T1 1.1.1 - 1.4.2 Introduction to markets and market failure

ECONOMICS AS A SOCIAL SCIENCE (1.1.1)

ECONOMICS AS A SOCIAL SCIENCE (1.1.1)

Why is it impossible to conduct economic experiments (3 issues, PET)

Practical issues - Impossible to control all variables

Ethical issues - Unfair in some cases to different people

Time - Economics changes very quickly therefore results can become outdated very fast

Why do economists use models

To simplify complex reality

To help governments and businesses make informed decisions

Show the relationships between different variables

POSITIVE AND NORMATIVE STATEMENTS (1.1.2)

POSITIVE AND NORMATIVE STATEMENTS (1.1.2)

What is a positive statement

A positive statement is a factual statement that can be tested, amended or rejected using available evidence

What is a normative statement

A normative statement is someone’s opinion which is made using value judgement and which cannot be tested using evidence

What are the 4 factors of production (CELL)

Capital

Enterprise 

Land

Labour

What is land

The natural resources of the planet

What is labour

Human resources used to produce goods and services

What is capital

Items used by labour in the production process (factories, machines, computers)

What is enterprise

The individual or group of individuals prepared to take a risk and combine the other three factors of production

THE ECONOMIC PROBLEM (1.1.3)

THE ECONOMIC PROBLEM (1.1.3)

What is the economic problem

That we have unlimited wants as a society but only limited factors of production

Who chooses how these factors are used in a command economy and a free market society

In a free market society, supply and demand chooses

In a command economy, the government chooses

PPF’S (1.1.4)

PPF’S (1.1.4)

What does a production possibility frontier (PPF) show

A PPF shows the maximum potential combinations of output that can be produced in an economy when resources are fully and efficiently used

What is combined by firms into output

The 4 factors of production (Land, labour, capital and enterprise)

What are the two types of goods that come from the output generated by the 4 factors of production

Capital goods - Generate further output (Machinery and buildings)

Consumer goods - Generate utility (Goods and services)

SPECIALISATION AND THE DIVISION OF LABOUR (1.1.5)

SPECIALISATION AND THE DIVISION OF LABOUR (1.1.5)

What is barter

Barter is how trade happened before the invention of money

What is the double coincidence of wants

For a trade to happen, both people must want what the other person has, at the same time and in the right amounts

What are the 4 functions of money

1. A medium of exchange

2. Measure of value

3. Store of value

4. A standard of differed payment 

How does division of labour increase productivity

Division of labour raises output per worker as people become proficient by learning by doing

What does this increased productivity help to achieve

Lower cost per unit which increases profit margins

What is the formula for Labour productivity

Labour productivity = Total output in given time / Number of units of labour used

Limitations of labour division

Low motivation

Boredom

Employees less punctual due to dissatisfaction

High worker turnover

Why can division of labour cause structural unemployment

Due to the division of labour creating a skill mismatch between what employers desire and what employees possess

Define specialsation

When we concentrate on a product or task (very general and not restricted to firms)

Specialisation positives

Higher output

Variety

A bigger market

Competition and lower prices

ECONOMIC SYSTEMS (1.1.6)

ECONOMIC SYSTEMS (1.1.6)

What are the 4 types of economies

Command economy

Free market economy

Mixed economy

Traditional economy

Who allocates resources in a command economy and why could this be an issue

The government

They may not have a good idea of what the people want / need

Who allocates resources in a free market economy

Through price mechanisms driven by the forces of supply and demand

RATIONAL DECISION MAKING (1.2.1)

RATIONAL DECISION MAKING (1.2.1)

What is the cost benefit principle

In many decisions, people consider the costs and benefits of their actions

What are the key features of bounded rationality

Limited information

Cognitive limitations

Time constraints

Satisfying behaviour

What do we assume for consumers

That consumers aim to maximise their welfare

What is the main aim for consumers

To maximise utlity

What is the main aim for firms

To maximise profits

DEMAND (1.2.2)

DEMAND (1.2.2)

What should you always do with a price and quantity diagram to gain application mark

Contextualise it (ie change in quantity of chocolate demanded as price increases)

What are the conditions of demand (PIRATES)

P - Population

I - Income (can consumers afford it)

R - Related goods (Has the price of a related good increased)

A - Advertising (How many people know about the product)

T - Tastes/fashion (Is the said product in trend?)
E - Expectations (Do consumers think the price will rise or the product become more scarce?)

