Economics - Markets, Consumers and Firms

HideShow resource information

1.1 Scarcity, choice and potential conflicts

The problem of scarcity

Economics is about how we allocate scarce resources to try and satisfy unlimited wants and needs. In a free market economy it is the market forces of demand and supply that determine the allocation of resources. In communist countries a Central Planning mechanism is used where the government controls supply in the market.

Choices and potential trade offs

Consumers, firms and governments all have to make choices as resources are scarce and they must decide on the best option for they're limited/finite funds, time and resources. A trade off is a situation where choosing more of one thing leads to having less of another rather than making an either/or choice.

Opportunity cost 

Opportunity cost - the cost of a decision expressed in terms of the next best alternative. All members of a market must make decisions about scarce resources. when they choose one option they forgoe the opportunity of the other

1 of 51

1.1.2 Business objectives

Business objectives are the goals that businesses set out to achieve often determined by balancing the requirements of various stakeholders in the organisation.

Financial business objectives 

  • Profit maximisation - involves short or long run processes by which a firm determines the price and output leven that returns the greatest profit and sets out to achieve this - to get rich
  • Sales maximisation - A firm selling as much as possible without making a loss - can be used to gain customer base and loyalty, gain a greater market share, could be short term then switch to profit maximising
  • Profit satisficing - A firm sets out to achieve a 'good enough' level of profit that ensures survival without undue stress or worry - being happy to make enough profit to have the lifestyle you want and be happy, often involves a trade off between time spent working and time spent at work


2 of 51

1.1.2 Business objectives (continued)

Non-Financial business objectives

  • Survival - the ultimate long term goal - represents personal achievement, continues family tradition, important inadverse conditions like recession 
  • Market share - to expand and gain a certain share of the market in order to increase market power - increases stability and security, linnked to proft maximisation
  • Cost efficiency - operating with minimum waste and the lowest possible unit costs - important when revenue is static/falling to retain a profit
  • Return on investment - how well the business van use its assets to generate profit - important when pressure from shareholders or looking for capital investment 
  • Employee Welfare - making sure that pay is adequate and working conditions are good - targeted for ethical reasons or increases productivity and staff retention which reduces costs
  • Customer Satisfaction - can be a source of competitive advantage, ensures repeat purchase, secures a good reutation for business 
  • Social objectives - the business aims to create benefits for society by pursuing social, environmental or ethical goals - improves brand image, ethical businesses
3 of 51

1.1.3 Stakeholders


Stakeholders are individuals or groups with an interest in or are affected by the actions of a business - Employees, Owners and shareholders, Customers, Suppliers, Local community, Pressure groups, Creditors, Government, Environmentalists. Economic agents are all those who take decisions to buy, spend, produce, sell or in any way affect how recourses are used. Shareholders are part-owners of the business, they recieve a divdend every year


The shareholder model is a traditional business model where shareholders' interests are the most important it encourages - Profit maximisation - Managers to concentrate on shareholders wishes - short run profit maximisation at the expense of long-term growth - other stakeholders do not take precedence over shareholders. it is criticised for being too short term, max profit is not always the best long term goal

The stakeholder model means that manager have to take into account interests all stakeholder groups - improved brand image - improved staff motivation and retention - closer relationships with suppliers - improved public relations and media coverage

4 of 51

1.1.3 Stakeholders (continued)

Stakeholder conflicts

Reconciling different demands from stakeholder groups is very difficult and there is almost always a trade off between the competing interests

  • Shareholders want to maximise profits
  • Employees want better pay and conditions
  • Customers want lower prices and better services 
  • Goverment wants more tax revenue
  • Local community wants minimum disruption and help with local infrastructure developments
  • Environmentalists want minimum damage to environment

In the short term balancing the interests of other stakeholders may have a negative impact on profits but this is okay for some businesses, it depends on the corporate culture the business has adopted 

Corporate Social Responsibility (CSR)

CSR is a moral responsibility a firm has to its stakeholders and the society in which it operates.

