Notesale: Turn your study into money

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Economics Theme 1
Microeconomics is the study of individuals or groupswithin a market context
...
1
...

Social science is the study of how people or societiesinteract with each other and how they work
...

Natural and social science difference: Only precise experiments can be done in natural sciences by
changing only one variable
...

Also, it is argued that human behaviour cannot be reduced to scientific laws, it is easier to predict
groups
...
They can both be simplified
...

CETERIS PARIBUS – All other things remain equal
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This helps economists to make simplified models
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Base period/year is an arbitrary time period selected to compare all other years
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Index number is a simplified and quick method of comparingnumbers in a given time period
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1
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They describe the world how it is
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They describe the world as it should be
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Positive statement example ‘economics is the most popular subject in the school
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’
Statements can be both normative and positive, ‘The UK has had over 300,000 coronavirus cases
since January
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’
Value judgements influence economic decision making and policy due to making different decisions
from the same statistics
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1
...
g
...
g
...
Though resources are scarce and are exhausted by people
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BASIC ECONOMIC PROBLEM – How can scarcity where resources are finite and wants infinite by
dealt with
...
This is because the resources to
produce goods cannot be used for something else at the same time due to limited resources
...

The problem is consumers may not know alternative options, it may be hard to switch to alternatives,
some factors dont have alternatives and there may be a lack of information on alternatives
...
g
...

● Labour which is productive human effort, with a worker valued as their human capital
representing future earnings and production this can be increased through education and
training (reward is wages)
...
They are two types working or circulating capital which are resources in
the production system being transformed into another good to be sold
...

● Entrepreneurship which is the willingness and ability to take risks of combining the other three
factors of production to make a good or product through organising production (reward is
profit)
...

Economic good is a product or service made with scarce resources that can command a price when
sold which has an opportunity cost e
...
road, apple
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g
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– some free goods have become economic goods e
...
clean beaches
...
g
...

Non-renewable resources are a resource of economicvalue that cannot be replaced by natural means
on an equal level to consumption e
...
oil, coal
...
g
...

Good is tangible like a table or bottle
...

Primary sector is where resources are collected through extraction, fishing, quarrying etc
...

Tertiary sector is where manufactured goods are sold
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1
...
This is long term orientated as benefits are observed when goods are produced which is
in the long run
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A consumer goods such as a laptop is used for personal consumption not to produce other goods
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This is short term orientated as you get personal
consumption straight away
...
Though if we move from capital goods to consumer goods the economy will stay the
same
...
These show the opportunity cost of using scarce resources
as there is a trade-off of what to produce
...
E
...
when 100 healthcare goods are made the opportunity, cost is
100 education goods as the opportunity cost
...

As you move along the graph you reallocate resources:
● Anywhere along the curve the resources are being allocated efficiently
...
This can happen in situations like
unemployment
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Economic efficiency is achieved when resources are used for their best use
...

Allocatively efficient is when social welfare is maximised so not all points on the PPF are allocatively
efficient
...
This can be
done when:
● There is an increase in finance
● Improvement of technology
● Increased skilled migration
● Discovery of raw materials
● Good weather
● Increase in education
● Increase in resources and their quality
Shift in production of one good
A shift of the curve inwards suggests economic decline (decrease production potential)
...
It also can remove skilled
labour
...

A shift of the curve indicates a change in the productive potential of the economy; this is either growth
or decline
...

A linear ppf shows constant opportunity cost (same ratio) whilst the concave ppf shows that
opportunity cost varies as more of one good is made
...
It is a simplified
model of reality, only considers two variables and does not show where maximum social welfare is
achieved
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1
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Division of labouris where the production process is divided into different stages allowing workers to
specialise in different tasks to make a good or service in cooperation with other workers
...
He focused on a pin factory to show
that when a production of a pin was divided into separate tasks and the workers divided accordingly
resulted in an exponential increase in productivity compared to one person making the pin, he claimed
this was because workers were specialised and so were more efficient
...

The car manufacturer that modernised this concept was ford motors
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●

Advantages of specialisation and division of labour:
● Lower unit cost, as a result of output increasingcost per unit reduces resulting in final unit
price can be lower
...

● Lower production costs as workers only need to be provided with a few specialist tools and
not multiple specialist tools
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● Higher quality as the workers are very specialised in the work
...

