Notesale: Turn your study into money

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COMPLETE THEME 1 NOTES
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Economists
develop models which attempt to simplify and improve our understanding of
how consumers and producers behave
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● Economics = the allocation of scarce resources to provide for unlimited
human wants
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This arises when there
are infinite human “wants” but finite resources
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This incurs an opportunity cost - the value of the next best
alternative foregone
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● Consumers are assumed to want to maximise utility, whilst firms are assumed
to want to maximise profits
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● Productivity = the output per unit input
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It does not carry a value judgement
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The economic problem
● The economic problem = this involves 3 parts: what to produce, how to
produce it and how to distribute it
...
g
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● Non-renewable resource = one whose stock level decreases over time as it
is consumed (e
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coal, oil and steel)
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● Opportunity cost = the value of the next best alternative foregone
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● Consumer goods = directly provide utility to consumers (e
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food, clothes
and holidays)
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PPF and opportunity cost
● If a point lies within the PPF, this is an inefficient combination because not
all resources are being fully utilized
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● If a point lies anywhere on the PPF then it is an efficient combination
because no resources are being wasted
...
g
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This shows productive efficiency
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● If a point is located above the PPF then that combination is not yet attainable
(but it could be if economic growth occurred)
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● If a PPF is curved then the opportunity cost will vary
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Shifts in the PPF
● If the PPF shifts outwards then this shows economic growth
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● PPFs occasionally shift inwards, indicating a decrease in the potential output
of an economy (e
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after a natural disaster)
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g
...
g
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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
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● However there will still be an opportunity cost involved
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''
● This is because some resources are better suited for the production of some
things than others (e
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many economic resources are not easily adaptable or
transferable)
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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)
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Specialisation advantages

● Leads to economies of scale - lowers the long run average cost for the firm
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● Rising standards of living
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● 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
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Zambia and fluctuating global copper prices)
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Overall, this should aid economic growth and living standards
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● Higher productivity achieved by…
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➔ Workers should become more skilled (faster) over time
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➔ Capital machinery can be used continuously in production
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Division of labour disadvantages
● Monotony of work - consequences include: workers becoming less
productive, increased staff turnover and therefore greater costs for
recruitment
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This could leave them structurally
unemployed
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So if one group of workers
go on strike, or one part breaks down then the whole production process will
be halted
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Functions and characteristics of money
● Money is anything that is generally acceptable in the payment of a good or
service, or a debt
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● Money has to act as
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This makes buying and selling easier
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➔ 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
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Types of economies - free market, command and mixed economies
● Free market economy = where scarce resources are allocated by the price
mechanism
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● Mixed economy = some resources are allocated by the price mechanism and
some by the government
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Free market economy
● Associated with the writings of Adam Smith
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● There are no pure free market economies in the world today
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● Advantages:
➔ Competition between firms results in lower prices for consumers and
greater efficiency
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➔ Consumers have lots of choice
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➔ Financial incentives due to little or no income or corporation tax
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These fuel economic growth
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➔ Erratic swings in the business cycle (very extreme boom and bust
periods)
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Information
gaps persist
...
g
...
g
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Command economy
● Associated with Karl Marx - believed that production should be driven by
human need rather than profit
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● North Korea = closest example
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g
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Advantages of a command economy

Disadvantages of a command economy

Cooperation between firms can lead to
high levels of output
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Reduction in inequality due to
government controlling workers’ wages
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Government can fund public goods and
services more (e
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defence and
healthcare) and tax harmful products
like tobacco (or carbon dioxide…)
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Other disadvantages of a command economy… asymmetric information can
occur because the government does not actually know what is best
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● Because consumers and producers are both driven by self-interest, the
interactions between them will lead to a mutually beneficial allocation of
resources
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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
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Friedrick Hayek - free market economy

