Economics Y11 T1 W4

Economic Problem

Basic economic problem is the decisions to be made to fulfil unlimited needs and wants with limited resources, creating scarcity.

Main economic agents AKA decision makers:

These 3 all produce / consume goods and services.

• Government

• Firms

• Individuals / households

Firms or individuals create products in the private sector.

Government create products in the public sector.

3 basic economic questions:

• What will be produced

• How will it be produced

• For whom will it be produced

Goods are tangible items, physical products e.g., pens.

Services are non-tangible, non-physical products e.g., healthcare.

Needs are essential items for human survival.

Wants are desires, not necessary for human survival. These are unlimited.

Economic goods are limited in supply and is scarce in relation to demand for product e.g., oil, cars and housing. Human effort is required to get this good.

Free goods are unlimited in supply and available for everyone to use e.g., air. It has no opportunity cost NOTE NOT SAME AS GOODS THAT ARE FREE (DONT HAVE TO PAY) AS THESE HAVE OPPORTUNITY COSTS.

Scarcity is when there are limiting resources to produce goods and all needs and wants are unable to be filled. Decisions need to be made to answer the 3 basic economic questions.

Efficiency is when scarce resources are not wasted and correct amount of goods and services are produced.

Ceteris paribus is when all other factors remain unchanged.

Economic growth is the increase in a country's total output

Rational economic decision making is when consumers prioritise maximum utility, producers prioritise maximum profits e.g., when economic agents maximise their objectives subject to constraints faced.

Social scientific method is the analysis and collection of data and development of feasible economic phenomena.

Demand Curve

Demand is the willingness and ability of consumers to purchase various quantities of goods or services at different price levels at a given time, ceteris paribus.

• Relationship between possible prices of a good or service and the quantities that individuals are willing and able to buy over some time period, ceteris paribus

LAW OF DEMAND: relation between price and quantity

• Higher price = lower quantity demanded

• Lower price = higher quantity demanded

Market demand total demand of individuals in the market for a product.

Extension of demand is the rise in quantity demanded caused by a fall in price.

Contraction of demand is the decrease in quantity demanded caused by increase in price.

Explain Law of Demand:

• Diminishing marginal utility: satisfaction decreases as more of a good in purchases, meaning less willing to pay higher prices, to purchase more quantity, product should be bought at lower price -> shown by lower price = higher demand

• Income effect: affordability where individuals are less willing and able to pay for expensive goods - ABILITY, PURCHASING POWER

• Substitution effect: cheaper products with same value as a more expensive product would be more desired - WILLINGNESS

Normal goods = demand increases with increase in consumer income.

Inferior goods = demand decreases with increase in consumer income.

Non-price determinants that shift demand curve:

• Tastes and preferences = goods go in and out of fashion

• Income = increase in income leads to increase in quantity demanded

• Market size = size and demographic of population, more people is more demand

• Expectations = expecting price change can influence demand e.g., sale next week, this week demand decreases

• Related goods (substitution or complements) =

• Seasons -> summer season = summer clothes quantity demand increases

Derived demand is when consumers are willing and able to buy a good based on willingness and ability to buy a related good.

Real income money retained after taxes have been paid for an individual.

Individual demand VS market demand.

Factors of Production

The 4 factors of production & factor income:

• Land -> natural resources required in production process.

  • REWARD: rent

• Labour -> human resources required in production process.

  • REWARD: wages and salary

  • Usually most expensive, replacing with machinery can increase productivity and decrease costs.

  • Labour mobility = ease of workers being able to change jobs or move to different economies.

    • Reduces unemployment and worker shortages

• Capital -> machinery or man-made resource required in production process.

  • REWARD: interest.

• Enterprise -> skills to manage all other factors.

  • REWARD: profit in businesses.

Mobility in factors of production refers to the ease of changing the factors of production.

• More mobile the factors are, more flexible production is and easier firm can respond to demand.

E.g., if a company can change from producing cars to trucks then it's CAPITAL is mobile.

Geographical mobility is the willingness and ability for a worker to move from one area to another for employment purposes.

• Can be hindered due to cost of living in other areas and family ties.

Occupational mobility is the willingness and ability for workers to change jobs.

Production Possibilities Curve

Production possibility curve shows the maximum potential of an economy to create goods and services. It demonstrates how limited resources creates scarcity where choices are required for allocation of these resources. There is usually opportunity cost with a choice which can either be constant or increasing.

Opportunity cost is the value of the next best alternative foregone when a decision is made.

Scarcity is when there are limiting resources to produce goods and all needs and wants are unable to be filled. Decisions need to be made to answer the 3 basic economic questions.

Assumptions / disadvantages:

• Only 2 types of goods produced in economy -> 2 axis

• All available resources are used efficiently

• Resource amount is fixed and fully employed

• Resources not fully interchangeable = increasing opportunity cost.

The law of increasing opportunity costs:  The shape of the PPC (concave to the origin) – can be explained by the:

• Principle of increasing costs – As production of a good expands, the opportunity cost of producing additional units generally increases. This is because certain resources are more efficient in the production of one good than the other good. (If opportunity cost were constant, i.e. no loss of efficiency when resources are transferred from the production of one good to the other good, then the PPC is a straight line.)

