Theme 1

Keywords

The basic economic problem

Individuals have infinite wants, but there are scarce resources. As such, these goods must be allocated in the most efficient way

Positive statement

Value-free and can be tested true or false using economic data

Normative statement

Value judgement that cannot be tested true or false using economic data

Production possibility frontier (PPF)

Illustrates the maximum potential output that an economy can produce between 2 goods when all its factors of production are efficiently employed.

Factors of production

Factors used in the production process: Land Labour Capital Enterprise

Opportunity cost

The value of the next best alternative forgone

Specialisation

Where a firm, country, or individual produces a limited range of goods and becomes specialists at it

The division of labour

Where the production process is broken down into specific roles, and each unit of labour specialises

Free market economy (Adam Smith)

Where there is no government intervention and goods are allocated via the price mechanism 

Command economy (Karl Marx)

Where all resources in the economy are allocated through the government

Mixed economy (Friedrich Hayek)

Where there is some government intervention but goods are also allocated via the price mechanism

Factors that shift supply curve

Costs

Productivity

Technology

Weather

Number of suppliers

Factors which shift demand curve

Fashion and trends

Advertising

Population and age structure

Seasons

Income

Price of other goods

Signalling

Where prices act as a signal to help producers eliminate excess supply or excess demand for a good

Rationing

Where scarce resources are allocated to whoever is willing to pay the most for the good

Incentive function

This causes consumers and producers to alter how much they buy or sell of the good, depending on the price

Consumer surplus

The difference between the maximum price a consumer is willing and able to pay for a good and the market price

Producer surplus

The difference between the minimum price producers are willing to sell a good and the market price

Total revenue =

Price × Quantity

Price elasticity of demand (PED)

The responsiveness of quantity demanded to a change in price

Factors which influence PED

Necessity

Addiction & habit

Substitutes

Brand loyalty

Income proportion

Time period

Income elasticity of demand (YED)

The responsiveness of quantity demanded to a change in income

Normal good

A good that you demand more of as your income rises and less of as your income falls. The YED will be positive.

Inferior good

A good that you demand more of as your income falls, and less of as your income rises. The YED will be negative.

Cross elasticity of demand (XED)

The responsiveness of quantity demanded of good B to a change in the price of good A

Substitute goods

Those which have similar characteristics to another and they are in competitive demand. The XED will be positive.

Complementary goods

Those which are bought together and they are in joint demand. The XED will be negative.

Price elasticity of supply (PES)

The responsiveness of quantity supplied to a change in the price

Factors which influence PES

Time

Economy state

Availability of factors of production

Stockpiles & perishability

Spare capacity

Short run

At least one factor of production is fixed

Long run

All factors of production are variable

Direct tax

One that is taken directly from an individual’s income or a firm’s profits

Indirect tax

One that is levied on goods and services

2 types of indirect taxes:

Specific tax and Ad valorem tax

Specific tax (unit tax)

Where each item of a good is taxed by a fixed amount (e.g. per litre of petrol)

Ad valorem tax

Where the total amount is taxed by a fixed percentage (e.g. VAT)

Hypothecate tax revenue

Where the government pledge to spend the tax revenue back on the original market failure

Subsidy

Grant given by the government to producers which decreases their production cost, leading to lower prices and higher output

Market failure

Where there is an inefficient allocation of resources

Externality

Third-party spill over effect arising from a private transaction

Marginal cost (MC)

Addition to total cost from producing an extra unit of output

Marginal benefit (MB)

Addition to total utility from consuming an extra unit of a good