Notesale: Turn your study into money

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A Level Economics
Revision
Theme 1(micro) – Pearson Edexcel
(Syllabus 2015 A)

LESSON 1 OUTCOMES
THEME 1

1
...
1
...
2 How Markets Work – What’s New?

1
...
3 Elasticity of Demand

1
...
5 Elasticity of Supply

2

1
...
5 SPECIALISATION AND THE DIVISION OF LABOUR
Key Points

The “invisible hand of the
market”

“It is not from the benevolence
of the butcher, the brewer and
the baker that we expect our
dinner, but from their regard to
their own self-interest”

The benefits of
specialisation

Pin factory example:

One person, on his/her own
could only make one pin per
day
10 people, each with a specific
task, could make 48,000 per
day

BENEFITS

Markets (and economies)
function most efficiently
when individuals are given
the freedom to pursue selfinterest

WHAT ARE THE ADVANTAGES AND DISADVANTAGES OF THE
DIVISION OF LABOUR?
•

Workers acquire specific skills → increase in labour
productivity

•

Trained to use machinery → increase in capital
productivity

•

Time saved due to workers not changing tasks

•

Workers specialise in tasks for which they are best
suited

COSTS/
EVALUATION

WHAT ARE ADAM SMITH’S KEY FINDINGS?
“An Enquiry into the Nature and Causes of the Wealth of
Nations” (1776)

•

Jobs may become monotonous → decrease in
labour productivity and quality of work

•

Increase in absenteeism due to poor job satisfaction

•

Some markets are too small to benefit from
specialisation e
...
a village convenience store
3

1
...
5 SPECIALISATION AND THE DIVISION OF LABOUR
Key Points

•

Increased production of G & S due to allocation
of resources to production of goods that can be
produced more efficiently (i
...
an increase in
productive efficiency)

•

Increased consumption by exporting G&S in
exchange for other G&S produced more cheaply
elsewhere

COSTS/
EVALUATION

BENEFITS

WHAT ARE THE ADVANTAGES AND DISADVANTAGES OF
SPECIALISATION AND TRADE?

•

WHAT COUNTS AS MONEY AND WHAT ARE ITS
FUNCTIONS?
“NARROW” MONEY
Notes and coins in
circulation i
...
outside
the Central Bank

“BROAD” MONEY
Notes and coins PLUS
bank deposits

Medium of
Exchange

No need for a double
coincidence of wants

Measure of value

Ability to compare and
value different goods and
services

Can lead to structural unemployment e
...

manufacturing in Northern England

•

A break down in the supply chain can have severe
consequences

Store of value

Ability to save money
enables people to store
wealth

•

Can lead to primary product dependency → price
volatility and deteriorating terms of trade

Method of
deferred payment

Ability to measure future
claims e
...
agree a salary for
the coming year

1
...
3 ELASTICITIES OF DEMAND
Key Points

5

1
...
5 ELASTICITY OF SUPPLY
Key Points
WHAT ARE THE KEY DETERMINANTS OF PRICE ELASTICITY OF SUPPLY?
COMPLEXITY/
MOBILITY OF
FACTORS OF
PRODUCTION

E
...
it is easier to transfer FoP to the
production of apple watches than it is to
transfer FoP to the production of hand-made
watches
•

TIME
•

Length of time to produce the good e
...

agricultural products take a long time to
produce
Time-frame: short-run vs long-run

SPARE
CAPACITY

E
...
higher levels of unemployment may
enable firms to be responsive to an increase in
demand

ABILITY TO
STORE

E
...
perishable goods (e
...
agricultural
products) have a lower price elasticity than
non-perishable goods (e
...
clothing)

6

1
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5 ELASTICITY OF SUPPLY
Key Points

WHAT IS THE RELATIONSHIP BETWEEN
PED/PES AND THE SLOPE OF A STRAIGHT
LINE DEMAND/SUPPLY CURVE?

Slope of Supply curve =

PES =

%Qs
%P

=

Qs P
x
P Q

Qs
Q
=
P
P

=

Qs
P

HOW DO YOU ILLUSTRATE PES ON A
GRAPH?
Any linear supply curve
that intersects the y-axis
will have a PES > 1

Qs P
x
Q
P

= Slope x

P
Q

Any linear supply curve
that intersects the x-axis
will have a PES < 1

7

1
...
3 & 1
...
5 - ELASTICITIES
Key Points

Explain how the incidence of an indirect tax
depends on PED and PES
...


