Mustafa Ramji Unit 1 AS Economics

Understand the problem of unlimited wants and finite resources. Needs – basic requirements for human existence Wants – we would like to have The problem is faced by consumers, firms and governments. Finite resources (factors of production): land (natural), labour (human), capital (manufactured goods) and entrepreneurship Scarce goods – Economic goods – e.g. coal Not Scarce – Free Goods – e.g. seawater Sustainable resources can be exploited repeatedly as they renew themselves Understand the advantages and disadvantages of specialisation and the division of labour. Production is the process of turning factors of production into final output Specialisation is when individuals, households, firms or countries concentrate in producing certain goods and services and trading surpluses with each other Division of labour is specialisation by workers on one particular part of production process  Increase labour productivity – output per worker  Suits a modern economy as it encourages exchange  Workers can specialise to tasks they are best suited to X If divided up too much, work becomes tedious, demotivation, less productivity X Over specialisation – when industries close down, unemployment becomes very high Use production possibility frontiers to depict opportunity cost, economic growth and the efficient allocation of resources. Distinguish between movements along and shifts in production possibility frontiers. PPF – all maximum possible combinations of 2 goods that a country can produce within a specified time period. All goods either capital or consumer Demonstrated limited resources, and opportunity cost of how we choose resources Y – Consumer goods, X – Capital goods Inside curve – productive inefficiency On curve – productive efficiency Outside curve – unattainable Movement of curve – economic growth Opportunity cost – highest valued alternative that had to be sacrificed for option chosen: Total given up/ Total gained – e.g. 2 goods given up for 1 = 2:1 PPF bowed outwards due to increasing opportunity costs – as nation concentrates more on one good, has to start using resources which are less suitable and would have been better suited to producing other goods. If OC constant, PPF straight line. Why PPF moves:  Investment in capital goods – more goods produced in long term  Immigration – more labour  Discovery of raw materials  Technological innovation – better productivity  Training-education Distinguish between objective statements and value judgements on economic issues Positive statement – factual and can be tested to determine whether true or false Normative statement – based on values and personal judgement

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Mustafa Ramji Unit 1 AS Economics

Understand the advantages and disadvantages of a free market economy and why there are mixed economies. Free market – will allocate resources without need for government intervention. All economic decisions taken by firms and households. Mixed economy – where resources partly allocated government, part free market, e.g. taxes, prices, public goods Command economy – government decides how resources are allocated Free market evaluation:  Works automatically without government decisions – supply/demand allow firms/ households maximise value for money  No expensive central planning  People work hard as they have incentives for better pay, profits etc  Competition between firms leads to lowering of prices, less wastage, more consumer welfare X More inequality X Immoral/ socially undesirable decisions by firms X Underproduction of goods such as public goods X Overproduction of socially undesirable goods such as cigarettes X Few firms dominate a market X Ethical objection – system encourages greed, materialism and self interest Understand the rationing, incentive and signalling functions of the price mechanism for allocating scarce resources. Rationing function – resources are finite, so not everyone can buy. When demand > supply, mechanism moves price up, so those who can afford to pay can buy Signalling function – allows suppliers to understand what to produce (where supply is low) Incentive function – help change behaviour of consumers, e.g. if cigarettes more expensive, less will smoke Understand how a change in price causes a movement along a demand curve. Demand is the quantity of a good/service that consumers are willing and able to purchase at given price level. Real Income effect: When price is high, less can afford it, so Qd is low. When price is low, more can afford it, so Qd is high. Downward sloping curve. Substitution effect: when goods are more expensive than substitutes, consumers will choose other goods. Relies on ceteris paribus (all other things being equal) Understand factors which may cause a shift in the demand curve, for example, changes in the price of substitutes or complementary goods; changes in real income and tastes. Price of substitutes increases, demand increases, people less willing to buy substitutes: Competitive demand Price of complements increases, demand falls as complement required to consume good: Joint demand As income rises, more people can afford so demand rises Speculation: If prices will be higher in future, more will buy in present, so demand increases Due to advertising or fashion, tastes will may be more favourable to a good, increasing demand Understand how a change in price causes a movement along the supply curve. Supply is willingness and ability of producers to produce a quantity of a good at a given price level Incentive of profits – higher the price, more profits so supply increases Costs – higher price, producers with high costs can enter market, as high price covers the costs Understand the factors which may cause a shift in the supply curve, for example, changes in the costs of production, the introduction of new technology, indirect taxes and government subsidies. As costs such as wages or raw materials, or taxes, increase, supply will shift left New technology improves efficiency, lowering costs and increasing supply If alternative products become more profitable, supply will fall Joint supply – e.g. cows (beef and leather) as beef supply increases, so does leather pg. 2

