Cambridge IGCSE® and O Level Economics Study Guide

Section 1: The Basic Economic Problem

The Nature of the Economic Problem

• Definition: The basic economic problem is concerned with how best to allocate scarce resources in order to satisfy people’s unlimited needs and wants.

• Formula for Scarcity: $Limited\,Resources + Unlimited\,Wants = Scarcity$

• Economic Agents (Decision Makers):
      * Households (Individuals): Private individuals in society.
      * Firms: Businesses that operate in the private sector to earn profit for owners.
      * The Government: Operates in the public sector to providing services like education and healthcare.

• Three Fundamental Economic Questions:
      1. What to produce?
      2. How to produce it?
      3. For whom to produce it?

• Goods vs. Services:
      * Goods: Physical items that can be produced, bought, and sold (e.g., pencils, cars).
      * Services: Non-physical items provided by firms (e.g., haircuts, internet access).

• Needs vs. Wants:
      * Needs: Essential goods and services required for human survival (food, water, shelter, healthcare).
      * Wants: Human desires, things we would like to have but are not necessary for survival. These are infinite.

• Economic Goods vs. Free Goods:
      * Economic Goods: Limited in supply (scarce) in relation to demand (e.g., oil, wheat). Human effort is required to obtain them.
      * Free Goods: Unlimited in supply (e.g., air, sunlight). There is no opportunity cost in their production or consumption.

The Factors of Production

• Definition: The resources required to produce a good or service. They are categorized by the acronym CELL:
      * Capital: Manufactured resources like machinery, tools, and vehicles.
      * Enterprise: Risk-taking and business skills required to manage the other factors.
      * Labour: Human resources, including skilled and unskilled labor.
      * Land: Natural resources such as coal, water, wood, and metal ores.

• Rewards for Factors (Income):
      1. Rent: Reward for Land.
      2. Wages/Salaries: Reward for Labour.
      3. Interest: Reward for Capital.
      4. Profit: Reward for Enterprise.

• Mobility of Factors:
      * Geographical Mobility: The willingness and ability of labor to move to different locations for work. Influenced by family ties and living costs.
      * Occupational Mobility: The ease with which a person can move between different jobs. Influenced by retraining costs and time.

• Changes in Quantity/Quality: Influenced by costs of factors, government policies (taxes/subsidies), new technology, migration, education, and weather.

Opportunity Cost

• Definition: The cost of the next best opportunity forgone when making an economic decision.

• Impact on Decision Makers:
      * Consumers: Choosing one product over another due to limited income.
      * Workers: Choosing one career path prevents them from pursuing others.
      * Producers: Choosing which product line to invest in.
      * Governments: Finite tax revenue must be allocated between infrastructure, defense, or healthcare.

Production Possibility Curve (PPC)

• Definition: A graphical representation showing the maximum combination of two categories of goods/services an economy can produce per period of time. It represents the economy's productive capacity.

• Significance of Points:
      * Points on the curve: Full use of resources and efficiency.
      * Points under the curve: Factors of production are idle (inefficiency).
      * Points beyond the curve: Unattainable with current resources.

• Shifts and Movements:
      * Movements along the curve: Incur opportunity cost (producing more of Good A requires producing less of Good B).
      * Outward Shift: Represents economic growth caused by increased quality or quantity of factors (e.g., new technology, skilled labor).
      * Inward Shift: Represents a decrease in productive capacity caused by natural disasters, war, or resource depletion.

Section 2: The Allocation of Resources

Microeconomics and Macroeconomics

• Microeconomics: The study of particular markets and individual decision makers (households and firms). Focuses on factors like product demand and specific firm costs.

• Macroeconomics: The study of behavioral and decision making for the whole economy. Focuses on aggregate variables like GDP, inflation, and unemployment.

The Role of Markets

• The Market System (Price Mechanism): A method of resource allocation using market forces (Demand and Supply) relative to prices.

• Market Equilibrium: Occurs when quantity demanded ($Q_d$) equals quantity supplied ($Q_s$). The market is "cleared."

• Market Disequilibrium:
      * Shortage (Excess Demand): Price is set below equilibrium. Q_d > Q_s.
      * Surplus (Excess Supply): Price is set above equilibrium. Q_s > Q_d.

Demand

• Definition: The willingness and ability of customers to pay a price for a product.

• Law of Demand: Inverse relationship between price and quantity demanded.

• Determinants (HIS AGE): Habits/Tastes, Income, Substitutes/Complements, Advertising, Government Policies, Economy.

• Movements vs. Shifts:
      * Movement: Caused by a change in price (Contraction/Extension).
      * Shift: Caused by non-price determinants (Increase/Decrease in demand).

Supply

• Definition: The ability and willingness of firms to provide goods/services at given price levels.

