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Economics AS Level Notes
Economics Definition – The study of how to allocate scarce resources in the most effective way Economic Problem Definition – How to allocate scarce resources among alternative uses Household Definition – A group of people whose spending decisions are connected Microeconomics Definition – The study of how households and firms make decisions in markets Macroeconomics Definition – The study of issues that affect economies as a whole
The Basic Economic Problem
The fact that resources are scarce compared to the unlimited wants → Choices having to be made Goods Definition – Tangible products, i.e. products that can be seen and touched, such as cars, food and washing machines Services Definition – Intangible Products, i.e. products that cannot be seen or touched, such as banking, beauty therapy and insurance
Factors of Production
Factors of Production Definition – The resource inputs that are available in an economy for the production of goods and services The Four Factors: Land – This is a natural resource. Things such as oil, coal, rivers and the land itself. Labour – This is the human resource that is available in any economy / The quantity and quality of human resources Some economies (generally poor countries) have large populations but lack a skilled workforce and for other countries like Germany with declining populations, they depend on immigrant workers to do both skilled and unskilled jobs. Quality of labour is essential for economic progress. Capital - Man-made aids for production / Goods used to make other goods It is combined with Land and Labour MERC - Machines, Equipment, Robots and Computers Entrepreneurship - The willingness of an entrepreneur to take risks and organise production. Entrepreneur Definition - Someone who bears the risks of businesses and who organises production.
Some Extra Definitions
The world’s poorest countries tend to have few or poor Factor Endowments (vice versa). Factor Endowments Definition - The stock of factors of production Production Definition - The output of goods and services Want Definition - Anything you would like, irrespective of whether you have the resources to purchase it Scarcity Definition - A situation where there are insufficient resources to meet all wants Choice Definition - The selection of appropriate alternatives Opportunity Cost Definition - The cost of the (next) best alternative, which is forgone when a choice is made / The next best alternative forgone Specialisation Definition - The concentration by a worker or workers, firm, region or whole economy on a narrow range of goods and services Exchange Definition - The process by which goods and services are traded
PPC Graph Information: Productive Efficiency – Any point on the line Allocative Efficiency – Choosing between two points Eg. E A Unemployed Resources - Any point inside the curve Eg. X Unobtainable – Any point outside the curve Eg. Y Bliss Points – Where the curve starts or ends Eg. 6 Computers or 21 Bicycles Economic Growth – Change in the productive potential of an economy Productive Potential – The maximum output that an economy is capable of producing PPC Shifters (Right):
- Changes in the quantity of resources o The quantity of labour may increase as a result of net immigration of people of working age, a higher proportion of women entering the labour force or a rise in the retirement age. o The purchase of extra capital goods, referred to as net investment, increases the quantity of capital goods causing the PPC to increase (shift to the right). o The quantity of enterprise may be increased by a reduction in rules and regulations placed on firms, privatisations and government incentives to start up new businesses
- Changes in the quality of resources o Improvements in education and training will improve the quality of labour and raise productivity causing the PPC to increase (shift to the right) o The quality of capital goods is raised by advances in technology causing the PPC to shift right. o The quality of enterprise may be raised by management training and improved education
NOTE – The fact that the line isn’t straight for any of the diagrams is because they are imperfect substitutes PPC Shifter Right (Graph): PPC Shifters (Left):
- Natural Disaster (Less resources Less of each product can be produced)
The advantages of a free market economy / The disadvantages of command economies(CIGE): Choice – Firms will produce whatever consumers are prepared to buy and there is no restriction on what they produce in the FM. Planners are more concerned that there are enough essentials goods to go around rather than allocating resources efficiently between all goods Innovation – Firms will look to produce something new in order to be competitive. Because of property rights(intellectual property rights through patents) there are incentives for innovation and producing better quality products. Planners do not have this incentive, they are happy just producing essentials. Higher Economic Growth Rates – Countries with economic systems closer to the free market tend to have higher economic growth. Efficiency – Free markets are very competitive. Most of their industries are assumed to be perfectly