Week 2: Market Failures and Public Goods (Demand & Supply)

Question 1

Demand

Answer 1

The quantity of a good or service that customers are willing and able to buy at given prices in a particular period of time.

Question 2

Price

Answer 2

The amount of money a customer pays in order to purchase a good or service

Question 3

Effective Demand

Answer 3

When customers distinguish their demand from a want or desire to buy something.

Question 4

Law of Demand

Answer 4

The quantity demanded of a good or service increases as the price falls, ceteris paribus.

Question 5

3 assumptions underlining the law of demand

Answer 5

1. Income effect
2. Substitution effect
3. Law of diminishing marginal utility

Question 6

Income effect

Answer 6

When the price of a good or service falls, the real disposable income of customers increases. Therefore, they are able to purchase more goods and services at lower prices.

Question 7

Substitution effect

Answer 7

As the price of a good or service falls, the more customers are able to pay, so they are most likely to buy the product and choose this over the substitute/rival they may have previously bought.

Question 8

Law of Diminishing Marginal Utility

Answer 8

As individuals consume more of a particular good or service, the utility (return or satisfaction) gained from the additional unit of consumption declines, so customers will only purchase more at lower prices.

At some point, customers will not want more because the marginal utility of consumption drops to zero.

Question 9

Normal Goods

Answer 9

Products that have higher demand when real disposable income increases. (e.g smartphones)

Question 10

Complementary Goods

Answer 10

Products that are jointly demanded as they go well together. (Phone + apps, cinema + popcorn, doritos + salsa dip, wedding dresses + wedding rings)

Question 11

Substitutes

Answer 11

Products that are in competitive demand. These are rival products that can be used as alternatives of one another. (E.g tea or coffee, Coca Cola and Pepsi, BMW, MB or Audi)

Question 12

List the non-price determinants of demand (RIPEN)

Answer 12

1. Related products (substitutes and compliments)
2. Income
3. Preferences and Tastes
4. Expectations of future prices
5. Number of consumers

Question 13

Related products (subs + complementary goods)

Answer 13

1. When the price of a good increases, the demand for its complementary good will decrease and vice versa

(e.g. when there is an increase in the price of the cinema, there is a decline in popcorn sales).

2. When the price of a good increases, the demand for the substitute increases.

(e.g when the price of pepsi cola increases, the demand for coca cola increases as people go for the cheaper alternative)

Question 14

Income

Answer 14

Higher levels of real income mean that customers are able and willing to buy more goods and services, owing to their greater purchasing power, ceteris paribus.

e.g in economically developed societies with rising average real incomes, the demand for smartphones has risen steadily.

Question 15

Preferences and Tastes

Answer 15

Products that become fashionable (e.g smartphones) cause an increase in demand whereas unfashionable items (e.g last szn clothes) reduce the level of demand

Question 16

Expectations of future prices

Answer 16

1. Consumer expectations of prices in the future can influence the demand for many products, especially in the case of expensive and luxury goods, such as consumer electronics products, motor vehicles and housing.
2. If people expect that the value of a good or service will increase in the foreseeable future, they will demand more of it now, ceteris paribus.
3. Similarly, there will be less demand in the market for stocks and shares if people expect prices will drop in the near future.

Question 17

Number of consumers

Answer 17

A change in the total number of consumers of a product = entire demand curve shift.

As more buyers enter the market, or existing customers buy more, the demand curve shifts to the right as in demand increases.

Question 18

List other non-price determinants of demand.

Answer 18

1. Advertising
2. Gov policies
3. Economy

Question 19

Advertising

Answer 19

Marketing messages - used to inform, remind and persuade the audience to buy a firm’s products.

McDonald’s and Samsung spend hundreds of millions of dollars each year on advertising to increase demand for their products.

Question 20

Gov policies

Answer 20

Rules and regulations e.g legal age on the purchase of tobacco + alcohol affect the demand for certain products

gov encourages people to use more energy-efficient cars to save env - increase demand

Question 21

Economy

Answer 21

Demand depends on whether economy is in boom or recession

e.g global financial crisis of 2008 caused demand for most goods and services to decline.

Question 22

Shift of demand curve is caused by?

Answer 22

Change in non-price factors

Question 23

Movement along the demand curve caused by?

Answer 23

Change in price

Question 24

A price rise will cause?

Answer 24

Contraction in the quantity demanded of the product

Question 25

A price fall will cause?

Answer 25

Expansion in the quantity demanded

Question 26

Rightwards shift in the demand curve from D1 to D3 represents?

Answer 26

Increase in demand

Question 27

Leftwards shift in the demand curve from D1 to D2 represents?

Answer 27

Decrease in demand

Question 28

Supply

Answer 28

Refers to the quantity of goods or services that firms are willing and able to sell at any given price, per time period.