S - Seasons (Winter jackets will be in higher demand in winter)

What happens to demand as the real income of people rises

It increases

Is an increase in price a movement along the demand curve or a shift outwards or inwards

A movement along it (Contraction/Expansion)

What would cause a shift outwards or inwards of the demand curve

A change in one of the factors of demand

What are substitute goods

Goods that are in competitive demand

What are complementary goods

Goods that are often consumed together

They are said to be in joint demand

What are normal goods

Goods and services of which the quantity demanded increases in response to an increase in real consumer incomes

What are inferior goods

Goods of which the quantity demanded decreases with a rise in real consumer incomes (eg supermarket own branded goods). Consumers tend to trade up as soon as they can afford it

What is derived demand

Demand for a good or service that is dependent on demand for another good or service

eg (the demand for bricks is derived from the demand for houses and the demand for labour is derived from the demand for the goods the labour produces)

1.2.3 PRICE ELASTICITY OF DEMAND

1.2.3 PRICE ELASTICITY OF DEMAND

Define price elasticity of demand (PED)

Price elasticity of demand measures the responsiveness of quantity demanded for a product to a change in price

What is the formula for calculating PED

%Change in quantity demanded / %Change in price

What does a product being elastic mean

It is highly price sensitive (holidays)

What does a product being inelastic mean

It is not very price sensitive

When is a product inelastic

If the change in the quantity demanded is less than the change in the price

What value is an elastic PED

>1

What value is an inelastic PED

Between 0 and 1

What is unitary elasticity value

1 (price change = same change in quantity demanded)

What are some factors that affect PED

Availability of subsistitutes - More subsititutes = more elastic demand

Time - Demand takes time to be more elastic as it takes time for consumers to adjust their habits

Luxury or necessity - Luxuries more elastic and necessities more inelastic

Proportion of income spent on the good - If a box of matches increases by 10% most people won’t even notice

Habit forming goods - Cigarettes are quite inelastic in demand

How to calculate total revenue

Total revenue = Quantity sold x Price

What would happen revenue if demand is elastic and price was increased

Total revenue would decrease

What would happen to total revenue if demand was price elastic and price was reduced

Total revenue would increase

What would happen to total revenue if the demand is price inelastic and the price is increased

The total revenue would increase

What would happen to the total revenue if the demand was inelastic and price was decreased

The total revenue would decrease

Why is PED important

Total revenue - For predicting how price changes will affect total revenue

Marketing

Branding - Business attempt to make their products more price inelastic by convincing consumers there is no substitute

Inelastic goods summary

%Change in QD is less than the %change in the price

Sightly responsive to price changes

Increase in price = higher revenue

Demand curve is downward sloping but steeper

Elastic goods summary

%Change in QD is greater than the price change

Highly responsive to price changes

Increases in price will lead to fall in total revenue

The demand curve is downward sloping but flatter

What is income elasticity of demand (YED)

Income elasticity of demand measures the responsiveness of quantity demanded for a good to change in income

In other words, if a person’s income changes, what happens to the demand for a good

What is the formula for calculating YED

%Change in quantity demand / %Change in income

What does it mean if YED is >1

The good is luxury good and income elastic

What does it mean If YED is between 0 and 1

The good is a normal good and income inelastic

What does it mean if the YED is <0

The good is an inferior good and negatively income elastic

What is cross price elasticity of demand (XED)

Cross price elasticity of demand measures the responsiveness of the quantity demanded for one good to a change in price of another good

What is the formula for calculating XED

%Change in quantity demanded for good X / %Change in price for good Y

What does it mean if XED is >0

The two goods are subsititutes

What does it mean if XED is <0

The two goods are complimentary

What does it mean if XED is = 0

The two goods are independent and there is no relationship between them

SUPPLY (1.2.4)

SUPPLY (1.2.4)

What are the conditions of supply (PINTWC)

P - Productivity

I - Indirect tax - (Increases cost of production)

N - Number of firms

T - Technology

W - Weather

C - Cost of production

What is joint supply

When an increase or decrease in the supply of one good leads to an increase or decrease in supply of a by product

What is market disequilibrium

When there is either less demand than supply or more supply than demand in a market