● Increase in productivity, specialisation allows workers to be experts in one task leading to an
output increase (productivity = output/worker)
...

● Trade and partnerships can be created between nations
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● Poor quality as it is more dull so not as much effort is put in, workers do everything to avoid
the job leading to low productivity
...

● Over specialised in one task, a danger the worker is specialising in one area this causes
structural employment hindering future job prospects
...
e
...
North england with coal
industry
● Overdependence, if one person/machine breaks downthe whole process comes to a halt
...

A market is a convenient set of arrangements by whichbuyers and sellers communicate to exchange
goods
...

Barter is swapping one good for another without the use of money
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Money is any item e
...
a coin that fulfils the functions of a medium of exchange, measure of value,
store of value and method of deferred payment
...
This can lead to
specialisation as money can be accepted to pay workers which lead to specialisation
...

Workers may be incentivised to become more specialised and skilled and this can be reflected
by being paid a higher measure of value in money to reflect their increased value
...
Specialisation can be increased by this
due to companys being able to save profit to buy a more specialised machine increasing
productivity
...
Credit and borrowing collapses when this is not a function
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It means workers can be incentivized to get bonuses
from specialisation
...


The assets in a modern economy that can be counted as money are:
● Cash e
...
notes with no intrinsic value and is a token money it is issued by the government
...

● Money in current accounts, cash can be withdrawn on demand and you get a credit card and
cheque book
...
Due to
inflation and little interest it may lose its value over time so its store of value can be lost
...
g
...
This gives interest rates so is more for
saving
...
This stops its
measure and store of value, also not normally a good deferred payment
...

● Money substitutes are anything that is a medium of exchange but do not store value e
...
credit
cards (only show ability to borrow)
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1
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An economic system's aim is to resolve the
basic economic problem
...
Resources can be allocated by planning rather than markets e
...
within firms and by
governments
...

Free market economies (laissez faire approach by the government):
● The resources are allocated by the price mechanism
● Resources are owned by the private sector and the actors are individuals and firms (capitalist
economy)
...

● There is high competition and high incentives of profit
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● Fredrich Hayek strongly believed in this market and it is implemented in areas like Hong Kong
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● Resources are owned by the private and public sector and the actors are governments,
individuals and firms
...

● They produce what consumers with high purchasing power and governments want, they
produce in a manner maximising profits/ to maximise welfare and produce it for consumers
with the highest purchasing power or for the whole society
...

● Adam Smith strongly believed in this market and it is implemented in areas like England
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● Resources are owned by the public sector and the actors are individuals and governments
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● There is little competition and incentive is social welfare
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They produce for society
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Adam Smith famous phrase- ‘It is not from the benevolence of the butcher, the brewer or the baker
that we expect our dinner but from their regard to their own self interest
...
The bourgeoisie refers to the factory
owners and the proletariat the factor workers
...
While Hayek argued that governments should not
intervene as it would worsen or distort markets e
...
national minimum wage
...
Hayek also argued the
government would not be able to process information effectively (information gaps) and
malinvestments will occur
...

Marx argued that free markets exploit workers and simply makes the rich richer with higher profits,
which do not get trickled down to the workers
...

Advantage of a free market:
● More choice (consumer sovereignty) in products and jobs and free to spend more, creating
higher welfare
...

● Strong incentives to innovate and produce high quality low priced goods in this competitive
market, however this may be outsitripped by monopoly power and manipulative advertising
...

● Automatic due to the invisible hand
...

● Higher economic growth due to innovation and efficiency especially in the short term, raising
living standards
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● Optimal allocation of resourcesto meet consumer needs
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● Prolonged trade cycles as markets take time to adjust, looking after the system
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● Negative externalities lowering living conditions/standards
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● There are often missing provisions and high risk with few benefits provided by the
government
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● Resources wasted on unproductive expenses like advertising
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Advantage of a command economy:
● Higher equality as the government equally tries to distribute resources and they charge higher
redistributive taxes
...

● No wasted resources on competition, the government fully employs them all
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● No boom and bust cycle
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● No exploitation of workers
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● Bribery and corruption at various stages, with poor slow decision making due to lack of
information
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● Lower quality products and low innovation
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● Low efficiency over all as jobs are less efficient due to lower incentives only meeting minimum
work
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● Lower economic growth due to inefficiencies and not a priority
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● The government choices may not be what the population wants
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● Redistributes income through benefits
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● Provision of public goods
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1
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1 Rational decision making
Rational behaviour refers to a decision making process based on making choices that result in an
optimal level of benefit or utility
...

