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• The basic economy problem is scarcity and choice since there are only a limited
amount of resources available to produce the unlimited amount of goods and
services we desire
...
It
includes land, gold, timber, oil, copper and water
...
• Labor – is the work performed by employees
• Capital - Capital includes the buildings, tools and machines that employees use to
make goods and services
...
An entrepreneur
finds ways to combine the other factors of production – land, labor and capital – to
produce a product and make a profit
...
• Opportunity cost – the benefit of the next best alternative sacrificed or forgone
...
It illustrates opportunity cost and trade-offs
• Shape of PPF illustrates principle of increasing cost- As more of one product is
produced then increasing amounts of the other product must be given up
‘opportunity cost’
• Points within the curve show when a country’s resources are not being fully utilized
...
They are
inefficient- we can increase both goods and services without any opportunity cost
...
It occurs because not all factor inputs are equally
suited to producing items
...
• Trade between countries allows nations to consume beyond their own PPF
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• Specialization – causes the PPF to shift to one side
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• Allocative efficiency- when it manages to produce the combination of goods and
services that people actually want
...
• Pareto efficiency or Pareto - optimality is a state of allocation of resources from
which it is impossible to reallocate so as to make any one individual or preference
criterion better off without making at least one individual or preference criterion
worse off
...
• Distribution of gains in output and whether or not an improvement in average living
standards has benefited the majority of consumers or whether there has been an
increase in inequality and relative poverty
...
• Determinants of demands: Price (movement), Income, Fashion / Tastes /
preferences, Price of Substitutes, Price of Complements, Weather / population,
Expectations about the future, Advertising (shift, non-price determinants)
• An increase in price will cause a CONTRACTION in demand
...
• A fall in price will cause an EXTENSION in demand
...
We could also describe it as showing an inverse
relationship between price and quantity
...
• Substitution effect - The effect of a change in price on quantity demanded arising
from the consumer switching to or from alternative (substitute) products
...
,
• Firm’s Expectations – seasonal goods (Christmas)
• Technology – improvement in efficiency of production
• Legislation – limit on production
• Indirect Tax – tax on sugar foods (coca cola, pepsi)
• Subsidies – grant to support production costs (wind turbines)
• Number of firms – many firms competing
• Equilibrium- quantity demanded is equal to quantity supplied
• D=S, no Xs, no TENDANCY to CHANGE
• High quantity supplied, but not enough demand- surplus or excess supply
• Consumer surplus- benefits of paying the equilibrium price (area above the Equil
price but below the demand curve)
• Producer surplus - benefits of receiving the equilibrium price (area below the Equil
price but above the supply curve)
• TWS is the sum of consumer surplus and producer surplus
• Adam Smith identified that the invisible hand means markets allocate goods in
society’s best interests
Why are prices important?
• They ration goods and services
• They signal information to the market and about the market conditions/expectations
• They provide incentives to actors in the market
What are inter-related markets?
• Complementary goods - are used/demanded together
...
• Derived demand - there is a demand for a good or factor of production resulting
from demand for another good or service
...
People
may demand oil because it can be used to create either petrol or plastics
...
Elasticity
• Elasticity - numerical measure of the responsiveness of quantity demanded (Qd) or
quantity supplied (Qs) to one of its determinants
...
e
...
PED = 0
2
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It is shown by a vertical demand line
• Relative inelasticity (Example: demand for petrol)
1
...
A percentage change in price results only in a smaller than proportional change
in quantity
3
...
|PED| = 1
2
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It cannot be a straight line
• Relative elasticity (Example: demand for luxury goods)
1
...
A percentage change in price results in a larger than proportional change in
quantity
3
...
|PED| = ∞
2
...
It is shown by a horizontal demand line
• There are 4 key factors that influence price elasticity of demand
1
...
The type of good – necessity or luxury
3
...
Time horizon
• Income elasticity of demand (Yed) - measures the relationship between a change in
quantity demanded and a change in real income
• Normal goods have a positive income elasticity of demand - income elasticity of
demand of between 0 and +1
• Luxuries - an income elasticity of demand > +1
• Inferior goods - negative income elasticity of demand
...
• Cross price elasticity of demand - the responsiveness of quantity demanded (of good
A) to changes in the price (of good B)
• XED
• Numerical
value
• Relationship between the goods
• POSITIVE
• 0–1
• Distant (weak) substitutes
• POSITIVE
• >1
• Close (strong) substitutes
• NEGATIVE
• 0 to (-1)
• Distant (weak) complements
• NEGATIVE
• < (-1)
• Close (strong) complements
• ZERO
• 0
• Independent goods – there is no relationship
between them
• Price elasticity of supply - the responsiveness of quantity supplied to changes in the
good’s own price
...
Spare capacity
2
...
The nature of production
4
...
• When demand is inelastic, a price increase causes revenue to rise
...