• constant VS increasing opp. cost

• Price Elasticity of Demand

   

  Elasticity is the responsiveness of an economic variable given a change in another.

   

   

  Price elasticity of demand is the responsiveness of quantity demanded given a change in price or real income.

  Formula:

   

   

   

   

   

   

   

  Due to law of demand, PED will always be negative. These numbers below are absolute figures.

   

  Price elastic	Change in price is proportionately smaller than change in quantity demand	PED > 1
  Price inelastic	Change in price is proportionately greater than change in quantity demand	PED < 1
  Perfectly price elastic	Change in price has an infinite change in quantity demanded e.g., money in foreign exchange	PED = infinity
  Perfectly price inelastic	Change in price has no effect on quantity demanded e.g., necessities like medication and water	PED = 0
  Unitary elastic demand	Change in price is proportional to change in quantity demand	PED = 1

   

   

   

  Determinants of PED:

  Acronym = SPLAT

   

  • S = no. Substitutes, more substitutes = price elastic, less substitutes = price inelastic

  • P = proportion of income, high proportion of income = price elastic, small proportion of income = price inelastic

  • L = luxury or necessary, luxury = price elastic, necessity = price inelastic

  • A = additive, addictive = price inelastic

  • T = time, short run = price inelastic (consumers need more time to respond to change), long run = price elastic

   

  PED can be used by businesses to set optimal price for their product, ensuring highest total revenue. This is called price discrimination.

   

  Dynamic or surge pricing can also be used -> increasing prices when demand is high and inelastic.

   

  Usually raw materials are more inelastic and manufactured goods are more elastic.

   

  Used by gov to see if taxation on demerit goods is efficient e.g., for cigarettes = inelastic, tax must be high enough that consumers aren't willing and able to pay such prices.

PED VS SLOPE:

Slope = gradient of the demand curve, represents relationship between price and quantity demanded, P BEFORE QD, measures just change

PED = represents responsiveness of quantity demanded to changes in price, QD BEFORE P, measures percentage change

top of demand curve = price elastic, bottom of demand curve = inelastic, midpoint = PED

 Circular Flow of Income

Closed economy - without government:

Open economy - with government and financial institutes

3 ways to calculate GDP:

• Income -> wages + rent + interest + profit

• Expenditure -> C + I + G + (X - M)

• Output -> sum of all sector's output

Types of economic systems:

• Market economy AKA capitalist or private enterprise

  • Freedom of enterprise and ownership of private property

  • Individuals free to decide where they spend money on

  • Resources owned by private individuals

  • Self interest, profit motive, consumer sovereignty

  • Price mechanism

  • Limited gov. intervention

• Command economy

  • Central gov plans and controls what happens in next 5 years

  • Limited variety and quantity in production

  • Firms have set quota, not in competition with other firms

  • State independence

  • Limited space for change

• Mixed economy

Positive VS normative statements.

Use of PED:

Businesses:

• Benefit from knowing how responsive consumers are to price changes at a given time

  • Seller knows demand in HIGHLY elastic, they want to lower price and capture new customers

  • Seller knows demand is HIGHLY inelastic, seller raises prices to enjoy higher revenue and not loose much quantity demanded

  • Can change the product from elastic to inelastic e.g., Coco-Cola which advertises products makes it a necessity from elastic -> inelastic

    • Brand loyal -> less responsive to high changes

Government:

• Needs to know how consumers will respond to taxes imposed on particular goods e.g., raise revenue from taxing goods, gov. Needs to know:

  • Indirect taxes on range of products e.g., GST

  • Gov put additional tax on certain product to reduce consumption of certain product and raise tax revenue DEMERIT GOODS

  • Inelastic = more expenditure on product if tax is implemented, QD doesn't decrease too much

    • Lower income groups, spend more of their income on product, greater burden

  • Elastic = greater response and greater impact

    • Less production, less workers, unemployment, economy effect (sig effect on workers and businesses)

Primary commodities are available from cultivating raw minerals without manufacturing processes. E.g., fishing, forestry, agriculture and oil. INELASTIC

• Low no. substitutes, necessity, lower proportion of income as low value of product, less time to respond to price change as frequently purchasing (cannot put off replacing)

Manufactured goods is the process of taking raw materials and making them finished goods through use of tools and processes. E.g., flour into bread or cotton into shirts. ELASTIC

• Durable goods last long time, 3 years or more e.g., fridge, cars

• Non durable goods are goods that consumers are constantly replacing e.g., food, gasoline, milk, shoes

  • Further down supply gain, greater the value due to value added for product, higher proportion of income, more time to respond to price change (Can still use good) = elastic

LEDC compete against MEDC where MEDC have adopted new technology so they can reduce prices which LEDC has to match in order to be competitive.

LEDC:

• Large agricultural or primary sector

  • Want to diversity into manufacturing and services for value add and more revenue since they loose revenue trying to match prices of MEDC

MEDC:

• More investment and capital = more manufacturing

EDC:

• Services increases and agriculture and manufacturing decreases