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AS and A Level: Markets & Managing the Economy
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How do markets work?
- 1 Economics is the study of the allocation of resources so understanding how prices are set and the amount of resources used for any particular product is important.
- 2 Most resources are allocated by the free market. Adam Smith called this ‘the invisible hand’ as no one is in charge of it. It just happens through the interaction of millions of individual buyers and sellers, all working in their own best interest.
- 3 The price and amount produced are determined where the amount supplied equals the amount demanded. This is known as market equilibrium or the market clearing output.
- 4 Any changes to the supply of a good e.g. costs change, weather disrupts production or any change in demand e.g. a product goes into or out of fashion will cause a change in the equilibrium point and so lead to a change in price and output.
- 5 When discussing this, always start with the change in supply and demand and talk about the change to price and output this causes. Not the other way round.
What is market failure?
- 1 Markets do not work perfectly all the time. Several things can and do go wrong with its operation. One of these is market power. If individuals or groups of producers (or consumers to a lesser extent) have too much power, they can distort the market.
- 2 Externalities – The production and consumption of many goods has an external cost e.g. pollution that is paid by other people than those who consume or produce the product. To determine how much of this product should actually be produced or consumed for the greatest benefit to society, this cost should be taken into account as well.
- 3 Public goods – Some goods would not be produced at all by the free market as it is impossible to stop other people benefiting from them (the free rider problem). Examples include defence, light houses and street lights.
- 4 Merit goods – Some goods would be under-consumed if it was left to individuals to decide how much they wanted to spend on them. This is because they have external benefits to society beyond the private benefits e.g. we all benefit from an educated workforce.
- 5 Make sure you are comfortable with the market failure graphs and some of the other reasons for market failure e.g. information problems, immobility of the factors of production.
Five key facts about price elasticity of demand
- 1 Elasticity matters because it determines the importance of shifts in the demand and supply curves and helps with our understanding of how markets operate. In theory all demand and supply curves have different elasticises at different points along them. We are interested at their elasticity where they intersect.
- 2 Price elasticity of demand measures the responsiveness of demand to a change in price. The formula is the percentage change in quantity demanded divided by the percentage change in price.
- 3 Demand for a product is elastic if the percentage change in demand is greater then the percentage change in price e.g. a 10% price rise causes a 20% reduction in demand.
- 4 Demand for a product is inelastic if the percentage change in demand is less than the percentage change in price e.g. a 10% price rise causes a 5% reduction in demand.
- 5 Remember the formulae for income and cross elasticity of demand and price elasticity of supply. Q always goes on the top in the formula. We always ‘queue up’.
However, more relevant to this question are his two main principles. The first is the liberty principle which asserts that ?each person has an equal claim to a fully adequate scheme of equal basic rights?, and this is lexically prior to the second principle. However, it is the second principle, known as the ?difference principle? which gives us the greatest insight into Rawl?s beliefs on economic distribution in a just society. Under the difference principle, inequalities in distribution are allowed only if they work to the advantage of all, and, attached to positions and offices open to all.
- Word count: 1260
Using economic analysis, explain the possible causes of the increase in the sales of electronic goods such as mp3 players in recent years. 
The term supply refers to the incentive to suppliers to produce a product at a given price point, while demand refers to the consumers? willingness and ability to purchase a given product. Technological advancement in recent years have allowed for electronics to be produced at costs considered unimaginable just a few decades back. The discovery of silicone based transistors and implementation of widespread computer aided manufacturing and automation have allowed manufacturers to create components for electronics at prices never before seen.
- Word count: 499
Explain, with examples, the significance of the value of a goods cross-elasticity of demand in relation to its substitutes and complements. 
In the case of substitutes, the cross elasticity of demand for a good will always be positive. This means that as the price of one good decreases, the demand for the other also decreases, this is because the two products are perceived as alternatives to each other and as such, consumers will tend to gravitate towards the lower priced product, as long as their perceived quality is relatively close. In the case of very close substitutes such as Pepsi and Coca-Cola, we can expect the price elasticity of supply to be incredibly high as the two products are almost identical
- Word count: 658
Explain whether you would expect the price elasticity of supply of an agricultural product, such as rice, in a market to be elastic or inelastic. 
In certain cases, the elasticity can be so low, that it can essentially be considered 0; this is known as fixed supply and is characterised by a complete inability of suppliers to adjust output levels in relation to changes in price, at least in the short to mid-term. This is most often the case in markets where increasing output requires very expensive and time consuming investments, such as in the case of movie theatre seats or parking spaces. Certain aspects of agricultural products make it likely that they will have a low price elasticity of supply.
- Word count: 794
A number of factors can affect the price elasticity of supply. One such factor is the production time of the product. A very long period of time from the start to the end of the production process will mean that if the product experiences a drastic change in its price, the supplier, despite willingness, would be unable to change the level of output as they are locked into producing the given quantity of the good.
