Summary
Summary Microeconomics- 1.2 How markets work
- Module
- 1.2 How markets work
- Institution
- AQA
Full exam revision notes on the AQA Microeconomics 'How markets work' section 1.2.1 - 1.2.10
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1.2.1 Rational decision makingUtility: is a measure of satisfaction we get from purchasing and consuming a good or service.
• Total utility: total satisfaction given
• Marginal utility: the change in satisfaction from consuming an extra unit
The standard economic theory believes in the idea of ‘diminishing returns’ where the narginal utility
of extra units declines as more is consumed
• Total utility is maximised when the marginal utility from the next unit consumed is zero
Rational decision making: assumes that the decision maker has full or perfect information about
alternatives, it also assumes that they have the time, cognitive ability and resources to evaluate
each choice against the others.
Homo economicus: The ‘economic man’ is the portrayal of humans as agents who are consistently
rational and narrowly self-interested, and who pursue their subjectively defined ends optimally.
1.2.2 Demand
Effective demand: refers to the willingness and ability of consumers to purchase goods at different
prices. Showing the amount of goods that consumers ae buying, supported by their ability to pay
Law of demand: there is an inverse proportional relationship between price and demnd of a
commodily.
Income substitute effect: when price falls, purchasing power of the consumer increases
Non- price factors which affect demand: Pasific
• Popilation
• Advertising
• Substitutes price
• Income
• Fashion
• Interest rates
• Complements price
p
p a
p i
n
a a a
1.2.3 PED, YED, XED
, Price Elastic Demand: PED %¢Qvantity
Demanded
Measures the responsiveness of demand after a change in price. %¢P na
0= perfectly inelastic. 0-1= inelastic. 1<= elastic. 1= unit elastic
p a e p p
s
o
D
a a a a
Factors affecting PED:
• Number of close substitutes available: the closer, the more price elastic
• Price of product relative to total income: if the % of the budget is high, more price elastic
• Cost of substituting between products: if prices are low, demand will be more price elastic
• Brand loyalty and habitual consumption: loyalty makes demand less elastic, advertising can also
help
• Degree of necessity or luxury: standard assumption is that necessities have a lower PED whereas
luxuries are an optional spend
PED can be used by firms to predict:
• The effect of a change in price on total revenue
• Price volatility in a market following a change in supply. Important for commodity producers who
suffer big price and revenue shifts
• The effect of a change in an indirect tax on price and quantity demanded, also if a business can
pass some / all tax onto the customer
Price discrimination: businesses can charge a higher price to consumers whose demand is price
inelastic
Cross-price elasticity of demand: XED A %¢QvantityDenande
Measures the responsiveness of demand for good A following a change in the price B %¢Pria of
(related) good B. There is a distinction between substitute and complementary goods.
Substitute: goods and services in competitive demand, having a positive XED. Meaning an incease
of the price of good A leads to an incease of the demand for good B(a substitute)
Complement: goods and services in joint demand, having a negative XED. Meaning an increase of
the orice for good A leads to the contraction of its demand and a fall in the demand for good
B(complement)
• Inferior goods: whose demand decreases when consumer income rises
• Giffen goods: consumed more as the price rises
Income elasticity of demand: YED %¢QD
Measues the responsiveness of the quantity demanded for a good to a change in income %¢Y
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