Economics

What is the economic problem?

What is the economic problem?

unlimited wants and limited resources

Decisions to overcome the basic economic problem

What to produce? How to produce? For whom to produce?

opportunity cost

the cost of the next best use of time and money when choosing to do one thing or another

Demand

the desire to own something and the ability to pay for it

Law of Demand

as price increases, quantity demanded decreases and vice versa. This is an inverse relationship.

What causes a shift in the demand curve?

a change in an area other than price

Factors that may shift the demand curve

Income, Demographic changes, Fashion/trends, Advertising, Substitutes, Complements

Supply

The quantity of something that producers have available for sale

Law of supply

producers offer more of a good as its price increases and less as its price falls. This is a proportionate relationship.

What causes a shift in the supply curve?

production cost, technology, indirect taxes, subsidies, natural factors

market equilibrium (AKA market clearing price)

the price at which the quantity demanded by buyers equals the quantity supplied by sellers

Shifts in demand in relation to equilibrium

If demand increases, equilibrium price will increase too.

Shifts in supply in relation to equilibrium

If supply increases, prices will fall

Removing excess supply and demand

-To remove excess demand, producers could raise prices or increase production to meet demand -If there is excess supply, producers could lower their prices or store excess products to sell at a later date (however may not be practical in some cases)

price elasticity of demand

a measure of how much the quantity demanded of a good responds to a change in the price of that good

formula for price elasticity of demand

% change in quantity demanded / % change in price

What is meant by price inelastic demand?

Demand is not very sensitive to price - the % change in demand will be smaller than the % change in price. PED <1 (a fraction or decimal) is inelastic

What is meant by price elastic demand?

Demand is very sensitive to price - the % change in demand will be bigger than the % change in price. PED >1 is elastic

Why is there a '-' (minus) before some numbers of PED?

If the % change in price is negative it is because the price fell or the demand fell.

What is the value of PED when demand is perfectly inelastic?

0

What is demand said to be when PED is infinite?

perfectly elastic

Is the demand curve vertical or horizontal when PED is 0?

Vertical

Is the demand curve vertical or horizontal when PED is infinite?

Horizontal

What is unitary elasticity?

When the PED is -1

What are the factors that effect PED?

-Availability of substitutes -Degree of necessity (necessary items are inelastic because people will need them even if the price is high) -Proportion of income spent on a product -Time

How does availability of substitutes affect PED?

products with a large number of available substitutes are generally elastic, because if the price of the original product were to rise, consumers would just switch to the available substitutes which are presumably cheaper.

How does degree of necessity affect PED?

products that are considered necessities generally have inelastic PED , this is because even if the price were to rise, consumers would still need to buy the product because by definition, they are necessities.

How does proportion of income spent on a product affect PED?

If consumers are going to buy something expensive like a TV, they may be willing to see if the price drops, making PED elastic. However, if the product is cheap, like a pencil, they are less likely to do this thus PED is usually inelastic

How does time affect PED?

PED is usually inelastic in the short term as it takes time for consumers to find substitutes.

An example of this is if petrol continued to increase, consumers may still demand it in the short term, however over time, consumers may switch to electric cars or public transport.

What is income elasticity of demand (YED)?

The responsiveness of demand to a change in income

YED formula

% change in quantity demanded / % change in income

necessities in relation to YED

Basic goods that people will have to buy even if their income changes. This makes them inelastic. YED that is between -1 and +1 is inelastic. Eg. water

Luxury goods in relation to YED

Discretionary expenditure, usually income elastic as people will typically buy them when they can afford them. Eg. air travel

Discretionary expenditure

Voluntary spending on non-essential goods and services when consumers can afford them.

Normal goods in relation to YED

Goods can be normal or inferior. Normal goods are when an increase in income results in an increase in quantity demanded (positive income elasticity).

Inferior goods in relation to YED

When an increase in income results in a decrease in quantity demanded (negative income elasticity). Eg. Shein products, dollar store

How could price elasticity be helpful for a business?

Could help predict effect of a price change on total revenue. Eg. if a product's demand is elastic, a price reduction could result in an increase in revenue.

Why might a producer of inferior goods up production when a recession is predicted?

When incomes fall quantity demanded for inferior goods rise. Incomes usually fall in recessions.

Why might governments put indirect taxes on a product?

They can raise more revenue by putting VAT and excise duty on products like alcohol and cigarettes. Usually put on products with inelastic demand as consumers would avoid heavily taxed products if demand for them was elastic

excise duty

tax on goods such as alcohol, petrol and tobacco

Why might governments consider PED when subsidizing businesses?

The purpose of a subsidy is to make goods cheaper and if demand is elastic it will only reduce the price slightly when supply is increased, thus govt's would target demand inelastic businesses like farmers.

What is price elasticity of supply (PES)?

The responsiveness of supply to a change in price

Formula for PES

% change in quantity supplied / % change in price

What is price inelastic supply?

When producers find it hard to change their production in a given time period (PES <1)

What is price elastic supply?

Producers can increase output without a rise in cost or time delay (PES >1)

What is privatization?

The act of selling a company or activity controlled by the government to private investors

What are monopolies?

The situation where an industry is controlled by only one company or by the government and other companies do not compete with it.

nationalised industries

Public corporations previously part of the private sector which were taken into state ownership.

natural monopolies

A situation that occurs when one firm in an industry can serve the entire market at a lower cost than would be possible if the industry were composed of many smaller firms.

Why does privatisation take place?

