Notesale: Turn your study into money

Document Preview

Extracts from the notes are below, to see the PDF you'll receive please use the links above

---

COMPLETE THEME 1 NOTES
1
...
Economists
develop models which attempt to simplify and improve our understanding of
how consumers and producers behave
...

● Economics = the allocation of scarce resources to provide for unlimited
human wants
...
This arises when there
are infinite human “wants” but finite resources
...
This incurs an opportunity cost - the value of the next best
alternative foregone
...

● Consumers are assumed to want to maximise utility, whilst firms are assumed
to want to maximise profits
...

● Productivity = the output per unit input
...
It does not carry a value judgement
...

The economic problem
● The economic problem = this involves 3 parts: what to produce, how to
produce it and how to distribute it
...
g
...

● Non-renewable resource = one whose stock level decreases over time as it
is consumed (e
...
coal, oil and steel)
...

● Opportunity cost = the value of the next best alternative foregone
...

● Consumer goods = directly provide utility to consumers (e
...
food, clothes
and holidays)
...

PPF and opportunity cost
● If a point lies within the PPF, this is an inefficient combination because not
all resources are being fully utilized
...

● If a point lies anywhere on the PPF then it is an efficient combination
because no resources are being wasted
...
g
...
This shows productive efficiency
...

● If a point is located above the PPF then that combination is not yet attainable
(but it could be if economic growth occurred)
...

● If a PPF is curved then the opportunity cost will vary
...


Shifts in the PPF
● If the PPF shifts outwards then this shows economic growth
...

● PPFs occasionally shift inwards, indicating a decrease in the potential output
of an economy (e
...
after a natural disaster)
...
g
...
g
...

Movement along the PPF
● There is no need for a change in the quantity or quality of the factors of
production for a movement along the PPF to occur
...

● However there will still be an opportunity cost involved
...
''
● This is because some resources are better suited for the production of some
things than others (e
...
many economic resources are not easily adaptable or
transferable)
...
However, if all resources are equally suited to all forms of production,
then the PPF would be a straight line,
Specialisation and the division of labour
● Specialisation = The process by which individuals, firms and economies
concentrate on producing those goods and services in which they have an
advantage (a limited range)
...
g Adam Smith’s pin factory)
...

Specialisation advantages

● Leads to economies of scale - lowers the long run average cost for the firm
...

● Rising standards of living
...

● Countries may become over reliant on the production of one product, so if
there is a shortage/depletion of resources then their economies will suffer
(e
...
Zambia and fluctuating global copper prices)
...
Overall, this should aid economic growth and living standards
...

● Higher productivity achieved by…
...

➔ Workers should become more skilled (faster) over time
...

➔ Capital machinery can be used continuously in production
...

Division of labour disadvantages
● Monotony of work - consequences include: workers becoming less
productive, increased staff turnover and therefore greater costs for
recruitment
...
This could leave them structurally
unemployed
...
So if one group of workers
go on strike, or one part breaks down then the whole production process will
be halted
...

Functions and characteristics of money
● Money is anything that is generally acceptable in the payment of a good or
service, or a debt
...

● Money has to act as
...
This makes buying and selling easier
...

➔ Measure of value = allows a comparison to be made between goods,
so that when they are traded it is understood that they are worth
different amounts
...

Types of economies - free market, command and mixed economies
● Free market economy = where scarce resources are allocated by the price
mechanism
...

● Mixed economy = some resources are allocated by the price mechanism and
some by the government
...

Free market economy
● Associated with the writings of Adam Smith
...

● There are no pure free market economies in the world today
...

● Advantages:
➔ Competition between firms results in lower prices for consumers and
greater efficiency
...

➔ Consumers have lots of choice
...

➔ Financial incentives due to little or no income or corporation tax
...
These fuel economic growth
...

➔ Erratic swings in the business cycle (very extreme boom and bust
periods)
...
Information
gaps persist
...
g
...
g
...

Command economy
● Associated with Karl Marx - believed that production should be driven by
human need rather than profit
...

● North Korea = closest example
...
g
...

