1.4 Choice, opportunity cost and efficiency in resource allocation
Resource Allocation
involves making choices or decisions about how scarce natural, labour and capital inputs are to be used or distributed among competing areas of production
Opportunity Cost
The cost and benefit of the next best alternative foregone, every economic decision has opportunity cost due to the limited resources available to meet all wants and needs.
Relative Prices
The price level of a good or service relative to that of another good or service. This may effect the level of resource allocation, due to the relative profits which may be available if higher relative prices.
The Production Possibility Frontier.
a way of illustrating the different production options, combinations or choices available for an economy.
Used to understand:
Relative scarcity
Efficiency and inefficiency in allocating resources
All choices or economic decisions about production and allocation of resources involve an opportunity cost
Assumptions of a PPF
Only 2 types of outputs can be produced by a nation.
A nation fully uses its scarce natural, labour or capital resources or produce (no wastage)
The nation uses the most efficient production method now available
Factors which may cause a nation to be operating inside or outside the PPF
Foreign Investment level
Level of skilled immigration
Discovery of new natural resources
Technological breakthroughs
Government spending on education/training workers
Level of worker productivity or efficiency
New Infrastructure.
Types of efficiency and the effect on resource allocation, the PPF and societal living standards.
Allocative efficiency
Occurs when resources are used to produce goods and services that best satisfy society’s needs and wants, maximising wellbeing and living standards.
Any point on the PPF represents an efficient use of resources, as increasing one output requires reducing another.
Productive/technical efficiency
Producing goods and services at the lowest cost with minimal resource waste.
At any given time, a society operating on the PPF is maximising output per input. Over time, improvements in technical/productive efficiency can expand the PPF outward, increasing allocative efficiency and enabling greater satisfaction of societal needs.
Intertemporal efficiency
Refers to balancing current consumption and saving for future investment to enhance long-term consumption.
Rapid economic growth today may deplete resources and worsen climate change, reducing future choices and impacting allocative efficiency.
Dynamic efficiency
Refers to the speed at which resources can be reallocated as needed to meet the changing needs and choices of consumers
On the PPF, it affects how quickly society can shift from one production point to another. High resource mobility enables faster adaptation to price changes, improving both allocative efficiency and ensuring resources are directed to their most valued uses.
Factors affecting the choices or economic decisions made by individuals, businesses and governments:
Choices and decisions by individuals
Limited level of disposable income
Personal tastes and beliefs
Seasonal conditions
Rational and non-rational behaviour
Choices and decisions by businesses
Productive costs and profitability
Decisions of rival firms in their industry
Community feelings and opinions
Government decisions and policies that alter business behaviour
Choices and decisions by governments
Political survival and election promises
Voter attitudes and expectations
Political party’s values
1.5 Market structure and the conditions for a free and perfectly competitive market
Market - an institution where buyers of goods and services, and sellers of goods and services, negotiate the price for each good or service.
Types of markets:
Perfect competition:
Many buyers and sellers
Buyers and sellers have perfect knowledge of market conditions
Sellers are all price takers, with limited power
Strong competition
Easy entry and exit
Closest but not pure examples:
Markets for some primary products or rural commodities, share market
Monopolistic competition:
Relatively small number of sellers
Imperfect knowledge of market conditions on the part of many buyers and sellers
Some sellers with greater market power than others determine the price
Lesser ease of entry and exit
Good examples:
Clothing manufacturers, retail trade, restaurants
Oligopoly
Relatively small number of sellers
Often with considerable price-making power and some potential for collusion
Significant brand differentiation
Difficult level of entry and exit
Good examples:
Supermarkets, banks, oil companies
Monopoly
Only one seller controls the market
No competition
Seller is the price maker
Extremely difficult level of entry and exit
Closest, but not pure examples:
Water companies, electricity transmissions
Meaning of these factors
Price maker - has sufficient market power to influence prices at which goods and services are sold within that market
Price taker - has very little power and will have to accept price levels determined by others in the market
Homogenous products - occurs when competing products are so similar that they can all be used for the same purpose
Product differentiation - occurs when particular sellers add features to their products that are not available in competing products, often meaning that they may not be interchangeable in terms of usage by consumers
Benefits of strong competition:
higher efficiency in resource allocation
lower prices and greater purchasing power of incomes
better quality goods and services and improved customer service
1.6 Microeconomics — the market as an important decision maker in Australia’s economy
3 Basic economic questions:
What and how much to produce
The market uses price signals and incentives to determine the types and quantities of goods and services produced, guiding firms to focus on profitable and high-demand items.
