Paper 1 Edexcel Economics B

How High Unemployment Benefits Firms Increases labour supply giving firms bargaining power to lower wages and production costs;

Effects of Unpredictable Inflation on Firms Reduces business confidence making it hard to predict interest rates unemployment and economic growth Leads firms to cut investment and wait for stable economic conditions

Creative Destruction

Proposed by Schumpeter this is the idea that new entrepreneurs are innovative and grow more productive than old idle firms which are eventually forced out of the market

Example of Creative Destruction

The evolution from DVDs to Blu

Main Incentive for Entrepreneurs

Taking risks for profit

How Entrepreneurs Make a Profit

By bringing together all four factors of production Land Labour Capital Enterprise

Non

Financial Motives for Entrepreneurs

Four Factors of Production

Land Natural resources like oil and coal Labour Human capital Capital Goods used in the production process Enterprise The innovator and risk

Specialisation

Each worker completes a specific task in the production process to improve efficiency and reduce average costs

Benefits of Specialisation

Higher output Opportunities for greater economies of scale;

Drawbacks of Specialisation

Work becomes monotonous and demotivating Can lead to structural unemployment if skills are not transferable

Why Higher Interest Rates Are a Disadvantage to Firms

Loans become more expensive increasing production costs Consumers save more and spend less reducing firm profits

Relationship Between Exchange Rates and Imports Exports

High exchange rate Imports cheap Exports expensive Low exchange rate Imports expensive Exports cheap SPICED Strong Pound Imports Cheap Exports Dear WIDEC Weak Pound Imports Dear Exports Cheap

How High Unemployment Benefits Firms

Increases labour supply giving firms bargaining power to lower wages and production costs

Effects of Unpredictable Inflation on Firms

Reduces business confidence making it hard to predict interest rates unemployment and economic growth Leads firms to cut investment and wait for stable economic conditions

Effective Demand

The quantity that consumers are willing to buy at the current market price

Individual Demand

The demand of an individual or firm

Market Demand

The sum of all individual demands in the market

Effect of Prices on Demand and Supply Curve

Prices cause movements along the demand and supply curves but do not cause shifts

PIRATES Mnemonic

Population Income Related Goods Advertising Tastes and Fashions Expectations Seasons

Types of Supply

Joint supply Composite supply Competitive supply

Reasons for Upward Sloping Supply Curve

Higher prices make it more profitable to supply Encourages new firms to enter the market Larger output increases costs passed to consumers

PINTSWC Mnemonic

Productivity Indirect Taxes Number of Firms Technology Subsidies Weather Costs of Production

Effect of Exchange Rates on Supply

A decrease in exchange rates increases import costs shifting supply curve left

Market Equilibrium Price

The price where supply meets demand with no tendency to change

Market in Excess Demand

Price is below equilibrium Demand exceeds supply Price increases until equilibrium is restored

Cons of Supply and Demand Model

Only shows certain markets Assumes price increases always lead to more supply Assumes perfect information Assumes perfect competition

Invisible Hand of the Market

The mechanism that determines market price as per Adam Smith

Functions of Price Mechanism

Rationing Incentive Signalling

Mass Market vs Niche Market

Mass market serves the largest consumer group Niche market serves a smaller specific group

Why Niche Markets Allocate Resources Better

They directly target consumers and understand specific needs

Primary vs Secondary Research

Primary research is direct like surveys Secondary research is from third parties like government reports

Pros and Cons of Primary Research

More specific but expensive compared to secondary research

Market Research

The collection of data to understand consumer needs and wants

Disadvantage of Market Samples

Samples may be biased leading to invalid results

Market Segmentation

Dividing the market into consumer categories based on characteristics and needs

Benefits of Market Segmentation

Helps firms better target products to fulfill specific consumer needs

Market Mapping

Illustrates product positions based on key dimensions identifying market gaps

Market Mapping Dimensions

High vs Low Price High vs Low Volume Heavy vs Light Good vs Lesser Quality

Competitive Advantage

When a firm produces better products than competitors

How to Gain Competitive Advantage

Using price quality cost or niche markets to differentiate from competitors

Product Differentiation

Distinguishing one product from another

Adding Value to Products

Using brand quality good service unique features and convenience

Pricing in Perfect Competition

Firms are price takers and accept the equilibrium price where supply equals demand

