A LEVEL ECONOMICS EDEXEL

positive statement

a factual statement that can be tested and verified it is not a value judgement

normative statement

normative statement is a statement that is subjective and involves value judgements and opinions they express how things should be rather than how they are

The main economic problem

the main economic problem is scarcity there are unlimited wants but resources are finite

opportunity cost

The cost of choosing one option over the other - the loss of the next best alternative forgone

PPC diagram

shows all the combinations of output using current resources - shows scarcity and trade-offs

What causes shifts in the PPF - outwards

Increase in quantity/quality so the productive potential of the economy increases so economic growth occurs

What causes the PPF curve to shift inwards?

Decreasing quantity/quality of resources so the productive potential of the economy decrease, economic growth becomes slower

Capital goods

goods that can be used to manufacture other goods eg machinery

consumer goods

goods which cannot be used to manufacture other goods such as clothing

specialisation

refers to the concentration of indivduals, firms or nations on producing a limited range of goods / services

advantages of specialisation

increased productivity and economies of scale

disadvantages of specialisation

include over-reliance on a limited range of products, potential unemployment, and vulnerability to market changes.

Division of labor

refers to the production process being broken down into many separate tasks

Advantages of division of labour

Increased output, less waste and lower unti costs

Disadvantages of division of labour

Worker dissatisfaction and reduced skill flexibility

Functions of money

Median of exchange, store of value, and facilitates exchange

free market economy

-          Also known as laissez-faire economies

-          no government intervention

-          Economic decisions are taken by private individuals and firms

-          Private individuals own everything

-          in reality, governments intervene by implementing laws and public services

command economy

-      also known as central planning

•     Government intervention

-          Government allocates all of the scarce resources

-          Karl marx saw free market as unstable – saw profits created in free market as coming from exploitation of labour and by not paying workers to cover the value of their work

mixed economy

-          Features of both command and free market economies

-          Most common economic system today

-          Uk is generally considered quite central

-          Government often provided public goods such as police, healthcare, education, merit goods etc

roles of the government in an economy

indirect taxation, subsidies, minimum and maximum pricing, state provision of public goods, regulation, trade pollution permits

indirect taxation

A tax imposed on goods and services that increases government revenue and decreases consumer spending on demerit goods. Two types - Ad valorem (based on the value of the item) and Specific (per unit of output)

Subsidy

grant given by the government to firms that meet requirements to reduce costs of production

main assumptions of rational decision making

-          Consumers aim to maximise utility (satisfaction from consuming a good/service)

-          Firms aim to maximise profit

main assumptions of irrational decision making

-          Poor computing skills do not weight benefits and costs

-          Lack of time

-          Peer influence

-          Asymmetric information

Demand

The quantity of goods/services that consumers are willing and able to buy at a given price in a given time period

why does the demand curve slope downwards

shows inverse relationship between price and quantity and because of law of diminishing marginal utility

what cause movement along the demand curve

price changes

What cause shifts in the demand curve

Changes in population, income, advertising, tastes and seasons

Price elasticity of demand

the responsiveness of demand of a good/services to changes in price

Price income elasticity of demand

the responsiveness of demand of goods/services to changes In income

price cross elasticity of demand

measures the responsiveness In the quantity demanded of one good when the price for another good changes

Factors that influence price elasticity of demand

-          Necessity – necessary goods will have a relatively inelastic demand

-          Substitutes – if the good has several substitutes, it is more price elastic

-          Addictiveness – demerit goods are price inelastic

-          Proportion of income spent on the goods – if the good only takes a small proportion of an income, demand may be inelastic

-          Durability of goods – elastic spend a long time to buy another

PED>1 higher price elasticity

incidence of tax falls mainly on supplier

PED<1 lower price elasticity

Incidence of tax falls mainly on consumer

how PED affects the incidence of subsidies and indirect taxes

-          Absolute value of tax increases as price of goof increases

-          If government subsidises goods/services with high PED increase in quantity demanded