Economic welfare is the level of prosperity of anindividual or group of individuals
...

● Workers may want to maximise incomes traditionally but also their work welfare most workers
want to ensure they get paid a fair and reasonable wage/salary
...
Though
firms can be run by managers who may not act in shareholders best interests
...
The UK is a welfare state that looks after its
citizens via benefits, the NHS etc
...

Marginal means extra in economics
...

Homo economicus is the economic man that makes rational decisions to maximise utility
...

Behavioural traits:
Influence of others- Some people will base decisions on what society thinks not what will maximise
utility
...
g
...

Inertia- This means the tendency to do nothing or remain unchanged
...
E
...
unsubscribing from a junk email or
moving money bank accounts due to laziness
...

Rule of thumb- Useful tools to help make decisions e
...
choosing middle priced options
...


In 2017 Richard Thaler was awarded the economic prize for his work on nudge theory
...

Behavioural theories:
Anchoring- A figure is imprinted on our minds and decisions are based around this value
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g
...

Bounded rationality- Most people do not have all the information to make the best choice and need to
make it on what they do have
...

E
...
Ikea has a one way system tempting customers to make impulse purchases on the way to a
checkout
...
g
...

Framing- A question or an offering is framed in a way that will attract our interest and make us believe
it is a good offer
...
g
...

Herd behaviour- When decisions are based on what other people are doing
...
g
...

1
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2 Demand
Demand is the amount of goods and services, consumersare willing to buy at a
given price over a period of time
...
It
is what people would buy, not how much they would like to buy, if all other
factors remain the same
...

A contraction of demandis when quantity demanded for a good falls as prices
rise
...

The relationship between demand and price is inversely proportional, there is a negative relationship
...

The curve slopes downward due to the law of demand having a negative relationship
...
A shift in the curve shows a change in other
factors
...
A movement in demand is due to a change in price
...

● Advertising and branding being successful increases demand and loyalty
...
g
...
This is due to
products being seasonal
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This is due to herd behaviour so trendy products
increase demand
...
Inferior goods demand will fall whilst normal goods demand will
increase
...
When the price of substitutes(e
...
pepsi for coke) increases the
demand for goods increases
...
g
...

● Expectations means that if people think the pricewill rise in the future then demand will rise
now
...

Marginal utility is the satisfaction gained from consumption of each additional unit
...

Adam Smith evaluated this wondering why diamond price was high whilst a necessity like water price
was low
...

This is why the demand curve is downward sloping, as the marginal utility diminishes as each extra
unit is consumed, so consumers place less value on each additional unit showing a negative
relationship between price and quantity demanded
...

The marginal utility curve is normally negatively sloping
...

1
...
3 Price elasticities of demand
Revenue is price * quantity, it is quantity sold times average unit price
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Price is what consumers pay for a finished item, whilst cost is what producers pay to create a good
...

PED formula = Change in quantity demanded (%) / Change in price(%)
PED formula = Price*Quantity change / Price change*Quantity
Elasticity types:
● Relatively inelastic PED is when 0unresponsive to a price change
...
The curve is steep
...
E
...
So quantity demanded changes by a larger percentage
than price
...
As price increases revenue
decreases
...
g
...

Types of demand elasticity:
● Unitary elasticity, a change in price is equal to the same
proportionate change in demand
...
(>1)
Graph B
● Inelastic demand, a change in price will lead to a smaller
proportionate change in demand
...
(0)
Graph D
● Perfect elasticity, a change in price will lead to an infinite change in quantity demanded, a rise
in price leads demand to fall to zero
...
This helps them to work out the best price to maximize their revenue
...
Petrol prices fell by 20% in 2014
...
2?

-0
...
The shard has 200 visitors
...
PED is -2
...
This is as if a seller tries to increase
the price the buyers will switch to the alternative
...
g
...

● Addictions/habitual, if something is addictive orsomeone is a habitual consumer the demand
will be relatively inelastic to a raise in price
...

● Necessities, if a product is a necessity then demandis inelastic as the consumer still needs to
buy it
...