Stable vs Dynamic Markets

Stable markets have constant prices while dynamic markets experience frequent price changes

Total Revenue (TR)

Price x Quantity Sold

Average Revenue (AR)

TR / Quantity Sold

Marginal Revenue

The extra revenue earned from producing one more unit calculated as the difference in total revenue between output levels

Types of Business Costs

Fixed Costs and Variable Costs

Fixed Cost Example

Rent

Variable Cost Example

Raw Material Costs

Percentage Change Formula

(Final Value

Contribution

The total profit made by selling each product

Contribution Formula

Selling Price

Why Contribution Excludes Fixed Costs

Fixed costs do not vary with output

Margin of Safety

The difference between actual output and break

Profit as a Market Signal

High profit margins attract new firms and low margins drive firms away

Price as a Market Signal

Indicates where resources are most needed in the market

Statement of Comprehensive Income

Shows revenues and expenses to provide an overview of a firm's financial position

Effect of Increased Expenditures on Net Income

Reduces net income as expenditures are cash outflows

Ways to Measure Profitability

Gross Profit Margin Operating Profit Margin Profit for the Year Margin

Operating Profit Margin

Profit earned from core business operations

Cash Flow Forecast

Identifies where businesses are spending more than they can afford

Private Costs

Determine how much of the good should be produced and its market price

Total Social Cost

Social Cost = Private Costs + External Costs

External Costs from a Graph

The vertical distance between the Marginal Social Cost (MSC) line and the Marginal Private Cost (MPC) line

MPC and MSC Lines

Do not move parallel as external costs increase disproportionately to output

External Costs of Production

When negative externalities exist MSC > MPC causing welfare loss and overproduction

External Benefits of Production

When positive externalities exist MSB > MPB causing welfare gain and underconsumption

Externality

A cost or benefit to a third party outside the market transaction

Socially Optimal Point

Where MSC = MSB

Market Failure

Occurs when the free market fails to allocate resources to the socially optimal level of output

Public vs Private Goods

Public goods are non

Underprovision of Public Goods

Free riders receive the same benefits as paying consumers so private firms lack profit incentive

Market Failure and Perfect Information

Market failure occurs because both parties rarely have perfect information leading to resource misallocation

Government Intervention in Free Markets

Governments intervene to correct market failure

Examples of Government Intervention

Regulation Indirect Taxes Subsidies

Types of Indirect Taxes

Ad valorem tax Specific tax

How Indirect Taxes Reduce Demerit Good Consumption

Firms pass taxes to consumers via higher prices reducing demand

Subsidy

A government payment to firms to lower production costs and increase output

Government Subsidy Example

Education is subsidized as a merit good to encourage learning and improve workforce quality

Effect of Subsidy on Supply Curve

Shifts the supply curve to the right by reducing production costs

Government Failure from Subsidies

Distorts price signals and disrupts the free market mechanism

Unintended Consequences of Government Policy

Policies can be expensive to implement

How Banks Encourage or Discourage Saving and Investing

They manipulate interest rates so high interest rates encourage savings and discourage investing

Bank’s Main Source of Profit

Interest rates earned through loaning money to consumers

Role of a Central Bank

To manipulate interest rates exchange rates and the money supply

Central Banks in Major Economies

European Central Bank Bank of England The Federal Reserve

Rate Controlled by Central Banks

The base rate

Mortgage

A loan taken out to buy a house where the house is used as collateral in case of default

Monetary Policy Committee (MPC)

A group of nine independent members who meet frequently to discuss future interest rate changes

Risk

The probability of damage loss or injury occurring

How Banks Face Risk

They face risks when they lend money as there is a possibility of debt not being repaid

Limited vs Unlimited Liability

Unlimited liability means owners' personal assets can be seized in insolvency while limited liability means owners only lose their investment

Types of Credit

Loans Overdraft Trade Credit

Trade Credit

A loan to a firm given by suppliers so goods can be bought immediately and paid for later

Pros and Cons of Overdrafts

Interest is only paid on borrowed money but rates are high and borrowing limits are low

Sources of Credit

Banks Venture Capital Share Capital Leasing