competitive and so allocative and productive efficiency occur. This is because decisions about what to produce are made by the consumers rather than by planners The advantages of command economy / The disadvantages of free market economies(PmdIE): Public, Merit and Demerit Goods - Public goods cannot be provided in the private sector. Merit goods are likely to be under consumed in the free market and demerit goods over consumed. In a command economy demerit goods are likely to be banned or heavily taxed and public goods and merit goods will be provided at high levels. Unequal Distribution of Income – Benefits will be low and health service and school unaffordable for a lot. Those who are poor are likely to fall to destitution. A command economy may not allow the successful to make millions but it will at least try to make sure the poor are not left to destitution so the economy is fairer Environment – Free market economies are likely to produce more pollution. Command economies will attempt to make sure that the level of output is the socially optimal level of output through things such as taxes and pollution permits although pollution does tend to still be high
Specialisation / Division of Labour
Division of Labour Definition – The specialisation of labour where the production process is broken down into separate tasks NOTE – Some extra explanation of each of the mark scheme points will most likely be necessary The Advantages of Specialisation / Division of Labour to Firm (From Mark Scheme): Increased output o With improvement in efficiency and use of machinery output is increased More innovation Improved quality Increased productivity o Specialised machinery can be used which further increases the productivity. Developing and maintaining a brand image Economies of scale The Disadvantages of Specialisation / Division of Labour to Firm (From Mark Scheme): Reliance on a narrow range of products Specialist factor inputs are more expensive per unit Limited market size Reliance on one specialist resources / suppliers or factor immobility Reduced flexibility Boredom of workers / demotivation Extra The Advantages of Specialisation / Division of Labour – TO THE FIRM: Specialist workers become quicker at producing goods o Production becomes cheaper per good because of this o Production levels are increased Each worker can concentrate on what they are good at and build up their expertise The Advantages of Specialisation / Division of Labour – TO THE WORKER: Increased productivity Higher pay for specialised work o Improved skills at that job The Disadvantages of Specialisation / Division of Labour – TO THE FIRM: Greater cost of training workers Quality of products may suffer if workers become bored by the lack of variety in their jobs The Disadvantages of Specialisation / Division of Labour – TO THE WORKER: Boredom as they do the same job Their quality and skills may suffer May eventually be replaced by machinery
Consumer Surplus – The extra amount that a consumer is willing to pay for a product above the price that is actually paid Producer Surplus – The difference between the price a producer is willing to accept and what is actually paid How a Consumer / Producer Surplus Changes (Mark Scheme) (4 Marks): Correctly labelled, Downward sloping demand curve / Upward sloping supply curve Original Consumer / Producer surplus identified Consumer / Producer surplus will Increase / Decrease Area of Consumer / Producer surplus Increase / Decrease indicated by letters or labels Comment on size of change of Consumer / Producer surplus: Change in price Elasticity of Curve
Demand
Demand – The quantity of a product that consumers are able and willing to purchase at various prices over a period of time Notional Demand – The desire for a product Effective Demand – The willingness and ability to buy a product Demand Curve - This shows the relationship between the quantity demanded and the price of a product Demand Schedule – The data that is used to draw the demand curve for a product Movement Along The Demand Curve – This is in response to a change in the price of a product Change In Demand – This is where a change in a non-price leads to an increase or decrease in demand for a product
ILAPTIMERS(Demand shifters / Determinants):
I – Income – Increase in Income Increase in D L – Legislation – Eg. Motorcycle Helmet Law Introduced Increase in D for Motorcycle Helmets A – Advertising – Increase in Advertising stimulates demand Increase in D P – Population – Increase in Population Increase in D T – Tastes – Consumer Taste changes to 3D TVs Increase In D for TVs I – Interest Rates – Decrease Interest Rates Increase in D M – Market Size – Increase in Market Size Increase in D (Not 100% sure about this one) E – Expectations of Future Prices – Price expected to increase D increases now R – Related Goods – Increase in price of Substitutes Increase in D for original product S – Seasons – Christmas is coming Increase in D for Santa Costumes Income Substitution Effect For A Price Increase – Why The Demand Curve Is Downwards Sloping:
- If the price of a good increases, then there will be two effects:
- Substitution Effect o The good is relatively more expensive than alternative goods and people can switch to other goods.