- Word count: 498
Discuss whether the elasticity of supply of manufactured goods is likely to be greater than the elasticity of supply of agricultural goods 
Beyond this, recent improvements in storage technologies such as refrigeration and freezing have allowed for most agricultural products to be stored for very long period of time, with refrigerated apples lasting up to 2 years and frozen produce last multiple years. All of these further increase the ability of agricultural products to be stocked and as such help increase the price elasticity of supply. Moreover, improvements in farming techniques such as pesticides and fertilizers, combined with improvements in education have vastly increased the occupational mobility of the factors of production land and labour in the farming process, all of which
- Word count: 1018
One potential benefit of the implementation of subsidies to farmers can be in helping domestic producers compete with lower priced imported agricultural goods. As a result of free trade, many economies may find their domestic farmers outclassed by farmers producing in other countries, either due to lower minimum wages, better infrastructure, economies of scale or substantial subsidies in that specific country. This in turn is likely to lead to an increased demand for imported goods which, on the one hand can cause a trade deficit, and on the other, can cause a fall in demand for the domestically produced counterpart.
- Word count: 1042
Discuss whether or not a firms revenue would increase, in response to price and income changes, if the price elasticity and income elasticity of demand for its product became highly elastic. 
A high income elasticity of demand means that as income changes, the quantity demanded for the good also experiences a disproportionately large change relative to the change in income. The income elasticity of demand is calculated by dividing the percentage change in the quantity demanded by the percentage change in income. The value of YED can be used to determine certain qualities of the product, most importantly, it allows for classification as a superior, inferior or normal good. In terms of price elasticity of demand, a highly elastic price elasticity of demand means that the consumers are very responsive to
- Word count: 727
Discuss whether it is better to introduce an indirect tax or to adopt policies to improve consumers knowledge and understand to deal with the problem of demerit goods. 
This will in turn cause a new equilibrium point to be formed with a lower quantity consumed and a higher price. Thus, such a measure can help curb the consumption of harmful demerit goods by integrating the cost to the consumer into the cost of the product itself. Beyond the benefit of lower consumption, the indirect will help increase tax receipts for the government which will then allow for more beneficial big government projects that will benefit the population of the country and the economy as a whole.
- Word count: 850
Discuss the usefulness to a business of a knowledge of price elasticity of demand and income elasticity of demand. 
In turn, this can lead the company to take actions in order to average costs per unit as to allow them to lower the price to a greater degree without losing profitability. Similarly, a very low price elasticity of demand can indicate that there is a lot of potential for increasing revenue by raising the price, as, due to a low elasticity, the increases per unit revenue will outweigh the loss of customers correlated to this increase in price. Moreover, if the company finds that the price elasticity of demand is very close to unit elasticity, meaning that total revenue
- Word count: 724
Discuss the effectiveness of government use of maximum and minimum prices to help consumers and producers. 
Moreover, this type of price control would also help lead to a fall in the cost of living which would then lead to an increase in the purchasing power of consumers, thus leading to an increase in the demand for other goods and services. On the one hand, this increase in purchasing power would lead to an improvement in the standards of living due to the fact that more needs and services can be consumed, and, on the other hand, it would also lead to an improvement in the long term growth prospects for the country due to the higher
- Word count: 795
A firm that produces yoghurt is given the following information the price elasticity of demand of various flavours: Strawberry (-0.8), Vanilla (-1.0), Pineapple (-2.5). Explain the pricing policy that the firm should adopt for each of the flavours if it wants to increase total revenue. 
A low price elasticity of demand indicates that consumers are not sensitive to the changes in the price of a good, while a high price elasticity of demand can indicate a very strong responsiveness of consumers. In regards to the Strawberry flavour, the relatively low value indicates price inelastic demand, thus the firm can expect to be able to raise the price while
- Word count: 410
Discuss how habit-forming demerit goods and goods with lots of substitutes are each likely react to price changes, and consider the extent to which knowledge of their likely response will would be useful to government policymakers. 
The reaction of a certain good in relation to a change in the product?s price is its price elasticity of demand (PED). The PED is a direct measure of the responsiveness of the quantity demanded of a product in response to changes in its price. It is calculated by dividing the percentage change in the quantity demanded by the percentage change in the price of the product, thus, as demand will always fall in response to an increase in price, the value of the PED will always be negative.
- Word count: 967
Discuss the policies that businesses might adopt to maintain sales when incomes are falling and consider which is most likely to be successful. 
the percentage change in the quantity demanded in relation to the percentage in the price of the product, if its value exceeds 1, then the increase in the quantity demanded wold be disproportionately higher than the fall in the price of the product, thus causing an increase in total revenue. Thus, through decreasing the price of their product in a period of falling real incomes, a firm could help maintain the same, or even higher levels of sales revenue. This policy is by no means perfect however, while a drop in the price may be highly effective at increasing revenues,
- Word count: 1034
Explain, using the concept of income elasticity of demand how a fall in income affects the demand of inferior goods and necessity goods. 
The values achieved can as such be either positive or negative. A negative value would indicate an inferior good, meaning that for this good, the income is inversely proportional to the demand for the product. Positive values indicate normal goods, meaning that demand increases with income. Such normal goods can then further be classified into two further categories, superior (or luxury) goods, these would be the goods that present an income elasticity greater than 1, meaning that as income increases, not only does demand increases, but the proportion
- Word count: 424