1.4 Choice, opportunity cost and efficiency in resource allocation

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.