1.2.1 Rational decision making

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    a) The underlying assumptions of rational economic decision making:
    Consumers aim to maximise utility and Firms aim to maximise profits
    Rational theory states individuals act in their own self interest and make logical and consistent decision to maximise satisfactions
    • Consumers – maximising utility • Firms – maximising profits
    Econs – Individuals, who make perfect calculations, can forecast future well and have all the information available to them
    Humans – Individuals who don’t make perfect calculations, can’t forecast future well and don’t have all the information available to them
    “Misbehaving” refers to acting inconsistently with economic theory
    Behavioural Economics – study of consequences of decisions of economic agents on markets and the economy (where economics meets psychology)
    1.2.2 Demand
    Demand is the quantity of goods and services that consumers are willing and able to buy at a given price in a given period of time
    Effective demand – situation where a consumers desire to buy a good or service is backed up by a financial ability to pay for it.
    What does the law of demand state?
    It states that if the price rises, the quantity demanded falls and vice versa (Ceteris Paribus)
    Seen during sales when reduced prices cause shoppers to buy more than they would’ve done if the prices remained the same
    There is an inverse relationship between the quantity demanded and the price of a good or service.

    a) The distinction between movements along a demand curve and shifts of a demand curve

    b) The factors that may cause a shift in the demand curve (the conditions of demand)
    Non – Price Factors cause a shift in demand (ceteris paribus)
    Changes in Income
    For normal goods, as income increases, demand will also increase and vice versa
    For inferior goods, as income increases demand will decrease (E.g. ASUS laptop)
    Increases in income generally leads to increases in wealth and increases in wealth leads to increases demand and vice versa
    Tastes and preferences
    Goods going in and out of fashion and at present, you could argue that a growing proportion of the population prefer a tablet to a laptop
    Government regulation
    Any form of government regulation can change demand for goods, for example ‘every schoolchild must have a laptop’ will increase the demand
    Changes in price of other goods (two types)
    Complementary goods are goods bought with one another E.g. a laptop and Microsoft office – If the price of Microsoft Office went up, demand for laptops is likely to fall
    Substitute goods are goods bought as an alternative to another E.g. tablets and laptop – if the price of tablets falls, then the demand for tablets will increase whilst the demand for laptops will fall
    Advertising
    Successful advertising campaigns can influence the demand for a good, if firms get a celebrity to endorse their product (Joe Hart and Head + Shoulders)
    Changes in a population of a country/ changes in interest rates

    c) The concept of diminishing marginal utility and how this influences the shape of the demand curve
    Downward Sloping demand curve
    Income effect – As the price of a good or service rises, the quality that a consumer is able to purchase with the same amount of income falls and vice versa
    Substitution effect – As the price of a good or service rises, the consumer will start to substitute away from this good or service and switch to alternative products
    If a price of a good or service falls, then the good is cheaper than alternative products so the quantity demanded of a the good increases
    Diminishing Marginal Utility – As more units of a good or service are consumed, additional units will provide less additional satisfaction than previous units, so consumers will be willing to pay less
    The price consumers are willing and able to pay is equal to the marginal utility of any given unit because they are only prepared to pay an amount that reflects satisfaction that they get from consuming it

    Violation 1: Veblen Goods (snob goods)
    Concept developed by economist – Thomas Veblen
    Quantity demanded rises as price rises due to the status gained from being seen by other people with expensive products. As the price of a product falls, so does the quantity demanded for it.
    Violation 2: Expectations or speculation
    When individuals expect the price of a good or service to rise, they decide to consume more of it
    This can be said for the following:
    • Houses • Shares • Currency • Gold
    Violation3: Giffen Goods
    Poor households need to maintain a certain calorie intake from staple foods and meat in order to work.
    Staple foods like potatoes have the most calories and make up a majority of our daily calorie intake.
    During potato famine in Ireland, price of potatoes rose whilst demand for them also rose.
    Because in order to maintain the same calorie intake, consumers substituted meat to have potatoes

     

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