Notesale: Turn your study into money

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1 Introduction to markets and market failure
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1 Positive economics
→ Concerned with facts and is value-free
→ Positive statements are true or false according to their reference to the facts
→ A positive statement must be verifiable either in the present or in the future
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3 Role of value judgments in economic decision making and policy
→ Personal preference, belief, and subjective assessment underpins normative economics
→ An individual’s propensity to take risks affects much of their behaviour, such as whether they would
choose to spend all of this month’s pay check on an expensive holiday, or instead save those funds
→ Value judgments also have a major effect on government policy making, for example when a
government is choosing to cut taxes rather than increase government spending on healthcare or
education

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3 The economic problem
→ The economic problem is based on scarcity, which arises because there are finite physical resources
to meet infinite human wants
→ We have to make choices over the use of our limited resources to provide for our unlimited wants
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2 Renewable and non-renewable resources
→ Resources, or factors of production, are inputs used in the production of goods and services, and
take the form of land, labour, capital and enterprise

→ A renewable resource is one whose stock level can be replenished naturally, i
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solar energy, wind
power, tidal power, fish, timber and soil
→ A non-renewable resource is one whose stock level decreases over time and cannot be naturally
replenished, i
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fossil fuels, steel, copper and aluminium

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4 Production possibility frontiers
→ A production possibility frontier shows the maximum potential level of output for two goods and
services that an economy can achieve when all of its factors of production are fully and efficiently
employed
→ It can be used to illustrate scarcity and opportunity cost
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2 Opportunity cost shown on the production possibility frontier
→ According to the production possibility frontier above, the opportunity cost of increasing output of
capital by 20 units is 30 units of consumer goods
→ It is therefore possible to work out the opportunity cost of each unit of output of capital goods
→ 30 ÷ 20 = 1
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5 units of
consumer goods
→ Inversely, increasing consumer goods output by 30 units carries the opportunity cost of 20 units of
capital goods output
→ 20 ÷ 30 = 2⁄3, and so the opportunity cost of each unit of consumer goods output is 2⁄3 of a unit
of capital goods output

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As land that is better suited to farming wheat is used to produce livestock, the
marginal opportunity cost rises dramatically, creating a convex production possibility frontier
→ A straight production possibility frontier is possible where all factors of production are equally good
at producing both goods – the opportunity cost of each good is the same across all factors of
production
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These goods have more inelastic demand than
manufactured goods, and so when world GDP rises, the price of manufactured goods will
increase more than the price of primary products, causing the gap between developing and
developed countries to increase
→ The division of labour is one form of specialisation where individuals focus on the production of one
particular element of the production process of a good or service

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A production process is broken down into a series of simpler tasks which are conducted by
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house construction required specialised architects, surveyors,
bricklayers, carpenters and electricians
Adam Smith explained how if a pin factory broke production down into 18 different
specialist tasks, each carried out by a different worker, output of pins at the factory could
increase by 2000%

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Without the division of labour,
they would have to fulfil all these roles in the general job of ‘sandwich maker’, and so division of
labour provides a broader choice of jobs
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Previously, workers in Adam Smith’s pin
factory would have the satisfaction of knowing that their work created a pin from raw materials to
final product
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Workers will be less motivated, and will therefore put less effort into their work,
decreasing productivity
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3 The functions of money
→ Money is anything that is generally accepted as a form of payment for goods and services, or to
repay a debt
→ It is crucial that consumers and businesses have confidence in the ability of the money being used to
fulfil its functions, and where this confidence is lacking, problems arise, e
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in Zimbabwe where too
many Zim dollars were printed, leading to a lack of confidence in its function as a store of value
→ There are four functions of money
▪ Medium of exchange – enables the buying and selling of products, making exchange easier

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Measure of value – enables a value to be placed on products so they can be bought and sold
with ease
Store of value – convenient way of storing wealth so it can be spent at a later date; if
inflation is too high then money fails to fulfil this purpose
Method of deferred payments – enables borrowing and lending, so that somebody can
borrow to buy something now instead of nothing until enough money has been raised to pay
up front

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6 Free market, mixed and command economies
→ An economy organises its resources in different ways to produce goods and services
→ The vast majority of economies comprise a mixture of both private enterprise (the free market) and
state economy (elements of command), thus being mixed economies
▪ In the UK, around 60% of resources are allocated by the private sector, and 40% are
allocated by the government
▪ In other European economies (France, Germany and Sweden) the state’s share is higher
▪ In North America (the USA and Canada) it is lower, but all are considered to be mixed
economies
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This results in productive efficiency
→ Quality of products: competition means that firms constantly try to improve the quality of their
goods to gain an advantage over rivals
→ Greater choice: consumers can often choose to buy from a wide selection of goods and services, and
workers have a wide range of employment opportunities
→ Private property rights provide an incentive to innovate, because the results of research can be
protected by intellectual property law
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For Marx,
the value of a good or service is equivalent to the value of the labour required to provide it (i
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the
price of a cup of coffee is the sum of the value of the labour of coffee bean farmers, milk producers,
wholesalers, distributors, baristas, and a share of the labour-value of the builders who constructed
the premises and the electricity producers providing energy to the premises)
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In this sense, profit is necessarily
exploitative

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Furthermore, the government sets the wage for all workers, so is able to legislate
against inequality
→ The government may limit the external costs from production and consumption: it can limit
pollution from firms and tax demerit goods, i
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tobacco and alcohol
→ The government can fund the provision of public goods such as defence or law and order
→ The government has more control of the economy so there are smaller swings in the economy
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2 Disadvantages of a command economy
→ The absence of the price mechanism may lead to shortages (excess demand) and surpluses (excess
supply), leading to allocative inefficiency
→ Lack of competition between firms leads to inefficiency, so productivity is low
→ Lack of competition leads to low-quality products, especially where the emphasis is on output
maximisation and not profit

→ There is less choice, both in terms of goods for consumers, and jobs for workers, who may be forced
into one role
→ Lack of financial incentives to innovate
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2 HOW MARKETS WORK
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1 Rational decision making in the market
→ Markets exist where consumers and producers come into contact with each other to exchange
goods and services
▪ A price, or exchange value, is arranged for goods and services
▪ Buyers or consumers represent the ‘demand’ side, and sellers or producers represent the
‘supply’ side of the market
→ Consumers are assumed to make rational decisions
▪ They will allocate their income to maximise utility, or the amount of satisfaction obtained
from consuming a good or service
▪ Economists assume that utility can be measured
→ Consumers do not have enough income to buy all the things they want, and so they have to make
decisions about where to allocate their income
→ If a consumer has an extra £100 to spend, and they choose to buy a £20 t-shirt and an £80 pair of
shoes
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5 units of utility per £1 spent)

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