Economics Seminar questions (S2)
Determinants of supply
(1)Price of the good (2)Factor prices (3)Technology (4)Organisational changes (5)Government policy
Determinants of Demand
(1)Tastes & preferences (2)Income and its distribution (3)Complement and substitute goods (4)Time preferences
What is a "perfectly competitive market"? Why are perfectly competitive firms said to be "price takers"?
A perfectly competitive market implies that: there are many firms, none are large, no barriers to entry, undifferentiated output, firms are price takers, firms only make normal profits and consumers have perfect information. Firms in perfectly competitive markets are said to be price takers as they can only charge one price. If they charge too much, then consumers will simply switch to a competitor and they will sell nothing. They are also unable to charge less due to their cost structures. This implies a horizontal (or perfectly elastic) demand curve.
What is a price ceiling and how is it used in policy making? Give some examples.
A price ceiling gives a maximum price for which a good or service can be sold. It is illegal to charge a price higher. Successive labour governments have proposed capping rents to what is seen nominally as an acceptable level.
Which of the following is TRUE?
Both recessions and inflations may reduce output in the future.
Name some factors affecting buyers "Willingness To Pay" (WTP) and sellers "Willingness to Sell"?
Factors affecting willingness to pay include: perception of quality, subjective value, mood, income, broader economic environment, information, peer influences, etc. For factors affecting willingness to sell: seller's mood, emotional attachment to product, cost of production, etc.
You would be willing to pay a maximum of £50 to attend a concert, and you can buy a ticket for £30. Your consumer surplus is:
£20.
Staple good:
A good where a fixed quantity is purchased irrespective of income
Necessity good:
Characterises a good where a specific quantity must be purchased regardless of income.
Opportunity cost:
Cost measured in terms of the best alternative forgone (Sloman et al, 2012, G.14).
What is price elasticity? Why is it important for a firm to know the price elasticity of its products? How will this help to inform strategy?
Elasticity represents how responsive quantity demanded (or supplied) is to a change in price. A firm may be able to maximize its profit by restricting its output.
What is the difference between normal profits and supernormal profits? What are the implications of each for consumer welfare?
Normal profits is defined as just enough to keep a firm (or entrepreneur) in business. To put it another way the return on capital employed is just higher than the next best alternative. Supernormal profits is anything in excess of that.
Consider the supply curve of organically grown wheat. What will be the effect of a government subsidy granted to farmers using organic methods?
Rightward shift
Explain what a government would have to do to keep the rents of houses and flats low.
The answer will largely depend upon the forces acting on the housing market. One option may be to cap rents another might be to incentivise construction companies or remove regulations.
Imperfect competition
The collective name for monopolistic competition and oligopoly (Sloman, 2009, p.164).
Which is the best definition of economics?
The study of how individuals and societies choose to use the scarce resources that nature and previous generations have provided
What is most likely to be a variable cost for a firm?
The taxes that are paid on employee wages
Which of the following is most likely to be a variable cost for a firm?
The taxes that are paid on employee wages
Which of the following correctly explains when a firm will choose to shut down?
When it can't cover its average variable costs in the short run
Do you think the equilibrium price depends on any factors other than WTP and costs? Give examples.
Yes - see answer above.
How can we use the observed WTP to construct the demand function for this market?
You need to observe sales at different price points, over a period of time.
The 'law of demand' states that:
as prices fall, quantity demanded increases.
Imperfect competition occurs when:
firms are neither monopolies nor perfect competitors.
Normal goods are:
goods whose demand rises as people's incomes rise.
A society can produce two goods: bread and biscuits. The society's production possibility curve is negatively sloped and 'bowed outward' from the origin. As this society moves down its production possibility frontier producing more and more units of biscuits, the opportunity cost of producing biscuits:
increases.
Ways in which the national economic environment affects business performance
interest rates, demand and supply, recession, inflation
A firm will maximise its profits if it produces and sells the level of output where:
marginal revenue equals marginal cost.
If the inflation rate is greater than the interest rate, the real interest rate is:
negative.
The perfectly competitive equilibrium of a large number of identical firms implies that:
no firm earns economic profits in the long run
The adjustment of ________ is the rationing mechanism in free markets.
price
Capital, as economists use the term:
refers to things that have been produced and are used to produce other things.
