Micro Economics Year 1

Nature of Economics

1.1.1 - 1.1.6

The Economic Problem

How to allocate scarce resources given the unlimited wants...

Scarce resources => Factors of production (Capital, Enterprise, Land, Labour)

Opportunity cost => the cost of the next best alternative when a choice is made. For example, when purchasing a packet of crisps for 1 pound instead of buying a chocolate bar.

Law of Diminishing Returns => continuous increase in one output factor while holding the other input factors fixed will lead to a decrease in the per unit output of the variable input factor.

Production Possibility Frontiers PPFs

PPF curve shows:

- Maximum pssoible production of 2 goods/services with given  factors of production

- The various combination of 2 goods/services that can be produced with factors of production

Efficiency in PPFs

Efficiency can be shown in PPFs:

- Productive Efficiency is using up all factors of production to the maximum.

If a point is on the curve it is productively efficient. Maximum production for all factors of production.

If a point is inside the curve it is productively inefficient. Wasting factors of production not maximising use.

If a point is outside the curve it is unattainable efficiency. Cant produce beyond the curve with the given factors of production

Allocative Efficiency in PPFs

Whether the goods produced are satisfying consumer demands.

If society wants tablets, producing laptops would be inefficient as there is no demand for laptops. Putting full production into tablets would make allocative efficiency successful.

Hard to figure out allocative efficiency from PPF. Consumer demand is needed.

Pareto Efficiency in PPFs

Pareto Efficiency is the idea that nobody can be better off without someone being worse off. For example, when producing more tablets people who want tablets will be better off compared to people who want laptops who will lose out. 

When shifting along the curve onside is going to be losing and onside will be gaining.

Increasing Production on PPFs

We have to improve CELL in order to see increase in production on PPFs. We can do this through:

• improving capital = this is when you invest and improve or buy better more efficient machinery
• improving labour = this can be done by making labour force fully productive and efficient or specialising the labour so that some jobs are more efficient and higher quality
• increasing quantity and quality of CELL can make a shift in PPF therefore producing more output from both good X and good Y

 Positive and Normative Statements

Positive statements are objective. Often have factual evidence which can be rejected or accepted. For example, high tempertaures will lead to an increase in demand for fans. This is a positive statement as its factual and accepted.

Normative statements are subjective/opinions. Based on value judgements. For example, increasing house prices is unfair for low income earners. This is normative as the word "unfair" shows opinion without any facts. 

Factors of Production

Capital: machinery -> the reward is interest from the investment

Enterprise: Managerial ability. Takes risks -> Profit which is an incentive to take risks

Land: Physical space where companies setup factories -> Rent

Labour: Human workforce -> they recieve wages for completing work

Specialisation and the Division of Labour

Specialisation is the production of a limited range of goods by a country/company. Makes trade essential.

Division of Labour when labour becomes specialised in a particular part of the production process.

ADV:

• labour productivity is increased. Workers will be quicker and more efficient with the same task
• higher quality goods and services

DISADV:

• Structural unemployment as skills are non transferable from current to a new job
• task can become boring and therefore lead to poor quality of work or workers leaving.

Functions of money:

To make trades possible money was invented as a currency to purchase goods/services. Workers get paid for producing work. Its a reward.

• A medium of exchange: can be used to buy goods and services accepted internationally. Money can buy everything and therefore people will accept this as main payments.

• A measure of value: can compare the value of two goods e.g a BMW 1 Series costing 1k-10k and a Lamborghini costing 100k+

• A method for deferred payment: money can allow for debts to be created. People can therefore pay for things without having money and can pay later. e.g Klarna 3 month 0% interest.

Free Market Economy

Government leave markets to their own devices for supply and demand. 

What to produce: determined by consumers preference

How to produce it: producer seek profits

For whom to produce it for: whoever has the greatest purchasing power in the economy, able to purchase the good.

ADV:

• Freedom gained as having free economy leads to more personal freedom.
• Failure of government intervention is avoided as its government free.

