1.2 - How markets work

In the order of, 2.1, 2.2, 2.4, 2.6, 2.7, 2.3, 2.5, 2.8, 2.9

Consumers aim to maximise _____

utility

Firms/producers aim to maximise _____

profits

3 reasons why consumers may not behave rationally

1. the influence of other people’s behaviour

2. Habitual behaviour

3. Consumer weakness at computation

The movement along a demand curve is caused by

a change in price

a shift outwards/inwards of the demand curve is caused by

non-price factors

3 factors that may cause a shift in the demand curve:

Change in consumer’s income, tastes/preferences and the price of other goods

Explain the concept of the marginal utility theory

It examines the increase in satisfaction consumers gain from consuming an extra unit of a good (the benefit of consuming an extra good)

What is a normal good (in terms of demand)?

Where quantity demanded increases in response to an increase in income

What is an inferior good (in terms of demand)?

where quantity demanded decreases in response to an increase in income

A movement along the supply curve is caused by

a change in price

a shift of the supply curve is caused by

non-price factors

5 factors that cause a shift in supply

1. taxes and subsidies

2. a change in cost of raw materials

3. Improvements in technology

4. An increase in productivity

5. An increase in available workers

Why is the supply curve upwards sloping?

The profit motive - if prices are higher, it will become more profitable to sell the good/service

Market equilibrium price =

when a quantity of a good or service supplied = the quantity demanded

Does this diagram show excess demand or supply?

Supply

Does this diagram show excess demand or supply?

Demand

What happens in the market when there is excess demand?

Producers raise prices in order to generate more revenue, causing an extension in S and a contraction in D

What happens in the market when there is excess supply?

Producers gradually lower prices in order to generate more revenue, causing a contraction in S and an extension in D

What are the 3 functions in allocating scarce resources?

1. rationing

2. signalling

3. incentive

What is rationing function? (as a price mechanism)

When resources become scrcer the price will rise further and only those who can afford it receive it

What is the incentive function? (as a price mechanism)

When highers prices incentivse producers to increase the quantity supplied

Is the incentive function a short term or long term view?

short term

What is signalling function? (as a price mechanism)

Where prices carry information which is used by consumers and producers to make their market plans

Is the incentive function a short term or long term view?

Long-term

Price mechanisms work in ____, _______ and ____ market

local, national , global

When do markets form

A market is formed when producers and consumers meet to exchange goods and services

Markets allocate ____ ________ to produce goods and services required to meet ______ _____

scarce resources, consumer demands

What does PED measure?

PED measures the responsiveness of the quantity demanded of a good or service to a change in its price

If a good/service is elastic it is….

responsive with a change in price

If a good/service is inelastic it is…

unresponsive with a change in price

What is the formula for calculating PED?

(%change QD) / (%change in P)

What is the PED coefficient if it is elastic?

>1

What is the PED coefficient if it is inelastic?

<1

What is the PED coefficient if it is unitary/perfectly price inelastic?

=1

What is the PED coefficient if it is perfectly price elastic?

Infinity

Why is there a - sign infront of the PED?

because price and demand have an inverse relationship

Is this product elastic/inelastic/perfectly inelasticor perfectly elastic?

Elastic

Is this product elastic/inelastic/perfectly inelastic or perfectly elastic?

perfectly inelastic

Is this product elastic/inelastic/perfectly inelastic or perfectly elastic? (it should say D not S)

perfectly elastic

Is this product elastic/inelastic/perfectly inelastic or perfectly elastic? (it should say D not S)

inelastic

4 factors that influence PED

1. availability of substitutes

2. Addictiveness/habital behaviour

3. £ of product as proportion of income

4. Timeframe

How does the availability of substitutes affect PED?

the more substitutes the higher value of PED = more elastic

How does addictiveness/habitual behaviour affect PED?

addictiveness turns products into necessities and habitual consumption, resulting in a low value of PED = more inelastic

How does the price of a product as a proportion of one’s income affect PED?

the lower the proportion of income the price represents, the lower the PED value will be = relatively inelastic

consumers are ____ responsive to price changes on cheaper products

less

How does timeframe influence PED?

