Microeconomics - The Market System

What is the basic economic problem of scarcity?

• There are unlimited wants

• But only finite (limited) resources

• This leads to the need to make choices

How does opportunity cost affect consumers?

Consumers must choose how to spend their limited income, giving up other goods or services.

How does opportunity cost affect producers?

Producers must decide how to use limited resources, giving up potential alternatives in production.

How does opportunity cost affect the government?

Governments must choose how to allocate limited funds, sacrificing spending on some public services to fund others.

What are possible causes of positive economic growth?

• Improved technology and innovation

• Improved efficiency

• Education and training

• Discovery of new natural resources

What is the main assumption about consumer and producer behaviour in economics?

• Consumers aim to maximise their benefit.

• Businesses (producers) aim to maximise their profit.

What are some reasons why consumers may not maximise their benefit?

• Consumers are not always good at calculating their benefits

• Consumers have habits that are hard to give up

• Consumers sometimes copy others’ behaviour

What are some reasons why producers may not maximise their profit?

• Managers may revenue maximise or sales maximise

• Producers may prioritise caring for customers

• Producers may complete charitable work

What factors cause a shift in the demand curve? (PAPFID)

• Advertising – Makes products more desirable.

• Income – More income = more demand (for normal goods).

• Fashion & tastes – Trends change what people want.

• Price of substitutes – If a substitute gets pricier, demand rises.

• Price of complements – If a complement gets pricier, demand falls.

• Demographic changes – More or different people = different demand.

What factors cause a shift in the supply curve?

• Costs of production – Higher costs = less supply.

• Technology – Better tech = more supply.

• Indirect taxes – More tax = less supply.

• Subsidies – More subsidies = more supply.

• Natural factors – Bad weather/disasters = less supply.

How is equilibrium determined?

It’s the price where quantity demanded = quantity supplied.

What is equilibrium price and quantity?

Where demand equals supply—market is balanced.

How do you calculate excess demand or supply?

Subtract quantity supplied from quantity demanded (or vice versa) at a given price.

How do market forces remove excess demand?

Price rises → demand falls, supply rises → market returns to equilibrium.

How do market forces remove excess supply?

Price falls → demand rises, supply falls → market returns to equilibrium.

What are market forces, and what is their role?

They are the forces of demand and supply, adjusting prices to restore equilibrium when there's excess demand or supply.

What is the formula for PED?

% change in quantity demanded ÷ % change in price

How do you show price elastic demand on a diagram?

Draw a flatter demand curve – a small price change causes a large change in quantity demanded.

How do you show price inelastic demand on a diagram?

Draw a steeper demand curve – a large price change causes only a small change in quantity demanded.

Perfect price inelasticity

0

Price inelasticity

between 0 and -1

Unitary elastic demand?

–1

Price elasticity

less than -1

Perfect price elasticity.

–∞

What are the factors influencing PED?

• Substitutes – More substitutes = more elastic (easier to switch if price rises).

• Degree of necessity – Necessities = inelastic (people still buy even if price rises).

• Percentage of income spent – Larger % of income = more elastic (price rise feels bigger).

• Time – Longer time = more elastic (consumers find alternatives or adjust habits).

What is the formula for PES?

% change in quantity supplied / % change in price

How do you show price elastic supply on a diagram?

A flatter supply curve – a small price change causes a large change in quantity supplied.

How do you show price inelastic supply on a diagram?

A steeper supply curve – a large price change causes a small change in quantity supplied.

Perfectly inelastic supply

0

Price inelastic supply

Between 0-1

Unitary elastic supply

1

Price elastic supply

greater than 1

Perfectly elastic supply

∞

What are the factors influencing PES?

• Factors of production – Easier to increase supply if factors of production (e.g. labour, capital) are flexible.

• Availability of stocks – More stock = more elastic supply (easier to supply more).

• Spare capacity – If producers have unused resources, they can increase supply easily.

• Time – Over time, supply becomes more elastic as producers can adjust production.

What is the formula for Income Elasticity of Demand (YED)?

