MICROECONOMICS - The Market System

What is the problem of scarcity?

Humans have unlimited wants and needs. However, resources are finite, meaning the quantity available is limited. These resources are scarce.

What is opportunity cost

Opportunity cost is the cost of the next best alternative given up.

OPPORTUNITY COST EFFECT ON: Consumers

They have to choose how to spend their limited budget

OPPORTUNITY COST EFFECT ON: Producers

They have to choose whether to spend their budget between advertising, training, buying a new machine, etc.

OPPORTUNITY COST EFFECT ON: Government

They have to choose whether to spend money on increasing welfare benefit, better health care, new schools etc.

What does a PPC represent?

A PPC (production possibility curve) shows a different combination of 2 goods that can be produced if resources are fully used.

What are the possible causes for positive economic growth? (4)

1. New technology

2. Improved efficiency

3. Education & Training

4. New resources

What is the possible cause for negative economic growth?

Resource depletion, which occurs when a country runs out of a natural resource.

What is the economic assumption? (2)

1) Businesses aim to maximise their profit.

2) Consumers aim to maximise their benefit.

Reasons why consumers may not maximise their benefit: (3)

1) Lack of information

2) Customer loyalty

3) Influenced / Trends

Reasons why producers may not maximise their profit: (3)

1. Charity focused

2. Different goal (other than making profit)

3. May have managers that maximise revenue or maximise sales

Define demand

Demand is the amount of goods that will be bought at given prices over a period of time.

Factors that may cause a shift in the demand curve (6)

1. Advertising

2. Trends

3. Income

4. Price of supplementary goods

5. Price of complementary goods

6. Demographic changes

Define supply

Supply is the amount of goods that sellers are willing to offer for sale at any prices over a given time

Factors that may cause a shift in the supply curve (5)

1. Indirect taxes

2. Natural factors

3. Subsidies

4. Changes in technology

5. Cost of production

Define surplus

Excess supply

Define shortage

Excess demand

Define PED

Price elasticity of demand is the responsiveness of demand to a change in price.

Formula of PED

% change in quantity demanded / % change in price

Interpret numerical values of PED that show:

perfect price inelasticity, price inelasticity, unitary price elasticity, price elasticity, perfect price elasticity

• perfect price inelasticity

PED = 0

• price inelasticity

PED < 1

• unitary price elasticity

PED = -1

• price elasticity

PED > 1

• perfect price elasticity.

PED = ∞

The factors influencing PED (4)

1. Income

2. Degree of necessity

3. Time

4. Percentage of income spent on goods or service

Calculation for total revenue

Price x Quantity

Relationship between total revenue & price elasticity

T.R after price change - T.R before price change

If there is a big difference, it is elastic.

If there is a small difference, it is inelastic

Define PES

Price elasticity of supply refers to the responsiveness of supply to a change in price.

Formula of PES

% change in supply / % change in price

Interpret numerical values of PES that show:

perfect price inelasticity, price inelasticity, unitary price elasticity, price elasticity, perfect price elasticity

• perfect price inelasticity

PED = 0

• price inelasticity

PED < 1

• unitary price elasticity

PED = 1

• price elasticity

PED > 1

• perfect price elasticity.

PED = ∞

The factors influencing PES (4)

1. Time

2. Availability of stocks

3. Spare capacity

4. Factors of production

PES for manufactured products and primary products

Manufactured products are mostly elastic, as they produce products at a fast rate.

Primary products are mostly inelastic, as their production time takes longer

Define YED

Income Elasticity of Demand refers to the responsiveness of demand to a change in income.

Formula of income elasticity of demand

% of price change in quantity demanded / % change in income

Interpret numerical values of income elasticity of demand that show:

luxury goods, normal goods, inferior goods.

Luxury goods:

YED > 1

Normal goods:

0 > YED > 1

Inferior goods:

YED < 1

USE OF YED + PED ON GOVERNMENT AND BUSINESS: The imposition of indirect taxes and subsidies

Governments choose products that have inelastic demand such as necessities so consumers can't avoid getting taxed by not purchasing elastic goods.

