unit 8

Question 1

what happens if a price is set above the equilibrium

Answer 1

there will be excess supply as more sellers want to sell but not all will find a buyer so they will lower price

Question 2

what happens if price is set below equilibrium

Answer 2

Excess demand so some buyers may offer more to ensure that they get the product thus price goes back to equilibrium

Question 3

what is competitive equilibrium (5)

Answer 3

when price and quantity remain the same

All transactions take place at the same price - law of one price

The market clears S=D

buyers and sellers are price takers

its Nash equilibrium as nobody could do better without making someone else worse off

Question 4

Conditions for competitive equilibrium (3)

Answer 4

Many buyers and sellers
Identical goods
Perfect knowledge

Question 5

why can competitive equilibrium be useful

Answer 5

it tells us the maximum surplus available in the market.

Question 6

what does the demand curve show

Answer 6

Willingness to pay (WTP) = the amount of money a consumer would be willing to pay for a good.

Question 7

what does the market supply curve

Answer 7

Willingness to accept (WTA) = the amount of money the seller would be willing to trade the good for, also referred to as the seller’s reservation price

Question 8

what is a price taker

Answer 8

A price taker accepts the market price and chooses quantity depending on marginal cost

Question 9

what happens to the profit maximising quantity when price changes

Answer 9

If the price falls below marginal cost you should immediately stop producing as you lose out on every unit produced

If the price rises above marginal cost of producing additional units then the, maximising quantity expands so production should increase

Question 10

what is the marginal cost function

Answer 10

it is the firms supply curve:
- it tell you the quantity to produce at each level of the market price
- profit maximisation is when MC = market price

Question 11

how do you find market supply curve

Answer 11

add up the total amount of all firms producing that product at each price

Question 12

what do supply curves tell us (3)

Answer 12

At a given price how much will be produced

At a given quantity we can find the marginal cost

Market supply curve is the marginal cost curve for all of the same products produced in an area

Question 13

when are potential gains exhaust

Answer 13

at competitive equilibrium total surplus is maximised

the last loaf produced is equal to the WTP of the last customer who buys

Question 14

what would occur if less of a product was produced

Answer 14

less gains from trade: some consumers would be WTP more than the cost of producing another loaf

Question 15

what would occur if more of a product was produced

Answer 15

total surplus would decrease as surplus on extras units would be negative and would cost more to make then consumers WTP

Question 16

what differs in price taking and price setting firms

Answer 16

price taking: at equilibrium total surplus is maximised
price setting: there is a deadweight loss as producers set a price above MC of the last item produced.

Question 17

is equilibrium for price taking firms Pareto efficient

Answer 17

yes because we cannot change the allocation to make a consumer or firm better off without making the other worse

Question 18

when does Pareto efficiency hold in a compatative market (4)

Answer 18

In a market with many buyers and sellers of identical goods

At equilibrium where participants are price takers

When trade has no external effects

When there is a complete contract between each buyer and seller

Question 19

is the price taking model realistic?

Answer 19

Most firms sell goods that are somehow differentiated from those of other firms and service and range of goods they offer

Price taking is rare

Many goods have external effects e.g. co2 emissions

Contracts are often
incomplete

Question 20

what teo things do we use to access an allocation

Answer 20

efficiency and fairness

Question 21

what does the distribution of total surplus depend

Answer 21

it depends on relative elasticity of demand and supply

Question 22

what happens when demand for a good increases

Answer 22

new equilibrium is reached where sellers sell at a higher price and to more customers

if supply curve was steeper the price would rise more and quantity would increase less.

If the supply curve was flat then price rise would be smaller and quantity increased would be larger

sellers now earn economic rent as profits are higher than necessary to keep the business going

Question 23

what can shifts in demand be called

Answer 23

exogenous shocks

Question 24

what happens if market is not in equilibrium

Answer 24

buyers and sellers can act as price makers to earn disequilibrium rents until equilibrium is reached

Question 25

what happens when supply rises

Answer 25

more is sold at a lower price

Supply curve shifts downwards as marginal cost is reduced at each level of output

Supply shifts to the right, as costs have fallen, the firm can supply more at each price.

there is excess supply so firms benefit from lowering prices to sell more

Question 26

what do average cost curves show

Answer 26

they show fixed costs, not only marginal costs

Question 27

what occurs if long run equilibirum is reached

Answer 27

rent seeking and competition will eliminate less efficient firms.

The firms remaining have low average cost and normal profits.

The market remains here unless there is a big change in demand or supply

Question 28

why did oil prices increase

Answer 28

prices increased due to OPEC controlling a large proportion of global oil resources and working as a cartel, restricting access to middle east oil.

Question 29

why is sustaining a cartel hard

Answer 29

If a single company chooses to charge a lower price to eliminate competition then the cartel falls apart and consumers get lower prices.

Question 30

why may a government impose a tax

Answer 30

to raise revenue to finance public expenditure and to redistribute resources and reduce inequality

Question 31

If a 30% tax is imposed on suppliers what are the effects on suppliers

Answer 31

suppliers marginal costs are 30% higher at each quantity so the supply curve shifts, but not in a parallel manner as the dollar paid in tax increases with quantity produced

Question 32

what are the effects of government tax on surplus

Answer 32

Consumer surplus falls: they pay a higher price and buy less salt

Producer surplus falls: producers supply less and receive a lower net price

Total surplus is lower: the tax causes a deadweight loss

Question 33

what goods to governments prefer to tax and why

Answer 33

the government would prefer to tax goods with low elasticity of demand so the fall in quantity is small, this means the tax affects mostly consumers.

This is to raise as much revenue as possible and reduce DWL

Question 34

why might governments intervene when there is market clearing price

Answer 34

to achieve other objectives e.g. fairness

Question 35

why may governments control the housing rent prices

Answer 35

to protect tenants who have little bargaining power with the landlords.

It could also be because rent may be too high for groups of workers that provide essential services