% change in quantity demanded / % change in income

Luxury goods

• YED - greater than 1.

• Income elastic

• Demand increases more than income as consumers can afford higher-end goods.

• Designer clothing, satellite tv, air travel.

Normal goods

• YED - between 0 and 1

• Income inelastic: As income increases, demand for normal goods also increases, but at a slower rate than the income increase.

• Groceries, clothes, public transport

Inferior goods

• YED - less than 0

• Demand decreases as income rises, as consumers shift to higher-quality alternatives.

• Used cars, second-hand clothing, cheap food

How does PED affect businesses with subsidies?

• Price elastic demand: Subsidies will cause a large increase in demand.

• Price inelastic demand: Subsidies will lead to a small increase in demand, but businesses still benefit from lower production costs.

How does PED affect businesses with indirect taxes?

• Price elastic demand: A tax increase will lead to a big drop in demand.

• Price inelastic demand: A tax increase will have less impact on demand, allowing businesses to maintain or increase revenue.

How does YED affect businesses with income changes?

• Luxury goods: Income rise leads to a large increase in demand.

• Normal goods: Income rise leads to a moderate increase in demand.

• Inferior goods: Income rise leads to a decrease in demand.

How does PED affect government with indirect taxes?

• Price elastic demand: Taxes reduce demand significantly, possibly lowering tax revenue.

• Price inelastic demand: Taxes generate more stable revenue with little effect on demand.

How does PED affect government with subsidies?

• Price elastic demand: Subsidies lead to a large increase in demand.

• Price inelastic demand: Subsidies have less effect on demand, but help reduce consumer costs.

How does YED affect government with income changes?

• Luxury goods: Income rise boosts demand for luxury goods, supporting economic growth.

• Normal goods: Income rise leads to moderate demand increase.

• Inferior goods: Income rise reduces demand, so government policies may focus on helping these industries adapt.

Who owns and controls private sector organisations?

• Sole Traders — Owned and controlled by one person (makes all decisions and keeps all profits).

• Partnerships — Owned and controlled by two or more people (share decisions, profits, and risks).

• Companies — Owned by shareholders and controlled by directors (shareholders invest money, directors manage the business).

What are the main aims of private sector organisations?

• Survival — Especially important for new or small businesses trying to stay open.

• Profit Maximisation — Making as much profit as possible for owners or shareholders.

• Growth — Expanding the business to increase market share and profits.

• Social Responsibility — Acting ethically, protecting the environment, and supporting the community (often to build a good reputation).

Who owns and controls public sector organisations?

• Central Government Departments — Owned and controlled by the national government (e.g. NHS, military).

• Public Corporations / State-Owned Enterprises — Owned by the state but run independently (e.g. Network Rail).

• Local Authority Services — Owned and controlled by local councils (e.g. schools, libraries, waste collection).

• Other Public Sector Organisations — Special cases owned by the state, but may have unique roles (e.g. BBC, Post Office, Bank of England).

What are the main aims of public sector organisations?

• Improving the Quality of Services — Focused on providing reliable and high-standard services for the public.

• Minimising Costs — Using taxpayer money efficiently and avoiding waste.

• Allow for Social Costs & Benefits — Making decisions that consider the wider impact on society and the environment, not just financial outcomes.

• Profit (in some cases) — In some countries, state-owned businesses aim to make a profit to fund public services or reduce government spending.

How are the problems of what to produce, how to produce, and for whom to produce solved in a mixed economy?

• What to produce — Decided by both consumer demand (through the market) and government planning (for essential services like healthcare, education, infrastructure).

• How to produce — Businesses choose the most efficient method to reduce costs and increase profits, while the government may set regulations for safety, environmental protection, and fair practices.

• For whom to produce — Based on people’s ability to pay in the market, but the government provides support (e.g. benefits, free healthcare, education) to make sure everyone has access to basic needs.

What are the main causes of market failure?

• Externalities — Costs or benefits that affect third parties (e.g. pollution, vaccinations) not reflected in market prices.