5 of 51

1.2.1 Role of an entrepreneur in the economy

Creative destruction 

Creative destruction refers to the skill of successfully organising the factors of production to create and set up your own enterprise, driving out les competitive businesses through constant innovation and creativity. Creative destruction keeps an economy moving and improving becoming more productive and raising standards of living


An entrepreneur is somebody who has the skill to organise the factors of production to make a business venture and is responsible for the risks involved   

The roles of an entrepreneur are to

  • Provide employment
  • Contribute towards Economic growth (GDP)
  • Provide goods and services
  • increase competition in the market 
6 of 51

1.2.1 Role of an entrepreneur in the economy

Adding Value

Adding value is creating something of a higher value to the customer than the bought in costs. Value is added by the activities of a business in creating a finished product, in dynamic markets this is often done by employees who design and innovate. The top 5 ways to add value are to 

  • Increase convenience and speed
  • Improve the design
  • Provide at a higher quality
  • Add the brand name
  • Create a USP
7 of 51

1.2.2 Entrepreneurial motives

Profit as an incentive

Profit = sales revenue - costs of production .    

For many entrepreneurs the main reason of starting their own business is to make money so they can improve their lifestyle and increase their standard of living, to do this their new business needs to make a profit. To achieve this entrepreneurs have to match their products with the needs of the buyers but this comes at a risk,consumers may not choose to buy their products, tastes and fashions can change, new competing products may seem better

Non-financial motives

  • Ethical stanceentrepeneurs who want to do the 'right thing', their businesses may focus on providing ethical or environmentally friendly products 
  • Social entrepreneurship - entrepreneurs who aim to benefit society as a whole
  • Independence - some people want to be their own boss and being able to achieve a dream or ambition 
  • Home working - people who want the convenience of working at home made possible by the digital economy
8 of 51

1.2.3 Factors of production

The central economic problem of scarcity arises because of unlimited wants and finite resources, these finite resoures are comonly grouped into four catogories; the factors of production. The factors of production are the resources of Land, Labour, Capital and Enterprse used to produce goods and services. 

Land is anything that can be classed as a natural resource - raw materials, energy sources, location

Labur is the human input in both physical and mental terms - employees, managers, owners 

Capital is the money invested to start up and run as well as the equipment used in production process - finance, simple tools, complex machines, telecommunictions, infrastructure

Enterprise is the entrepreneur that brings the other three factors together to create output for consumption - market research, business plan, promotion

9 of 51

1.2.4 Specialisation

Specialisation refers to the way in which people, businesses and economies focuss all of their resources on what they do best as they have an advantage in that field

Division of labour

Division of labour occurs where production is broken down into many seperate tasks allowing specialisation to occur


  • Workforce becomes more productive as each worker repeats the same job over and over becoming faster and more efficient 
  • Specialist expertise can be used to deliver a better quality product


  • Loss of motivation due to repetitive and boring work 
  • Job dissatisfaction 
10 of 51

1.2.4 Specialisation (continued)

11 of 51

1.2.5 The wider economic environment

Interest rates

An interest rate is the price of borrowed money, it affects how much you have to pay back on a loan. The higher an interest rate the more expensive it is to borrow money, as interest rates rise, the demand for loans decreases. The Bank of England's Monetary Policy Commitee set the base rate of interest that influences bank's interest rates.

Rising interest rates                                      -  Lower interest rates have an opposite effect

  • less demand
  • less investment (B)
  • costs of production increase (B)
  • fewer new business start ups (B)
  • slower growth (B)
  • fall in demand for products (B)
  • less disposable income (C)
  • worse standard of living (C)
  • decrease in agregate demand (E)
12 of 51

1.2.5 The wider economic environment

Exchange rates

An exchange rate is the price of one currency expressed in terms of another. Most exchange rates 'float' meaning they may go up or down. If the exchange rate goes down it is called Depreciation, if an exchange rate goes up it is called appreciation

- Businesses that export will want a depreciating £ as it will make them more competitive on the international market

- Businesses that import will want an appreciating £ as their costs will fall and they can make more profit