• To generate income

• To reduce inefficiency in the public sector

• To reduce political interference

Negative externalities

Occur when production or consumption impose external costs on third parties for which no compensation is paid.

Example of positive externalities of production

If a company discovers something, other companies can use this if it's not patented (e.g. COVID vaccines)

Example of positive externalities of consumption

Masks can prevent/decrease the spread of some diseases which benefits wider society.

When does a shift in the demand curve occur?

when the quantity demanded changes at every price. This is caused by any factor other than price. Eg. income change

When does movement along the demand curve occur?

When the good's price changes

private costs

costs of an economic activity to individuals and firms

social costs

External Costs + Private Costs. (costs of economic activity to society and the individual/firm, negative externality)

Government regulation

Passing laws to prevent companies/individual taking certain actions, usually about the environment. However, laws for regulation may take many years to be passed and many externalities may be created within that time.

Fines

An amount of money to be paid as a result of an action like speeding to prevent a negative externality like a car crash

Taxation

An amount of taxes that businesses have to pay. Usually targeted to products that cause negative externalities like cigarettes. They can be placed on other things too, but are usually higher on products like cigarettes. Taxation causes the cost of a product to be higher and thus lowers demand. However, sometimes companies relocated to other countries with lower taxes.

Subsidies

Money or benefits given to a business by the government so they can improve society by reducing a negative externality or creating more positive externalities.. For example, grants for a company to build a recycling plant, therefore reducing the negative externality of pollution. There is also tax allowance, where a business can pay less taxes to produce more goods. However the negative of subsidies is that the government needs to pay and thus decide what will lower the most negative externalities/create more positive externalities.

Congestion charging

Increase in cost of car usage (like tolls in certain zones in peak hours), to decrease negative externalities like pollution or congestion. Not very effective however, since the price elasticity of demand of cars is inelastic.

Social benefits

private benefits + external benefits (positive externality)

factors of production

Land, Labour, Capital and Enterprise

Productivity

the amount of output you generate given the amount of input. The more that is produced, the more productive the inputs are being.

Ways to increase the factor of production of land

Quantity: -Discover new resources -New processes to make it more efficient Quality -Environmental protection -Fertilizer

Ways to increase the factor of production of labour

Quantity: -Number of hours worked -Immigration -Lower working age Quality: -Education -Training -Access to higher education

Ways to increase the factor of production of capital

Quantity: -New tech -New processes -Mechanisation Quality: -Research & development

Ways to increase the factor of production of enterprise

Quantity: -Business education Quality: Training

What is the shape of an average cost curve? Why?

A bowl shape. Average costs were initially falling because productivity was increasing, but then when productivity declined, AC increased again.

Formula for average cost

total cost/quantity produced

Why is productivity important for firms?

An increase in productivity means more can be produced with less resources, thus lowering costs and hopefully increasing profits.

Labour intensive production

Production methods that make more use of labour relative to machinery

Capital intensive production

Production methods that make more use of machinery relative to labour

Why is capital intensive production typically favoured over labour intensive production?

Labour is harder to manage and cannot work as many hours as machinery. It can also be expensive. However, machinery is also expensive and smaller firms may not want to take this risk.

Sector

A group of businesses that provide similar goods/services.

What is the difference between a business and a sector?

A business is an individual firm, but is is part of a group of businesses within its sector.

Primary sector

the part of the economy that draws raw materials from the natural environment

Secondary Sector

the part of the economy that transforms raw materials into manufactured goods

Tertiary sector

Sector involved in the delivery of services

Quaternary Sector

A subset of the tertiary sector and involves service jobs concerned with research and development, management and administration, and processing and disseminating information.

Chain of production

primary --> secondary --> tertiary Each sector is interdependent.

Which type of country has the majority of its economy being the primary sector?

Lower developed countries. Eg. Pakistan, Tanzania

Which type of country has the majority of its economy being the secondary sector?

Developing countries. Eg China. India

Which type of country has the majority of its economy being the tertiary sector?

Developed countries eg. Germany, UK

Sectoral change

Change over time in the importance of each sector in terms of a nation's earnings (GDP) and employment.

Factors that cause sectoral change

-Increase in GDP -Increase in employment in a certain sector and vice versa -Increase or decline in manufacturing

Two issues an economy could face when going through sectoral change.

Poverty, a lot of people cannot keep up with changes. Exploitation, may not have as many regulations for the emerging sector

Why does the number of businesses determine industry size?

an industry is made up of a group of businesses, thus its size is measured by how many businesses are in the sector.

free market economy

vast majority of goods and services are provided by private businesses Eg. Hong Kong

Mixed economy

An economy where goods and services are provided by both private and public sectors Eg. UK

Command economy

An economic system in which the government makes all economic decisions, how to produce, what to produce and how to distribute. Eg. North Korea

public sector

the part of an economy that is controlled by the government.

Role of Public Sector

To provide public services that cannot be sufficiently provided by the private sector due to it causing a 'free-rider problem'

free rider problem

When people enjoy the benefits of something while allowing others to pay.

Central government departments

departments controlled by teams/boards led by govt. minister. e.g. NHS, department of defence

public corporations or state-owned enterprises

Organizations wholly owned by the government but run as commercial establishments, e.g. the BBC

Local authority services

Services delivered by local councils e.g. library, sports hall

Other public sector organisations

Run by a trust/board led by an expert selected by the govt.. e.g. bank of England

Aims of public sector

Improving the quality of services, minimising costs, allow for social costs and benefits, profit (in some cases)