● Time, if a consumer has a longer time to browse andpurchase goods and find other
producers then demand is elastic and price difference is more noticeable
...

● Goods with several uses like water or cannot be postponed like emergency plumbing are
inelastic
...
2
...
The YED sign shows if a good is inferior or normal
...
g
...
This is very elastic (>1) and is positive income elastic
...
g
...
This is inelastic (<1) and is a positive income elasticity
...
g
...

This can be inelastic or elastic and is a negative income elasticity
...

YED formula = Change in quantity (%) / Change in income (%)
YED formula = Income*Change in quantity demanded / Quantity*Change in income
Question example:
1
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She now earns 2000 and goes to
the cinema 3 times a month
...
67
2
...
333
3
...
15
...
15 = X/20
x = -3%
There are two types of goodsnecessities (basic goods) and luxuries (superior goods)
...
However items with an elasticity
of less than 1 such as tea may not always be considered a necessity
...
In times of a recession a firm may
allocate resources to goods with lower elasticity and inferior goods and in times of a boom they could

switch to products or services with high YED
...

If a government is aware of YED, governments can maximise their revenues by imposing indirect taxes
(VAT) on goods that have high YED in times of a boom
...

1
...
3c Cross elasticities of demand
Cross elasticity of demandmeasures the proportionate response of one good to the proportionate
change in price of another
...

XED formula = Change in quantity demanded of good X(%)/Change in price of good Y (%)
XED formula = Price*Change in quantity demanded / Quantity*Change in Price
Question example:
1
...
30 to £1
...

XED is 4 how much has demand for coffee increased?
4 = x/30
...
2%
2
...
50 to £2
...
5*190/150*-1
...
3
3
...
What is XED?
XED = 0
Good relations affected:
● Substitutes are a good that can be replaced by another to satisfy a want
...
g
...
Substitutes have positive cross elasticities (+)
...
A rise in the
price of a compliment good will lead to a fall in the complement demanded
...
g
...
Complements have
negative cross elasticities (-)
...

● Goods which are not related are unaffected by the price change of other
goods
...

If firms are able to identify the XED this can allow them to change the prices of goods
to maximise revenue
...

1
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4 Supply
Supply is the quantity of goods and services sellersare willing to sell at a given
price over a period of time
...
The law of supplyis
that as the price of a good increases firms will expand production as they seek
to increase profit from the higher prices, which will increase supply
...

The assumptions here are that firms are motivated by profits and the cost of
producing a unit increases as output increases
...
An extension of supplyis when price increases and thus quantity supplied increases
...

Factors that cause a shift in supply:
● Raw materials- If more raw materials are discovered,the cost of production falls and thus
increasing the amount produced increases supply
...

● Government legislation- If controls are removed suchas anti-pollution measures, cost of
production falls and supply increases
...

● Weather- In agricultural markets good weather conditions increase productivity and thus
supply
...

● Production costs- When production costs decrease firms will pass this onto the customer in
the form of lower prices as profits increase and thus can be more competitive
...
If production increases to a price where it is not profitable to supply firms
may even stop producing this could be down to new government regulations
...

● Firms in the industry- If there are more firms enteringthe industry there will be more available
in the market increasing supply
...

● Subsidies- If the government gave subsidies to producersthen they have more money to
produce goods and services increasing supply
...

Wars or disasters may mean technology is destroyed and replaced with less efficient
technology reducing supply
...
Though if a goods substitutes quantity
increases it results in a decrease in supply of that good, as producers will switch production
to take advantage of higher profits in the substitute
...
2
...

PES formula = Change in quantity supplied (%) / Change in price(%)
PES formula = Price*Quantity supplied change / Price change*Quantity supplied
PES will always be positive due to the law of supply
...
A positive sign shows an upward sloping curve
...
PES if the price of orange increases by 15% and supply increases by 20%?
PES = 20/15
PES = +1
...
Meaning
they were responsive to a change in price therefore PES is elastic
...
PES if house prices increase by 32% and supply increases by 25%?
PES = +0
...
Meaning
that supply was quite unresponsive to a change in price therefore PES is inelastic
...
(1)
Graph A
● Elastic, a change in the price will lead to an even bigger change in
supply
...
(<1)
Graph C
● Perfectly inelastic, is when a change in price leads to no change in the proportion of supply
...
(∞)
Graph E
Factors affecting elasticity of supply:
● Substitutes (producer alternatives), these are goods a producer can easily produce as
alternatives e
...
another car model
...
This will make an elastic supply
...
This can be due
to production time, spare capacity, difficulty to hold stocks and ease to switch between
production
...