                                      EXPORTERS            INPORTERS

APPRECIATING £ -             Unhappy                     Happy         

DEPRECIATING £ -              Happy                     Unhappy         

S. P. I. C. E. D  -  Strong Pound Imports Cheap Exports Dear

13 of 51

1.2.5 The wider economic environment


There are many types of taxation but they can be split into two catogories 

DIRECT TAXATION - charged on earnings - Income tax, National Insurance, Corporation tax

INDIRECT TAXES - Excise duties (alcohol, petrol), Car tax, Insurance tax VAT, others

An increase in direct taxes will result in less desposiable income and therefore demand for products and services willl decrease, but government expenditure can increase

An increaase in indirect taxes such as VAT will increase the prices of goods and services, this will decrease demand for them and lead to less profit. An increase in corporation tax will lead to businesses pulling out of the UK damaging future growth and deter foreign investors

Businesses also have to pay business rates which are taxes to the local authorities 

14 of 51

1.2.5 The wider economic environment


Unemplyment is defined as the number of people able and willing to work but not able to find a payinng job. It does not include full time students, the retired, children, or those not looking for a paying job

Impact of rising unemployment 

  • more people with less income so demand for luxeries decreases
  • wages are less likely to inrease so real income decreases
  • easier for employers to find skilled workers - less skill shortages
  • Demand for inferior goods increases
  • Long term unemployment can lead to a worker losing their skills and getting into bad habits


15 of 51



Inflation is a sustained increase in the average price level in the economy, The government has an inflation target of 2%. Inflation is affected and controlled by the base rate of interest set by the MPC


  • Inflation is uncertain and makes it hard for businesses to plan future investment
  • Inflation can lead to an increase in the cost of supplies and wages this can reduce profits
  • some pensions and wages do not rise with inflation so less real income
  • if UK inflation higher than other countries their costs rise faster so become less competitive
  • to reduce inflation interest rates are raised this means businesses are less likely to invest and grow
16 of 51

1.3.1 Demand

A market is any medium in which buyers and sellers can exchange any types of goods, services and information at an agreed price. A free market allows buyers and sellers to follow their own interests creating the market forces of supply and demand that determine the price and quantity sold.Buyers create demand in a market and sellers create supply.

Demand - the quantity of a good or service that people are willing and able to buy at a given price at a given time.

Consumer objectives and decisions

Consumers will weigh up the opportunity costs of each purchase and potential trade offs before deciding on a product that will yield the greatest benefit to them, given their limited income and the price of the good or service

There is an inverse relationship between price and quantity demanded, as price increases quantity demanded decreases and as price decreases quantity demanded increases

17 of 51

1.3.1 Demand

The Demand curve

18 of 51

1.3.1 Demand

Factors affecting Demand 

  • Changes in the prices of substitutes and complementary goods - As the price of complimentary goods increases the Quantity demanded of the origional good decreases. If the price of substitute good increases then the Quantity demanded of the origional increases
  • Changes in real incomes - When real incomes increase so does the Quantity demanded for normal goods, when real incomes increase the Quantity demanded of inferior goods decrease
  • Changes in tastes and fashions - If the preference for a particular good increases the demand curve shifts to the right as more will be sold at the same price 
  • Advertising and branding - If a good is well branded or advertised well demand for the good will increase resulting in a shift to the right on the demand curve
  • Changes in size and age distribution of the population
  • Changes in price - Causes a movement along the demand curve 
19 of 51

1.3.2 Supply

Supply is the amount of a good or service that producers are willing and able to provide at a given price and time.

Producer objectives and decisions

Producers base their decisions of how much of a good or service they are willing to supply into a market on the costs of inputs and the amount of profit they are likely to make, together with any other objectives the may have. There is a positvie relationship between price and quantity supplied, as the price that a producer can sell a product for increases so does the incentive to produce and sell more of these products 

20 of 51

1.3.2 Supply

The Supply curve

21 of 51

1.3.2 Supply

Factors affecting supply

  • Changes in the costs of production - An increase in costs shifts the supply curve to the left as there is less incentive to supply into the market as the producers will make less profit so less is supplied into that market
  • The introduction of new technology - Technological progress allows firms to produce a given item at a lower cost increasing the profits and shifting the supply curve to the right
  • Indirect taxes - An increase in tax raises the costs for the producer and results in a shift of the supply curve to the left
  • Subsidies - payments to a producer to encourage production cutting the cost of production and shifting the supply curve to the right
  • Changes in the number of firms in an industry - If more competitors enter the market the output of an industry grows and the supply curve shifts to the right. If the market then shrinks the supply curve shifts to the left 
  • External shocks - The supply of some goods is dependant on events beyond the producer's control such as harvest yield and natural disasters
  • A change in price - will cause a movement along the supply curve
22 of 51

