Notesale: Turn your study into money

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AS Economics- Markets in Action
Chapter 1: The reasons for individuals, organisations and
societies having to make choices
Definition of economics
Economics: the study of how to allocate scarce resources in the most effective way
...

Household: group of people whose spending decisions are connected
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Model: a simplified view of reality that is used by economists as a means of
explaining economic relationships
...

-Problem of scarcity, which arises from infinite wants and only finite resources
available
...
There is not enough of everything to go around
...

Opportunity cost: in decision-making, the cost of the next-best alternative forgone
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1
...
g
...

Labour: the quantity and quality of human resources
...
Land: natural resources (often scarce in cities) including raw materials like oil
and coal, the earth’s river and land itself
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3
...
g
...

Capital: man-made aids to production
...
Entrepreneurship and management
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Goods: tangible products, i
...
products that can be seen and touched, such as cars,
food and washing machines
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Entrepreneur: someone who bears the risks of the business and who organises
production
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Production: the output of goods and services
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Choice: the selection of appropriate alternatives
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Specialisation: the concentration by a worker or workers, firm,
 region or whole
economy on a narrow range of goods and services
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Benefits of Specialisation:
 Specialist workers become quicker at producing goods
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 Bigger market
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 An increase in the output of goods and services (should raise living standards)
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 It allows workers to become more skilled at what they specialise in
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 Output may go down, if workers become bored of doing the same jobs
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 Taste of consumers may change leaving a country’s exports in a vulnerable
position
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Division of labour: the specialisation of labour where the production process is
broken down into separate tasks
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Production Possibility Curves
-We can use a production possibility curve to explore the notion of opportunity cost
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-In an economy, what is produced is determined by the quantity and quality of
resources that are available:
 In developed countries many thousands of goods are produced because of the
extensive availability of factors of production
...

 For developing economies, the quantity and quality of resources will be much
lower and consequently less will be produced and there will be less variety of
production
...

Graph:

-To produce more of Product A you need to produce less of Product B
...

-This curve shows an increasing opportunity cost of loosing wine from point A to
point B and to point C
...
However, they may be able to produce
many of another good
...

-Point X is where it is producing less that it could from the resources available
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-It has an increasing opportunity cost because resources are not perfect for the
production of both goods
...

Later on there are not many non-helpful resources for cotton production available so
there is a high opportunity cost
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 When there is a positive technological change (advances in technology), more
of both types of products can be produced, shifting the possibility curve to the
right
...

Economic growth: change in the productive capacity of an economy
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Calculate the opportunity cost for Colin and for Debbie when producing 1 bracelet?
What can you tell about the opportunity cost? What would the PPC look like
...
This means
the opportunity cost in constant so the PPC is linear
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5 pots
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Trade-off: the calculation involved in deciding on whether to give up one good for
another
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The 3 questions faced by economies:
1
...

2
...

3
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3 main types of economic system:
1
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-Resources are allocated by the forces of demand and supply through price
mechanism (by the people)
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Supply: the quantity of a product that producers are willing and 
 able to provide at
different market prices over a period of time
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-The government has little or no direct involvement in this process
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-Only exists in theory (government will always keep a watch on the market)
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Command or centrally planed economy:
Command economy: an economic system in which resources are state owned and
also allocated centrally
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 How to produce
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-Central government and its organisations are responsible for the allocation of
resources
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 Prices of most essential items and the determination of wages are also
controlled
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-Only exists in theory
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Mixed economy:
Mixed economy: an economic system in which resources are allocated through a
mixture of the market and direct public sector involvement
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-Decisions involve an interaction of firms, labour and the government, mainly through
market mechanism
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Chapter 2: Competitive markets and how they work
What is a ‘competitive market’?
Market: where or when buyers and sellers meet to trade or exchange products
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Also known as a
market segment
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 Stock market
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 Housing market
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 Commodity market, to include agricultural and mineral products
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 eBay
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-A willingness to trade or exchange goods or services (usually done using money)
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 Demand is in order to consume a product, but in order to consume it you have
to be able to afford to pay for it
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-The distinction between wants and demand can be made clear in terms of notional
demand and effective demand
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Effective demand: the willingness and ability to buy a product
...
This is known as ceteris paribus, which literally means ‘other things
remain equal’
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Relationship between price and quantity demanded:
-There is an inverse relationship between the price of a product and the quantity
demanded
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-The higher the price, the less that will be demanded
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Demand curve: this shows the relationship between the quantity demanded and the
price of a product
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Graph:

-There is a normal inverse relation ship between price and quantity demanded
...

