SimpleStudy® 1.2 How Markets Work Q@ simptestuay 1.2 How Markets Work 1.2.1 Rational Decision Making + Assumes that consumers aim to maximise utility and firms aim to maximise profits + In economic theory, rational decision-making implies individuals make choices aimed at obtaining the greatest benefit or satisfaction given their available resources. 1.2.2 Demand + Movement along a demand curve represents a change in quantity demanded due to a price change. * Shifts in a demand curve indicate a change in demand due to factors other than price (conditions of demand, e.g. income, tastes). + The law of diminishing marginal utility underpins the downward-sloping demand curve. 1.2.3 Price, Income & Cross Elasticities of Demand * Elasticity measures the responsiveness of quantity demanded to changes in price (price elasticity), income (income elasticity), and the prices of other goods (cross elasticity). + Calculations use formulae and interpret if goods are necessities or luxuries, substitutes or complements. * Elasticity affects firms’ and government policies, such as indirect taxation and subsidies. 1.2.4 Supply * Movement along a supply curve represents a change in quantity supplied due to a price change. * Shifts in a supply curve indicate a change in supply due to factors other than price (conditions of supply, e.g. technology, resource prices). 1.2.5 Elasticity of Supply * Elasticity of supply measures the responsiveness of quantity supplied to price changes. * Itis calculated using formulae, with elasticity distinction between short-run and long-run supply. * Influencing factors include the flexibility of production and stocks. 1.2.6 Price Determination + Equilibrium price and quantity are the points where supply and demand curves intersect. + Excess supply/demand are shown with supply and demand diagrams and are resolved b market forces moving toward equilibrium. * Changes in demand and supply shift the equilibrium point.+ The price mechanism allocates resources through rationing, incentives, and signaling functions. + Itoperates differently in various market structures, including local, national, and global. 1.2.8 Producer & Consumer Surplus + Consumer surplus is the difference between what consumers are willing to pay and what they actually pay; producer surplus is the difference between the price at which producer are willing to supply and the actual price + Changes in supply and demand can affect surpluses, shown via diagrams. 1.2.9 Indirect Taxes and Subsidies * Indirect taxes and subsidies have impacts on consumers, producers, and government revenue. * The analysis considers the incidence (distribution) of these impacts and how it relates to the elasticity of supply and demand. + Diagrams illustrate the areas that represent producer and consumer subsidy. 1.2.10 Alternative Views of Consumer Behaviour + Recognizes that consumers may not always behave rationally due to factors like the influence of others, habit, and computational weakness. * This explores why consumers might deviate from the conventional model of rational decision-making,