1.3.3 Price determination

Equilibrium price and quantity and how they are determined 

The equilibrium price is the price at which supply and demand are equal and both parties are happy. There will be no unsold stocks at this price and customers will be able to buy all they demand at that price, the market clears. Market clearing happens at the equilibrium price.


23 of 51

1.3.3 Price determination

Excess supply and excess demand 

Excess demand occurs when the quantity demanded is greater than the quantity supplied, the price is too low for the market to clear. This creates a shortage of that particular good.

Excess Supply occurs when the quantity supplied is greater than the quantity demanded, the price is too high for the market to clear. This creates a surplus of that particular good.

24 of 51

1.3.3 Price determination

The operation of market forces to eliminate excess demand and excess supply
In a free market when there is excess supply or excess demand, market forces operate to restore equilibrium.
When there is excess demand, some customers who cannot get the product are willing to pay more for it. Suppliers will then be able to raise the price and still sell the product so the price will start to rise towards the equilibrium level. However, some customers who would have bought at the old low price will drop out, this will cause a movement up the demand curve. At the same time, producers will be attracted by the rising prices to increase production, this will cause a movement up and along the supply curve. These trends will continue until the equilibrium price is restored. The opposite is true of excess supply

The limitations of the supply and demand model and its predictions

  • The model is based on simplified assumptions about the way markets work
  • It assumes that all markets are competitive but if one business outcompetes others in the industry, it may gain market power that reduces the impact of competitive forces
  • Relies on the condition that everything else is equal or frozen so can only look at one variable at a time
25 of 51

1.3.4 Price mechanism

The price mechanism describes the system of the invisible hand whereby the market forces of supply and demand determine the prices and decisions made by producers and consumers. The profit signalling mechanism refers to the way that potential profits will attract entrepreneurs and potential losses will lead to businesses leaving the market. When demand increases the profit signalling mechanism is triggered as prices are likely to rise and potential profit. The price mechanism allocates resources three ways.

  • The rationing function - The price mechanism rations consumer goods according to buyer's ability to pay. Prices act as a rationing device because only those willing and able to pay the price get the product meaning more scarce recources are more expensive to purchase
  • The incentive function - Profitability motivates firms to produce more and encourages more businesses to enter the market
  • The signalling function - Prices give signals to producers and consumers what to buy and produce

Consumer sovereignty describes the role of the consumer in determining the allocation of resources by buying what they want most signalling to producers what they should produce.

26 of 51

1.3.4 Price mechanism

Mass and Niche markets

Mass Market - A large market which includes the majority of the relevent population. Products are usually standardised and targeted at a broad market segment. Production is large scale and costs can be driven down with economies of scale. Businesses that cater for mass markets are usually very large and powerful. Mass market products are sensitive to price change. They are highly competitive markets and price is usually competed on, the cheapest product is usually has the highest demand.

Niche Market - A small segment of a market with distinctive, specialised requirements. They may be associated with subcultures. Products will be carefully differentiated increasing the costs of production but means a higher price can be achieved. Niche market products are less sensitive to price change. Profits tend to rely more on style or design then price.

Potential market growth - Market growth implies an increase in demand. In theory market growth allows all businesses in the relevant industry to expand, in practise this is not always true. 
New tech -----> cheaper or beter -----> increased sales -------> increased profit ------>further                                           products                                                            investment and innovation

27 of 51

1.3.5 Understanding the consumer

Market research is any activity that gives a business information abouts its product or service, its customers, its competitors or the market it operates in. Businesses do market research to find out whats happening in the market now to predict what will happen in the future and explore new possibilities in the market.