Advantages of a command economy

Disadvantages of a command economy

Cooperation between firms can lead to
high levels of output
...


Reduction in inequality due to
government controlling workers’ wages
...


Government can fund public goods and
services more (e
...
defence and
healthcare) and tax harmful products
like tobacco (or carbon dioxide…)
...


Other disadvantages of a command economy… asymmetric information can
occur because the government does not actually know what is best
...

● Because consumers and producers are both driven by self-interest, the
interactions between them will lead to a mutually beneficial allocation of
resources
...

Karl Marx’s view - command economy
● Marx argued that a free market economy creates inequality and exploitation of
workers, so eventually the lower classes would revolt and seize the means of
production
...

Friedrick Hayek - free market economy

● Supporter of the free market and very critical of command economies,
because he believed that consumers know best
...
He believed that governments should not intervene in
resource allocation decisions, except in the provision or protection of public
goods
...


1
...

● Reasons why consumers may not make rational decisions = the influence of
other people’s behaviours, addiction, consumer weakness at computation or
habitual behaviour
...

● Market = where consumers and producers come into contact with each other
to exchange goods and services
...

● Individual vs market demand
...

● You can only move along
the demand curve when
there is a change in
price
...

● Marginal utility = the
utility gained from
consuming one extra unit
of a good or service
...

As marginal utility falls from each extra good consumed, it means consumers
will only buy more of it if the price falls - hence the downwards-sloping
demand curve
...

A shift in the demand curve is caused by PASIFICL = Population, Advertising,
Substitute’s price, Income effect, Fashion/tastes, Interest rates, Complement’s
price and Legislation
...
Also called the market clearing
price (because there is no excess demand or supply, so the market is
“clear”)
...

Law of demand = as prices rise, quantity demanded falls (and vice versa inverse relationship)
...

Complements effect = if demand for one product (e
...
dishwashers) rises,
then demand for related or similar products will also rise (e
...
dishwasher
tablets)
...

● Elastic = if a price change leads to a considerably bigger change in quantity
demanded
...

● Percentage change = (difference/original) x 100
● PED = % change in quantity demanded / % change in price
...

● A PED of <1 = inelastic
...

● PED of infinity = perfectly elastic
...

● Factors that affect PED = Substitutability, Proportion of income spent on the
good/service, Luxuries/necessities, Addictiveness and Time
...

➔ On a quantity demanded vs
...
g
...

➔ Include minus signs in your answer
...

● YED = % change in quantity demanded / % change in income
...

● If goods have a negative YED, then they are inferior (income rises, so
demand decreases)
...

● XED = % change in quantity demanded of good X / % change in the price
of good Y
...
g
...

● A positive XED = the goods are substitutes (e
...
oranges and tangerines)
...
g
...

Supply
● Supply = the amount of a
good or service that firms
are willing and able to supply
at a range of price levels
...

● Reasons why the supply curve is upward sloping = profit motive (when market
price rises it is more profitable for businesses to increase their output)
...

● The only factor that causes a
movement along the supply
curve is price
...

● An increase in supply OR
demand = always a shift to the
right
...

● Joint supply = when an increase of supply of good x, means more is
automatically supplied of good Y (e
...
beef and leather)
...

Price elasticity of supply
● PES = a measure of how responsive supply is as a
result of a change in price
...

● Momentary (e
...
immediately) elasticity of supply will
be zero (perfectly inelastic) because suppliers cannot
instantly meet a change in demand
...

● In the long term, PES is relatively elastic
...

Price determination
● Equilibrium price = the price where the quantity demanded equals the
quantity supplied for a good or service in a market
...

● Excess demand = where the quantity demanded exceeds the quantity
supplied for a good at the current market price
...

● ARSI = Allocates scarce resources, Rations excess demand/supply, Signals
that price is too high/low, Incentives to change price
...
For example, an
increase in consumer demand for a good or service raises the price and
causes producers to produce more of that good or service to meet demand
...
For example, if prices fall due to
PINTSWC factors then this is signalled to consumers with lower prices and
they will respond by expanding their demand
...
Also, consumers have more incentive to consume goods after
supply increases as the price will be lower
...
Rations supply: when supply decreases
there will also be a shortage so few people can obtain the good or service
...