Question 29

Law of Supply

Answer 29

Positive correlation between the quantity supplied of a product and its price, ceteris paribus.

Higher price creates incentives for existing firms to increase output and for new firms to enter the market, thus increasing market supply of a product, ceteris paribus.

Question 30

2 Assumptions underlining the law of supply

Answer 30

1. Law of diminishing marginal returns
2. Increasing marginal costs

Question 31

Difference between the law of diminishing marginal returns and the law of diminishing marginal utility.

Answer 31

DMR - refers to production

DMU - refers to consumption

Question 32

Law of diminishing marginal returns

Answer 32

Describes how output is affected when a firm uses more variable inputs (factors of production) while maintaining at least one factor of production as fixed in the short run.

The law of DMR states that by employing additional variable factors of production (such as labour), the marginal returns (additional output) for each additional unit of input will eventually decline.

Question 33

DMR only applies in…

Answer 33

Short run - all factors of production are variable in the long run.

Question 34

What is usually assumed about capital?

Answer 34

Fixed in the short run - This is because a firm’s real or physical capital (such as buildings, machinery, equipment and vehicles) does not usually change in a short period of time, so is kept fixed when demonstrating this law

Question 35

An addition of extra workers creates…

Answer 35

Benefit for the firm - makes teamwork and the division of labour possible, improving efficiency and productivity.

Question 36

DMR in relation to addition of extra workers

Answer 36

Initially, there are increasing marginal returns for each additional worker.

The marginal returns will eventually diminish because each additional worker will gradually contribute less than the one before as work cannot be efficiently divided so well.

Question 37

Marginal Cost

Answer 37

Cost of producing an additional unit of output.

Question 38

Increasing Marginal Costs

Answer 38

Marginal costs rise with each successive unit produced owing to diminishing marginal returns.

Hence, firms are willing and able to increase production only if they receive a higher price for the additional units of output.

Question 39

Movement along the supply curve is caused by?

Answer 39

Changes in price, causing a change in quantity supplied

Question 40

Shift of the supply curve is caused by?

Answer 40

Non-price determinants of supply, causing a change in supply

Question 41

Non-price determinants of supply (CISTERN)

Answer 41

1. Costs of production of factors of production
2. Indirect taxes
3. Subsidies
4. Technological change
5. Expectations of future prices
6. Prices of Related products (joint supply or competitive supply)
7. Number of firms in the industry

Question 42

Changes in costs of factors of production

Answer 42

Changes in the cost of any factors of production will shift the supply curve.

1. An increase in the cost of FOPs will cause the supply curve to shift to the left (e.g rise in wages and/or increase in rent costs)

• Higher costs of production mean that existing firms cannot produce the same quantity as before and fewer firms are willing and able to supply output.
• Less will be supplied at each price level as costs of prod. rise

Question 43

Define Indirect taxes

Answer 43

Government levies or changes on expenditure. Imposed on the supplier of a product, which adds to the costs of production, even if the producer can pass on some of the tax to the consumers in the form of higher prices.

Question 44

Indirect taxes as a non-price determinant of supply

Answer 44

They reduce the profitability of firms and reduce market supply, therefore causing a leftwards shift of the supply curve.

Question 45

Define subsidies

Answer 45

Form of financial assistance from the government to help encourage output or supply, by reducing costs of production.

Question 46

Subsidies as a non-price determinant of supply

Answer 46

Subsidies - usually given to producers that provide goods/services beneficial to society as a whole - e.g provision on education, healthcare and training

Question 47

Technological change

Answer 47

Advances in technology mean there can be greater levels of output at price levels - prod becomes more efficient and so avg costs of prod falls.

Question 48

Expectations of future prices

Answer 48

Price acts as a signal to producers to allocate their resources to the production of provision of goods and services with greater profitability.

• If sellers expect the demand for their product to increase sharply in the near future (thus causing higher prices), then the firms may choose to increase production in the current time period.
• Similarly, if producers are concerned about future market conditions deteriorating and causing prices to fall, production would fall

Question 49

Prices of Related products (joint supply or competitive supply)

Answer 49

Competitive Supply - the output of one product (such as apples) prevents or limits the output of alternative products (such as oranges). This is due to competing resources, as producers have limited resources such as land and labour, so cannot supply more of one product without producing less of the other.

Joint Supply - an increase in the production of one product automatically increases the supply of at least another (joint) product, such as cows, milk and leather or lamb and wool.

(less important product is called by-product e.g mutton being main, wool being by-product)

Question 50

Number of firms in the industry

Answer 50

If the market for a good or service increases, then it is likely that there will be an increase in the number of firms in the industry.

An increase in the number of firms in a market would shift the supply curve outwards to the right.