- Income Effect o The increase in price decreases one’s purchasing power and so one’s real disposable income decreases. This lower income is likely to reduce demand for normal goods but increase demand for inferior ones.
Elasticity
Elasticity: Is a numerical estimate Measures the response to a change in price or to a change in any other factors that determine the demand or supply of a product Elasticity Definition – The extent to which buyers and sellers respond to a change in market conditions
Price Elasticity (PED)
Price Elastic Definition – Where the percentage change in the quantity demanded is sensitive to a change in price of the product {Greater than 1 or Less than - 1 } / Further away from 0 Price Inelastic Definition – Where the percentage change in the quantity demanded is insensitive to a change in price of the product {Less than 1 or Greater than - 1 } / Closer to 0 Price Unit Elastic Definition - Where the percentage change in the quantity demanded is equal to a change in price of the product {Equal to 1} Price Elasticity Of Demand (PED) Definition – The responsiveness of the quantity demanded to a change in the price of the product Price Elasticity Of Demand (PED) Formulae Determinants Of The Price Elasticity Of Demand (SHITBND): The availability and closeness of substitutes – the more substitutes, the more price elastic demand is Habit Forming – Habit forming goods tend to have very price inelastic demands The relative expense of the product with respect to income – Increased price elasticity with relatively expensive goods Time (Short Term / Long Term) – Consumers are less likely to change spending habits in the short term but in the long term will become more aware of substitutes increasing price elasticity. Also products that don’t warrant instant consumption and take up a large proportion of income (cars, bathrooms etc…) are usually more price elastic. Brand Loyalty – Products with strong brands tend to have more price inelastic demands Necessities – Necessities tend have very price inelastic demands Durability – Goods that are expected to last a long time tend to be more price elastic as the purchase can be delayed whereas milk will run out quickly and need to be repurchased even if its price rises
Income Elasticity Of Demand (YED)
Income Elasticity Of Demand Definition - The responsiveness of demand to a change in income Income Elastic Definition – Goods for which a change in income produces a greater proportionate change in demand Income Inelastic Definition – Goods for which a change in income produces a less than proportionate change in demand Normal Good Definition – Goods for which an increase in income leads to an increase in demand / Goods with a positive income elasticity of demand YED > 0 Normal Necessity – YED = 0.1 - 0. Pure Normal – YED = 0.6 - 0. Superior Good Definition – Goods for which an increase in income leads to a relatively large increase in demand / Goods with a relatively large positive income elasticity of demand YED > 1 Inferior Good Definition – Goods for which an increase in income leads to a fall in demand / Goods with a negative income elasticity of demand YED < 0 Giffen Good – YED < - 2 Income Elasticity Of Demand (YED) Formulae Comment on Income Elasticity of Demand:
- YED Coefficient – What type of good is it? + Its Elasticity
- 10% Example – YED = 1.5 Income goes up 10% Demand goes up 15%
- Does the YED correspond with economic theory? e.g. A TV can’t be an inferior good
- These are estimates + They may also be unreliable
- These estimates can change over time
- Assumes ceteris paribus which may not apply (Usually accepted)
Price Elasticity Of Supply (PES)
Price Elasticity Of Supply (PES) Definition – The responsiveness of the quantity supplied to a change in the price of the product Price Elasticity Of Supply (PES) Formulae Determinants Of The Price Elasticity Of Supply (FTSCN): Factor Mobility – When labour is the most important factor of production, supply is elastic as labour is generally easy to obtain. When capital is the most important factor of production, supply is inelastic as new machinery must be installed (additionally market conditions may change before the new machinery is installed so resources may be wasted) Time Period – In the short-term supply is more inelastic. In the long-term supply is more elastic. The Availability Of Stocks Of The Product – For stock that can be stored (Store items) the supply is elastic. For stock that cannot be stored (Hotel rooms and Cinema Seats) the supply is inelastic as the product must be consumed on a particular day or within a certain time period Existence of Spare Capacity – Supply is more elastic, the greater the spare capacity, as it is easier to raise output if the price rises Number Of Producers - Supply will be more price elastic as the more producers there are the easier the market can respond to a change in price Comment on Price Elasticity of Demand/Supply:
- PED / PES Coefficient – Elastic or Inelastic
- 10% Example – PES = 1.5 Price goes up 10% Supply goes up 15%
- Does the PED / PES correspond with economic theory? e.g. PES can’t be negative
- These are estimates + They may also be unreliable
- These estimates can change over time
- Other factors can affect Supply / Demand
- Assumes ceteris paribus which may not apply (Usually accepted) How information on elasticity can be collected: Sample surveys Past records from within a company Competitor analysis NOTE* – For thing such as commodities, oil or housing PES is generally inelastic. This is because it takes a long time to for quantity supplied to respond to a change in price, due to crops taking long to grow, oil taking time to mine and houses taking lots of time to be built Both comments (7 + 8) are very similar and so you may only get one mark for mentioning both.