-The relationship is linear (the demand curve is a straight line)
...
For example at price 2, 3 will be demanded
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Calculation of Total Expenditure and Total Revenue
Total expenditure of consumer/revenue of supplier = price × quantity
demanded/supplied
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Other Factors Affecting Demand
1
...
The quantity may not
change, but the price at which they are willing and able to buy the product will
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Disposable income: income after taxes on income have been deducted and state
benefits have been added
...

-If it is a normal good, demand increases with an increase in income
...

-If it is an inferior good, demand decreases with an increase in income
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2
...

Substitute: a competing good
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Complements: goods for which there is joint demand
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Tastes and fashion:
-If something is fashionable or trendy people will pay more for a certain quantity
...

-Tastes are to do with personal preferences
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4
...

A change in demand due to a change in non-price factors:
-When there is a change in demand, it results in a shift of the demand curve
...

Change in demand: this is where a change in a non-price factor leads to an increase
or decrease in demand for a product
...
This
means that more of the product is demanded at the same price
...
This means
that less of the product is demanded at the same price
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 A decrease in quantity demanded from L to L’ at price P
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 A increase in quantity demanded from L to L” at price P
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Supply: the quantity of a product that producers are willing and 
 able to provide at
different market prices over a period of time
...

Profit: the difference between the total revenue (sales revenue) of a producer and
total cost
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-The lower the price, the less that will be supplied
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-This is because if the price of a product rises they are more likely to make a larger
profit, so they will be more willing to supply it
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Supply curve: this shows the relationship between the quantity supplied and the price
of a product
...

-A change in price affects the producer’s willingness to supply
...
As the
price of the product increase, the quantity supplied increases
...

-It is possible to use the market supply curve to find out the expected quantity supply
at any particular price
...

Producer Surplus

Producer surplus: the difference between the price a producer is willing to accept
and what it is actually paid
...
Costs of production:
-If cost of production goes up, the curve shifts to the left
...

2
...
In turn, the increased prices will affect
the willingness to supply
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-Subsidies:
 The government might pay the company to reduce costs, and hence prices to
consumers
...
Natural disasters or disease:
-This might destroy factories, or kill many factory workers
...
So the supply
curve would shift to the left
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-In others, price competition is less important
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A change in supply due to a change in non-price factors:
-When there is a change in supply, it results in a shift of the supply curve
...

Change in supply: this is where a change in a non-price factor leads to an increase or
decrease in supply for a product
...
This means
that more of the product is supplied at the same price
...
This means that
less of the product is supplied at the same price
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 A decrease in quantity supplied from 50 to 30 at price £10
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 A increase in quantity supplied from 50 to 70 at price £10
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Price: the amount of money that is paid for a given amount of a particular good or
service
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Equilibrium price: the price where demand and supply are equal
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 The price set by producers is too high
...
Supplier is forced to lower the price to
clear the surplus supply
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Surplus: an excess of supply over demand
...
More products could be sold,
because consumers demand is higher (shortage)
...
So when demand is greater than supply, price will rise
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Graph showing surplus:

-At P2, Q2 everything that is produced is sold (equilibrium)
...

-This causes pressure for the prices to be lowered to return to equilibrium
...

-When price is lowered from P2 to P3, there is a shortage of goods supplied (not at
equilibrium) of Q3-Q1
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Clearing price: same as equilibrium price
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Effects of a Change in Demand or Supply on the Equilibrium Position
1
...


2
...


3
...


Elasticity
-Elasticity is:
 A numerical estimate
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Elasticity: the extent to which buyers and sellers respond to a change in market
conditions
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-All factors that affect demand remain unchanged
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Formula:

Price elasticity of demand=

% change in quantity demanded
% change in price

Size:
-PED<1 inelastic (any change in price causes a proportionally smaller change in
quantity demanded)
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-PED>1 elastic (any change in price causes a proportionally larger change in
quantity demanded)
...