The reason that opportunity costs arise is that:
resources are scarce.
Kathy eats five slices of pizza on a Saturday night but admits each slice of pizza doesn't taste as good as the previous one. This suggests that for Kathy:
the marginal utility of a slice of pizza is positive but decreasing.
In the theory of the firm the long run is:
the period of time in which all factors can be varied.
In terms of the production possibility curve, an increase in productivity attributable to new technology would best be shown by:
the production possibility curve shifting up and to the right.
Suppose it is observed that the price of cereal falls but that the quantity sold rises. From this we can deduce that:
the supply curve has shifted to the right, but we cannot deduce whether or not the demand curve has shifted.
Subsidy:
•Government financial assistance to a domestic producer (Hill, 2013, p.680).
What is a production function? How is it used in the context of economic analysis? (long answer)
•The production function can be defined as the process of turning inputs into outputs. An example of a production function Cobb-Douglas function: Q = ALαKβ. •It has micro (marginal costs, etc.) and macro applications (allocative efficiency). •Micro applications: The profit maximization problem. For instance a firm can experience diminishing, constant or increasing returns with respect to a particular factor input. This is important for deciding the optimal capital to labour ratio etc. •Macro applications: Production possibility frontier (curve)
•Diminishing marginal utility:
As more units of a good are consumed, additional units will provide less additional satisfaction than previous units (Sloman, 2012, G:5).
In which of the following situations will the demand curve for a good shift to the right?
An increase in the supply of a complementary good
Production Possibility Curve:
A curve showing all the possible combinations of two goods that a country can produce within a specified time period with all its resources fully and efficiently employed (Sloman, 2012, G:16).
•Production Possibility Curve:
A curve showing all the possible combinations of two goods that a country can produce within a specified time period with all its resources fully and efficiently employed (Sloman, 2012, G:16).
Assume that a firm can produce 6 units of good X or 12 units of good Y per hour with its current resources. The opportunity cost of a unit of X is:
2 units of Y.
•Economic efficiency:
A situation in which each good is produced at the minimum cost and where individual people and firms get the maximum benefit from their resources (Sloman, 2012, G:6).
•Allocative efficiency:
A situation in which the current combination of goods produced and sold gives the maximum satisfaction for each consumer at their current levels of income. (Sloman, 2012, G:1)
Can you think of other cases for which adding "a duplicate" for a small number of passengers may be sensible? What do these cases have in common?
Airplane, trains and boats. Other less relevant examples include entertainment events, postage services, taxis, restaurant seats, smoking/non-smoking areas, adult only hotels and fair access
Why may it still make economic sense for the company to put on a coach for just one or two passengers rather than turning them away?
Due to the staggered nature of costs, in the short-run it is better to turn down a few extra passengers. In the longer run forgoing short-term profitability may raise sales through a variety of means.
What are the main determinants of supply?
The five main determinants include (there are others see Sloman): price expectations, factor prices, technology, organisation changes and government policy.
Define the three different types of unemployment. Explain the factors that drive unemployment in each case and discuss the policies that are typically used to tackle them.
Frictional, structural and cyclical unemployment. Frictional unemployment results from workers switching jobs. This can be reduced by helping workers transition, perhaps through a national job seekers website or job centre programme. Structural unemployment results from a mismatch between skills that employers demand and workers possess. Policies to remedy this unemployment type might be to establish a re-skilling programme or reform the education system. Lastly, cyclical unemployment results from the business cycle. Better economic management will help reduce its incidence.
What is the price mechanism?
Governed by the forces of demand and supply. In a pure market economy in the absence of externalities, it ensures those who value the good the most can obtain them and that resources are efficiently employed.
Why is it concave to the origin?
If the curve is drawn as concave (bowed outwards to the orgin) then we are assuming that there is an increasing opportunity cost of production.
Referring to case study "How big is the underground economy" (homework #12) discuss the following questions: Is the size of the underground economy likely to increase or decrease as the level of unemployment rises?
Increase - as formal sources of employment are hard to come by some people will supplement their income via the underground economy.
Define the concept of "inflation" and explain how it can be triggered by the depreciation of a country's currency.