● Supporter of the free market and very critical of command economies,
because he believed that consumers know best
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He believed that governments should not intervene in
resource allocation decisions, except in the provision or protection of public
goods
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1
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● Reasons why consumers may not make rational decisions = the influence of
other people’s behaviours, addiction, consumer weakness at computation or
habitual behaviour
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● Market = where consumers and producers come into contact with each other
to exchange goods and services
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● Individual vs market demand
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● You can only move along
the demand curve when
there is a change in
price
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● Marginal utility = the
utility gained from
consuming one extra unit
of a good or service
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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
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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
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Also called the market clearing
price (because there is no excess demand or supply, so the market is
“clear”)
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Law of demand = as prices rise, quantity demanded falls (and vice versa inverse relationship)
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Complements effect = if demand for one product (e
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dishwashers) rises,
then demand for related or similar products will also rise (e
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dishwasher
tablets)
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● Elastic = if a price change leads to a considerably bigger change in quantity
demanded
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● Percentage change = (difference/original) x 100
● PED = % change in quantity demanded / % change in price
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● A PED of <1 = inelastic
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● PED of infinity = perfectly elastic
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● Factors that affect PED = Substitutability, Proportion of income spent on the
good/service, Luxuries/necessities, Addictiveness and Time
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➔ On a quantity demanded vs
...
g
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➔ Include minus signs in your answer
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● YED = % change in quantity demanded / % change in income
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● If goods have a negative YED, then they are inferior (income rises, so
demand decreases)
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● XED = % change in quantity demanded of good X / % change in the price
of good Y
...
g
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● A positive XED = the goods are substitutes (e
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oranges and tangerines)
...
g
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Supply
● Supply = the amount of a
good or service that firms
are willing and able to supply
at a range of price levels
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● Reasons why the supply curve is upward sloping = profit motive (when market
price rises it is more profitable for businesses to increase their output)
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● The only factor that causes a
movement along the supply
curve is price
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● An increase in supply OR
demand = always a shift to the
right
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● Joint supply = when an increase of supply of good x, means more is
automatically supplied of good Y (e
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beef and leather)
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Price elasticity of supply
● PES = a measure of how responsive supply is as a
result of a change in price
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● Momentary (e
...
immediately) elasticity of supply will
be zero (perfectly inelastic) because suppliers cannot
instantly meet a change in demand
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● In the long term, PES is relatively elastic
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Price determination
● Equilibrium price = the price where the quantity demanded equals the
quantity supplied for a good or service in a market
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● Excess demand = where the quantity demanded exceeds the quantity
supplied for a good at the current market price
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● ARSI = Allocates scarce resources, Rations excess demand/supply, Signals
that price is too high/low, Incentives to change price
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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
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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
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Also, consumers have more incentive to consume goods after
supply increases as the price will be lower
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Rations supply: when supply decreases
there will also be a shortage so few people can obtain the good or service
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● Producer surplus = the
difference between the market
clearing price that firms receive
and the price at which they are
willing and able to supply
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Indirect taxes and subsidies
● Tax = a compulsory financial
contribution to state revenue
...
g
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● Indirect taxes = taxes levied on the expenditure of goods or services (e
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VAT)
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● Specific tax = a tax which is a fixed rate per unit, like the tax on a pint of beer
is 41
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● Incidence of tax = the distribution of the tax paid between consumers and
producers
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Incidence of tax

Subsidies - advantages
➔ Enables greater social efficiency
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➔ If you subsidise public transport, it will encourage people to drive less, and
reduce their negative externalities
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It will encourage firms to develop more products
with positive externalities
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➔ Potential increase in employment within subsidised industries, e
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farming
and the EU CAP
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Some taxation, e
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income tax,
may reduce incentives to work
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g
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Difficult to estimate the extent of the positive externality
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Difficult to quantify external benefits and place a monetary value on
them
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There is a danger that government subsidies may encourage firms to be
inefficient and they come to rely on subsidy rather than improve efficiency
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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
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● 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
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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
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Consumers become unwilling to change the bias, even if doing so will benefit
them, if it goes against the norms of society
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One example is the stock
market, and this causes huge market bubbles
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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
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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
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3
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Also, consumers are sometimes poor at self-control and so do things they
know they shouldn’t
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One example of this
is consumers saving up for their pensions: many put off doing this because
they fail to look long term
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3 Market Failure
● Market failure = when the price mechanism leads to an inefficient allocation
of resources, leading to a net welfare loss
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● Complete market failure occurs when, unless the good or service is publicly
provided, it would not be provided at all (e
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military)
...
g
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Externalities
● Externalities = the third party costs or benefits which affect someone who
was not involved in the transaction
...
g
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● External benefits = positive externalities
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● Private costs = costs that are internal to a transaction, so affect me or the
firm (taken into account by the price mechanism)
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● External benefits = positive third party effects outside a transaction (e
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vaccinating someone against measles reduces the possibility of others
catching measles)
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● Social benefits = external benefits + private benefits
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● 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
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lack of education = low skilled future
workforce = low productivity)
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● Social optimum = where marginal social benefit equals marginal social cost
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● Marginal private benefit (MPB) is drawn as a “demand curve” (but don't say
that in the exam)
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● We only need to know the negative externalities of production graph
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The bit that’s
shaded in blue is the welfare loss
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This can only be corrected through government
intervention
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This graph (below) shows the difference between MPB and MSB
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It shows that from Q3 to Q4 there is
an underconsumption of cars
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The vertical line DF
represents the value of the external
benefit
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● NOTE: these graphs
assume that consumers are rational
and that demand and supply are both
consis

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