-PED=1  unitary (any change in price causes the same change in quantity
demanded)
...

-Does not have to be included
...
2
PED =
® 10 ®
= 0
...

Determinants of price elasticity of demand for a product:
1) The availability and closeness of substitutes:
-The more close substitutes there are to a product, the more likely it is to be elastic
...

-This means the demand for the product is very price responsive
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-This makes it more likely to be inelastic
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3) Time:
-In the short term, most consumers find it difficult to alter their spending habits
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-Over time, as consumer find out more about possible substitutes, demand for a
product is likely to become more price elastic
...
Such products tend not to be necessities and
are likely to take up a large proportion of income
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-Therefore it is inelastic
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Increase or decrease price table:
Increase in Price
Decrease in Price
Elastic
Loss total revenue
Gain total revenue
Inelastic
Gain total revenue
Loss total revenue
Importance of price elasticity of demand of a product:
-So companies know whether or not to change their prices in order to maximize total
revenue and profits
...
This also
avoids unemployment due to huge decrease in quantity demanded
...

When asked to comment on elasticity:
-Any form of elasticity calculation is an estimate and may or may not be accurate
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Income Elasticity of Demand (YED)
Income elasticity of demand (YED): the measure of the responsiveness of the
quantity demanded to a change in income
...

Normal goods:
Normal goods: goods for which an increase in income leads to an increase in
demand; goods with a positive income elasticity of demand
...

-As real disposable income rises (from Y1 to Y2), demand for these products will also
rise (from Q1 to Q2)
...

Income elastic: goods for which a change in income produces a
proportionally greater change in demand
...

Income inelastic: goods for which a change in income produces a
proportionally smaller change in demand
...

-Negative income elasticity of demand
...

-Graph:

Cross Elasticity of Demand (XED)
Cross elasticity of demand (XED): the measure of the responsiveness of the quantity
demanded for one product in relation to a change in the price of another product
...

-An increase in the price of good y, means less people demand good y and substitute
it for good x so demand for good x would also increase
...

-An increase in the price of good y, means less people demand good y and therefore
demand less of good x as a complement, so demand for good x would decrease
...

-A change in price of good y does not cause a change in quantity demanded of good
x
...

-Good or close substitutes will have a higher cross elasticity of demand (+)
...

Graph for substitutes:

Graph for complements:

Graph for 0 XED:

Price Elasticity of Supply (PES)
Price elasticity of supply (PES): the responsiveness of the quantity supplied to a
change in the price of the product
...

-This means if the price falls, it will be highly unusual for the supplier to produce
more good for the market in a free market situation
...

-PES>1  elastic (producers are able to respond with a relatively large change in the
quantity supplied when the price changes)
...

Graph:

-S3= inelastic
...

-S1= unitary
...

1) Availability of stocks of the product:
-Stocks or inventory allow suppliers to store goods in a warehouse
...

2) Availability of factors of production:

-The harder it is to get factors of production, the harder supplying is, making it more
inelastic and vice versa
...

a) Labour:
-Usually the most available factor of production
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b) Capital:
-If more machinery has to be purchased, the elasticity of supply will be inelastic
...


Business relevance of elasticity estimates:
Ways of collection information for elasticity:
-Sample surveys of consumers (e
...
PED and YED)
...
g
...

-Competitor analysis (e
...
XED)
...

-Difficult to get data for a full range of price changes (much easier to obtain data for
price changes that are close to each other)
...

Use of PED:
-Used as an essential input into the pricing strategy of firms, enabling them to
maximise sales revenue
...
So the company should increase the price to maximise sales revenue
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So the company should decrease the price to maximise sales revenue
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-So firms who produce goods and services with a high positive income elasticity of
demand can expect to do well in the future
...

-Deciding whether they are inferior or normal goods helps the company predict
whether demand will increase or decrease with an increase in income
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-Where there are close substitutes (high positive XED), then firms are likely to cut
down their prices in order to steal market share from their rivals
...