Inflation is defined as a sustained increase in the general price level over a period of time. A depreciation in a country's currency means that each unit now buys less of another currency. This implies that imports will become relatively more expensive (raising prices domestically) and exports relatively more attractive (economic stimulus raising AD).
How did the use of a price ceiling affect the number of transactions in this experiment? Why?
It led to fewer units being sold as it was not profitable for higher cost producers to supply to the market.
If the amount of cash used in the economy falls, does this mean that the size of the underground economy must have fallen? Relate your answer to the recent Indian 500 and 1000 rupee note demonetisation experiment.
Most likely - organised crime use high-denomination notes to conduct business. These are hard to track and do not leave a digital trail. Using other means will likely involve a higher transaction cost. Likewise, individuals might also want to hide their true earnings from the authorities for tax purposes.
What is a production function? How is it used in the context of economic analysis?
The production function is a mathematical function that represents how inputs are turned into outputs. Probably the simplest example is the Cobb-Douglas function where quantity produced depends on some multiplicative factor of capital and labour.
Can you think of some more recent examples, where structural changes in the economy may have a long lasting effect in economic activity (and the housing market)? Think Tata, for instance.
Students could discuss aspects like transitioning from a manufacturing to service-based economy and the rise of nationalism.
What are the key factors driving house prices in the UK? How have they changed over the years?
Students should discuss issues related to a growing population, changing household dynamics and supply of new housing stock.
What is a production possibility curve?
The curve shows all possible combinations of two goods that a country can produce in a given time period assuming all resources are fully and efficiently employed.
Distinguish between the income and substitution effects of a price change.
The precise reaction to a price change will encompass both an income and substitution effect. Both usually operate in the same direction to decrease consumption of a good after a price rise. Assuming this is the case, a substitution effect reflects the fact that other goods now offer a more attractive prospect as they are relatively cheaper after the price change. An income effect reflects the fact that an individual's income physically can't buy as many units of that good after the price change.
How and why are shortages and surpluses eliminated and equilibrium restored in a market? Use an example to explain how the goods and factor markets are interdependent?
The price mechanism will ensure that the quantity demanded and supplied will converge. For instance, if cranberries are hailed as a new superfood demand will increase. This will lead to a price rise which will incentivise cranberry growers to increase production and new producers to enter the market.
What are the four key objectives of macroeconomic policy?
These concern price stability, sustainable economic growth, equilibrium unemployment and balance of payments.
Discuss with the person sitting next to you the ways in which the national economic environment affects business performance.
This question offers a fair degree of scope, not limited to... •Negative externalities - Marginal Private Cost ≠ Marginal Social Cost ØSugar tax (Announced 2016 - adv. 18-24p litre on soft drinks etc.) ØAlcohol duty (£11.06 1ltr bottle of vodka etc.) ØTobacco duty (Flat rate £3.93 plus 16.5% of retail price etc.) ØFuel duty (petrol/diesel 57.95p a litre etc.) •Positive externalities - Marginal Private Benefit ≠ Marginal Social Benefit ØSubsidies encouraging investment in renewable energy ØEducation provision ØResearch grants (technology, medical etc.) ØPatents (technology, medical etc.) ØInfrastructure spending Ø •Policy nudging - auto-enrolment pensions, opt-out organ donation (Wales), etc. Ø (Macroeconomics) Fiscal Policy, Monetary Policy, Exchange Rates, International Relationships etc
When a decrease in the price of good A causes an increase in demand for good B, the goods are:
complements.
1.Name some factors affecting buyers "Willingness To Pay" (WTP) and sellers "Willingness to Sell"? ● 2.How can we use the observed WTP to construct the demand function for this market? ● Do you think the equilibrium price depends on any factors other than WTP and costs? Give examples First select the module in blackboard, then select the MyEconLab tab. Click on homework and tests. Select lecture 3 "Market clearing". At the bottom should be a tab "Price floors experiment - single player". Click on that.
WTP influences Perception of quality, subjective value (influenced by demographic, psychographic and behavioural aspects), mood, income, broader economic environment, information (market knowledge) and peer influences (fashion). • WTA influences Assessment of potential customer (demographic, vocal and behavioural traits), seller's mood, emotional attachment to product, and costs (acquisition price, factor prices, technology, organisational factors and government policy). Constructing a demand and supply function A demand and supply schedule can be constructed by observing purchases for both buyers and sellers (amount sold, price paid, etc.). See class demo. (Q3) See Q1 above.
