24

What production should take place? How should production take place? For whom should production take place?

Question 25

What is the price mechanism?

Answer 25

Refers to the system of relying on the market forces of demand and supply to allocate resources

Question 26

What are the features of the price mechanism?

Answer 26

• There is no government interference in economic activities. Resources are owned by private economic agents who have the economic freedom to allocate scarce resources.
• Goods and resources are allocated on the basis of price - Goods and services are sold to those who have the willingness and ability to pay
• The allocation of fator resources is based on financial incentives
• Competition creates choice and opportunities for firms and private individuals. Consumers can thus benefit from a variety of innovative products, at competitive prices and of high quality.

Question 27

Define equilibrium price

Answer 27

The price at which the demand curve for a product intersects the supply curve for the product. The market is therefore cleared of any excess demand or supply.

Question 28

Explain excess demand and shortages

Answer 28

Excess demand: Refers to a situation where the market price is below the equilibrium price, thus creating a shortage in the market.

Shortage: Occurs when demand exceeds supply because the price is lower than the market equilibrium.

Question 29

Explain a surplus and excess supply

Answer 29

Surplus: Created when supply exceeds demand because the price is higher than the market equilibrium price.

Excess supply: Refers to a situation where the market price is above the equilibrium price, thus creating a surplus in the market.

Question 30

Define PED (Price Elasticity of Demand)

Answer 30

This is a measure of the responsiveness of quantity demanded (the extent to which demand changes) to a change in price

Question 31

Define price inelastic demand

Answer 31

Demand for a product that is unresponsiveness. Change in price causes a proportionally smaller change in quantity demanded. PED is less than 1.

Question 32

Define price elastic demand

Answer 32

Demand is responsive to a change in price, a change in price causes a proportionally larger change in quantity demanded. PED is greater than 1.

Question 33

What is the formula to calculate PED?

Answer 33

Percentage change in quantity demanded
___________________________________
Percentage change in price

% Change in QD = new quantity - old quantity/old quantity x100
% Change in price = new price - old price/old price x100
PED will always be negative. But you have to take the absolute value so that it will be positive.

Question 34

Explain unitary price elasticity

Answer 34

https://www.youtube.com/watch?v=vejSVjeDkCw

https://www.youtube.com/watch?v=tBNMRL3zb_Y

Occurs when the percentage change in the quantity demanded (or supplied) is proportional to the change in price, so there is no change in the sales revenue. PED is exactly equal to one. *Look at pic of graph of this*. On a demand curve graph the graph is curved away from the axes.

Question 35

Explain perfect price inelasticity:

Answer 35

PED is equal to 0. Change in price has no impact on quantity demanded. *Look at graph for this/vertical line at specific QD*

Question 36

Explain perfect price elasticity:

Answer 36

PED is equal to infinity. Consumers are only willing/able to buy at one specific price, a change in the price leads to 0 quantity demanded. *Look at graph for this/horizontal line from specific price point*

Question 37

Determinants for the price elasticity of demand

Answer 37

Factors of elasticity (SPLAT):
Substitutes (number, quality, accessibility, closeness, awareness of substitutes)
When consumers can choose between a
large number of substitutes for a product,
demand for any one of them is likely to be
price elastic. Consumers can easily switch
their demand away from a good whose price
has risen and choose a now relatively
cheaper substitute. So demand will be price
inelastic when there are few substitutes.

Proportion/percentage of income spent
Goods that people only spend a small % of
their income on tend to be price inelastic in
demand because even if the price were to
rise by 20% or 30% for example, that would
still only represent a small amount of money.
The opposite would also apply. EG even a 3%
rise in the price of apartments in Singapore
would constitute a large proportion of income
and would cause demand to fall by greater
than 3%.

Luxury or necessity?

Addictive/habit-forming properties of the good
Goods which are addictive tend to be price
inelastic in demand as most consumers will
continue to purchase that good despite a
relatively significant price change because of
its habit forming properties.

Time period
The period of time under consideration can
affect the value of PED because people need
time to change their habits and behavioural
norms. Overtime they can adjust their demand
based on permanent price changes by
seeking out alternative products. If the price
of a product rises over time consumers will
search for cheaper substitutes. The longer
people have to find a cheaper alternative, the
more likely they will be able to find one.
Demand will be more price elastic in the long
run.

Question 38

What is the significance of price elasticity of demand for decision makers

Answer 38

——-> Price discrimination - occurs when firms charge different customers different prices for essentially the same product due to differences in PED

——> Helping producers to decide on their
pricing strategy - If the price falls firms would prefer to sell price elastic products.
Demand is price elastic when the percentage change in quantity demanded is more than the percentage change in price. A fall in price will cause a large extension in quantity demanded so that total sales revenue rises. A rise in price, therefore, causes total revenue would fall.
If the price rises firms would prefer to sell price inelastic products.
Demand is price inelastic when the quantity demanded changes by a smaller percentage than price. A fall in price will cause a small extension in quantity demanded so that total sales revenue falls. A rise in price, therefore, causes total revenue to rise.