● Spare capacity, if there is spare capacity more canbe supplied easily making it elastic
...
Perishable goods cannot be stored for short periods of time and are
thus more inelastic
...

● Factor substitutability, if a product can be madewith alternative factors (changing the factors
of production) then it can be supplied making it more elastic
...
The long run means all
factors of production are variable, however technology remains constant (elastic)
...
This
means despite house prices increasing supply of housing cannot keep up and will have a lower PES
...
g
...

1
...
6 Price determination
Equilibrium is when the demand and supply curve intersect
...
Equilibrium price/market clearing price and
equilibrium quantity are both also where the demand and supply curve intersect
...

Neoclassical economists believe that markets do clear
...
In some cases like the labour market forces are not strong enough arguably and
external measures are needed
...
There is a surplus of products in the market
at this price
...
g
...

Excess demand is when there is more demand than supply
...
E
...
the release of the new iphone
...
This is according
to the law of supply as higher prices mean more people are willing to supply due to higher profits
...
This would result in supply contracting and demand extending
to reach the market clearing price
...

Equilibrium may not be the most desirable price always
...
g supporting the defence of a country, or
equity
...
So actual demand (realised or ex post) must always equal (real or ex post supply)
...
Thus this is equilibrium
...
This
changes the point of equilibrium of price and quantity for a good and service
...
Though they may both shift resulting in an
increase, fall or maintenance of price level
...

1
...
7 The price mechanism
Adam Smith used the term the invisible hand to explain the price mechanism
...

The 3 functions of the price mechanism:
● Signalling, when the price of a product rises dueto demand, it sends a signal to producers to
increase their supply
...

● Rationing, when there are shortages in supply, price acts as a rationing function to eliminate
these shortages
...

● Incentivising, when the price of a product is highit incentivises producers to allocate their
scarce resources to produce more of that product to increase profits
...

It is useful as it means all resources are allocated efficiently without a cost, with consumers deciding
what is produced and prices kept to a minimum
...
Some unintended consequences include blood donors
pulling out due to a price
...
This will send a signal to house owners that they can increase prices as there is demand
...

1
...
8 Consumer and producer surplus
The consumer surplus is the difference between how much is willing to be paid by a
consumer and what they actually pay
...

The producer surplus is the difference between what the producer is willing to supply
at and what they actually supply at
...

A shift in either the supply/demand curve changes the size of these surpluses
...
This is as the consumer is prepared to pay higher prices for the same good as they
value it more and so their surplus increases
...
The surplus added is the extra area
added to the triangle
...
The steeper (more
inelastic) the supply curve the greater the producer surplus
...

1
...
9 Indirect taxes and subsidies
Direct taxes are paid directly by the person, who it is imposed or levied on e
...
income or
corporation tax
...
g
...

A tax is imposed which means less can be supplied due to higher costs, supply shifts inwards
from S to S1
...
Demand
contracts due to the rising prices
...
E
...
Excise duties (bringing goods over), £196
...
For the specific tax there is a parallel shift of the
supply curve
...
E
...
VAT (20%
in the UK)
...
There is a
pivoting shift of the supply curve
...

When taxed to draw a curve:
1
...
The equilibrium moves from Q1P1 to Q2P2
3
...
From there draw a line to the Y axis
5
...
The consumer pays the final price
7
...
The
equilibrium change is consumer tax
Demerit goods like alcohol and cigarettes may be taxed to limit both production and consumption as
such goods are deemed to be bad for society, which can act as a source of revenue for the
government
...

The revenue change for producers is Q1*P1-Q2*P2
...
The
new revenue for producers is new revenue minus the government tax
...

A subsidy is a grant given by the government to encourage production through reducing production
costs
...

A subsidy may be granted for goods with positive benefits for society, reduce unemployment, help
producers grow or to encourage competition
...
g
...

1
...
The equilibrium moves from QP to Q1P1
3
...
Draw a line to the Y axis
5
...

6
...

7
...
Subsidies on inelastic demanded goods have little effect on output and are
thus more expensive to impose
...