What is a monopoly and how does it decide on its pricing schedule? What are the main advantages and disadvantages of having a monopolist?
We equate marginal cost to marginal revenue. Unlike a competitive equilibrium the demand curve is not equal to the marginal revenue curve as the monopolies output setting decision influences the market price. Advantages of a monopoly include: economies of scale and capacity to reinvest profits as R&D (important in imperfect capital markets). Disadvantages include: lower welfare (deadweight loss), cumulative inefficiency over time (lack of incentives to re-invest profits and ability to control/drive down costs) and harm to other firms in the industry (monopsony power).
An increase in supply is represented by:
a rightward shift of the supply curve.
Macroeconomics is concerned with:
both long-run trends and short-term fluctuations in economic activity.
The limits imposed on household choices by income, wealth, and product prices are the:
budget constraint.
In oligopoly, firms:
by virtue of their size are able to influence price regardless of whether or not the product is differentiated or standardised.
Luxury good
•A good which requires a certain income threshold to be reached before any 'units' are consumed. Moreover, once this income threshold is breached, proportionally quantity demanded will rise faster than income.
Demand curve:
•A graph showing the relationship between the price of a good and the quantity of the good demanded over a given time period. A demand curve can be for an individual consumer or group of consumers, or more usually the whole market. (Sloman, 2012, G:19).
Supply Curve:
•A graph showing the relationship between the price of a good and the quantity of the good supplied over a given period of time. (Sloman, 2012, G:19).
Perfect competition
•A market structure where there are many firms, none of which is large; where there is freedom of entry into the industry; where all firms produce an identical product; and where all firms are price takers (Sloman, 2009, p.164).
Monopoly
•A market structure where there is only one firm in the industry (Sloman, 2009, p.164)
Complementary goods:
•A pair of goods consumed together. As the price of one goes up, the demand for both goods will fail (Sloman, 2012, G:3).
Substitute goods:
•A pair of goods which are considered by consumers to be alternatives to each other. As the price of one good goes up, the demand for the other rises (Sloman, 2012, G:19).
1.What is a price ceiling and how is it used in policy making? Give some examples.
•A price ceiling can be used to artificially control prices. In effect it sets a maximum price that it is illegal to trade above. To be effective the price ceiling must be below the equilibrium price. Controls such as this may paradoxically increases prices or be circumnavigated. •In the general election in 2015 Ed Miliband announced plans to cap rents for private tenants. Such an approach may however create issues with maintenance/acceptable living conditions in the short-run and lead to a long-run reduction in the quantity of properties available to rent. •Other examples include: rent controls in New York, Finland, sportsperson wages (Coulter Law in Australian football league), State farm insurance and food in Venezuela.
How and why are shortages and surpluses eliminated and equilibrium restored in a market? Use an example to explain how the goods and factor markets are interdependent? (long answer)
•A shortage or surplus usually results from a contraction/expansion in demand or supply. •For example, a shortage would occur if quantity demanded at a given price is greater than quantity supplied at said price. A surplus occurs in the opposite scenario, where quantity supplied exceeds quantity demanded at a particular price. •In order to resolve either situation price adjusts in order to equate demand with supply and establish a new equilibrium. •To see this in action let us suppose an increase in demand occurs for fresh Cranberries, in a competitive market, leading to a shortage. Perhaps a study reveals they have additional health benefits and are subsequently hailed as a new Super Food. In this situation we invoke Adam Smith's notion of the 'invisible hand'. As the number of buyers increases, sellers are unable to accommodate all of the increase in demand and as a result increase prices. Price continues to rise until a new equilibrium is established. •Importantly, the degree of price rise is likely to be greater in the short-run (steeper supply schedule) due to the existence of fixed factors of production. In the long-run we assume that as all factors of production are fully flexible, producers are able to re-organise their production, reducing costs which through competitive influences lowers price. Although price per punnet remains above pre-shortage levels. •Let us demonstrate this diagrammatically...
Indifference set:
•An indifference curve shows bundles of goods at which the consumer is indifferent.
Isoquant set:
•An isoquant show minimum combinations of inputs to make a given output. Different points on an isoquant reflect different production techniques.