Use of PES:
-PES is always positive as when price rises so does the quantity supplied
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Allocative Efficiency
-For efficiency to happen, the factors of production must be fully employed to meet
customer’s needs, and the prices charged by producers should be at the lowest level
...

-To achieve allocative efficiency the quantity supplied must be equal to the quantity
that is demanded (the market must function at equilibrium position)
...

Allocative efficiency Graph:

-Allocative efficiency is often not achieved in practise
...

-In contrast, if the quantity produced is more than Q*, too many resources are being
allocated to the production of this product in relation to demand
...


Chapter 3: Market failure and government intervention
What is meant by market failure?
-Market failure is when resources are not being used in a way that produces the best
allocation for consumers
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-Prices are too high or too low
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Productive efficiency: where production takes place using the least amount of scarce
resources
...

Economic efficiency: where both allocative and productive efficiency are achieved
...

Inefficiency: any situation where economic efficiency is not achieved
...

Free market mechanism: the system by which the market forces of demand and
supply determine prices and the decisions are made by consumers and firms
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-According to the definition of economic efficiency, the free market is producing the
best allocation of resources when consumers are maximising their welfare
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-Examples:
 Where consumers are not aware of the benefits and, in some cases, the
harmful effects of consuming a particular product
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 Where product packaging makes claims that are inaccurate or misleading
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 Health care  when you visit the doctor with an illness you do not have the
same medical knowledge as your doctor
...

 Environment  as individuals we know very little about the environmental
consequences of burning up fossil fuels
...

 Consumer purchases  what might at first seem to be a good deal mat turn
out not to be so
...

 Insurance  When applying for insurance, as a purchaser you know far more
about your circumstances than the company that is selling you a policy
...


Externalities
-An externality is also known as a spillover
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-Third parties are those that have not had any input into the decisions that are
affecting their well-being
...


Costs and Benefits
1) Private costs and private benefits:
Private benefits: the benefits directly accruing to those taking a particular action
...

-These are experienced by the people (firm, individual or anyone else) who are
directly involved in the decision to take a particular action
...

External benefits: the benefits that accrue as a consequence of externalities 
 to third
parties
...

3) Social costs and social benefits:
They consist of private costs and benefits and any external costs and benefits that
arise
...

Social costs: the total costs of a particular action
...

Negative externality: this exists where the social cost of an activity is greater than
the private cost
...

-Graph:

-Description:
 Is at P1Q1 (MSC=MPB)
 Should be at P*Q*
...

 Too many scarce resources are used, due to overconsumption (Q1>Q*)
-Example:
 People start to consume too much alcohol, resulting in them dying and not
being able to work, which will affect the company they work at and economy
...

-Graph:

-Description:
 Is at P1Q1 (MPC=MSB)
...

 P*Q* is where there is social optimum (MSC=MSB) and community surplus
is maximised
...


Positive Externalities
-Positive externality is when the benefits received by a third party are over and
above those that are received by those responsible for carrying out a particular activity
or action
...

Consumption:
-You consume too little
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 P1Q1 is where there is social optimum (MSC=MSB) and community surplus
is maximised
...

-Example:
 Students that consume too little education, and therefore are not as trained as
they could be so company’s suffer and productivity goes down
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-Description:
 It is at P1 to Q1
...




P*Q* is where there is social optimum (MSC=MSB) and community surplus
is maximised
...

-Example:
 A company purifies the water it produces less, so this affects local firms that
rely on it
...

Demerit goods: their consumption is more harmful than is actually realised
...

De-merit goods graph:
-Consumption causes less benefit than consumers realise due to information failure
...
g
...


Merit goods:
-Consumption causes more benefit than consumers realise due to information failure
...
g
...


Public Goods

-It is difficult to charge for public goods directly, so there is a need for them to be
financed by the government from general tax revenue
...

-If left to the free market, most public goods would not be provided, despite the
benefits they give to those who consume them
...

-They are provided for all, irrespective of whether they have paid for the product
indirectly through taxation
...

-Not all residents pay this tax, nor do overseas visitors, yet neither group is denied
access to the police if the need arises (free riders)
...