-          If the PED is low the  indirect taxes will have relatively limited effects on quantity bought

effect elasticity of demand on total revenue

-          Elastic demand - A rise in price lowers total revenue total revenue increases as price falls

-          Inelastic demand – a rise in price increases total revenue and total revenue decreases as price falls

supply

the amount of a good/service supplied at a given price in a given time period

Why is the supply curve upward sloping

As the price of the product rises the business is more incentivized to make more of the product

Movements along the supply line

due to changes in price

explain what causes movements along the supply curve

-          Change in price of a good/service

-          When price increases quantity supplied increases

-          When price decreases quantity supplied decreases

Shows a direct relationship

Price elasticity of supply

the responsiveness of a good/service supplied to changes in price

PES equation

percentage change in quantity supplied / percentage change in price

If supply is elastic

Firms can increase supply quickly at little cost   PES>1

if supply is inelastic

  supply will be expensive for firms and take a long time   PES<1

Factors influencing elasticity of supply

-          Short run – supply may be less elastic as it takes more time to adjust to production capacity

-          Long run supply can more elastic as firms can make capital investments to expand capacity

-          Mobility of factors of production

short run

money wage rates, factor prices and the state of technology are fixed – a change in these, results in a shift of the curve – in a time frame

long run

all factors or production are variable

how the short run affects PES

supply may be less elastic as it takes time to adjust productive capacity

how the long run affects PES

supply may be more elastic as firms can make capital investments to expand capacity

how the equilibrium price and quantity are determined

-          If there was an increase in the size of the population demand would shift from d1 to d2

-          Price would increase to p2 and the suppliers would supply a larger quantity of q2- a new market equilibrium is established at p2 Q2

Excess demand

when the supply of goods/services doesn’t meet the demand and therefore there is an excess of unmet demand in the economy

excess supply

when not enough goods/services have been demanded so there is excess supply

 how shifts in supply or demand change the equilibrium price and quantity

-          When the demand or supply curve shifts due to the PIRATES (population, income, relevance, advertising, taxation..) or PINTSWC, a new market equilibrium is established

explain how the market mechanism corrects the problems of excess supply and

demand

the price moves resources to where they are demanded or where there is a shortage

-          Removes resources from where there is a surplus

-          When there are scarce resources prices increase due to the excess of demand

-          The increase in price discourages demand and continuously rations resources

Price mechanism

refers to the ways in which price determines the allocation resources and influences the quantity supplied and quantity demanded of goods and services

functions of the price mechanism

• allocating resources

• Signally changes in supply and demand

• Providing incentives to producers and consumers

consumer surplus

additional benefit when consumers are willing and able to buy goods/services at a given price - represents the difference between how much consumers are willing to pay for a good/service and how much they actually pay for a good/service

Producer surplus

the difference between the price at which a product or service is sold and the cost of producing it – it represents the additional profit that producers earn above and beyond their costs of production

Effects of supply on consumer surplus

Decrease

-          Consumer surplus decreases as consumers pay more for the same quantity of a good Increase

-          Consumer surplus increases as they consumers benefit from lower prices

Effects of supply on producer surplus

Decrease

Producer surplus increases as they receive higher prices

Increase

Producer surplus may decrease as prices fall

effects of demand on consumer surplus

Decrease

-          Consumer surplus may increase as consumers benefit from lower prices

Increase

-          Consumer surplus may increase as more people benefit from lower prices

effects of demand on producer surplus

decrease

Producer surplus may decrease as they receive less for each sold unit

Increase

Producer surplus may increase as producers can charge higher prices

Indirect taxes and elasticity

the more inelastic the demand is the more the indirect tax is passed onto consumers

specific tax

a fixed amount of tax imposed on each unit of a good/service

Ad valorem tax

a tax based on the value of the good/service sold

Why are indirect taxes imposed

-          Indirect taxes generate revenues for governments

-          These revenues can then be spent on capital investment/public expenditure (e.g hospitals for the NHS)

