Economics U3/4 Exam revision

[U3 AOS1 | Relative scarcity] Define relative scarcity.

The basic economic problem of having a finite set of resources to satisfy unlimited wants and needs; society must therefore choose which wants will be met.

[U3 AOS1 | Relative scarcity] Define resource allocation.

Making choices about how scarce resources are used or distributed among competing areas of production.

[U3 AOS1 | Relative scarcity] What are the three basic economic questions?

What and how much to produce; how to produce; for whom to produce.

[U3 AOS1 | Relative scarcity] Define opportunity cost.

The value of the next best alternative forgone when a decision is made.

[U3 AOS1 | Relative scarcity] Who are the main economic agents?

Households, private businesses and government.

[U3 AOS1 | Relative scarcity] What are the four factors of production?

Natural resources, labour, capital and enterprise.

[U3 AOS1 | Relative scarcity] Define natural resources as a factor of production.

Things that exist naturally on earth, such as minerals, forests and water.

[U3 AOS1 | Relative scarcity] Define labour as a factor of production.

The effort and skills of people who work to produce goods and services.

[U3 AOS1 | Relative scarcity] Define capital as a factor of production.

Tools, machinery and other physical assets used to produce goods and services.

[U3 AOS1 | Relative scarcity] Define enterprise as a factor of production.

Entrepreneurs taking the initiative to create goods/services by combining the other factors of production.

[U3 AOS1 | Relative scarcity] Distinguish wants from needs.

Wants are preferences for non-essential goods/services; needs are goods/services required for survival.

[U3 AOS1 | Relative scarcity] Define the production possibility frontier (PPF).

A model of an economy producing two products with finite resources, showing productive capacity when all available resources are used efficiently and completely.

[U3 AOS1 | Relative scarcity] What causes an outward shift of the PPF?

An increase in the volume and/or efficiency of productive resources, increasing productive capacity and potential economic growth.

[U3 AOS1 | Relative scarcity] What does a point inside the PPF indicate?

Inefficient use of resources, such as unemployment or idle inputs.

[U3 AOS1 | Relative scarcity] What does a point on the PPF indicate?

Productive efficiency: resources are fully and efficiently employed.

[U3 AOS1 | Relative scarcity] What does a point outside the PPF indicate?

An output combination currently unattainable with available resources and technology.

[U3 AOS1 | Efficiency] Define allocative efficiency.

The optimal distribution of goods and services that maximises society’s overall satisfaction; achieved where price equals marginal cost.

[U3 AOS1 | Efficiency] What is the key focus of allocative efficiency?

The optimal distribution of goods and services; resources go to their most valued uses.

[U3 AOS1 | Efficiency] How is allocative efficiency shown on a PPF?

Only one point on the PPF boundary represents the allocatively efficient mix.

[U3 AOS1 | Efficiency] Define productive/technical efficiency.

Maximum output from a given level of inputs while average production cost is minimised.

[U3 AOS1 | Efficiency] What is the key focus of productive efficiency?

The optimal method of producing goods: producing at the lowest possible cost.

[U3 AOS1 | Efficiency] How is productive efficiency shown on a PPF?

Every point on the PPF boundary is productively efficient because output is at its limit.

[U3 AOS1 | Efficiency] Define dynamic efficiency.

How effectively an economy or producer responds to market changes, reallocates resources and innovates over time to remain competitive.

[U3 AOS1 | Efficiency] What is the PPF interpretation of dynamic efficiency?

The speed at which the economy can move from one allocatively efficient combination of output to another.

[U3 AOS1 | Efficiency] Define intertemporal efficiency.

The extent to which an economy balances resources allocated to current use with resources conserved for future use.

[U3 AOS1 | Efficiency] What is the central trade-off in intertemporal efficiency?

Current consumption versus future consumption/capital goods.

[U3 AOS1 | Efficiency] Distinguish allocative and productive efficiency.

Allocative efficiency is about what mix of goods/services is produced; productive efficiency is about producing a given output at minimum cost.

[U3 AOS1 | Efficiency] Distinguish dynamic and intertemporal efficiency.

Dynamic efficiency concerns the speed of adaptation and innovation; intertemporal efficiency concerns the balance between current and future use of resources.

[U3 AOS1 | Markets and competition] Define a market.

Any place or venue where buyers and sellers can exchange goods and services.

[U3 AOS1 | Markets and competition] What characterises perfect competition?

Many buyers and sellers, homogeneous products, strong competition, price-taking firms, perfect knowledge, no branding and easy entry/exit.

[U3 AOS1 | Markets and competition] What characterises monopolistic competition?

A moderate number of sellers, similar but differentiated products, fairly strong competition, advertising/branding and relatively easy entry/exit.

[U3 AOS1 | Markets and competition] What characterises an oligopoly?

Relatively few large sellers, low-to-moderate competition, significant market power, important product differentiation and high barriers to entry.

[U3 AOS1 | Markets and competition] What characterises a monopoly?

One seller, no close substitutes, no rival competition, difficult entry/exit and a price-making firm with substantial market power.

[U3 AOS1 | Markets and competition] Define market power.

