1.2 How Markets Work

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1.2.1 What is the assumption of economic agents?
That they think rationally. Consumers aim to maximise utility. Firms aim to maximise profits. Governments aim to maximise social welfare.
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1.2.2 What is a market?
Anywhere buyers and sellers can exchange goods or services.
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1.2.2 What is demand?
The quantity of goods and services that consumers are willing and able to buy at a given price in a given period of time.
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1.2.2 What can cause movements along a demand curve?
Changes in price.
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1.2.2 What causes shifts in a demand curve?
P-population A-advertising S-substitutes I-income F-fashion I-income tax C-complements > PASIFIC
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1.2.2 What is the concept of diminishing marginal utility?
For each additional unit of a good consumed. the marginal utility gained decreases. If marginal utility decreases with each extra good consumed then the price a consumer is willing to pay will decrease. This explains why the demand curve slopes down.
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1.2.3 What is price elasticity of demand (PED)?
A numerical measure for the responsiveness of demand following a change in price. PED = % change in quantity demanded / % change in price
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1.2.3 Why is PED usually negative?
As price increases, demand usually falls.
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1.2.3 What PED's are different elasticities?
Perfectly elastic = PED=infinite. Relatively elastic = PED>1. Unitary elasticity = PED=1. Relatively inelastic = PED<1. Perfecly inelastic = PED=0.
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1.2.3 What is income elasticity of demand (YED)?
A numerical measure for the responsiveness of demand following a change in real income. YED = % change in quantity demanded / % change in incomes
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1.2.3 What goods do different YED's represent?
YED=+ve and greater than 1 represents a luxury good. YED=+ve and less than 1 represents a normal good. YED=-ve represents an inferior good
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1.2.3 What is cross elasticity of demand (XED)?
A numerical measure for the responsiveness of demand for one good following the change in price of another good. XED = % change in quantity demanded of good x / % change in price of good y
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1.2.3 What goods do different XED's represent?
+ve XED = subsitutes. -ve XED = complements. XED = 0 are unrelated goods/
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1.2.3 What factors influence PED?
Substitutes=width of definition. Greater availability of substitutes means a more elastic PED. Need or want. Needs-inelastic. Wants-elastic. Percentage of income spent on the good. Time.
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1.2.3 What is the significance of elasticities of demand?
Information of YED can be used in sales forecasting. They can be used in pricing policies. Useful for firms to know XED's of goods to ensure they maximise demand of their products. Governments can use YED's - imposition of taxes and subsidies.
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1.2.3 What is the relationship between PED and Total Revenues?
When PED = +/- 1 Total revenue is maximised. MR = 0. Unitary elasticity. Total revenue = price x quantity sold.
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1.2.4 What is supply?
The quantity of a good or service a firm is willing to supply at a given price over a given period of time.
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1.2.4 What causes movements along a supply curve?
Changes in price.
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1.2.4 What causes shifts in the supply curve?
Changes in the cost of production. Improvements in technology. Changes in productivity. Indirect taxes and subsidies. Changes in the price of other goods. Numbers of suppliers.
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1.2.5 What is price elasticity of supply (PES)?
A numerical measure for the responsiveness of supply following a change in price. PES = % change in quantity supplied / % change in price
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1.2.5 Why is PES usually positive?
The higher the price charged for a good the greater incentive to supply more.
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1.2.5 What factors influence PES?
Time. In the short run supply is inelastic as at least one factor of production is fixed (capital/land). In the long run all factors of production are variable. Unemployment means PES is elastic. High stock levels means PES is elastic.
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1.2.6 What is the market equilibrium?
Where planned demand = planned supply. When supply and demand aren't equal this is disequilibrium.
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1.2.7 What is the price mechanism/'invisible hand'?
When changes in the demand and supply for a good/service lead to changes in price of the good/service bought or sold.
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1.2.7 What is the rationing function of the price mechanism?
Limited supply of scarce resources are restricted to those who can afford to pay for it.
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1.2.7 What is the incentive function of the price mechanism?
Higher prices acts as an incentive for consumers to work hard. Higher prices encourage firms to supply more .
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1.2.7 What is the signalling function of the price mechanism?
A signal where resources should be used. When prices rise, producers move resources into the manufacture of that product.
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1.2.8 What is consumer surplus?
The difference between the price the consumer is willing to pay and the price they actually pay.
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1.2.8 What is producer surplus?
The difference between the price the supplier is willing to produce their product at and the price they actually receive for it.
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1.2.9 How do elasticities of demand effect consumer and producer gains/burdens from subsidies and taxes/
The more inelastic demand is for a good the greater the consumer gain from a subsidy. The more price elastic demand is the greater producer gain from subsidies. The more inelastic demand is the greater tax burden on consumers and vice versa.
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1.2.10 What are reasons consumers may not behave rationally?
Influence. Habitual behaviour. Computational weakness.
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1.2.2 What is a market?

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Anywhere buyers and sellers can exchange goods or services.

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Card 4

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1.2.2 What can cause movements along a demand curve?

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1.2.2 What causes shifts in a demand curve?

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