Definition & Concepts
Define Demand
Demand is the quantity of a good/service consumers are willing and able to buy at different prices in a given time period
How is PED calculated?** If a 10% price increase leads to a 15% decrease in quantity demanded, calculate PED and determine its elasticity type.
Given: Price ↑10%, Qd ↓15%.
\[ PED = \frac{-15\%}{10\%} = -1.5 \]
Interpretation: Elastic (|PED| > 1).
What is a Price Ceiling?** Analyze its impact on the market (e.g., rent control).
- A max price set below equilibrium (e.g., rent control).
**Effects**: Shortage (Qd > Qs), black markets, reduced quality.
Compare Specific Tax and Ad Valorem Tax** in terms of their effects on the supply curve.
- **Specific tax**: Fixed amount per unit (parallel S shift).
- **Ad valorem tax**: Percentage of price (diverging S shift).
Dynamic Analysis**: If technological progress lowers production costs while consumer incomes rise, use supply-demand diagrams to predict changes in equilibrium price and quantity.
Tech progress → S shifts right → lower P, higher Q.
- **Income rise → D shifts right → higher P, higher Q.
**Net effect**: Q definitely rises; P depends on relative shifts.
Define supply
Supply is the quantity of a good/service producers are willing and able to sell at different prices
Why do necessities (e.g., salt) typically have inelastic demand?
Essential goods (e.g., salt, medicine) have few substitutes.
- Consumers will buy them even if prices rise (low %ΔQd).
What is a Price Floor?** Provide an example (e.g., minimum wage).
A min price set above equilibrium (e.g., minimum wage).
**Effects**: Surplus (Qs > Qd), unemployment (for labor markets).
Why do Public Goods lead to market failure?** Discuss non-excludability and non-rivalry.
- **Non-excludable**: Can’t exclude non-payers (e.g., streetlights).
- **Non-rivalrous**: One person’s use doesn’t reduce availability.
→ No profit incentive for private firms → under-provision.
Elasticity & Tax Incidence**: If a tax is imposed on an inelastic good, who bears more of the burden—producers or consumers? Why?
- Consumers bear more tax burden (steep D curve → Qd barely falls).
- Example: Cigarette taxes.
Define equilibrium price
The price where quantity demanded = quantity supplied (Qd = Qs).
Analyze why luxury goods usually have elastic demand
- Luxuries (e.g., designer bags) are non-essential and have substitutes.
- If prices rise, consumers can delay purchases or choose alternatives (high %ΔQd).
Explain how an Indirect Tax affects market equilibrium**, using a diagram.
- Tax shifts supply curve left (upwards).
- New equilibrium: Higher price (Pc), lower quantity (Qt).
- Tax burden shared by producers/consumers.
Externality Problem**: Use a diagram to show how negative externalities (e.g., pollution) cause welfare loss.
- Draw MPC (private cost) and MSC (social cost) curves.
- Market equilibrium (Qm) > Socially optimal (Qopt).
- Welfare loss = area between MSC and MPC from Qopt to Qm.
Welfare Analysis**: Using consumer and producer surplus, explain the deadweight loss from price controls.
Price ceiling creates shortage → lost welfare (area between D and S from Qs to Qd).
Distinguish between a "movement along the demand curve" and a "shift in demand"**, providing examples.
Movement along**: Caused by price changes (e.g., cheaper smartphones → higher Qd).
- **Shift in demand**: Caused by non-price factors (e.g., higher income → demand curve shifts right).
Explain Income Elasticity of Demand (YED)**: If a good has YED = +2.5, what type of good is it?
\[ YED = \frac{\%\Delta Qd}{\%\Delta Income} \]
YED = +2.5 → **Luxury good** (YED > +1).
How does a Subsidy shift the supply curve?** Analyze with an example like agricultural subsidies.
- Subsidy shifts supply curve right (downwards).
- New equilibrium: Lower price, higher quantity.
How can taxation correct negative externalities?** Calculate the difference between socially optimal output and market output.
- Tax = vertical distance between MPC and MSC.
- Example: Carbon tax reduces output to Qopt.
Explain Price Elasticity of Demand (PED)** and write its formula
PED measures how much Qd responds to price changes.
**Formula**:
\[ PED = \frac{\%\Delta Qd}{\%\Delta P} \]
Cross Elasticity of Demand (XED)**: If XED is negative, what is the relationship between the two goods?
XED < 0 → **Complementary goods** (e.g., cars and petrol).
What is Market Failure?** List three causes.
1. Externalities (e.g., pollution).
2. Public goods (free-rider problem).
3. Imperfect information (e.g., asymmetric info).
Explain Asymmetric Information**, giving a real-world example (e.g., the used car market).
- One party has more info than the other (e.g., used car sellers know hidden defects).
→ Leads to market inefficiency (e.g., "lemons problem").