•

This is because an indirect tax increases a firm’s costs of
production, causing the supply curve to shift inwards
...


•

However, the price that producers receive is the difference
between P2 and the tax per unit, which is equal to Pp
...


•

The tax burden on the consumers is shown by area A and the tax
burden on producers is shown by area B
...
2
...
2
...


Price

Portion of tax (per unit)
paid by consumers

Portion of tax (per unit)
paid by producers

S2 = S1 + Tax

The tax burden will fall proportionately more on the group
whose activities are less responsive to changes in price (i
...
less
price elastic)
...


Whereas, as shown in diagram 2, where PED is greater than PES,
the tax burden on producers is greater than the tax burden on
consumers
...
2
...
2
...
2
...
2
...


SIGNIFICANCE
FOR FIRMS AND
GOVERNMENTS

USING A DIAGRAM
ILLUSTRATE THE
RELATIONSHIP BETWEEN
PED AND TR

PED = 1

Inelastic
Portion

EVALUATION

Elastic
Portion

FIRMS – enables firms to set prices in order
to maximise revenue
GOVERNMENTS – enables governments to
estimate the impact/incidence of
taxes/subsidies on consumers/producers and
tax revenue raised/cost of subsidy

• Difficult to know PED without conducting
experiments – relate to 1
...
1
• Relationship between PED and TR based on
assumptions – rationality and ceteris paribus
• Doesn’t tell us anything about costs – firms
seek to profit maximise not revenue maximise?
11

1
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3 ELASTICITIES OF DEMAND
Key Points

GOVERNMENTS – gives an indication of the growth
of certain sectors over time, the resilience of the
economy to a recession and a country’s terms of
trade

•

YED for a product varies from country to country
depending on the income levels

•

Difficult to know YED without conducting
experiments – link to 1
...
1

•

Relationship between income and demand is based
on various assumptions – ceteris paribus

SIGNIFICANCE
FOR FIRMS

FIRMS – as economies (and therefore incomes) tend
to grow over time, it gives firms an indication of the
demand for their product over time
...


•

Pricing strategy for complementary goods – if a
competitor cuts/increases price of complement,
firms will use XED to determine effect on
demand for their product

•

Pricing strategy for substitutes goods – as above
but with respect to substitutes

• Difficult to know XED without conducting
experiments – relate to 1
...
1

12

1
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7 PRICE MECHANISM
Key Points
With reference to the diagram below,
explain how the market equilibrium moves
from A to C
...


SIGNAL EFFECT
Higher prices acting as a
signal to other producers
that there is a shortage

INCENTIVE EFFECT
Higher prices incentivises
producers to increase supply
and consumers to decrease
demand

RATIONING EFFECT
Higher prices reduces the number
(i
...
rations) of consumers that are
willing and able to purchase the good

Prices will continue to increase until there is no longer a shortage and a
new market equilibrium is reached (point C)
...
2
...
2
...
Depends on tax incidence

•

Decrease in price → increase in disposable income → standard
of living, inequality…
• Increase in consumer surplus
• BUT…
...

• Decrease in producer surplus

BUT…
...
revenue → impact on budget/spending…
...
welfare loss (if no externalities or due to govt
...
→ reinvested → dynamic efficiency
Increase in producer surplus
BUT…
...
welfare loss (if no externalities or due to govt
...
3 Market Failure – What’s New?

1
...
1 (a) Understanding Market Failure

1
...
2 Externalities

1
...
4
...
3
...
e
...


Productive efficiency
Full employment of all
resources

Capital
Goods
S = MC

Price,
Costs,
Benefits

MC = MB at the market
equilibrium
CS and PS (and therefore
SS) is maximised at the
market equilibrium
...
3
...
g
...
e
...


Popt = Pm

External Cost

MSC

Price,
Costs,
Benefits

The free market equilibrium
MPC = MPB is not the same
as the socially optimal
equilibrium, MSC = MSB
...


Free market equilibrium is
NOT allocatively efficient
...
3
...
g
...


•

As a result the MPC (supply) curve, which reflects the firm’s private costs of
production, diverges from the MSC curve, which reflects the cost to society of
producing the good or service
...


•

The vertical distance between MPC and MSC is the external cost
...


•

The free market equilibrium is given by the intersection of MPB and MPC
...


•

The free market overallocates resources to the production of the good and
too much of it is produced relative to the social optimum
...
As a result welfare (equal to the shaded
area on the graph) is lost
...
3
...