How to produce
The market determines production methods by setting resource prices, enabling businesses to choose the most cost-effective and efficient options to maximise profits.
For whom to produce
The market determines the distribution of goods, services, and incomes based on individuals' economic contributions, allowing higher earners to afford more than lower earners.
Theories explaining the law of demand
The income effect
When the good or service becomes more expensive and less affordable for most, fewer people have the necessary income to spend on it, and so the quantity demanded contracts.
The substitution effect
When the good or service becomes more expensive, buyers also look for cheaper alternatives or substitutes the quantity demanded contracts.
Theories explained the law of supply:
The profit motive
Other things like production costs remaining equal or unchanged, a higher selling price in the market usually means an increase in sales revenue and profits, making the production or supply of this good more attractive than if it is sold at a lower price. Sellers expand supply.
Consideration of opportunity costs
If sellers recieve a higher price for what they sell, other things being unchanged, the opportunity cost of producing another good or service rise, making it more profitable to reallocate away from uses so that output can be increased, thus increased supply.
Determining the marker equilibrium price and quantity traded:
The equilibrium market price is where buyers and sellers agree, balancing quantity demanded and supplied. At this price, there is no surplus or shortage, ensuring market stability and satisfaction for both parties.
Expansion in demand - occurs when the price falls and consequently, there is a movement downward along the demand curve, representing a greater level of demand for the product.
Contraction in demand - occurs when there is a price rise and a consequent movement upwards along the demand curve, representing a reduction demand for the product.
Expansion in supply - occurs when the prices rise and consequently ,there is a movement upward along the supply curve, representing a greater willingness of sellers to supply the product.
Contraction in supply - occurs when there is a price fall and a consequent movement downwards along the supply curve, representing a reduced willingness of sellers to supply the product
1.7 The effects of changes in non-price demand and supply factors on market equilibrium and the allocation of resources
Non price factors which shift the demand curve.
Disposable income
Changes in demographics - population sizes
Changes in fashions and tastes
Interest rates
Substitutes
Price of an original product increases = demand for substitutes products increase.
Price of an original product decreases = demand for substitutes products decreases
Complementary goods and services (these are goods and services such as when you buy a car, you need fuel, tyres, repairs, etc)
When the price of a product increases, the demand for the complementary products will decrease
Business and consumer confidence
High confidence, high demand
Low confidence, low demand
Government policy and regulations
Subsidies Increases demand
Taxation decreases demand
The effect of a decrease in the quantity demanded at a given price:
A decrease in the quantity demanded at a given price occurs when non-price factors weaken, leading to a shift to the left of the demand curve.
The effect of an increase in the quantity demanded at a given price:
When non-price factors strengthen, increasing demand at all price levels, the demand curve shifts to the right.
The effect of a decrease in the quantity supplied at a given price:
When supply conditions weaken, reducing the quantity sellers are willing to produce at any price, the supply curve shifts inward to the left. In the wool market example, factors like drought or higher production costs decrease supply, shifting the supply.
The effect of an increase in the quantity supplied at a given price:
When supply conditions improve, increasing the quantity sellers are willing to produce at any price, the supply curve shifts outward to the right.
1.8 The meaning and significance of price elasticity of demand and supply
Price elasticity of demand
measures the responsiveness of the quantity demanded relative to the percentage change in price.
PED calculated as:
price change in the quantity demanded ÷ percentage change in its price
Factors of PED:
Degree of necessity
Availability of substitutes
Time
Proportion of income
Price elasticity supply - measures how responsive sellers are to price changes. According to the law of supply, quantity supplied increases with price. The degree of responsiveness is shown by the steepness of the supply curve.
3 types of price elasticity of supply
Elastic
Inelastic
Unit elastic (normal; without change)
Factors of PES:
Storability and durability
Spare capacity
Time
The significance of price elasticity of demand and supply:
The price polices of sellers
Businesses consider price elasticity of demand (PED) when setting prices. Retailers offer discounts to boost sales if demand is elastic, preventing revenue loss. Firms with essentials, inelastic goods can raise prices to increase revenue and profits.
The raising of government revenue
Governments tax inelastic goods like tobacco, alcohol, and fiel to raise revenue, as consumers keep buying despite higher prices. However, if the goal is to reduce consumption, high taxes are less effective when demand is unresponsive.