● It gives rise to black markets, meaning worse quality products will be
consumed having negative externalities
...

● May be imposed on wrong goods due to lack of information
...

● Taxes disincentivize workers and firms
...

● The rich may leave to go to low tax havens
...

● The magnitude of the taxis important, without a lot of money we can’t do anything with it and
it won’t cause a large change
...
How true is this?

Subsidy problems:
● Interfering with the free market against capitalist ideology and has an opportunity cost
...

● Allowing failing industries to survive creating inefficiencies in the market and means firms
may be incentivised to be lazy to gain subsidies
...

● It distorts the market and is unfair for industries not gaining subsidies, this subsidised good
may not be as good as the product they are trying to replace
...

1
...
1 Market failure types
You can get complete market failure when the free market price mechanism fails to supply any goods
creating a missing market resulting in a loss in social welfare
...

Merit goods are deemed to be beneficial to society e
...
healthcare whilst demerit goods are harmful to
society e
...
cigarettes
...
g
...

The free market is incentivised by profits catering to individuals with effective demand
...
However
the free market won’t cater to poorer individuals that want healthcare due to no incentive of profit
...

As they don’t provide profits there is no incentive to pay for them
...
There is a large incentive for individuals
not to pay for a good in hope someone else will
...
These effects are born by third parties who are
not part of the economic transaction
...
g
...
These can be positive or negative
...
This may lead to a decision that does not maximise utility
...
3
...
The more drastic the difference between private and social costs the
greater the externality
...

Negative externality of productionexists if the netsocial cost is greater than net private cost in
production, caused by the production of demerit goods and services e
...
factory pumping sewage into
a river at no cost to them
...
g
...

A private cost is the cost borne by an individual economic agent as a result of an economic activity
...
A social cost
is the cost of an economic activity to the rest of society and the individual agent as a whole (private +
external cost)
...

However social costs are things like global warming, nuclear waste pollution in a river, value of nearby
properties etc
...

The socially optimal point is when the allocation of resources is used in a manner that maximises
social welfare
...

The welfare gain is the area society can gain when the externality is eradicated
...


The marginal private benefit is the benefit received of producing an extra unit for the individual
economic agent
...

The marginal social benefit is the benefit borne by society through the production of one extra unit
...

● Identify the free market equilibrium
...

● Draw marginal social cost above marginal private cost
...

● The triangle is society's welfare loss
...

There is this welfare loss triangle as the cost to society is higher than the cost of production
...
g
...
The socially optimal point is arguably the best place to operate; however
without intervention firms operate at the free market equilibrium where mpc = mpb
...
Methods to do this include
taxes, subsidies (cleaner substitutes), quotas and tradable pollution permits
...

Positive externality of productionexists if the netsocial benefit is greater than net private benefit in
production, caused by the production of merit goods and services e
...
supermarkets redeveloping a
derelict site building roads and cleaning up pollution at the same time
...
g
...

The private benefit is the benefit gained by an individual economic agent from consuming a good or
service
...
g
...

The external benefit is the benefit gained by the third party as a result of consuming a good or service
e
...
one step closer to ending lockdown
...

A positive externality is when the benefits to society outweigh the benefits to the private agent, they
occur from underconsumption of goods/services
...
Identify
the free market equilibrium
...

● Draw the marginal social benefit above the marginal
private benefit
...

● Identify the welfare gain triangle
...

In this graph the marginal private benefit is below the marginal social benefit as there is an
underconsumption of this merit good and thus society is not benefiting fully
...
g
...


Without any intervention firms would operate at free market equilibrium where marginal private cost is
equal to marginal private benefit
...

Methods to move to a socially optimal point include subsidies to make it cheaper to produce more
products, regulation and free provision
...
g
...

Transport private costs- Gas, cost of maintaining vehicle, parking, tax and insurance
...
g
...

Education private benefit- Employability, human capital, earnings, personal happiness, ability to
purchase land and better informed judgements
...
3
...
The marginal cost of
providing an extra unit is zero
...

A private good is rivalry and excludable e
...
a chocolate bar as once consumed means no one else
can have it and if you buy it it prevents other agents buying it
...