• Law of Supply: Positive relationship between price and quantity supplied.

• Determinants (TWO TIPS): Time, Weather, Opportunity cost, Taxes, Innovations, Production costs, Subsidies.

Elasticity

• Price Elasticity of Demand (PED):
      * Formula: $PED = \frac{\%\,change\,in\,Quantity\,Demanded}{\%\,change\,in\,Price}$
      * Values:
          * PED > 1: Price Elastic (Responsive).
          * PED < 1: Price Inelastic (Unresponsive).
          * $PED = 1$: Unitary Elastic.

• Price Elasticity of Supply (PES):
      * Formula: $PES = \frac{\%\,change\,in\,Quantity\,Supplied}{\%\,change\,in\,Price}$
      * Determinants: Spare capacity, stock levels, number of producers, time period.

Market Failure and Economic Systems

• Market Failure: Occurs when resources are allocated inefficiently.
      * Public Goods: Non-excludable and non-rivalrous (government must provide as firms have no profit motive).
      * Merit Goods: Under-consumed if left to markets (e.g., healthcare).
      * Demerit Goods: Over-consumed (e.g., cigarettes).

• Economic Systems:
      1. Market Economy: Private sector ownership; resources allocated by price mechanism.
      2. Planned Economy: Public sector control; government allocates resources.
      3. Mixed Economy: Combination of both (prevalent globally).

• Government Intervention: Includes maximum/minimum prices, indirect taxes (on demerit goods), subsidies (on merit goods), rules/regulations, and privatization/nationalization.

Section 3: Microeconomic Decision Makers

Money and Banking

• Functions of Money: Medium of exchange, Measure of value, Store of value, Standard of deferred payment.

• Characteristics of Money: Durability, Acceptability, Divisibility, Uniformity, Scarcity, Portability.

• Central Banks: Oversee money supply, act as government's bank, bankers' bank, and lender of last resort.

• Commercial Banks: Retail banks providing loans, deposits, and credit creation.

Households and Workers

• Disposable Income: Income available after compulsory deductions like income tax.

• Saving and Borrowing: Influenced by interest rates, confidence levels, and wealth.

• Wage Determination: Determined by the interaction of labor demand and labor supply.

• Specialization vs. Division of Labour:
      * Specialization: Expertise in a profession.
      * Division of Labour: Breaking processes into specific tasks. Increases efficiency but can cause boredom/alienation.

Firms, Costs, and Market Structure

• Costs of Production:
      * Total Cost (TC): $TC = Fixed\,Costs (FC) + Variable\,Costs (VC)$.
      * Average Total Cost (ATC): $ATC = \frac{TC}{Output}$.

• Economies of Scale: Falling average costs as output increases (e.g., bulk-buying, technical, financial).

• Market Structures:
      * Competitive Markets: Many firms, price takers, low barriers to entry.
      * Monopoly: Single supplier, price maker, high barriers to entry.

Section 4: Government and the Macro Economy

Macroeconomic Aims and Policies

• Five Major Aims: Economic growth, low unemployment, stable prices (low inflation), balance of payments stability, and redistribution of income.

• Fiscal Policy: Use of taxation and government spending. Expansionary (stimulate economy) vs. Contractionary (slow down inflation).

• Monetary Policy: Manipulation of interest rates and the money supply.

• Supply-side Policies: Long-term measures to increase productive capacity (e.g., education, deregulation, tax incentives to work).

Economic Growth, Employment, and Inflation

• GDP Formula: $GDP = C + I + G + (X - M)$

• Business Cycle: Pattern of Boom, Recession (2 consecutive quarters of falling GDP), Slump, and Recovery.

• Unemployment Rate: $\frac{Number\,unemployed}{Labour\,force} \times 100$

• Consumer Price Index (CPI): Measures inflation via a weighted basket of goods.

• Types of Inflation:
      * Demand-pull: Excessive demand relative to supply.
      * Cost-push: Rising production costs driving prices up.

Section 5 & 6: Development and International Trade

Economic Development and Globalisation

• Standard of Living Indicators: Real GDP per capita and HDI (Education, Healthcare, Income).

• Poverty: Absolute (lives on less than $1.25/day) vs. Relative (comparative level within a society).

• Population Growth Factors: Birth rate, Death rate, Net migration rate ($Immigration - Emigration$ ).

• Globalisation: Interconnection of world economies.

• International Trade:
      * Visible Balance: Trade in physical goods.
      * Invisible Balance: Trade in services.
      * Trade Barriers: Tariffs (tax on imports), Quotas (limits), Subsidies, Embargoes.

• Exchange Rates: Price of one currency in terms of another. Determined by market forces (Floating) or government pegging (Fixed).