Market research 

-gives information that are used to make better informed decisions about a businesses future 
-allows businesses to understand consumer behaviour 
-helps companies improve their products to gain a competitive advantage
-reduces the risks to business start ups 
-allows businesses to keep up with market trends

28 of 51

1.3.5 Primary and secondary research

Primary research is data gathered first hand by the business that is interested in it. It involves fieldwork and can be directly related to the needs of the individual business. This includes questionnaires, interviews and observations

>can be tailored to the business >up to date and relevent >not available to competitors
-expensive  -takes a long time -can give misleading if questions are worded with bias

Secondary research uses data that has been gathered previously by another organisation. This includes research online, research competitors the Office of National Statistics.

>Available immediately >Normally cheaper  -can be out of date -may not meet businesses needs

Qualititve research - research examining opinions and feelings
Quantitive research - data is numerical and can be analysed statistically

Limitations - If using a small or non-representative sample the data can be biased or innacurate, research can be costly, markets may change before product comes out. 

29 of 51

1.3.5 market segmentation

Sampling involves collecting data from a number of people to represent the target market or population as a whole. There are three types of sampling - Random sampling can be effective and accurate but hard to be completely random, needs to be large sample size - Stratified sampling targets the market effectively but may more complex to organise results - Quota sampling is a cheap and effective way of sampling but is suseptable to bias.

Market segmentation is the process of subdividing a market into groups of consumers with similar needs or characteristics that are likely to exhibit similar purchasing behaviour. This enables products to be more effectively targeted for a particular segment

      >Age     >Gender     >Culture     >Income       >Location      >Lifestyle     >Social Class 


  • Responsive products that meet the needs of the market place
  • Effective and cost efficient promotional tactics and campaigns
  • Gauging the companies market position, reduces direct competition
  • fine tuning current marketing stratagies
30 of 51

1.3.6 The competition

Market positioning is the way in which businesses design and place their products in a market or market segment in relation to competing products in the minds of the consumers. Businesses can decide to follow the competition with a similar product or they can spot a gap in the market and differentiate their product to fit in this gap

Market Mapping is the use of a grid showing two features of a market, such as price and quality or consumer age. Individual brands or businesses are added to the grid to show how products position in relation to each other and help spot gaps in the market.

Competitive advantage - Any attributes of a product or service that enables it to outperform its rivals. It may be based on price, quality, service, reputation or innovation. If a business cannot establish a competitive advantage it will encounter falling sale and rising losses. Cutting costs may allow a business to compete on price and still make a profit, this can be done by:

  • Improvements in staff training
  • improving relationships with suppliers
  • Striving for greater efficiency (may involve investing in new production tech) 
31 of 51

1.3.6 Adding value to products/services

Added value is the difference between the price of the finished product/service and the cost of the inputs involved in making it. Adding value can make the product more useful, reliable or desirable and enhance their competitive advantage. Businesses can add value by

  • Introducing completely new products or redesigning existing ones - adittional functionalities 
  • Improve product reliability 
  • Improve customer service (staff training)
  • Add a good brand to the product (Apple, Nike)
  • Improve convenience

Product differentiation is any feature of a prdouct or service that distinguihes it from a competitor. These specialist features are often their USPs (Unique Selling Points) that allow the business to have a competitive advantage over rivals. Branding can be a large part of differentiating a product.

32 of 51

1.3.6 How firms decide on price

A pricing strategy is the way in which a business decides upon the price of its product. Price and output depends on a range of factors: Its competition, if it is differentiated from other products and the state of the economy.

Nature of markets
Markets that are changing all the time are known as dynamic markets. A dynamic market is one in which the pace of change is rapid, requiring companies to change their products and services in order to survive. High-tech products are in a fast moving market where the pace is determined by the changes in technology and is supply side. Clothing is another dynamic market but its change is determined by a change in fashions and tastes it is determined by the demand.
A stable market is one where there is very little change to the product or services being offered over a long period of time, the pace of the market is slow and market size and share are fairly constant. Innovations in a stable market are very rare.

