1.2 how markets work

What is the satisfaction gained from consuming a product called

Utility

What is the term for a rational consumer in economic theory

Homo Economicus

What do consumers aim to maximize according to economic theory

Utility

What is the main aim of firms under economic theory

To maximize profit

Why do firms aim to maximize profit

To satisfy owners and shareholders

What do governments aim to maximize according to rational decision-making assumptions

Social welfare

Why do governments aim to maximize social welfare

To increase public satisfaction and meet citizens' needs

Which school of economics questions the assumptions of rational decision-making

Behavioral economics

What do behavioral economists argue about rational decision-making

Economic agents may not always have the information to act rationally

What concept describes consumers not always making calculated decisions

Bounded rationality

What is demand

The ability and willingness to buy a good at a given price and time

What causes a movement along the demand curve

A change in the price of the good

What causes a shift in the demand curve

A change in the conditions of demand

What is a contraction in demand

A decrease in quantity demanded due to a price increase

What is an extension in demand

An increase in quantity demanded due to a price decrease

What does a leftward shift in the demand curve indicate

A decrease in demand

What does a rightward shift in the demand curve indicate

An increase in demand

What mnemonic helps remember the conditions of demand

PIRATES

How does population affect demand

An increase in population raises demand

How does income affect demand for most goods

Higher income increases demand

What happens to demand for inferior goods when income rises

Demand decreases

How does the price of substitutes affect demand

If the price of a substitute rises

How does the price of complementary goods affect demand

If the price of a complement falls

How does advertising affect demand

Successful advertising increases demand

How do tastes and fashion affect demand

Popular goods have higher demand

How do future price expectations affect demand

Expectation of rising prices increases current demand

How do seasons affect demand

Demand for some products changes with weather or seasonal patterns

What is total utility

The total satisfaction gained from consuming a good

What is marginal utility

The satisfaction gained from consuming one additional unit of a good

What is the law of diminishing marginal utility

Satisfaction decreases as more of a good is consumed

How does diminishing marginal utility affect the demand curve

It explains why the demand curve slopes downward.

What does elasticity of demand measure

The responsiveness of quantity demanded to changes in price

What does it mean if a good is elastic

Demand is relatively responsive to changes

What does it mean if a good is inelastic

Demand is relatively unresponsive to changes

What is price elasticity of demand (PED)

The responsiveness of demand to a change in the price of the good

What is the formula for PED

% Change in Quantity Demanded / % Change in Price

What is the typical sign of PED values

Negative (because of the inverse relationship between price and demand)

What does PED = 1 indicate

Unitary elasticity

demand changes by the same percentage as price

What does PED > 1 indicate

Elastic demand

demand changes by a larger percentage than price

What does PED < 1 indicate

Inelastic demand

demand changes by a smaller percentage than price

What does PED = 0 indicate

Perfectly inelastic demand

price changes have no effect on quantity demanded

What does PED = infinity indicate

Perfectly elastic demand

any price change causes demand to fall to zero

How does the availability of substitutes affect PED

More substitutes make demand more elastic

How does time affect PED

Demand becomes more elastic over time as consumers find alternatives

How does necessity affect PED

Necessities have inelastic demand

How does the proportion of income spent on a good affect PED

Goods that take up a small proportion of income are more inelastic

How does addiction affect PED

Addictive goods tend to have inelastic demand.

How does PED affect the incidence of indirect taxes

The more inelastic the demand

How does PED influence government tax revenue

Inelastic demand generates higher tax revenue

What happens to revenue if demand is elastic and price decreases

Revenue increases

What happens to revenue if demand is inelastic and price decreases

Revenue decreases

What is income elasticity of demand (YED)

The responsiveness of demand to a change in income

What is the formula for YED

% Change in Quantity Demanded / % Change in Income

What does YED < 0 indicate

An inferior good

demand decreases as income rises

What does YED > 0 indicate

A normal good

demand increases as income rises

What does YED > 1 indicate

A luxury good

demand increases significantly as income rises

What does YED < 1 indicate

An inelastic good

demand changes less than income changes

Why is YED important for businesses

It helps predict how demand will change with income levels

How does YED influence product focus during economic prosperity

Firms focus more on luxury goods during prosperity

What is cross elasticity of demand (XED)

The responsiveness of demand for one good to the price change of another good

What is the formula for XED

% Change in Quantity Demanded of Good A / % Change in Price of Good B

What does XED > 0 indicate

Substitutes

an increase in the price of one good increases demand for the other

What does XED < 0 indicate

Complements

an increase in the price of one good decreases demand for the other

What does XED = 0 indicate

Unrelated goods

no impact on demand for one good due to price changes of the other

How does the size of the XED value affect the relationship between goods

Larger absolute values indicate a stronger relationship

Why is XED important for businesses

It helps understand competition and the impact of price changes on demand for their products.

What is supply

The ability and willingness to provide a good or service at a particular price and time

What causes a movement along the supply curve

A change in the price of the good

What is a contraction in supply

A decrease in quantity supplied due to a price decrease

What is an extension in supply

An increase in quantity supplied due to a price increase

What causes a shift in the supply curve

A change in the conditions of supply

What does a leftward shift in the supply curve indicate

A decrease in supply

What does a rightward shift in the supply curve indicate

An increase in supply

What happens to supply if production costs increase

Supply decreases

How does the price of other goods in joint supply affect supply

A rise in the price of one good increases supply of the other (e.g.

How does the price of goods in competitive supply affect supply

A rise in the price of one good decreases the supply of the other (e.g.

How does weather affect supply

Good weather increases supply (right shift)

How does new technology affect supply

It increases supply by reducing production costs

How does government legislation affect supply

Regulations can increase or decrease supply (e.g.

How do taxes affect supply

Taxes increase production costs and decrease supply

How do subsidies affect supply

Subsidies decrease production costs and increase supply

What are producer cartels

Groups that restrict supply to raise prices and profits.

What is price elasticity of supply (PES)

The responsiveness of supply to a change in the price of the good

What is the formula for PES

% Change in Quantity Supplied / % Change in Price

What does PES = 1 indicate

Unitary elasticity

supply changes by the same percentage as price

What does PES > 1 indicate

Elastic supply

supply changes by a larger percentage than price