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Business and Economics Unit 4
How markets work?
Productive efficiency
o Firms producing lowest possible unit cost with the resources available
Allocative efficiency
o Economies resources are allocated to their most efficient usage i.e. output is
optimised to meet the needs of the market.
o Allocative efficiency
Point before the curve means economy is not working at maximum
productive efficiency
Resources which are not being used can be allocated to a specific sector
without reducing the output of another sector.
Increase the overall output and achieve closer figure to 100% allocative
Both sectors grown
Balanced out economy
Pushed line closer
Must be demand, demand is decreasing causing line being pushed
away from Production Possibility Boundary
When not up to Production Possibility Boundary curve, not all
resources being used, i.e. unemployed people
Production possibility boundary
o To increase boundary - Increase people, technology.
o If more emphasis was placed on manufacturing, the opportunity cost would be a
reduction in output of services.
Factors that Shift the Production Possibility Boundary to the right
o Improvements to technology
R&D, investment in capital goods, innovation production processes
o New resources discovered
Mineral deposits found
Birth rate increases
Therefore increased labour resource
o Improving quality of existing resources
Skills, training, education
Improvements in quality of level
o Better management of resources
Division of labour and specialisation
Lean management/ JIT
o Encouraging enterprise
Government incentives the entrepreneurs to create wealth
It is possible to increase the output of one particular sector of the economy without
compromising output in other sectors
o Increase the potential productive capacity of output of services due to adaption of a
new technology breakthrough.
Shifting the Production Possibility Boundary left
o Maximum potential capacity of output in the economy reduces, occurs when
firms/industries `die' and are not replaced. E.g. UK shipbuilding.
Factors that shift the Production Possibility Boundary to the left

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Net emigration
o Demographic shifts
o Political instability
o War between sovereign states
o Natural disaster
Market failure
The quantity of a product demanded by consumers does not equate to the quantity
supplied by suppliers. This is a direct result of a lack of certain economically ideal
factors, which prevents equilibrium.
Six reasons why market failure occurs
1. Poor productive and allocative efficiency
High prices
Limited choice
Poor quality
2. Negative market externalities
Social costs exceed private costs/benefits of consumption
3.…read more

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Government has duty to intervene to reduce consumption and prevent
market failure
o Tobacco
o Alcohol
o Fast food/processed food
o Illegal substances
o Gambling/betting
Some of these can be catastrophic upon the individual and society as a whole
E.g.…read more

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Not a matter of over or under provision by private sector but that the good will not
be provided to all
Public goods have 2 characteristics
o Benefits derived from provision of this good cannot be
confirmed to those who have actually contributed towards
its cost
o Consumption of the good by one person does not reduce
the benefits to another
Street lights
Flood control
Parks and gardens
Coast guard
Not normally provided by private sector because no
profit…read more

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Externalities are the spill over effects upon 3rd parties resulting from production
and/or consumption of goods and services
Externalities result in market failure if the price mechanism does not reflect the full
costs of production and consumption to the whole society
Government has a responsibility to `internalise' the negative externality through the
tax system
Negative externalities
Private costs- Internal and direct financial costs to the individual/firm +
External costs- Costs of the side effects/spill over from
production/consumption by the individual/firm = Social costs- Represents…read more

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Limitations/Measurement problems:
Externalities difficult to accurately place a value on externalities ­ both pro
and con = intangible
Economist `impute' s monetary value
Value of short term benefits can have a long term cost
CBA must state assumption on which results base.
Ideally range of estimates based upon different assumptions
Circumstances can change therefore affect outcome/consequences
Can't be valued in monetary terms accurately, as hard to do this.…read more

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The emission trading scheme has been introduced to regulate the amount of
emissions caused by particular industries
Max. Permitted levels of pollution are permitted for each industry and each
business within it.
Given a permit by government allowing to pollute up to agreed limit
If they do not pollute up to limit, sell their permit unused quota to the highest
Provides two advantages:-
Firms have incentive to invest in clean technologies and sell their permits
Governments can control max.…read more

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Strategies firms may use to dominate a market
o Collusion means agreeing with competing producers to avoid any action that would
make competition stiffer
o Cartel ­ agreement not to complete between two or more producers within an
industry.…read more

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Can government control the economy?
Aggregate demand
o Sum total of all demand/services in the economy at a moment in time
o AD = C + I + G + ( X- M )
C = spending by households
I = investment by firms
G = government expenditure on public services
X ­ M = difference between export earnings and import costs "trade
Aggregate supply
o Sum total of the output of the economy at a particular moment in time
o Increasing output results…read more

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o Fiscal policy
Increase direct and indirect tax
Cut public expenditure
Reduce government spending
o Monetary policy
Increase interest rates
Decrease supply of money
o Effects of fiscal and monetary :
Reduces AD resulting in reduced consumption, investment and government
Creates unemployment
Low/negative growth
Lower inflation ­ deflation
o Objective
Slow economy down from excessive growth in AD resulting in high inflation
Achieve a soft landing without tipping economy into recession/depression
Should government intervene in society and what effects will it…read more


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