Stratergies for survival: - change the product style or design - spend more on advertising - seek out new market segment or niches - diversify & enlarge the range of products

How to do this: -Being market orientated (fitting the needs of customer) - careful product positioning(market mapping) - Differentiating, adding value - spotting gap in market (

33 of 51

1.4.1 Role of banks in the economy

  • Provide a safe place for savers' funds and usually pay interest on savings accounts
  • Offer loans to borrowers (individuals and businesses), in return for payments

Banks are finnancial intermediaries that channel funds from savers to borrowers most often home buyers or businesses in need of investment. Interest payments are the rewards for saving and the cost of borrowing money. 

The role of banks in providing credit

  • Allow individuals to afford to buy homes that are worth several times there annual income and so they still have enough disposable income to meet all their needs
  • Help businesses to undertake big investment projects which in turn encourages economic growth
  • Provide working capital to businesses (the money needed by a business to cover costs of production until sales revenue comes in
  • Banks can help the government to cover defecits

Banks lend more money than they have in the deposits because they know that not everyone will withdraw their savings at the same time, banks facilitate investments and raise standars of living

34 of 51

1.4.1 Interest rates and collateral

The Monetary Policy Comitee, part of the bank of England, set interest rates in the UK. The current base rate of interest is 0.5%. The interest borrowers have to pay back on their loan depends on the degree of risk involved. High risk borrowers can offer colateral to lower the rate of interest. Collateral refers to asssests that can be used to repay the bank if the borrower does not have enough money to do so.
Risk and Liability
Risk measures the likelihood that a particular outcome may or may not occur, the outcome is unknown but the probability of it occuring is calculated.
Liability is a legal claim for payment if someone is liable the have the responsbiltiy for the financial debts of the business.
Unlimited liability - Legally the individual that sets up the business is personally responsible for the debs of the busines.
Limited liability - Legally the financial debts of the business are limited to the business and not the owners, you can only lose the money invested into the business
Private limited Company (Ltd) - Businesses owned by the shareholders who are usually friends and family they have limited liability
Public limited Company (PLC) - Businesses which anyone can own shares in shares are sold on the stock exchange, shareholders have limited liability 

35 of 51

1.4.3 Types and sources of credit

  • stick on table


36 of 51

1.4.3 Challenges in obtaining credit

Without sources of credit, businesses would find very hard to start up and expand, it is vital for the UK's economy that businesses do this allowing the UK to trade products and services to increase our GDP.

The problem with many investors is short-terminism, they are looking for quick, garunteed returns on their investments. However, many higher risk businesses miss out on investment because of this, as well as this, many businesses also holdback on reinvesment as they do not see strong enough demand in the economy.  

37 of 51

1.5.1 Market failure and externalities

There are three types of costs and benefits:

Private costs - costs to the producer or consumer - giving up income to consume the good, costs of production
Private benefits - benefits to the producer or consumer - profits made by producer, fufilment of entrepreneurial abd business objectives, satisfaction from consuming good or service that satisfies wants and needs
External costs - costs or negative side-affects imposed on a third party who is neither the producer nor the consumer - Pollution, congestion
External benefits - Benefits or positive side-effects that benefit a third party who is neither the producer nor consumer - education, healthcare
Social costs - The total costs of producing goods and services calculated by adding both the private and external costs 
social benefits - The total benefits of producing goods and services calculated by adding both the private and external benefits 

38 of 51

1.5.1 Externalities

External costs and benefits are known as externalities, there are both positive and negative externalities associated with most goods.
Positive externalities are the external benefits experienced by third parties but payed for by someone else. Negative externalities are external costs that have a detrimental effect on the lives of third parties.

39 of 51

1.5.1 Market failure

Market failure occurs when the market is unable to efficiently allocate resources to meet the demands of society. This is because of the external costs that the consumer or producers do not have to pay for leading to over production/consumption.

Under-consumption occurs when products that are socially desirable are too expensive for everyone to cover the costs themselves. e.g Education creates a skilled labour force but not everyne can afford it.