The degree to which a firm can influence price in a market, including the ability to raise price above marginal cost without losing profits to new entrants.

[U3 AOS1 | Markets and competition] List the nine assumptions of a free/perfectly competitive market.

Consumer sovereignty; no government controls; low entry/exit barriers; homogeneous products; profit maximisation; rational consumers; perfect information; strong competition/no market power; mobile resources.

[U3 AOS1 | Markets and competition] What is consumer sovereignty?

Consumers, through price signals, determine what goods and services are produced.

[U3 AOS1 | Markets and competition] Why do low barriers to entry and exit promote competition?

Firms can move in and out of markets easily, keeping the number of rivals high.

[U3 AOS1 | Markets and competition] Why does homogeneous production strengthen price competition?

With no product differentiation, consumers have close substitutes and firms have little ability to raise price.

[U3 AOS1 | Markets and competition] Why is resource mobility important in competitive markets?

Resources can move quickly between uses to respond to changes in relative prices and profit opportunities.

[U3 AOS1 | Markets and competition] How do competitive markets improve resource allocation?

Profit-seeking firms direct resources to areas where consumers value them most, improving allocative efficiency.

[U3 AOS1 | Markets and competition] How does strong competition affect prices?

It pressures firms to improve efficiency and lower costs, generally resulting in lower prices.

[U3 AOS1 | Markets and competition] How does strong competition affect quality?

Firms compete to win customers, encouraging higher-quality goods and services.

[U3 AOS1 | Markets and competition] What happens when market power is low?

Competition is high; firms must maximise output, keep prices low and maintain quality, supporting higher living standards.

[U3 AOS1 | Markets and competition] How do perfect competition and monopoly compare on market power?

Perfect competition has very low market power; monopoly has very high market power.

[U3 AOS1 | Markets and competition] How do perfect competition and monopoly compare on resource allocation?

Perfect competition tends toward very efficient resource allocation; monopoly tends toward low efficiency.

[U3 AOS1 | Supply and demand] Define demand.

The quantity of a good or service consumers are willing to buy at a particular price.

[U3 AOS1 | Supply and demand] State the law of demand.

Price and quantity demanded have an inverse relationship, ceteris paribus.

[U3 AOS1 | Supply and demand] Explain the income effect.

When price rises, a good becomes less affordable, reducing consumers’ real purchasing power and causing quantity demanded to contract.

[U3 AOS1 | Supply and demand] Explain the substitution effect.

When a good becomes more expensive, buyers switch toward cheaper substitutes, so quantity demanded contracts.

[U3 AOS1 | Supply and demand] What causes a contraction in quantity demanded?

A rise in the good’s own price; movement upward/left along the demand curve.

[U3 AOS1 | Supply and demand] What causes an expansion in quantity demanded?

A fall in the good’s own price; movement downward/right along the demand curve.

[U3 AOS1 | Supply and demand] Define supply.

The quantity of goods and services sellers are willing and able to supply at a given price.

[U3 AOS1 | Supply and demand] State the law of supply.

Price and quantity supplied have a direct relationship, ceteris paribus.

[U3 AOS1 | Supply and demand] Explain the profit motive behind the law of supply.

A higher price raises potential profit, motivating firms to produce and supply more.

[U3 AOS1 | Supply and demand] Explain opportunity cost in the law of supply.

A higher price in one market raises the opportunity cost of producing other goods, encouraging resources to move into the more profitable market.

[U3 AOS1 | Supply and demand] What causes an expansion in quantity supplied?

A rise in the good’s own price; movement upward along the supply curve.

[U3 AOS1 | Supply and demand] What causes a contraction in quantity supplied?

A fall in the good’s own price; movement downward along the supply curve.

[U3 AOS1 | Supply and demand] Define market equilibrium price.

The price at which quantity demanded equals quantity supplied for a given period, with neither shortage nor surplus.

[U3 AOS1 | Supply and demand] What pressure does a market shortage place on price?

Upward pressure on price.

[U3 AOS1 | Supply and demand] What pressure does a market surplus place on price?

Downward pressure on price.

[U3 AOS1 | Supply and demand] What is a non-price factor?

A variable other than the good’s own price that shifts the whole demand or supply curve.

[U3 AOS1 | Supply and demand] List major non-price factors of demand in the notes.

Demographics; trends/fashion; interest rates; prices of substitutes; prices of complements; consumer/business confidence; season; government policy.

[U3 AOS1 | Supply and demand] How does the price of a substitute affect demand?

If the price of a substitute rises, demand for the original good tends to increase; if it falls, demand tends to decrease.

[U3 AOS1 | Supply and demand] How does the price of a complement affect demand?

If the price of a complement rises, demand for the original good tends to decrease; if it falls, demand tends to increase.

[U3 AOS1 | Supply and demand] How do interest rates affect demand?

Higher rates raise borrowing costs/reward saving, tending to reduce demand; lower rates tend to increase demand.

[U3 AOS1 | Supply and demand] How does confidence affect demand?

Greater optimism about economic prospects tends to increase willingness to spend and shifts demand right; weaker confidence tends to shift demand left.

[U3 AOS1 | Supply and demand] List major non-price factors of supply in the notes.

