economics a level

ceteris paribus

assumption that all other factors remain unchanged

positive economics

• concerned with objective statements of how a market or an economy works

• can be proven true or false

positive statements

statements that can be proven true or false with evidence

normative economics

focuses on value judgements

study of policy prescriptions about economics

normative statements

statements that cannot be supported or refuted

viewpoints/opinions

basic economic problem

finite resources available in relation to the infinite wants and needs

factors of production

land

labour

capital

enterprise

Economics is the

study of scarcity and its implications for resource allocation in society

scarcity impact on prices (in a free market)

the scarcer the resource, the higher the price

the less scarce the resource, the lower the price

Opportunity cost is the

loss of the next best alternative when making a decision

what is an economic model

simplified version of reality

Production Possibility Frontiers (PPF) model is

• economic model that considers maximum possible production (output) a country can generate

• if it uses all factors of production to produce only two goods/services

Many PPF (production possibility frontier) diagrams show

• capital goods (y axis)

• consumer goods (x axis)

• Capital goods are

• assets that help a firm or nation to produce output (manufacturing)

consumer goods

end products and have no future productive use

inward shift

economic decline

outward shift

economic growth

Economic growth occurs when there is

an increase in the productive potential of an economy

outward shift/ economic growth is caused by

increase in the quality or quantity of the available factors of production

Economic decline occurs when there is

any impact on an economy that reduces the quantity or quality of the available factors of production

division of labour is when

a task is broken up into several component tasks allowing workers to specialise by focusing on a few of the components that make up the production process

gaining a skill

division of labour (hence specialisation leads to)

higher output per worker over a measured time period and so increases productivity

advantages of division of labor/specialisation in production

• creates many low skilled jobs

• increased productivity (possibility for expansion)

• lower cost/unit means more profit (may mean higher wages) or lower cost for customer

• Higher labour productivity lowers cost/unit

disadvantages of division of labor/specialisation in production

• boredom and worker demotivation which may mean less productivity and lower quality

• may increase worker turnover rates

• may be hard for the worker to find a new job as theyre only specialised in one skill

• Mass produced products often lack variety

advantages of division of labor/specialisation in trade

• lower cost makes firm more competitive internationally (exports)

• Increased exports can result in economic growth for the nation

• Economic growth leads to higher income and a better standard of living

• income from exports can be used for imports, increases variety of goods available in a country

disadvantages of division of labor/specialisation in trade

• may create over-dependency on other countries' resources, may cause problems if conflict arises

• will increase the rate of resource depletion in a country

• Many firms in an entire industry may close, leading to structural unemployment

structural unemployment

unemployment caused by mixmatch between a workers skill and the available jobs in the economy

money functions as

• a medium of exchange

• measure of value

• a method of deferred payment

in order to solve the basic economic problem of scarcity, ________ emerge or are created by different economic agents within the economy

economic systems

economic agents

• consumers

• producers

• government

• special interest groups

any economic system needs to decide how to answer the three fundamental economic questions

• what to produce

• who to produce for

• how to produce it

• A free-market economy is an

• economy that has no government intervention in the allocation of resources or the distribution of goods/services

• A command economy is

• an economy in which all of the resources are owned by the state and the government controls the distribution of goods/services

• A mixed economy is

• a blend of the free market and planned economy as individuals, firms and the government own factors of production and distribute goods/services

Free Markets - Adam Smith

• advocated for free markets with low levels of government intervention

• recognised that there was a role for governments to ensure efficiency

• believed economies function best when private individuals work in their own self-interest 

Mixed Economies Friedrich Hayek

• believed that command economies were flawed

• information gaps between what the economies actually required and what the central planners in command economies were saying it required

• gaps led to shortages or surpluses of goods/services in command economies

• threat to efficiency and economic growth is overly heavy government intervention

Command Economies, Karl Marx

believed that free markets lead to capitalism, in which the owners of the factors of production (Capitalists) exploited the workers

creates inequality, lead to a breakdown between the classes

role of the State is to share the means of production and ownership with all of the workers in society

required the abolition of private property

required the State to become the central planner, deciding how each of the three economic questions would be answered

advantages of free market economy

• Profit incentive motivates people to work or develop entrepreneurial ideas

• Greater variety of goods/services

• Competition leads to better quality of goods/services

• Competition leads to lower prices of goods/services

• Competition encourages innovation and product development

• Profits, income and wealth are unlimited resulting in better standards of living

• More efficient use of scarce resources

disadvantages of free market economy

• Wealth is concentrated in the hands of few as they are able to keep buying up the scarce factors of production, increases inequality so the gap between the rich and the poor continues to grow

• Sometimes product quality falls as firms lower quality standards in order to increase profits

• Workers get exploited

• Resource depletion and environmental degradation are often ignored

• Monopolies develop as firms increase market power through mergers and acquisitions, leads to exploitation of consumers and supply chains

command economy advantages

• Social equality is the goal of the system, opposed to profit maximisation— less inequality

• All workers receive the same wage irrespective of role/career, helps create social equality

• Less unemployment

• Resources of the nation can be directed towards urgent priorities quickly

• government owns monopoly businesses so consumer exploitation through high prices can be avoided

command economy disadvantages

• Receiving the same wage creates disincentives for people to acquire difficult skills