Over-consumption occurs when social costs exceed private costs, if the consumer had to pay the external costs as well as the private demand would drop dramatically e.g Petrol damages the environment if the true cost of the damage was added to the petrol price, demand would reduce rapidly 

In order to address such issues governments can intervene in the market

40 of 51

1.5.2 Government intervention

Government intervention is any action taken in a market to fix a market failure by balancing production and consumption social costs. The government intervene in a market to 

  • Reduce the impact of external costs e.g Pollution and greenhouse gasses
  • ensuring that potentially under-produced products are available to all, as with healthcare and education 
  • ensuring that over-consumed ptoducts such as tobacco, drugs, alcohol and carbon-emmiting products are discouraged or prevented 
  • Reducing the impact of anti-competitive business behaviour so that prices are fair to the consumer 

The government can intervene in 6 ways 
o regulation                                                Taxation, Regulation, Information, Pollution permits
o legislation                                                Subsidies, State provision
o indirect taxation
o grants and subsidies                                 S.T.R.I.P.S
o voluntary agreements Subsidies

41 of 51

1.5.2 Methods of intervention

Subsidies - Are used to increase consumption or production when the market has failed due to under-consumption/production. A subsidy is a direct payment from the government to producers or in some cases the consumers to make a product cheaper and increase demand for it e.g solar pannels, wind turbines. This is represented by a shift to the right of the supply curve 

Taxation - Taxes are ued to discourage the consumption of a demerit good that is over consumed/produced. An indirect tax is a fee charged by the government on a good or service. The increased cost to the producer and consumer discourages consumption, this is shown by a shift in the supply curve to the left. e.g Tobacco, alcohol

Regulation/legislation - Legislation refers to the passing of new laws to change the behaviour of individuals and businesses e.g drug illeagal, everyone must be educated by law. Regulation is a type of legislation that sets wide range standards and defines the responsibilities of consumers and producers.

Information - Information failure occurs when there is asymmetric information meaning on party knows more than the other and sales are made at the wrong price, the government can prvide information through comparrisson websites or new regulation to force producers to provide more information

42 of 51

1.5.2 Methods of intervention (continued)

Pollution permits - A permit that allows the owner to emmit a certain amount of pollution. If the permit is not used or partially used it can be sold to another polluter, if firms do not have sufficient permits to cover their pollution they will  prosecuted.

State provision - The government finances the production of a range of proucts through tax revenue then provides them for free or nearly free for consumers e.g. education, health care that would be under consumed otherwise

Voluntary agreement - The government can try to pursuade businesses within a specific industry to change their behaviour in order to reduce harmfull externalities, this can be effective but requires all the businesses in an industry to comply

Price stabilisation schemes - Involves minimum and maximum pricing schemes that are used to balance social externalities. Minimum pricing creates an exsess supply in the market due to over incentive to supply and lack of demand. Maximum pricing creates a lack of supply in the market that is not good for example a maximum price on social housing creates huge demand for these houses but fewer firms are willing to supply at the new price.

43 of 51

1.5.2 Government failure

Although government intervention aims to address dificut issues in the market successfully, it can sometimes just lead to another missallocation of recources and government failure. There are three main reasons government intervention fails:

  • Governments don't have enough information to make good decisions, some solutions have unintended consequences that worsen the problem.
  • Some governments decide upon popular policies that are used for political gain that are not always the best solutions
  • Some of the decisions are not extreme enough and do not move fast enough to solve the worst problems

Distortion of price signals - Subsidies can attract new unreliable suppliers, minimum and maximum price stratergies create supply issues 

Unintended consequences - Many outcomes to interventions are hard to prdict and can result in causing another problem and market failure, often linked to lack of information 

Excessive administrative costs - with new regulations, voluntary agreements and legislation it is very difficult to ensure every business is complying with the rules and comes at great cost 

44 of 51

Maths - Theme 1

  • Percentage change = Difference / origional x100 = ____%
  • Total Revenue = Price x Quantity sold
  • Average Cost = Total cost / Quantity sold
  • Total cost = Fixed costs + Variable costs
  • Total Variable costs = Variable cost per unit x Quantity sold
  • Contribution = Selling price - Variable cost per unit 
  • Gross Profit = Total revenue - Total variable costs 
  • Net / Operating profit = Total revenue - Total Costs
  • Profit for the year = Operating profit - (taxes + interest)
  • Break even output = Fixed Costs / Contribution 
  • Break even revenue = Total revenue - Total costs = 0 
  • Margin of safety = Actual (current) level of sales - Break even output 
  • Net/Operating Profit margin = (Operating profit / Total revenue) x100 = ____%
  • Gross Profit margin = (Gross profit / Total revenue) x 100 = _____%
  • Mark up = Selling price - Cost price
45 of 51