E
...
effects of pollution
...
E
...
causing social benefits to outweigh private
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•
Private sector being unable to supply important public goods profitably to consumers
...
•
Immobility of factors of production
•
Equity and issues of fairness
•
Market - A place where buyers and sellers meet to exchange goods and services
...
No
market in which it can be sold or produced
...
2) No account is taken of the social costs/benefits
...
Demerit goods also usually have
negative externalities – where consumption/production of these goods causes a harmful effect to a
third party
...
When social costs exceed private costs negative externalities exist
...
This incentivises the producer to produce in a manor that does not benefit society as
much as if private costs exceeded social costs
...
This leads to the producer not accounting for externalities in their calculations (overproduction) ……
...
When social benefit exceeds private benefit positive externalities exist
...
This leads to the producer not accounting for externalities in their calculations as they
ignore the benefit to society (under-production) ……
...
So the market needs to encourage consumption and the benefit society will gain ie
...
•
•
Merit Good - a good which can have a positive impact on the consumer – but these beneficial
effects may be unknown or ignored by the consumer/producer, as they do not realise the true
personal benefits for example, people underestimate the benefit of education or getting a
vaccination
...
•
Therefore in a free market, there will be under consumption of merit goods
...
•
Social Benefit - Benefit to society of an economic transaction, including private and external
benefits
...
•
Production
Find alternative ways so plastic is not used in production / packaging of goods
...
Tax incidence refers to how the burden of a tax is distributed between firms and
consumers (or between employer and employee)
...
Subsidies lower the marginal private costs of production, increasing the supply, reducing the price
and increasing the quantity demanded for the good being subsidised
...
The higher price incentivises firms to provide a greater quantity, resulting in
a more efficient allocation of resources towards the good
...
Examples include opting for plastic alternatives such as: waste disposal, sustainable alternatives,
and so on…
•
The short run
1
...
All may be fixed: this is known as the immediate period
3
...
•
The long run
1
...
Technology is fixed
3
...
•
The very long run
1
...
•
Fixed costs - Do not change with the quantity of output
•
Variable costs - Do change with the quantity of output
•
Average Fixed Cost (AFC) curve falls as output increases because fixed costs represents an ever
decreasing proportion of total cost as output increases;
•
MC curve at first falls and then rises as diminishing returns sets in;
•
The lowest point on the MC and AVC curves shows the point where diminishing marginal returns
and diminishing average returns set in respectively;
•
The MC curve will intersect the AC curve from its lowest point
•
If the MC is above the AC the Average cost will rise
•
•
If the MC is below the AC the Average cost will fall
Long run
•
There are 3 possible outcomes for product:
•
•
Increasing returns to scale
•
When the factors of production are increased, output increases by a greater proportion than Total
Costs (TC)
•
•
So average costs (AC) must be falling
•
Constant returns to scale
o When the factors of production are increased, output increases by an identical proportion
o AC are constant
•
Decreasing returns to scale
•
When the factors of production are increased, output increases by a smaller proportion than TC
•
So average costs must be increasing
•
Costs
SRAC1
SRAC2
•
•
•
•
LRAC
•
•
•
Output
•
•
The MES marks the output at which long-run average costs first reach their minimum level as
output rises
...
•
Productive efficiency occurs when average costs are minimised
•
There may be more than one efficient point on the LRAC
•
Economies of scale
•
Diseconomies of scale
•
Internal sources
•
Internal sources
•
Technical economies
•
Managerial factors
•
Managerial economies
•
Geographical factors
•
Purchasing & marketing economies
•
•
Financial economies
•
•
External sources
•
External sources
•
Spatial advantages / networks
•
Expansion that is too rapid
•
Training costs
•
•
Export contracts
•
•
•
Commercial / Bulk buying:
If you buy a large quantity then the average costs will be lower
...
•
Some production processes require high fixed costs e
...
building a large factory
...
By using the
factory to full capacity average costs will be lower
...
•
With little training they can become very proficient in their task, this enables greater efficiency
...
•
Marketing:
•
A large firm can spread its advertising and marketing budget over a large output
...
•
A bigger firm can get a better rate of interest than small firms
...
•
E
...
if the industry gets bigger all firms will benefit from better infrastructure, access to specialized
labour and good supply networks
...
Therefore there will be decreasing returns to scale
•
Diseconomies of scale can occur for the following reasons:
•
1
...
Alienation: Working in a highly specialized assembly line can be very boring, therefore workers
become de motivated
•
3
...
It is due to economies of scale and
diseconomies of scale
...
•
However, after a certain output, a firm may experience diseconomies of scale
...
•
For example, in a big firm it is more difficult to communicate and coordinate workers
...
It is possible the LRAC could
just be downward sloping
...
•
External economies & diseconomies of scale are the result of growth within the industry in which
a firm operates
...