Mustafa Ramji Unit 1 AS Economics

Composite demand – e.g. milk used for yoghurt and cheese; if demand for yoghurt increases, cheese will fall Random shocks such as earthquakes reduce factors of production Speculation of future price changes – if price likely to rise in future, will hold onto stock in short term Explain equilibrium price and quantity and how they are determined. Understand how the operation of market forces eliminates excess demand and excess supply. Apply the price mechanism in markets, such as goods, services, commodities or labour. At the point where supply and demand curves meet, equilibrium price and quantity are determined Excess demand/shortage – when demand > supply, difference is called ED. Price is too low, so price will rise Excess supply/surplus – when supply > demand, difference is called ES. Price is too high, so price will fall Distinguish between consumer and producer surplus. Illustrate consumer and producer surplus on a demand and supply diagram. Consumer surplus – difference between what consumer is willing to pay and actual market price. Calculation – area of triangle between price at lowest Qd, market equilibrium and (lowest Qd, market price) Producer surplus – difference between what producer is willing to sell at and actual market price. Calculation – area of triangle between price at lowest Qs, market equilibrium and (lowest Qs, market price) Explain price, income and cross elasticities of demand. Understand factors that influence elasticities of demand and their significance to firms and government. PED is responsiveness of demand to change in price  % Change in Qd % Change in P PED = 0-1  price inelastic PED > 1  price elastic PED = 1  unitary Changes in PED due to number and closeness of substitutes, habit forming, proportion of income spent, easier to postpone purchase of good and time period (longer time = more elastic) YED is responsiveness of demand to change in income  % Change in Qd % Change in Y YED < 0  inferior good – when income rises, Qd goes down, e.g. “value” products YED > 1  luxury good – e.g. air travel YED 0 - 1  income inelastic and normal necessity e.g. milk XED is responsiveness of quantity demand of a good to change in change in price of another good  % Change in Qd Good A % Change in P Good B XED < 0  compliments. XED = 0- -1  weak compliments, XED < 1  strong compliments XED > 0  substitutes XED = 0- 1  weak substitutes, XED > 1  strong substitutes XED = 0  unrelated, independent Understand the relationship between price elasticity of demand and total revenue. Type of good Prices  Prices  Demand is elastic Revenue Revenue Demand is inelastic Revenue Revenue

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Mustafa Ramji Unit 1 AS Economics

Explain price elasticity of supply; understand factors that influence price elasticity of supply. Distinguish between the short run and long run in economics and understand its significance to price elasticity of supply. PES is responsiveness of supply to change in price  % Change in Qs % Change in P PES > 1  price elastic PES < 1  inelastic Changes in PES due to availability, flexibility and mobility of resources, storability (easily stored = elastic), production time and time period Use supply and demand analysis to demonstrate the impact and incidence of taxes and subsidies on consumers, producers and the government. Indirect tax is a tax on expenditure. Ad valorem tax is percentage of selling price. Flat rate/ specific tax id where tax is a fixed amount Subsidy reduces cost of production and paid for by government

Understand the factors which influence the demand and supply of labour. Recognise that demand for labour is derived from the demand for the final product it makes (derived demand). Understand that factors influencing the supply of labour include population migration, income tax and benefits, government regulations (for example, national minimum wage) and trade unions. Households supply labour, businesses demand labour Demand for labour is derived demand. As more goods demanded, businesses require more workers Factors affecting supply of labour include an increase in the working population, changes in non-monetary rewards (e.g. working conditions), benefits, income tax, immigration and the demographic of the population (e.g. ageing of population) National Minimum Wage is minimum amount paid to a worker per hour by employer  Helps alleviate poverty, reduce inequality  Increases incentive to work, reduces unemployment trap  Boost morale of workers X Could lead to unemployment, as excess supply of labour X Decisions based pay differentials, so workers will ask for more X Does not take into account regional differences in cost of living Define and understand different types of market failure. Market failure - when free market provides goods/ services in the wrong quantities, or fails to provide them, leading to misallocation of resources. Externalities – spill over effects of an economic activity on a third party Missing markets – free market fails to provide public goods, e.g. streetlights Imperfect market information – asymmetric information, leading to conning etc. pg. 4

Mustafa Ramji Unit 1 AS Economics

Labour immobility – due to lack of skills, or unable to move geographically, unemployment of labour resources Instability in commodity markets – producers unsure of how to plan, large shortages/ surpluses of goods. Government intervention is desirable to stabilise prices Government failure – can lead to further misallocation Illustrate external costs and external benefits using marginal analysis, distinguishing between the market and social optimum positions. The welfare loss or gain areas are required. Understand the impact of externalities and government intervention in various markets, for example, transport, health care, education, environment, waste disposal and recycling. Externalities not reflected in price, spill over effect on third party of an economic activity Private cost – direct cost of an activity imposed on consumer, firm or government Social cost – total cost to society of economic activity = Private cost + externality Welfare gain