-In the case of police service, if one person is being protected by the police service,
this should not affect the local service that is provided to all other member of the
community
...

-Quasi-public goods tend to have the non-excludability characteristic, but not the nonrivalry
...

-For example a bed in an NHS hospital, where anyone can go and use it, but the
consumption of it by one person can affect the consumption of all others (takes a
place away)
...


Government Intervention to Correct Market Failure
Examples of Intervention:
1) Negative externalities:
-Laws banning fly tipping
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-Environment laws are passed
...

-Funding for education and training and subsidies for major transport project, because
of their wider social and economic value
...

4) Public goods:
-Charging people by using them
...

-For example, subsidies, indirect taxation and the provision of information
...


Taxes
-All forms of taxation are paid to the government, which in turn allocates tax revenue
to various forms of public spending
...

Two main types:
1) Direct taxes:
Direct tax: one that taxes the income of people and firms and that cannot be avoided
...

-All of which are taxes on the incomes of individuals and firms
...

-Such as the value added tax (VAT) and excise duties, which tax the sale of certain
products
...

-Used to discourage production of demerit goods and other goods and services that
produce negative externalities
...

-This leads to increased prices in the markets
...

-In this way the external cost is internalised to the producer (polluter pays principle)
...

-Graph showing effects if imposing an indirect tax:

Advantages:
-Provides incentives to reduce the negative externality
...

Disadvantages:
-There are problems in determining the exact amount of tax, since it is difficult to
measure the level of the externality
...

-Discourages production, which may lead to unemployment rising
...

Depends on:
-Whether what you are taxing is positive or negative externality
...

-How long you tax for
...


Subsidies
-A subsidy has the purpose to reduce the cost in order to provide a higher level of
production or consumption than would exist if it was left to the free market
...

-Such payments are particular relevant in the case of merit goods and where products
generate positive externalities
...

2) To consumers:
 For example the winter fuel payment to people aged 60 and over
...

-In some ways a subsidy works in the opposite way to an indirect tax
...
It is therefore used to potentially solve market failure due to a
positive externality
...


-When given to the consumer it can encourage them to benefit more from consuming
something like education, which can be beneficial to the private user
...

-Firms can spend more money on advertisement and therefore correct information
failure
...

-Opportunity cost to the expenditure on the provision of merit goods
...

-Can encourage inefficiency:
 Firms rely on subsidies, rather than improve efficiency
...

-A provision of subsidy does not mean the producer will lower the price
...


Regulations, standards and legal controls
-Purpose is to over-rise the workings of the market mechanism
...

b) Transport:
-Legislation governing the compulsory use of seat belts and vehicle speed limits
...

d) Use of demerit goods:
-Restrictions on the sale of tobacco products and alcohol
...

-Limits too low:
 Increase in cost of production
...

b) How do you divise the amount to fine?
-Too high?
 Decrease in firm’s ability to compete i
...
fines lead to an increase in cost of
production
...

c) Cost of enforcement
...


Tradable Permits
Tradable permits: a permit that allows the owner to emit a certain amount of
pollution and that, if unused or only partially used, can be sold to another polluter
...

-Tradable: they can sell unused permits to companies, which incentivizes them to
reduce pollutants by investing in research in development to reduce pollutants
...

-The European Union’s Emissions Trading Scheme (ETS) is a practical working
example of a tradable permit scheme
...

-Different countries have different regulations and laws:
 Causing companies to move country and produce more pollution in that
country
...

-Hard to monitor and predict:
 Can’t exactly count the amount of pollution a company produces
...

b) Estimates:
-The levels at which the government place both the fines and the permits are only
estimates, as it is difficult to measure the externality:
 Therefore some companies are over/under fined and sometimes the
government is allocating too many or too few permits
...


-Smaller firms may not be able to afford as many permits and therefore may be
restricted with:
 How much they can supply
...

 Whether they may potentially want to expand
...

Examples:
-Health warnings on cigarette packets
...

-Improved labelling on food products, such as ‘traffic light’ system that indicate the
fat, sugar and salt content
...

Advantages:
-Consumers receive truthful and impartial information
...




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