● Producer surplus = the
difference between the market
clearing price that firms receive
and the price at which they are
willing and able to supply
...

Indirect taxes and subsidies
● Tax = a compulsory financial
contribution to state revenue
...
g
...


● Indirect taxes = taxes levied on the expenditure of goods or services (e
...

VAT)
...

● Specific tax = a tax which is a fixed rate per unit, like the tax on a pint of beer
is 41
...

● Incidence of tax = the distribution of the tax paid between consumers and
producers
...

Incidence of tax

Subsidies - advantages
➔ Enables greater social efficiency
...

➔ If you subsidise public transport, it will encourage people to drive less, and
reduce their negative externalities
...
It will encourage firms to develop more products
with positive externalities
...

➔ Potential increase in employment within subsidised industries, e
...
farming
and the EU CAP
...
Some taxation, e
...
income tax,
may reduce incentives to work
...
g
...

Difficult to estimate the extent of the positive externality
...
Difficult to quantify external benefits and place a monetary value on
them
...

There is a danger that government subsidies may encourage firms to be
inefficient and they come to rely on subsidy rather than improve efficiency
...


Producer subsidy and consumer subsidy on a graph

Alternative views on consumer behaviour
● Reasons why consumers may not make rational decisions = the influence
of other people’s behaviours, addiction, consumer weakness at computation
or habitual behaviour
...

● BUT the underlying assumptions for all rational decision making is that
customers aim to maximise utility, companies aim to maximise profit and
governments aim to maximise welfare of citizens
...
Influences of other people: Rationality assumes people act individually to
maximise their own benefits but sometimes individuals are influenced by
social norms, known as a bias
...


Consumers become unwilling to change the bias, even if doing so will benefit
them, if it goes against the norms of society
...
One example is the stock
market, and this causes huge market bubbles
...
Influence of habitual behaviour: Most people have habits and these habits
reduce the amount of time it takes to do something, because consumers no
longer have to consciously think about their actions
...
Habitual behaviour includes addictions and so this influences
people’s decisions, for example consumers will buy more drugs/alcohol even
though they know they should give up
...

3
...

Also, consumers are sometimes poor at self-control and so do things they
know they shouldn’t
...
One example of this
is consumers saving up for their pensions: many put off doing this because
they fail to look long term
...
3 Market Failure
● Market failure = when the price mechanism leads to an inefficient allocation
of resources, leading to a net welfare loss
...

● Complete market failure occurs when, unless the good or service is publicly
provided, it would not be provided at all (e
...
military)
...
g
...

Externalities
● Externalities = the third party costs or benefits which affect someone who
was not involved in the transaction
...
g
...

● External benefits = positive externalities
...

● Private costs = costs that are internal to a transaction, so affect me or the
firm (taken into account by the price mechanism)
...


● External benefits = positive third party effects outside a transaction (e
...

vaccinating someone against measles reduces the possibility of others
catching measles)
...

● Social benefits = external benefits + private benefits
...

● By ignoring the external benefits of production and consumption, this can lead
to: underproduction, underpricing, potential welfare gain and long-term
consequences of underproduction (e
...
lack of education = low skilled future
workforce = low productivity)
...

● Social optimum = where marginal social benefit equals marginal social cost
...


● Marginal private benefit (MPB) is drawn as a “demand curve” (but don't say
that in the exam)
...

● We only need to know the negative externalities of production graph
...
The bit that’s
shaded in blue is the welfare loss
...
This can only be corrected through government
intervention
...

This graph (below) shows the difference between MPB and MSB
...


It shows that from Q3 to Q4 there is
an underconsumption of cars
...
The vertical line DF
represents the value of the external
benefit
...

● NOTE: these graphs
assume that consumers are rational
and that demand and supply are both
consistent
...


A paper and glass
recycling plant reduces
the waste that goes to
landfill, using wind
turbines reduces the
emissions from fossil
fuels and construction of
a new university attracts
more students
...