• Lack of Competition — Monopolies or few sellers can overcharge and limit choice, leading to inefficient outcomes.

• Missing Markets — Some goods and services (like public goods) are not produced by the market, even if society needs them.

• Lack of Information — Buyers or sellers make poor decisions because they don’t have full or accurate knowledge (e.g. health risks, hidden costs).

• Factor Immobility — When resources like labour or capital can’t easily move to where they are needed, causing unemployment and wasted potential.

Why might a government need to intervene in the economy when market failure happens?

• To correct externalities (e.g. taxing pollution, subsidising education).

• To provide public goods (e.g. street lighting, defence) that the market won’t supply.

• To increase competition (e.g. breaking up monopolies, enforcing anti-trust laws).

• To ensure consumers and producers have the right information (e.g. product safety labels).

• To reduce inequality and help people affected by factor immobility (e.g. retraining schemes, welfare).

What are public goods and how do they cause the free rider problem?

• Non-Excludability — No one can be stopped from using the good (e.g. street lighting).

• Non-Rivalry — One person’s use doesn’t reduce availability for others (e.g. national defence).

What is the role of the public sector and private sector in the production of goods and services?

• Public Sector: The government produces goods and services to meet the needs of society, particularly when markets fail (e.g. healthcare, education, public transport, national defence). It focuses on public welfare rather than profit.

• Private Sector: Private individuals or businesses produce goods and services with the goal of making a profit. They are driven by consumer demand and competition (e.g. retail businesses, technology companies).

How do the public sector and private sector differ in importance across different economies?

• In a Market Economy: The private sector plays a dominant role in producing goods and services, driven by profit motives and competition. The public sector is smaller and mainly focuses on providing essential services (e.g. defence, law enforcement).

• In a Planned Economy: The public sector is much larger, with the government controlling most industries and services. The private sector is minimal or non-existent.

• In a Mixed Economy: Both sectors play significant roles. The private sector drives economic growth and innovation, while the public sector provides essential services, regulates markets, and corrects market failures.

How does privatisation affect consumers?

• Positive Effects: Consumers may benefit from improved efficiency and better quality of services as private companies compete to attract customers.

• Negative Effects: There might be higher prices if competition is limited or if the private company focuses on profit over consumer welfare.

How does privatisation affect workers?

• Positive Effects: Workers might experience improved working conditions and incentives due to private companies focusing on performance and efficiency.

• Negative Effects: Workers could face job losses, wage cuts, or worse conditions as private companies seek to reduce costs and increase profits.

How does privatisation affect businesses?

• Positive Effects: Privatised businesses have greater freedom to operate efficiently and pursue profits, often leading to innovation and market growth.

• Negative Effects: Businesses may face increased competition or pressure to focus solely on profitability, possibly leading to lower long-term investment in non-profitable areas.

How does privatisation affect the government?

• Positive Effects: The government can reduce public sector spending, raise revenue through the sale of assets, and potentially reduce its involvement in certain sectors.

• Negative Effects: The government loses control over essential services and may face backlash if privatised companies provide poor services or raise prices for consumers.

What are some examples of external costs?

• Pollution: Harmful emissions from factories, cars, and industrial activities cause air pollution, water pollution, and soil contamination, affecting public health and ecosystems.

• Congestion: Traffic jams in urban areas create delays and higher fuel consumption, leading to wasted time and increased pollution.

• Environmental Damage: Activities like deforestation, mining, or overfishing cause loss of biodiversity, habitat destruction, and climate change, impacting both nature and human populations.

What are some examples of external benefits?

• Education: When people are educated, they not only benefit themselves but also contribute to a more productive workforce and reduced crime rates, benefiting society as a whole.

• Healthcare: A healthy population reduces the spread of diseases and lowers healthcare costs, creating positive effects for the entire community.

• Vaccinations: Vaccinated individuals reduce the spread of contagious diseases, helping protect those who cannot be vaccinated (e.g., infants, elderly), creating a healthier society.

What is the social costs formula?

Private Costs + External Costs

What is the social benefits formula?

Private benefits + external benefits.