Indirect tax impacts on consumers

Could increase prices for consumers due to increasing costs of goods such as cigarettes or fuel If producers choose to pass the goods on consumers

Indirect taxes effect on producers

Increases production costs therefore producers may supply less

indirect taxes effect on the government

Indirect taxes generate revenue for governments that could be spent on public expenditure and capital investments

Tax incidence

explains how the final burden of tax is shared out

Tax incidence and PED

-          If demand for a good is price elastic and a tax is imposed then tax may fall mainly on the producer as producers will be unable to put up prices without losing a lot of demand

-          If demand for a good is inelastic then the tax imposed may fall mainly on the consumer as they are able to rise price and demand for the good will be unaffected

Why are subsidies given out?

•   To encourage the production or consumption of certain goods or services

•      Aim to correct market failures

• Correct positive externalities

• lower production costs

Impact of subsidies on producers

•   Increased revenue

•    Lower cost of production

• Increased governmental support

Impact of subsidies on consumers

-          Increased consumer surplus

-          Lower prices

-          Higher overall welfare

Impact of subsidies on governments

-          Could create distortions in the market

-          Misallocation of resources – money could be spent elsewhere

-          Creates dependency on government support

-          Discourages private investment and innovation

-          Could lead to government failure if it leads to an inefficient outcome

Advantages of subsidies

• greater supply of goods/services

• more market competition

• lower costs of production

Disadvantages of subsidies

• firms may become over reliant on them

• increased government expenditure could come out of consumers taxes

• subsidised goods may be lower quality

• could lead to market failure if resources are misallocated

market failure

when the price mechanism fails to allocate scarce resources efficiently or when the operation of market forces lead to a net social welfare loss

Types of market failure

• externalities

• lack of provision of public goods

• information gaps

externalities

the cost or benefit a third party receives from an economic transaction outside of the market mechanism – the spill-over effect of the production or consumption of a good/service

Private cost

producers are concerned with private costs of production for example – the rent, the cost of machinery and labor

private benefit

the gains or advantages that accrue directly to individuals or firms engaging in an economic activity 

External cost

costs that are not borne by the person or entity that causes them

external benefit

a benefit that a third party feels as a result of the actions of another party

Social cost

the total costs of economic activity which include both private costs and any external costs that affect third parties not directly involved in the activity

Social benefit

the total benefits to society from an economic activity

Marginal private cost

the cost for the producer of producing an additional unit of output

Marginal private benefit

the additional satisfaction or utility that an individual receives from consuming one more unit of a good/service

Market equilibrium

when demand is equal to supply

Social optimum

when marginal social benefit is equal to marginal social cost

negative externalities

costs that are borne by society, not by the producers or consumers of a good or service. noise pollution and pollution are examples of this

positive externalities

third parties benefit from the spill-over effects of production/consumption e.g. the social returns from investment in education & training or the positive benefits from health care and medical research.

How do negative externaliities lead to market failure

-          Externalities are the effects that producing or consuming goods have on third parties or society as whole

-          Buyers or sellers do not consider externalities when making decisions

-          This can lead to market failure because goods or services can be under or over consumed

How can positive externalities lead to market failure

-          Since external benefits are not reflected in the market price the good or service is under consumed

-          Resulting in an inefficient allocation of resources

-          Private returns are smaller than social returns

public goods

goods that are beneficial to society but will not be provided by private firms. They are non-rivalary and non excludable, this means they can occasionally lead to a free rider problem

Private goods

goods which firms are able to provide to generate profits. They are rivalary and excludable as only those who can afford them are able to consume the good.

non rivalrous goods

anyone can consume the good it is non-excludable these are public goods

free rider problem

it is impossible to exclude the benefits of a public good from someone as a result people that don’t pay for the product will receive the same benefit as those that do

why does the free-market not provide public goods

-          Underprovided in the free market because of the free rider problem

-          Public goods are missing from the free market but they offer benefits to society

-          For example – street lights, flood control