Education and training
programmes increase
output/productivity,
improving the appearance
of your garden increases
the value of neighbouring
properties and the
consumption of vaccines
leads to herd immunity
...

● This means that…
➔ You cannot stop others from benefiting from them (non-excludability)
...

● Street lights, defence and refuse collection are all examples of pure public
goods
...
g
...

● Education and healthcare are not public goods - they are better described as
merit goods (which have external benefits to society)
...

● This leads to market failure because it is impossible to withhold the good from
consumers who refuse to pay for it
...

● This means that the government has to provide public goods, but in doing so
they have to guess their marginal social benefit (which may be inaccurate)
...

● Rational people never want to contribute towards the payment of public
goods, hence why we have taxes
...

● Non-rivalry = the consumption of a good by one person does not reduce the
amount available for others
...

Information gaps
● Information gaps = where consumers, producers or the government have
insufficient knowledge to make rational economic decisions
...

● Symmetric information = when consumers and producers have access to
the same information about a good or service in the market
...
g
...

● Asymmetric information can lead to thin markets - these are where there are
few buyers and sellers in a market
...
4 Government intervention

Why do governments intervene in markets?
➔ If there is an overconsumption of demerit goods (e
...
due to a lack of
information)
...

➔ Irrationality
...

● Tax = a compulsory financial contribution to state revenue
...
g
...
g
...

● Indirect taxes occur when goods have significant external costs - e
...

cigarettes, alcohol and petrol
...

● 2 types of indirect tax - ad valorem tax (which is taken as a percentage of the
value of a product, like VAT = 20%) and specific tax (a fixed rate per unit, like
the tax on a pint of beer is 41
...

● Deadweight loss = the loss of welfare to society because taxes are
introduced
...

● Incidence of tax = the distribution of the tax paid between consumers and
producers
...

➔ They work with market forces so there is still choice over production and
consumption (unlike some regulations/legislation)
...

➔ Convenient - paid in small amounts and regularly rather than one lump sum
...

Indirect taxes - disadvantages
➔ Difficult to quantify external costs and then place a monetary value on them
...

➔ Widespread use may be inflationary
...

➔ Tax revenue raised may not be used to compensate victims/clean up the
environment
...
g
...


➔ Burden of indirect taxes may fall on low-income groups
...

● Diagram:

Subsidies - advantages
➔ Enables greater social efficiency
...

➔ If you subsidise public transport, it will encourage people to drive less, and
reduce their negative externalities
...
It will encourage firms to develop more products
with positive externalities
...

➔ Potential increase in employment within subsidised industries, e
...
farming
and the EU CAP
...
Some taxation, e
...
income tax,
may reduce incentives to work
...
g
...

➔ Difficult to estimate the extent of the positive externality
...
Difficult to quantify external benefits and place a monetary value on
them
...

➔ There is a danger that government subsidies may encourage firms to be
inefficient and they come to rely on subsidy rather than improve efficiency
...

Buffer stocks
● Influences market supply through holding or releasing stocks to stabilise
prices or incomes
...

● Used in agriculture and other commodities where supply can be volatile
...

Issues with long-term sustainability and indirect effects on LIDCs
...

● Benefits: good because farmers are unlikely to invest if they have an
uncertain future, encouraging production of goods
...
Overproduction if incomes are guaranteed
(surplus)
...
They are an attempt to solve the problem of pollution by creating a
market for it and are allocated through an emissions trading system (e
...
the
EUETS)
...

● Set up to try and limit greenhouse gas emissions by major polluters in the EU
- e
...
power generators, steel, paper, cement and ceramics industries
...

● “Cap and trade” system - each year, the European Commission allocates a
set amount of CO2 permits to national governments, which then divide up the
allowances among the firms in the scheme
...

● ETS also allows firms to invest in schemes outside the EU that offset their
own carbon emissions
...

● 1 allowance, or “carbon credit” = 1 tonne of CO2 (for example)
...

● Long-term goal is the decarbonisation of the EU economy
...