In the short-term, consumrs are less responsive to price changes = inelastic, over the long-term consumers may look for substitutes (elastic)

YED measures:

the relationship between a change in QD for a good/service and a change in the consumers’ real income

What are the 4 different types of goods

Normal, Luxury, necessity, inferior

What is a normal good (YED)

a normal good is a good which when incomes are falling, demand for normal goods will fall e.g. name-branded food

what would the coefficient of a normal good be (YED)

+ (positive Y)

what is a luxury good

a luxury good is a good which will have a signficant decrease in demand with a drop in income e.g. designer clothes (luxury good classification is subjective)

what would the coefficient of a luxury good be (YED)

YED>+1 (high and positive)

what is a necessity good

a necessity good is where there wont be/will be a very little decrease in demand if incomes drop e.g. basic food

what would the coefficient of a necessity good be (YED)

YED is between 0<YED<1

what is an inferior good

if following an increase in real income, less of the good is purchased then it is an inferior good e.g. public transport

what coefficient would an inferior product have (YED)

(-) negative YED

What is the formula for YED

%change in QD / % change in income

Why is YED important for businesses

it helps firms to predict the effect of changes in the economic cycles on their sales

XED measures:

the responsiveness of the QD of one good to a change in the price of another related good

XED is useful in analysing the relationships between ______ and ___________ goods

substitute, complementary

what is the formula for XED

%change in QD of good A / %change in QD of good B

Substitutes have a _____ XED

positive

an ______ in the price of one product will lead to a rise in ______ for its substitute

increase, demand

do these substitutes have a strong or weak relationship

strong

do these substitutes have a strif XED is _ong or weak relationship

weak

compliment goods have a ________ XED

negative

the ______ the coefficient for complementary goods, the closer the compliments are

higher

Does these compliment goods have a strong or weak relationship?

weak

Does these compliment goods have a strong or weak relationship?

strong

PED is important to firms in determining their ______ ________

pricing strategy

If demand is inelastic then an increase in price leads to an ______ in total revenue

increase

If demand is inelastic then an fall in price leads to an ______ in total revenue

fall

If PED is elastic then a rise in price ______ total revenue

reduces

If PED is elastic then a fall in price ______ total revenue

increases

PED is also important to governments in terms of understanding the burden of _______ on producers and consumers

taxation

The more price inelastic the good, a ______ proportion of the tax is paid by the consumer than the producer

greater

For subsidies, the more price inelastic the good, the greater the price ____ for consumers

fall

If YED shows demand for a firm’s product is income elastic and the economy experiences a recession, demand is likely to ____ significantly

fall

XED will tell a firm how demand for their own product will change following a _____ ______ by their __________

price change, competitiors

Calculation for total revenue (TR)

TR = P x Q

What is price elasticity of supply (PES)?

PES measures the responsiveness of the quantity supplied to a change in price

If supply is elastic producers can ______ their output without an ______ in cost or a time delay

increase, increase

If supply is inelastic, firms find it ____ to change their production in a given time period

hard

What is the formula for PES?

% change in QS / % change in P

What is the coefficient for price elastic PES?

>1

What is the coefficient for price inelastic PES?

<1

What is the coefficient for perfectly price elastic PES?

infinity

What is the coefficient for perfectly price inelastic PES?

0

4 factors that influence PES:

1. spare production capacity

2. stocks of finished products and components

3. Time period and production speed

4. ease and cost of factor substitution/ factor mobility

How does spare production capacity influence PES?

If there is plenty of spare capacity then a business can incrtease output without an increase in costs

How does stocks of finished products and components influence PES?

If stocks of raw materials and finished products are at a high level, then a firm is able to repsond to a change in demand (supply = elastic)

How does the time period and production speed influence PES?

supply is more elastic the longer the time that a firm is allowed to adjust its production levels

How does the ease and cost of factor substitution / factor mobility influence PES?

if capital and labour are occupationally mobuile then PES is likely to be higher as resources can be mobilized to supply the extra output

PES - In the short run it is _______ to adjust production

difficult

PES - Why is it difficuly for firms to adjust production in the short run?

because some factors are fixed

In the long run all factors of production can be _______

adjusted

In the long run firms can increase production, which makes supply ____ ______

more elastic