Opportunity Cost:
•Cost measured in terms of the best alternative forgone (Sloman, 2012, G:14).
What is price elasticity? Why is it important for a firm to know the price elasticity of its products? How will this help to inform strategy? (First Class Answer - 1:1)
•Elasticity is a useful concept applied to demand and supply. •Specifically, students should mention and fully explain the various types i.e. price elasticity of demand (PɛD), cross-price elasticity (XɛDAB), income elasticity (XɛDAB) and elasticity of supply (SɛD). •For instance own price elasticity can inform as to whether it may be profitable for a firm or business to raise prices. •Students would be expected to illustrate graphically elastic and inelastic demand. •However bright students will note the effect of a price rise might go beyond just affecting the good that it affects i.e. cross-price (complement and substitutes). •Crucially though firms must have good quality information across two or more periods to make accurate forecasts/predictions. (PɛD) = %Δ Quantity Demanded %Δ Own-price (XɛDAB) = %Δ QD of Good B %Δ Price of Good A XɛDAB) = %Δ QD of Good %Δ Income (SɛD) = %Δ Quantity Supplied %Δ Own-price
Inferior good:
•Goods whereby quantity demanded decreases as consumer incomes increase. •. Such goods have a negative income elasticity of demand (Sloman et al., 2012, G:10).
Normal good
•Goods whereby quantity demanded increases as consumer incomes increase. Albeit, proportionally the rise in quantity demanded is less than the rise in income. •. They have positive income elasticity of demand. Luxury goods will have a higher income elasticity of demand than more basic goods (Sloman et al., 2012, G:14).
Stakeholders
•People who are affected by a company's activities and or performance (customers, employees, owners creditors, people living in the neighbourhood, etc.). They may or may not be in a position to take decisions, or influence decision taking in the firm (Sloman et al., 2012, G:19). Examples of stakeholders include: shareholders, employees, customers, suppliers, financial intermediaries, government and the local community.
What are the key factors driving house prices in the UK? How have they changed over the years? (long answer)
•Growing population ØUK predicted to become the most populated country in Europe in the next few decades ØDeclining birth rate < net migration into UK Ø •Household dynamics - trend towards smaller but more numerous households ØRelatively high divorce rates and more singletons ØOverseas buyers, holiday homes and second home ownership ØGeneration rent and the rise of buy-to-let investors ØUnderutilisation of existing housing stock Ø •Supply of new housing is not keeping pace with demand ØRestrictions on building on green field land and environmental legislation ØRegulation and red tape (stamp duty, planning and building regulations) ØGeneral tightening of finance i.e. mortgage provision etc. ØPossible under investment in the sector (public and private) Take home Activity: Open up the Office for National Statistics website. Here you can find the latest UK economic and social data. Quantify the UK birth rate and net migration into UK for example.
What is the price mechanism? (long answer)
•In a free market economy individuals make consumption and production decisions based on the forces of demand and supply. •Market economy: In a market economy, the government plays no role in allocating resources. Instead markets allocate resources to the production of various products (Begg & Ward, 2007, p.360). •Prices represent signals of relative scarcity which ration availability to consumers (lower quantity demanded) and encourage producers to increase production (profit motive). •You will (already or in the next few weeks) be given access to a short game via MyEconLab which simulates a market for cranberries. You will take turns as the buyer and seller and set the purchase price (based on a set willingness to pay) and sale price (based on a set willingness to accept). • Example: Stock market •The price of a stock at a specific moment in time is what the public aggregately value a share of ownership in the company to be worth. Net worth is based on the future earnings potential of the firm in the long-run. •The price will rise if the number of buyers at a given price outnumbers the number of sellers and vice-versa.
Distinguish between the income and substitution effects of a price change. (long answer)
•Income effect (of a price change): The effect of a change in price on quantity demanded arising from the consumer becoming better or worse off as a result of the price change (Sloman, 2012, G:9). • •Substitution effect (of a price change): The effect of a change in price on quantity demanded arising from the consumer switching to or from alternative (substitute) products (Sloman, 2012, G:19). • •Suppose that an individual can only consume two goods. • •Assuming the individual is a utility maximizer, they consume the bundle of goods A and B (given their budget constraint) that maximizes their utility. •An example might milk and biscuits if the price of milk were to rise people would be able to purchase less goods overall (income effect) but would switch some consumption to biscuits.