● Demand for carbon credits decreases during recessions
...

● Disadvantages: the EU may issue too many/too few permits due to
information gaps, expensive to implement schemes, market for permits is still
subject to failure, firms may pass the cost of purchasing permits onto
consumers leading to higher prices, the price of pollution permits fluctuates so
firms don’t want to invest in new technology due to uncertainty and the EU is
just one part of the world - China is the world’s largest polluter
...

● Issues with deregulation: some natural monopolies need regulation,
consumers no longer protected from anti-competitive behaviour, healthy and
safety issues, cannot necessarily fix all market failures (e
...
externalities)
...

● Issues with regulation: value judgement involved with which industries to
regulate and how to regulate them, expensive to monitor firms and enforce
regulation (opportunity cost), firms may have to close down if new regulations
increase their costs of production
...

Government provision
● The government either provides state provisions itself (e
...
state education) or
provides goods and services free at the point of consumption that its bought
from the private sector (e
...
private health services offered to NHS patients)
...

● Advantages: reduces inequality by redistributing income, without state
provision some unprofitable services may not exist
...

● Government provision of information may include information and
advertisements about vaccines and healthy lifestyles (e
...
Drinkaware,
smoking kills and Change4Life)
...
May
be enforced through legislation
...

● A maximum price is
usually set below the free market price,
leading to shortages (or excess
demand)
...

● A maximum price that’s set above the free market equilibrium will have
no effect
...
prices

Disadvantages of max
...


Unintended consequences may occur
(e
...
govt intervention distorts the
operation of the price mechanism =
excess demand and inefficient
allocation of resources)
...
g
...


They can reduce inequality (e
...
a cap

It can reduce the supply of key products

on the salaries of highly-paid bankers)
...


They can help people on low incomes to Producer surplus falls so there may be
afford key products like rental housing
...

Issues over how to allocate excess
demand, since prices cannot increase
...
g
...

*A shadow market includes any unregulated private market in which individuals can
purchase goods or services that are not
publicly traded
...

May be enforced through government
legislation
...
g
...
g
...

● Used in agriculture - EU farmers are guaranteed a minimum price for many
commodities
...

● There will be excess supply due to a contraction in demand (because fewer
people can afford to buy the product) but an expansion in supply (because
there's more of an incentive for profit-maximising firms to supply the goods)
...

● Minimum prices can be used in monopsony markets
...
The main aim of these
schemes is to protect producer incomes
...
prices

Disadvantages of min
...


Unintended consequences may occur
(e
...
govt intervention distorts the
operation of the price mechanism =
excess supply and inefficient allocation
of resources)
...


low incomes
...


Demand for goods like sugar and
alcohol are price inelastic, so minimum
prices may not be effective
...

employment
...


Storage costs for food surpluses
...


A national minimum wage reduces
exploitation of workers whilst providing
an incentive to work
...

Less incentive for farmers to try and
increase their efficiency - overeliant
...

● Causes of government failure: government can cause the distortion of price
signals, unintended consequences (e
...
smuggling), political self-interest,
excessive administrative costs and information gaps
...

● Buffer stocks have traditionally been an example of government failure
...
However, there has
been no evidence of this in the UK
...

● Unintended consequences = a cause of government failure whereby the
government’s actions result in unexpected effects
...
This was meant to
smooth out the price fluctuations but it ended up leading to overproduction in the EU
and a fall in agricultural prices in other parts of the world as EU surpluses were
disposed of at cheap prices outside of Europe; this was not the intention of the

scheme
...
This is not what the government intended when they
introduced the targets
...

● Distortion of price signals = the actions of the government which distort the
operation of the price mechanism and so misallocates resources
...

A lot of money given to the NHS etc
...
Excessive
administration on the Apprenticeship Levy, which aims to increase the
quality and quantity of apprenticeships, has meant that little money is spent by firms
...

Any decisions that the government makes must be based on some data but the
information they have is always going to be limited, for example you cannot
accurately predict the number of cancer patients or the number of cars on the road
...
It is impractical, and usually impossible, for the government to get every piece
of information they need

---