Free market output

Evaluation: Imperfect knowledge – based on assumptions Quantifying externalities – hard to put a monetary value on externalities Size of welfare loss/gain Consider external costs if positive, external benefit if negative Explain why public goods may not be provided by the market. Distinguish between public and private goods. Public good – underprovided or not provided in free market. - Non-rivalry – one person’s consumption does not reduce ability of another to consume product - Non – excludability – no one can be prevented from consuming Private good – excludable and rivalrous If either non-rivalrous/ non-excludable, it is quasi-public good Free rider problem – as no one can be prevented from using them, firms have no profit incentive Distinguish between symmetric and asymmetric information. Understand how imperfect market information may lead to a misallocation of resources, for example, health care, education, pensions, tobacco and alcohol. Symmetric information – when buyers and sellers have access to same amount of information about products Asymmetric information – buyers/sellers have different amounts of information Caused by uncertainty about costs and benefits, like merit goods, or inaccurate/ misleading information

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Mustafa Ramji Unit 1 AS Economics

Understand geographical and occupational immobility of labour may result in structural unemployment. Assess government measures to reduce factor immobility such as training programmes and relocation subsidies. Labour immobility is the failure resulting in inability of workers to move easily between jobs Geographical immobility – could be due to high house prices, social reasons or home ownership Occupational immobility – lack the skills/ training for jobs available. Structural unemployment when unemployed do not have skills/ training to take up jobs Government policies: Geographical immobility – housing subsidies, but expensive (opportunity cost) and time lag Occupational immobility – training and education – Apprenticeship schemes, but expensive, time-lag and exploitation of cheap labour Understand the causes and effects of fluctuating commodity prices on consumers and producers. Assess the impact of government intervention in the form of minimum prices and buffer stocks. Use diagrammatic analysis for minimum prices and buffer stocks. Commodity market instability caused by unpredictable supply, which is inelastic as supply of wheat cannot be instantly changed. Also, farmers base decisions on previous year prices for the future; if demand changes, producers cannot respond. Increase in commodity prices leads to increase in prices of goods derived from commodities e.g. bread. Government intervenes because: 1. Unstable prices lead to unstable incomes for farmers 2. Long-term falling prices leads to falling incomes for farmers 3. Desire to protect agriculture and maintain food supplies 4. Imperfect competition – small businesses rely on powerful, larger firms Minimum prices (floor prices) can be above equilibrium prices prevents prices falling further - excess supply. No impact if below equilibrium price.  Prevents extreme downward price fluctuations  Encourages farmers to stay in market  Scheme can be self-financed if combined with buffer stock X Could hold price artificially high, leading to fall in consumer demand X Government must buy up excess supply – expensive X Can create mountains of unwanted stock, dumping stock on LEDCs, where local farmers suffer X Government may pay producers to produce less Buffer stocks buy up excess supply, sells when there is a shortage. Supply released when shortage, lowering price. Buy up surplus, increasing price.  Stabilise prices for consumers and producers  Could be profitable X Will not work for perishable goods, e.g. milk X Expensive at first X Difficulty of knowing where to set price band X Persistent dumping on LEDCs Understand the different measures of government intervention to correct market failure, for example, indirect taxation, subsidies, buffer stocks, tradable pollution permits, extension of property rights, state provision and regulation. Apply, analyse and assess the effectiveness of each method of government intervention for correcting market failure. Taxation – internalises externality, emitting negative externality. Polluter pays principle. X Level of tax hard to decide on pg. 6

Mustafa Ramji Unit 1 AS Economics

X Tax would have to be very high on inelastic goods to change Qd X Passed onto consumer, often the poor Subsidise increases supply and therefore consumption of goods with external benefits by reducing costs of productions. X Can be expensive for government X Hard to measure external benefit, hard to decide level of subsidy, may affect effectiveness X Producers may take subsidy and not increase supply State provision of public goods X Expensive, opportunity cost X Can result in inefficiency – bureaucracy X High costs for regulation Advertising/ information campaigns change attitudes X Expensive X People become immune to information campaigns Regulation, such as limiting goods with externalities X Costly to enforce laws X Deterrents may be too lenient, no incentive to follow regulation X Difficult to know where to set regulation Tradable permits “Cap and Trade” creates a market to pollute, internalising externality. The more permits you buy, the more you can pollute. X Where to set limit X Too many permits - government failure X Cost of monitoring very high X Large companies can make profits from selling permits Extending property rights, e.g. local people own air, so if polluted by company, company pays X Difficult to allocate X Compensation difficult to assess X Expensive, time consuming Define and explain different types of government failure, for example, undesirable outcomes from agricultural stabilisation policies; environmental policies; transport, housing and the national minimum wage. Government failure occurs when government intervention leads to further misallocation of resources and a net welfare loss. Public choice/ interest theory, whether free market allocates resources efficiently and if intervention is required. Cost Benefit Analysis by government helps assess total costs and benefits of intervention and if investment should go ahead. X Difficult to measure external costs and benefits - Monetary value on health X Administrative costs and delays - Terminal 5 Heathrow X Future costs and benefits difficult to measure - Allowing for inflation

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