• lack of competition means less innovation and product development

• continual lack of efficiency as central planning always results in surpluses or shortages of goods/services

• Black markets multiply as the population seeks to address shortages

• Access to higher standards of living is limited for most of the population

• Personal freedoms are restricted

how does government intervention occur in mixed economies

taxation (to raise revenue)

spending the revenue to redistribute income and provide essential goods/services

different type of tax interventions

• personal income tax

• corporation tax

• value added tax

• tariff on imports

• inheritance tax

Income is redistributed through the creation of a

welfare system

• Consumers are assumed to act rationally. They do this by maximising their

satisfaction gained by a good/service

• Producers are assumed to act rationally. They do this by selling goods/services in a way that

• maximises their profits

• Workers are assumed to act rationally. They do this by

• balancing welfare at work with consideration of both pay and benefits

• Governments are assumed to act rationally. They do this by

• placing the interests of the people they serve first in order to maximise their welfare

Demand is the

amount of a good/service that a consumer is willing and able to purchase at a given price in a given time period

A demand curve is a graphical representation of the price and quantity demanded (QD) by consumers

• price in y axis

• quantity demanded in x axis

• downward slope

law of demand

price and quantity demanded are inversely proportional

Marginal utility is the

extra utility (satisfaction) gained from the consumption of an additional unit of a product

The Law of Diminishing Marginal Utility states that

as additional products are consumed, the utility gained from the next unit is lower than the utility gained from the previous unit

explain the reason why the demand curve is downward sloping

The Law of Diminishing Marginal Utility

law of demand states that

when there is an increase in price, there will be a fall in quantity demanded

Price elasticity of demand reveals

how responsive the change in quantity demanded is to a change in price

PED formula

% change in quality demanded / % change in price

The PED value will always be

negative

PED = 0

perfectly inelastic

QD is completely unresponsive to a change in price

PED =infinity

perfectly elastic

QD will change to zero with any percentage change in price

Factors that influence the PED

Availability of substitutes

Addictiveness of the product

Price of product as a proportion of income

Time period

Income elasticity of demand (YED) reveals

how responsive the change in quantity demanded is to a change in income

YED formula

%change in quantity demanded / % change in income

YED = 1

normal necessity

YED > 1

normal luxury

YED<0

inferior good

YED is influenced by

any factors in an economy which change the wages or salaries of workers

Cross price elasticity of demand (XED) reveals how

responsive the change in quantity demanded for good A is to a change in price of good B

XED formula

% change in quantity demanded for product A/ % change in price for product B

XED = -

two products are complements

XED> 1 (ignoring signs)

strong

XED<1 (ignoring signs)

weak

XED < 0

Complementary goods

XED > 0

substitutes

XED = 0

unrelated goods

Knowledge of PED is important to firms seeking to

maximise their revenue

to firms if a product is inelastic

should raise their prices

to firms if a product is elastic

lower their prices

Knowledge of PED is important to Governments with regard to

taxation and subsidies

for governments if the tax price inelastic in demand products, they can

raise tax revenue without harming firms too much

how can XED help firms

• help them adjust pricing strategies for substitute and complementary products

• can help them understand the likely impact of competitors' pricing strategies on their sales

Knowledge of YED is important to firms as they seek to

maintain sales and maximise profits through periods of recession or economic growth

total revenue rule states that

in order to maximise revenue, firms should increase the price of products that are price inelastic in demand and decrease prices on products that are price elastic in demand

sales revenue =

price of product x quantity sold

when prices increase and the product is price inelastic in demand, the quantity demanded

falls but it is less than proportionate fall than increase in price

Supply is the

amount of a good/service that a producer is willing and able to supply at a given price in a given time period

supply curve

• upward slope

• positive relationship between price sold and quantity supplied

law of supply states that

when there is an increase in price, producers will increase the quantity supplied and vice versa

Price elasticity of supply (PES) reveals

how responsive the change in quantity supplied is to a change in price

Price elasticity of supply formula

% change in quantity supplied/ % change in price

PES = 0

Perfectly Price Inelastic

quantity supplied is completely unresponsive to a change in price

supply curve is vertical

PES = infinity

Perfectly Price Elastic

QS will fall to zero with any % change in price. However, supply is unlimited at a particular price

The factors that determine the responsiveness are called the determinants of PES and include:

Mobility of the factors of production - if producers can quickly switch their resources between products, then the PES will be more price elastic

Availability of raw materials

Ability to store goods: if products can be easily stored, then PES will be higher (price elastic) as producers can quickly increase supply

Spare capacity: if prices increase for a product and there is capacity to produce more in the factories that make those products, then supply will be price elastic

Time period: In the short run, producers may find it harder to respond to an increase in prices as it takes time to produce the product, in the long run, producers can change any of their factors of production so can produce more

factors of production

land

labour

capital

enterprise

Short-run is

any period of time in which at least one factor of production is fixed and this is a limiting factor

Long-run is

any period of time in which all the factors of production are variable (it is also called the planning stage). Producers are able to vary all of their resources to respond to changing market conditions

market is

any place that brings buyers and sellers together

free market economy, prices are determined by the

interaction of demand and supply in a market

consumer sovereignty

economic power exerted by consumers in a market, customers refusing to buy

Equilibrium in a market (market clearing price) occurs when

demand = supply