1.6.1 Revenue and costs

Fixed costs are those that do not increase with the level of output and are covered before anything is actually produced 
>Mortgages/rents    >Salaries    >Interest payments    >Business rates    >Insurance

Variable costs are those that that increase or decrease in relationship to output or sales
>Wages    >Materials/stock    >Fuel    >Income tax    >Advertising    >Employee benefits 

Contribution is the difference between the price of a product and its variable cost, Every time a product is sold, its contribution can be used to pay off the fixed costs of the business. Once the break even point is reached the contribution becomes the profit 

The break even point is the level of output at which the total revenue is equal to the total costs, at this point, neither a profit nor a loss is being made

46 of 51

1.6.2 The relationship between revenue and costs

Margin of safety is the difference betwwen the actual level of output and the break-even level of output
Break even analysis helps decide wheter a business venture is viable, profit levels can be estimated at different levels of output and the analysis is a key part of a business plan when a business is trying to raise finance 

47 of 51

1.6.2 Limitations of break-even analysis


>Helps to assess the strength of a business idea and whether it is worthwhile
>Estimates the level of output needed to make a profit, provides target
>Integral part of a business plan used to secure finance 
>Shows the impact of changes in price and costs on profit levels
>Enables the calculation of profit or loss over different levels of output 


>It is based on predicted costs and revenues
>The model assumes that all of the output is sold, in reality this does not happen
>Markets are dynamic so even if your numbers are right something could happen that throws the analyisis e.g new competitor, recession 
>Assumes that costs rise steadily, bulk buying can reduce cost per unit 
>All costs can vary in reality

48 of 51

1.6.3 Profit and Loss

The profit signalling mechanism provides incentives for new businesses to enter the market if there is potential for profit and pushes businesses out of the market if losses are being made.

Revenue - cost of sale --> Gross profit - fixed costs --> Operating profit - taxes and interest                                                              -->profit for the year (Net)

A statement of comprehensive income shows a company's net profit or loss, over a given period of time. This is usually monthly, quarterly or annually. It details all the revenues and costs of the busines

A profit margin tells the business what percentage of its turnover is actually profit. It is the ratio of profit to turnover expressed as a percentage. The gross profit margin shows how efficently the business is with relation to its costs of sales. The operating profit margin is a measure of a firms profitability and efficiency as a whole.  

Firms increase profits by: Adding value. improving reliability, repositioning the product, increased market research and promotion. These all attract more customers increasing revenue. Firms can also increase profits by cutting the costs and prices to make the products more competitve. 

49 of 51

1.6.4 Business survival and cash flow

There is a difference between profit and cashflow. Cash is the money available to the business to cover costs. Profit is the difference between revenue and costs. Businesses can survive for long periods of time without making a profit if they have enough working capital to cover costs. In comparrisson businesses cannot survive for long without cash to pay the bills.

Cash flow is particularly important when starting up a business or if the business has to pay bills ahead of the time of its sales revenue. e.g Builders have to pay for land, labour, materials, contractors and more to build a house but they do not get any revenue until the house is finished and sold.

A cashflow forecast is a statement over time of the cash entering a business from its sales (inflows) and the cash leaving a business to pay for its costs (outflows). The difference between the cash inflows and outflows is the net cash flow and is a crucial indicator of the ability of a business to cover its day to day running costs.  

By monotoring the closing balance, businesses can see how much cash they have each month. If the closing balance is a negative figure then it is a prompt to seek extra finance e.g a loan or overdraft. If cash flow problems are foreseen, businesses can plan ahead and reduce outflows. 

50 of 51

1.6.4 Cash flow


51 of 51


No comments have yet been made

Similar Economics & Business Studies resources:

See all Economics & Business Studies resources »See all Markets, Consumers and Firms resources »