——-> Predicting the impact on producers
following changes in the exchange rate - for instance, firms which rely on exports would benefit from low exchange rates.

——–> Deciding which products to impose sale
taxes on

———> Determining taxation policies (specifically to do with demerit goods)

Question 39

Give examples of essential products with high PEDs

Answer 39

• food
• fuel
• medicine
• housing
• transportation

Question 40

Define PES

Answer 40

Measures of the degree of responsiveness of the quantity supplied of a product following a change in its price

Question 41

Explain price inelastic supply

Answer 41

Percentage change in price is proportionally greater than percentage change in quantity demanded. PES is less than 1.

Question 42

Explain price elastic supply

Answer 42

If the percentage change in price causes a proportionally larger percentage change in quantity supplied. PES is greater than 1.

Question 43

What is the formula to calculate PES?

Answer 43

Percentage change in quantity supplied
________________________________
percentage change in price

% change in quantity supplied =
((new quantity - old quantity) / old quantity) x 100

% change in price =
((new price - old price) / old price) x 100

Question 44

Explain perfect price inelasticity of supply

Answer 44

PES is equal to 0. Change in price has no impact on quantity supply. *Look at graph for this/vertical line at specific QS*

Question 45

Explain perfect price elasticity of supply

Answer 45

PES is equal to infinity. Producers are only willing/able to produce at one specific price, a change in the price leads to 0 quantity supplied. *Look at graph for this/horizontal line from specific price point*

Question 46

Explain unitary price elasticity of supply

Answer 46

Occurs when the percentage change in the quantity supplied is proportional to the change in price, so there is no change in the sales revenue. PES is exactly equal to one. *Look at pic of graph of this*. On a supply curve graph a straight line goes through the origin.

Question 47

What are the factors affecting PES?

Answer 47

——> Factor mobility
The extent to which it is easy to move factors of production easily between the production process
E.g. capital and labour are mobile in a beverage industry that can switch production easily between producing soft drinks, sugared drinks, coffee, etc
The ease of factor mobility makes supply price elastic (firms can react easily to change in prices of goods they produce)

——> Level of capacity (is there spare capacity?) - Spare unused resources
If the firm has plenty of spare capacity, it can increase supply with relative ease, without increasing the cost of production
E.g. Coca-Cola’s bottling plants can produce 10,000 bottles of water every minute

——> Availability of resources
The greater availability of resources, the more price elastic is the supply of the goods
E.g. Apple products

——> Time to produce goods
In the short run, firms are unlikely to change their factor inputs, e.g. farmers are unlikely to change the size of the farmland, supply will be price inelastic
In the long run, firms are more likely to adjust their level of production according to price changes in the market, supply will be price elastic

——> Storage possibilities
Supply of goods will be price inelastic if there is difficulty in storing the goods or the goods are perishable e.g. food items

Question 48

What is the significance of PES for decision makers?

Answer 48

firms can become more responsive to changes in market prices by:
- creating storage capacity
- keeping large volume of stocks
- improving storage systems to prolong shelf-life
of products
- Adopting or upgrading to the latest technology
- Improving distribution systems (how the
products get to the customers)
- Developing and training employees to improve
labour occupational mobility (to perform a range
of jobs)

Question 49

Define an economic system

Answer 49

An economic system describes the way in which an economy is organised and run, including alternative views of how scarce resources are best allocated. There are 3 main types of economic systems, market economy, mixed economy, and planned economy.

Question 50

Describe the market economic system

Answer 50

This relies on the forces of demand and supply to allocate resources with minimal government intervention.

Question 51

Describe a planned economy

Answer 51

This system relies on the government (public sector) to allocate resources. It is often associated with a communist political system that strives for social equality.

Question 52

Describe a mixed economy

Answer 52

A combination of the planned economy and market economy, some resources are owned by private individuals and firms, and some resources are owned by the government

Question 53

What are the advantages of the market economy?

Answer 53

• Efficiency: Competition leads firms to become much more efficient as to gain more profit. This encourages more innovations, and also allows for this market system to become a lot more responsive and dynamic.
• Freedom of choice - There are no restrictions placed by the government, consumers may purchase whatever they want/need
• Incentives: The profit motive for firms and the possibility for individuals to earn unlimited wealth creates incentives to work. This helps to boost economic growth and living standards in the economy.

Question 54

What are the disadvantages of the market economy?

Answer 54

• Income and wealth inequalities: In a market economic system, the rich have far more choice and economic freedom. Production is geared to meet the needs and the wants of the wealthy, thus basic services for poorer members of society may be rejected.
• Social hardship: No public goods provided, relief of poverty becomes a lot harder
• environmental issues
• Wasteful competition: Competitive pressure means that firms use up unnecessary resources.

Question 55

All types of taxes:

Answer 55