•

The vertical distance between MPB and MSB is the external benefit
...


•

The free market equilibrium is given by the intersection of MPB and MPC
...


•

The free market underallocates resources to the production of the good and too
little of it is consumed relative to the social optimum
...
As a result welfare (equal to the shaded area
on the graph) is lost
...
g
...

As a result the MPB (demand) curve, which reflects the individual’s private benefits
of consumption, diverges from the MSB curve, which reflects the benefits to society
from consumption of the good or service
...
4
...
g
...
europa
...
g
...
g
...
4
...


The price of the
permits is determined
by demand and supply
...

22

1
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1 (b) – OTHER METHODS OF GOVERNMENT INTERVENTION
How is the price of permits determined?

Draw a supply and demand diagram for carbon
permits (Note: think carefully about the
elasticity of the supply curve)
...
4
...


MSC = MPC + price of permit

Price,
Costs,
Benefits

S = MPC

Additional
cost per
unit

Pm = Popt
Pm

What impact would a cap and trade scheme also have on the
size of the external cost in the LONG RUN?

Illustrate this impact on a supply and demand diagram that
shows the negative production externality caused by carbons
emissions
...
4
...
4
...
4
...

What non-price determinants might cause shifts
in the demand and supply of permits?

Factors that may cause changes in demand for
permits:
• Economic growth → increase in real output
→ increase in demand for permits
•

•

Price of
permits

S

P2
P1
P3

D2

Development and adoption of low cost, low
emission fuels → lower carbon emissions →
decrease demand for permits
Anything that increases the supply of a good
or service → increase in carbon emissions →
increase in demand for permits

Supply of permits is perfectly
inelastic as the supply is fixed by the
government/international
organisation (and is therefore
completely unresponsive to changes
in price)

D3 D1
Q1

Quantity of permits
26

1
...
1 (b) – OTHER METHODS OF GOVERNMENT INTERVENTION
How does a cap and trade scheme effect costs of production and the external cost of carbon emissions?
What impact would a cap and trade scheme have on the costs of
production for firms that have high levels of carbon emissions in
the SHORT RUN?
Illustrate this impact on a supply and demand diagram that
shows the negative production externality caused by carbons
emissions
...


MSC = MPC + price of permit
MSC2
S = MPC

Price,
Costs,
Benefits
Popt1

Allocative
Efficiency at
market
equilibrium

As firms adopt
“cleaner”
technology, carbon
emissions (and
therefore the
external cost) will
decrease

Popt2
Pm

D = MPB = MSB
Qm = Qopt Qm

Quantity

D = MPB = MSB
Qopt1 Qopt2 Qm

Quantity

27

1
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1 (b) – OTHER METHODS OF GOVERNMENT INTERVENTION
What is a “carbon tax” and how does it differ from cap and trade?
What is a carbon tax and how does it differ from a cap and trade scheme?
SHORT RUN

LONG RUN

MSC = MPC + tax

Price,
Costs,
Benefits

S = MPC
Tax per
unit

Pm = Popt
Pm

Popt1
Allocative
Efficiency at
market
equilibrium

Pp
Government
revenue

MSC = MPC + tax
MSC2
S = MPC

Price,
Costs,
Benefits

As firms adopt
“cleaner”
technology, carbon
emissions (and
therefore the
external cost) will
decrease

Popt2
Pm

D = MPB = MSB
Qm = Qopt Qm

Quantity

D = MPB = MSB
Qopt1 Qopt2 Qm

Quantity

What is the difference between a tax on emissions and a tax on OUTPUT?

28

1
...
1 (b) – OTHER METHODS OF GOVERNMENT INTERVENTION
What is the difference between interventionist policies and market-based policies?
What is the difference between interventionist policies and market-based
policies?

INTERVENTIONIST

MARKET-BASED

Force the producers to act the public
interest

Incentivise producers to act in the public
interest through intervention in the
market

• Set a maximum level of permitted
carbon emissions (i
...
just a cap (no
trade))
...


• Require firms to adopt cleaner
technology

Increase costs of production/restrict supply
→ shift MPC (supply) close to MSC
Reduce the external cost → shift MSC
closer to MPC (supply)
29

1
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1 (b) – OTHER METHODS OF GOVERNMENT INTERVENTION
Carbon Pricing, Incentives and Reducing Emissions at the Lowest Overall Cost

Imagine a country had 5 major power plants operating with the following
emissions
...