USE OF YED + PED ON GOVERNMENT AND BUSINESS: Changes in Income

If firms know the YED of their product, they can respond to predicted changes in incomes.

Define the mixed economy

Public + Private sector

Define public sector

Government organisations that provide G&S in the economy

Define private sector

Business that are owned by individuals or group of individuals that provide G&S in the economy

OWNERSHIP & CONTROL + AIMS: Private sector (3) (5)

OWNERSHIP & CONTROL: Sole traders, Partnerships and Companies.

AIMS: Survival, Profit maximisation, Growth, Social responsibility

OWNERSHIP & CONTROL + AIMS: Public sector (3) (4)

OWNERSHIP & CONTROL: Central government departments, SOEs, Local authority services

AIMS: Profit, Minimising costs, Quality of services, Social costs + benefits

PRIVATE & PUBLIC SECTOR: How to produce

PRIVATE SECTOR: Made using production methods that helps them maximise quality and minimise costs.

PUBLIC SECTOR: Services would be provided by the government organisations and goods are sometimes produced by the private sector.

PRIVATE & PUBLIC SECTOR: What to produce

PRIVATE SECTOR: Goods such as food, clothes, leisure and entertainment are best chosen by consumers.

PUBLIC SECTOR: Goods such as education, street lighting, roads and protection are more likely to be provided by the state. The public sector tends to provide goods that the private sector might fail to provide in sufficient quantities.

PRIVATE & PUBLIC SECTOR: For whom to produce

PRIVATE SECTOR: Those who can afford it.

PUBLIC SECTOR: Everyone

Define market failure

Market failure is where market lead to inefficiency.

Factors on why market failure occurs (5)

1. Externalities

2. Lack of competition

3. Lack of information

4. Missing markets

5. Factors Immobility

How does the government intervene with the 5 market failures?

Externalities: Regulation / Fines

Lack of competition: Legislation

Missing markets: State money can be used provide public goods.

Lack of information: Pass legislation forcing firms to provide more information about products.

Factor immobility:Retraining workers when their previous jobs became redundant.

2 traits of Public Goods

Goods that would not be provided in sufficient quantities by the private sector.

NON-EXCLUDABILITY: once public good is provided, any consumer cannot refuse consumption of it.

NON-RIVALRY: the consumption of a public good by one consumer cannot reduce the amount available to other.

Define the Free-Rider problem

Free rider refers to an individual who enjoys the benefit of a good but allows others to pay for it.

Define Privatisation

Act of selling a company / activity controlled by the government to private investors.

EFFECT OF PRIVATISATION: Consumers

Consumers would benefit from privatisation as businesses are now under pressure to meet customer need and return a profit for the owners. Because of this, businesses will try to be efficient and provide good quality products, benefitting the consumers.

EFFECT OF PRIVATISATION: Workers

Privatisations may lay off workers. This may weaken companies through the loss of experienced staff and make it more difficult and more expensive to scale up in the future.

EFFECT OF PRIVATISATION: Business

After privatisation, business's objectives have changed to profit. Many firms have increased investments. Mergers and takeover may also occur. Many privatised businesses have diversified into new areas.

EFFECT OF PRIVATISATION: Government

Governments have also benefited from privatisation, earning a huge amount of revenue that has been generated.

Define external costs

Negative spillover effects of consumption or production - they affect third parties in a negative way.

Examples of external costs (6)

Noise pollution

Air pollution

Water pollution

Overcrowding

Resource depletion

Traffic congestion

Define external benefits

Positive spillover effects of consumption or production - they bring benefits to the third parties.

Examples of external benefits (3)

Education

Healthcare

Vaccinations

Define Social cost/benefits

Cost/Benefit of an economic activity to society as well as the individual or firm.

Define Private cost/benefit

Costs/Benefits of an economic activity to individuals and firms

Formula for Social cost/benefit

External cost/benefit + Private cost/benefit