Market Failure and Government Intervention
Market Failure – When the free market fails to achieve allocative efficiency Allocative Efficiency – When resources are used to produce the goods and services that consumers want and in such a way that consumer welfare is maximised Productive Efficiency – Where production takes place using the least amount of scarce resources Economic Efficiency – Where both allocative and productive efficiency are achieved Inefficiency – Any situation where economic efficiency is not achieved Free Market Mechanism – The system by which the market forces of demand and supply determine prices and the decisions made by consumers and firms Regulations – Consists of laws/ restrictions imposed by the government Government Failure – Government failure is a situation where government intervention in the economy to correct a market failure creates inefficiency and leads to a misallocation of scarce resources
Information Failure
Information Failure – A lack of information resulting in consumers and producers making decisions that do not maximise welfare Asymmetric Information – Information not equally shared between two parties Examples of Information Failure: When consumers are not aware of the benefits or the harmful effects of consuming a particular product When advertising over stimulates demand Overconsumption Inaccurate or misleading claims on product packaging Examples of Asymmetric Failure Information Failure: Health Care – You are forced to rely on the doctor’s experience and competence. They have more knowledge than you Environment – We know less about our negative effects on the environment than environmental experts. Consumer Purchases – Eg. Mobile phones – The seller is likely on commission and has more knowledge than the buyer leading them to make a bad choice potentially. Insurance – You know more about your circumstances than the company selling you a policy. They are relying on your honesty and integrity. NOTE - Information failure distorts how the market allocates resources. It causes the market to fail.
Negative Externality Graph (Costs and Benefits Version): Positive Externality Graph (Costs and Benefits Version): Merit Good – These have more private benefits than their consumers actually realise Demerit Goods – Their consumption is more harmful than is actually realised Costs and Benefits Quantity Costs and Benefits Quantity
Public Goods
Public Goods – Goods that are collectively consumed and have the characteristics of non- excludability and non-rivalry Non-Excludability – Situation existing where individual consumers cannot be excluded from consumption Non-Rejectable – Situation existing where individual consumers cannot reject consumption Non-Rivalry – Situation existing where consumption by one person does not affect the consumption of all others Free Riders – Someone who directly benefits from the consumption of a public good but who does not contribute towards its provision Quasi-Public Goods – Goods having some but not all of the characteristics of a public good Direct Tax – One that taxes the income of people and firms and that cannot be avoided Indirect Tax – A tax levied on goods and services Indirect Tax Graph: Polluter Pays Principle – Any measure, such as a green tax, whereby the polluter pays explicitly for the pollution caused Polluter Pays Principle Problems: Amount of Tax – Virtually impossible to estimate the cost of the negative externality Producers not paying full amount of tax - Some of it often gets pushed onto the consumer PED is often Inelastic – Consumption not reduced by as much as intended so production is higher than intended Better quality information for consumers – May lead to consumption being decreased too much