E
...
A hospital cannot be prevented from being used as it's a public good but as it gets filled up
patients may be competing to be seen or a road may be a public good but during rush hour consumers
compete with each other to benefit and there is congestion, further toll roads and congestion charges
may exclude some people from using the road
...
A free rider is a person or organisation that receives the benefit of a
good/service that others have paid for but they have not contributed to
...
This means no one would end up providing the good/service as the profit motivated
company would not profit from producing it and thus there would be no market for it
...
E
...
If a private firm
put up a street light consumers would not pay for it and thus they would not profit
...
E
...
a firm may want to
charge a high price to cover pot holes on a road, to ensure it makes some profit, however residents on
the road may not see the benefit and refuse to pay as they don’t drive
...
3
...

Asymmetric information occurs when one economic agent has more information than
the other in a transaction this can be a producer (selling a second hand car) or a
producer (buying an antique in a car sale)
...
However it can be argued the true value of an item is what the
consumer is willing to pay for it
...
Other factors
not information gaps such as weather/access to technology may cause over/underproduction
of goods
...


The principal agent problem occurs when one economic agent makes decisions that affect another,
the principle
...

E
...
In a business context managers may make decisions that maximise personal gains than the needs
of the shareholders which is to maximise dividends
...

Examples:
● Consumers not knowing the extent of the effect of drugs/alcohol (asymmetric information),
therefore there is overconsumption of these demerit goods
...

● Parents may allow their children to avoid school (principal agent problem) as they may not see
the value from it causing the underconsumption of the service
...

1
...
1 Government intervention in markets
Governments may intervene to correct market failure, they do this through:
● Indirect taxation (ad valorem or specific)
● Subsidies
● Maximum and minimum prices
● Trade pollution permits
● Provision of public goods
● Provision of information
● Regulation
Indirect tax
Indirect tax is a tax on consumption or expenditure
...
This can shift the MPC inwards closer to the MSC as firms cut
production to maximise revenue resulting in a production closer to the socially optimal point
...

● It raises prices reducing the consumption of elasticdemerit goods
● Internalising the externality
● Increases the cost of production soless supply of the good/service
The disadvantages:
● Difficult to target and achieve the right size, no one knows how market will react and the size
of the externality (asymmetric information)
● No effect on inelastic goods demand
● Taxes are unpopular politically
● Regressive, the more you earn the less you play as a proportion of income
● This creates income loss and job loss due to firms cutting production
● Black market arises with negative externalities such as crime
The supply and tax line gets steeper, this is because as the level of output
increases the proportion paid increases as well e
...
Vat
...

The impact of the tax is output falls from QE to Q1 and price increases from
PE to P1
...

A unit tax would not get steeper as the amount taxed increases unitarily with each additional unit
...

Subsidy

Subsidy is a grant given by the government to reduce the cost of production and increase
consumption
...

● Subsidies can correct market failure and provide jobs
...

● Increases merit good consumption and positive externalities
...

The disadvantages:
● Difficult to target and know the size with asymmetric information and a constantly changing
market
...

● It is unfair to other industries and there may be information failure when selecting industries
...

● They can be difficult to remove e
...
riots
...

The price decreases from P to P1 and from Q to Q1
...

This could be imposed to increase positive externalities of a good being produced or
consumed
...
Maximum prices are when merit goods with positive externalities
are underconsumed due to being unaffordable e
...
food and the market
price is perceived to be too high, above where MSC = MSB
...

E
...
In Cyprus there is a maximum price on milk
...
This is imposed to correct a market failure on demerit goods
with negative externalities to where MSC = MSB
...
This
is for demerit goods that are over consumed
...

E
...
The Scottish government imposed minimum prices on alcohol
consumption
...

Creates a black market for the goods where they are sold below the minimum price which may
have larger negative externalities
...

The quality may drop for maximum price goods due to price decreasing
...

Asymmetric information may lead to the government setting the min/max price in a place that
will not affect the price level thus causing government failure
...
g
...

Trade pollution permits
A trade pollution permit is a permit issued by the government to firms to allow a fixed amount of
pollution to be created up to the stated amount, this can be used by the owner or sold to another firm
...
Cap and trade schemes set a limit on a
particular type of pollution and then issue pollution permits to the total of that limit, which can thus
then be bought and sold between firms who pollute
...
The government indicates the maximum pollution that is legally allowed and will then allocate
permits accordingly
...
Firms will then buy the required amount and pollute accordingly
...