Consumer surplus:
•Is the sum of each consumers willingness to pay minus the price actually paid.
Producer surplus:
•Is the sum of each producers willingness to supply minus the price actually received.
Can you think of some more recent examples, where structural changes in the economy may have a long lasting effect in economic activity (and the housing market)? Think Tata, for instance. (long answer)
•June 23rd 2016 UK voted to leave the European Union. •Worse case scenario (hard withdrawal) the UK could leave the European Union with no trade agreement. Consequently, the UK's access to the single market would be withdrawn and tariffs on goods and services introduced from around the EU. •The future of Tata Steel's Port Talbot plant in South Wales is unclear. •If it were to close it would have a far reaching effect on the local economy. As this plant is either the main employer in this area or is one of the major employers. Structural unemployment may ensue, whilst wages would be depressed. As such demand would fall for housing and other services. This would likely result in a reduction in house prices and a subsequent fall in the available housing stock. •However, hopes of a rescue deal for this plant (and the survival of the UK steel industry in general) may actually have been boosted by Brexit vote and associated drop in the value of sterling. The beneficial effect will however depend on whether the volume of additional sales (exports more price competitive) compensates for the additional cost of importing raw materials.
Explain the purpose of a production possibility curve [PPC]. Why might it be concave to the origin?
•Production Possibility Curve (PPC): [also known as a Production Possibility Frontier (PPF)] A curve showing all the possible combinations of two goods that a country can produce within a specified time period with all its resources fully and efficiently employed (Sloman et al., 2012, G: 16). •If a PPC is drawn concave to the origin it will appear bowed outwards. •Starting from the centre as we move towards the axis, progressively more of the other good will need to be sacrificed in order to produce an additional unit. •This indicates that the opportunity cost of additional production of a good is increasing. •Opportunity cost: Cost measured in terms of the best alternative forgone (Sloman et al, 2012, G.14). •Use an appropriate example e.g. bread and biscuits. Illustrate to follow. "Coming up with your own unique examples will help differentiate you from the crowd in the exam and showcase your understanding."
Explain what a government would have to do to keep the rents of houses and flats low. (long answer)
•The answer will largely depend upon the forces acting on the housing market. These would need to be identified. • •Several options are available to the policy maker, all of these must attempt to bolster supply but will be influenced by political forces: vProvide informational guidance and support to reduce information inequality. vIncrease the social housing stock whilst also perhaps removing the 'Right to Buy' scheme. vImprove efficiency, perhaps by deregulating the private rental sector. vGovernment subsidies to enable buy to let mortgages. vMake greater use of the existing housing stock - spare bedroom tax. vEncourage room letting within owner occupied housing.
. What are the main determinants of supply? (1st Class Answer - 1:1)
•There are five main determinants of supply these are: (1) Price expectations - expectations about future price changes act as an incentive for suppliers to enter/exit. (2) Factor prices - price of raw materials into the production process, in part determines a supplier's WTS. (3) Technology - technological know-how the process of turning inputs into outputs, relates to WTS. (4) Organisational changes - inside the black-box... Internal processes and management of production. (5) Government policy - taxation, regulation i.e. anything that interferes with free market operations. •Student's may like to demonstrate one of the above using a supply and demand diagram i.e. taxation/subsidy would result in a leftward/rightward shift in the supply curve (optional). •Nevertheless, supply is often assumed to be fixed in the short-run. For instance an unexpected increase in demand will initially result in a smaller increase in quantity supplier and higher prices in the short-run. In the long-run suppliers are able to adapt their productive processes and supply more at a reduced unit-price. •Indeed, this is in contrast to the determinants of demand which are: income, tastes & preferences, complement and substitute goods and time preferences. •Overall though, its is the interaction of demand and supply in free market systems that determines what and how things are produced.
2.How did the use of a price ceiling affect the number of transactions in this experiment? Why?
•Will reduce the number (we saw this in the simulation for the market for cranberries) as suppliers are not willing to supply as many units (or supply anything at all) at the lower prices. However, a large number of potential consumers will be dissatisfied as they could not purchase any product at a price below their willingness to pay. Resulting in a shortage/excess demand.