MARKET-BASED POLICY: Suppose instead that each firm is issued with
permits to emit CO2, and that each firm is given a total number of permits
equal to 50% of their current emissions levels (e
...
Firm A will be given 400
permits i
...
1 permit per tonne of CO2)
...


INTERVENTIONIST POLICY: the government insists that each power
plant reduces their emissions by 50% (NOTE: this is a type of “regulation”)
...
(Note: for each
firm compare the cost of reducing emissions vs cost of purchasing the
necessary permits)

Calculate the costs of emissions reduction using this policy
...
25
...
50

£0
...
50

£2

N/A

2000

0

1500

3500

£937
...
50

£0
...
50

£2

N/A

Cost of
reducing
emissions by 1
tonne

New Emissions

400

1000

1000

350

750

3500

New Emissions

0

Cost of
Reduction

£400

£1,500

£800

£175

£1,500

£4,375

Cost of
Reduction

£800 - £500
= £300

£1,250

£1600 £1,250 =
£350

0
£350 - £437
...
50

1
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1 (b) – OTHER METHODS OF GOVERNMENT INTERVENTION
Summary of advantages and disadvantages of policies to reduce carbon emissions

EXAMPLE

“Cap and Trade” – EU
Emissions Trading System
MARKET-BASED POLICIES

INTERVENTIONIST

Carbon Tax – Canada
imposing a tax of $10 a
tonne

Regulation – EU Law
https://www
...
co
m/environment/2017/feb/15
/european-commissionissues-final-warning-to-ukover-air-pollution-breaches

ADVANTAGES
•
•

•

DISADVANTAGES

Lower emissions at lower overall •
economic cost
“Internalise” the externality – it
•
still allows the market to operate
but forces firms to take on the
•
full social costs
•
Easily adjusted to magnitude of
the problem once in place
•
•

•

Simplicity i
...
lack of technical
difficulties and quicker to
implement/take effect

•

No need to rely on incentives for
compliance
•

Technical difficulties:
• Valuation of external cost?
• Number of permits?
Some firms may just pay tax
rather than reduce emissions
Lack of international cooperation
“Tax on life” and size of consumer
tax incidence
Impact on unemployment
Do not differentiate between
those producers that have
higher/lower costs of reducing
pollution – higher overall
economic cost
No continuing incentive to
reduce emissions

31

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1 (b) – OTHER METHODS OF GOVERNMENT INTERVENTION
Government policies that can be used to correct both positive consumption externalities
POLICIES TO
CORRECT
POSITIVE
CONSUMPTION
EXTERNALITIES

DIRECT
GOVERNMENT
PROVISION
E
...
NHS

SUBSIDIES

REGULATION

E
...
Feed-in-tariffs

E
...
Compulsory school age

ADVERTISING
https://www
...
com/watch
?v=AY5AILaXDdA

32

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1 (b) – OTHER METHODS OF GOVERNMENT INTERVENTION
What is the impact of direct government provision, subsidies, advertising and regulation on positive consumption
externalities?
DIRECT GOVERNMENT PROVISION

Price,
Costs,
Benefits

S = MPC = MSC
S2 = S + Govt
...
4
...
4
...

To what extent do you agree with this statement?
[25 marks]
DEFINITIONS
Definitions may include:
•
•
•

Tradable pollution permits
Negative production externality
Carbon tax

APPLICATION
Examples may include:
•
•
•

EU ETS
Canadian carbon tax
EU regulations

ANALYSIS

EVALUATION & JUDGEMENT

Diagrams may include:

•
•
•
•

Negative production externality
Market for tradable permits
Impact of tradable permits/carbon tax on costs of
production (short run)
Impact of tradable permits/carbon tax on external
cost (long run)

Explanation may include:
•
•

•
•
•

Why carbon emissions are an example of a
negative production externality
Why negative production externalities result in
overallocation of resources, overprovision of the
good/service and allocative inefficiency
Why negative production externalities result in
welfare loss
How tradable permits reduce carbon emissions
How carbon taxes reduce carbon emissions

Evaluation may include:
•

Advantages and disadvantages of tradable pollution
permits

•

Advantages and disadvantages of carbon taxes

•

Advantages and disadvantages of regulation

•

Impact of tradable permits in the short run vs
impact of tradable permits in the long run

•

Valued judgement regarding the most effective
policy used to reduce carbon emissions e
...
biggest
issue is lack of international cooperation, until this
is solved, neither will be effective

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