3
...
The higher the price of the
permits, the greater the incentive for carbon emitting firms to reduce their emissions
...
The firms that do not utilise all of the permits can also sell these pollution permits at a higher
price
...
The aim is to reduce pollution and encourage greener technology as a substitute
...
This is also a source of government revenue as well as the fines for firms exceeding their
quota
...

● It increases the costs for businesses and this passed onto consumers results in higher prices
for inelastic goods thus decreasing consumer surplus and affecting the poor
...

Pollution permits costs to society and the industry is lower than with regulation as each firm will
consider whether it is possible to reduce pollution and at what cost
...

Provision of public goods
Public goods which are non rivalrous and non excludable will not be provided by the free market
mechanism
...
Goods such as education and defence yielding
positive benefits to the whole of society will be underprovided or not at all
...

Disadvantages of the scheme:
● The schemes are expensive and there is a significant opportunity cost
...

● The wrong mix of goodsmay also thus be provided
...
They could also force firms to provide full/accurate information e
...
forcing
cigarette companies to put information on packets of the dangers
...

● Individuals may not act rationally and not listen to the information provided
...
g
...
E
...
quality standards, mandatory
consumption of education and restriction of alcohol sold to individuals under a certain age
...
This also corrects market failure through forms such as closing
information gaps such as banks forced to tell customers the rate of interest on a loan
...

Disadvantages:
● Bribery and corruption in the government or employed civil servants may stop this occurring
due to being susceptible to bribes
...
E
...
The fall in pollution being worth £20 million may have
cost the firm £30 million to fix
...

● Regulation does not discriminate against different costs of reducing externalities
...
g
...

Buffer stock schemes
Buffer stock schemes aim to stop price volatility
...

When there is an excess in stocks due to a good harvest there is an
extension in demand resulting in a price drop resulting in a producer
welfare loss
...

Maximum and minimum prices being set thus stops these fluctuations in price reducing the loss in
consumer and producer welfare
...

Disadvantages:
● There are perishable products reducing storage potential
...

● Excessive administration costs
...

1
...
2 Government failure
Government failure occurs when the government intervenes to correct market failure yet it still fails
...
Thus this action's social cost is larger than the social benefits
...

Example:
● By imposing a maximum price the government aims to make the good more affordable for
society, however firms will no longer find it profitable to supply those goods and therefore may
leave the market which means consumers may lose out as there is excess demand and they
can no longer consume the good, also resulting in a loss of jobs reducing employment levels
for workers
...

Distortion of price signals
When the government imposes maximum/minimum prices, levees taxes or grants subsidies they are
interfering with the free market
...
This distortion may lead to excess demand/supply, black markets arising and the
allocation of funding towards failing industries
...
However this results in higher prices
and does not allow a more efficient usage of the land that would occur without this price
distortion
...

● Price signal changes in the labour market e
...
due to minimum wage being too high results in
people put out of work due to wages being too high for firms to afford and their thus being
excess workers in the labour market
...

Information gaps
When the government does not have full information this might lead to them to make incorrect
decisions
...

Example:
● The pandemic led to the government having to make assumptions as it was impossible for
them to have all the information
...

Interventions such as buffer stock schemes, pollution permits are schemes which require
governments to monitor and fund these operations
...

Example:
● The government may spend £30,000 a worker to put them back in work, however the overall
gain may be worth less than this resulting in an overall reduction in social welfare due to this
opportunity cost
...
This involves buying and selling agricultural stock
...

● Housing market, the government has tried to impose maximum prices on rented
accommodation to make living more affordable
...
Similarly by reducing
deposits for first time buyers (the help to buy scheme, you need 5% instead of the normal 20%)
leading more to come to the market pushing up house prices making it more unaffordable
...
However they may have a negative YED as people may prefer the comfort of their
own private vehicle or ubers which does not produce congestion
...

● Fishing industry, the government may implement fishing quotas to limit overfishing
...
Further if the fisherman went over the quota they
may dump dead fish to avoid fines which is highly wasteful, which is also difficult to monitor
...
However decisions thus lead to higher opportunity costs
sometimes, resulting in conflicting objectives of importance
...

Politicians maximising their own social welfare and corruption
Much of economics assumes that governments maximise social welfare howeverpublic choice theory
opposes that
...
g
...
g
...




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Title: alevel economics notes theme 1 unit 1 year 1
Description: micro alevel economics notes year 1

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