Costs of production; technology/productivity; climatic conditions; government policies such as subsidies/taxes; other supply-chain disruptions.

[U3 AOS1 | Supply and demand] How do production costs affect supply?

Higher costs reduce firms’ willingness/ability to supply at each price, shifting supply left; lower costs shift supply right.

[U3 AOS1 | Supply and demand] How do technology and productivity affect supply?

Improved technology/productivity lowers unit costs and increases output capacity, shifting supply right.

[U3 AOS1 | Supply and demand] How do favourable climatic conditions affect supply?

They can raise production and shift supply right; adverse weather can disrupt supply and shift it left.

[U3 AOS1 | Supply and demand] Explain the adjustment after an increase in demand.

Demand shifts right; shortage at the old price creates upward price pressure; price rises; quantity supplied expands and quantity demanded contracts until a new higher-price, higher-quantity equilibrium.

[U3 AOS1 | Supply and demand] Explain the adjustment after a decrease in demand.

Demand shifts left; surplus at the old price creates downward price pressure; price falls; quantity supplied contracts and quantity demanded expands until a new lower-price, lower-quantity equilibrium.

[U3 AOS1 | Supply and demand] Explain the adjustment after an increase in supply.

Supply shifts right; surplus at the old price creates downward price pressure; price falls and equilibrium quantity rises.

[U3 AOS1 | Supply and demand] Explain the adjustment after a decrease in supply.

Supply shifts left; shortage at the old price creates upward price pressure; price rises and equilibrium quantity falls.

[U3 AOS1 | Elasticity] What is the PED formula?

PED = percentage change in quantity demanded ÷ percentage change in price.

[U3 AOS1 | Elasticity] Define price elasticity of demand (PED).

A measure of how sensitive quantity demanded is to a change in price.

[U3 AOS1 | Elasticity] What does relatively elastic demand mean?

PED > 1; quantity demanded changes proportionally more than price.

[U3 AOS1 | Elasticity] What does unit elastic demand mean?

PED = 1; quantity demanded changes by the same proportion as price.

[U3 AOS1 | Elasticity] What does relatively inelastic demand mean?

PED < 1; quantity demanded changes proportionally less than price.

[U3 AOS1 | Elasticity] What does perfectly elastic demand mean?

PED is infinite; the demand curve is horizontal and the firm cannot raise price without losing all buyers.

[U3 AOS1 | Elasticity] What does perfectly inelastic demand mean?

PED = 0; quantity demanded does not change when price changes; the demand curve is vertical.

[U3 AOS1 | Elasticity] What are the NITS determinants of PED?

Necessity, Income proportion, Time period, Substitutes.

[U3 AOS1 | Elasticity] How does necessity affect PED?

Necessities tend to have more inelastic demand; luxuries tend to have more elastic demand.

[U3 AOS1 | Elasticity] How does proportion of income affect PED?

A high proportion of income makes demand more elastic; a low proportion makes demand more inelastic.

[U3 AOS1 | Elasticity] How does time affect PED?

Demand becomes more elastic over time because consumers have more opportunity to find substitutes or change behaviour.

[U3 AOS1 | Elasticity] How do substitutes affect PED?

Many close substitutes make demand more elastic; few or no substitutes make it more inelastic.

[U3 AOS1 | Elasticity] What is the PES formula?

PES = percentage change in quantity supplied ÷ percentage change in price.

[U3 AOS1 | Elasticity] Define price elasticity of supply (PES).

A measure of how sensitive quantity supplied is to a change in price.

[U3 AOS1 | Elasticity] What does relatively elastic supply mean?

PES > 1; firms can readily expand or contract output when price changes.

[U3 AOS1 | Elasticity] What does unit elastic supply mean?

PES = 1; quantity supplied changes by the same proportion as price.

[U3 AOS1 | Elasticity] What does perfectly inelastic supply mean?

PES = 0; quantity supplied does not respond to price changes.

[U3 AOS1 | Elasticity] How does storability/durability affect PES?

Storable durable goods tend to have more elastic supply; perishable goods tend to have more inelastic supply.

[U3 AOS1 | Elasticity] How does spare capacity affect PES?

High spare capacity makes supply more elastic; little/no spare capacity makes it more inelastic.

[U3 AOS1 | Elasticity] How does time affect PES?

Supply becomes more elastic over time as firms can expand capacity, invest in capital and hire labour.

[U3 AOS1 | Elasticity] What is total revenue?

Price × quantity sold.

[U3 AOS1 | Elasticity] Total revenue test: what happens if price rises when demand is inelastic?

Total revenue rises.

[U3 AOS1 | Elasticity] Total revenue test: what happens if price falls when demand is inelastic?

Total revenue falls.

[U3 AOS1 | Elasticity] Total revenue test: what happens if price rises when demand is elastic?

Total revenue falls.

[U3 AOS1 | Elasticity] Total revenue test: what happens if price falls when demand is elastic?

Total revenue rises.

[U3 AOS1 | Elasticity] Why is PED significant for seller pricing?

With elastic demand, price reductions/sales can increase revenue; with inelastic demand, higher prices can increase revenue.