DISADV:

• Free market ignores inequalities. Benefits those who hold most of the wealth.
• Overconsumption of demerit goods like cigarettes which is a negative externality/cost

Command economy:

Where the government allocates all of the scarce resources in an economy where they think there is greater needs. Central planning.

What to produce: depends on government

How to produce it: government and employees

For who: who the government prefers

ADV: 

• might be easier to coordinate resources in times of crisis e.g war, pandemic
• prevent the abuse of monopoly power
• inequality could be reduced in society. Everyone recieves basic necessitiies

DISADV:

-Limits democracy and personal freedom -May not meet consumer preference -Gov failure 

Mixed Economy:

Has features of both command and free economies and is the most adopted system today.

What to produce: determined by both consumer and government

How to producei it: determined by producers making profits and government

For who: both the government preference and purchasing power of private individuals.

ADV:

• incentive to be efficient. Private firms aim to be efficient so they can maximise profits unike government controlled firms.
• reduce market failure. Gov can regulate monopoly power abuse. Taxation and regulation of goods with negative externalities e.g pollution.

DISADV:

• How much should the gov intervene -> difficult to know how much intervention is needed

How Markets Work 

1.2.1 - 1.2.10

Rational Decision Making:

• Consumers aim to maximise utility: Satisfaction from consuming product. Rational customer (Homo Economicus) calculates which product will give most satisfaction before choosing.

• Firms aim to maximise profits: Firms aim to maximise profits so shareholders are happy and profit is made.

• Governments aims for social welfare: Government voted by public and therefore needs to maximise satisfaction from decisions causing increase in social welfare.

Conditions to shift demand: PIRATES

Population = If population increases there will be increase demand causing expansion of demand.

Income = If people have more disposable income they are able to purchase more items. Increasing demand. If there is cut in disposable income, reduce demand.

Related goods = If prices go up, consumers will resort to cheaper alternatives causing demand to reduce. Opposite effect for prices going down.

Advertising = If a firm makes a successful advert, demand from their shop will go up and competitors demand to reduce.

Taste/Fashion = If a trend causes something to become fashionable demand goes up.

Expectations = If consumers think there will be a shortage of a item price will go up as it is in demand but not enough supply.

Season: Some items will be special to season e.g Christmas Tree in winter.

Shifting the supply curve: PINTSWC

• Productivity: higher productivity causes outward shift in supply average cost decrease.
• Indirect Taxes: inward shift in supply as less people will buy as prices are higher
• Number of firms: the more firms, the more supply there is in the market.
• Technology: Advancement in technology causes outward shift.
• Subsidies: outward shift as it helps businesses increase supply and lower price
• Weather: good for agriculture in some cases which could shift outwards but if a flood happens, crops are ruined causing supply to decrease and supply to become shortage. Causing an inward shift
• Cost of production: if production costs fall firms can make more supply. If production cost increase supply decreases.

Types of supply:

Joint supply: when increasing supply of one good it causes an increase in another good. e.g producing lamb and gaining wool too.

Diminishing Marginal Utility:

Diminishing Marginal Utility: the extra satisfaction the consumer gains from having one more unit of a good/service. 

This explains why demand curve would slope downwards. If more of a good is consumed, there is less satisfaction from the good. Consumers will pay less at high supply since they are gaining less satisfaction.

Total Utility: represents satisfaction gained by the overall consumption of a good e.g the satisfaction from eating a whole sandwich

Marginal Utility: represents the increased satisfaction from consuming an extra unit of the good e.g taking another bite of a sandwich.

Price elasticity of demand: is the responsiveness of demand to a change in the price of the good.

%change in quantity demanded /%change in price = PED formula

Factors influencing PED: SPLAT

• Substitutes: if a product has mulitple subs the demand may go down if there are cheaper alternatives on the market.
• Percentage of income: the consumer may switch to cheaper alternatives if their disposable income is low
• Luxury/Necessity: if the good is a necessity the demand will go up as it is vital to daily life e.g water. Luxury demand may go down as people dont need it but want it. If they dont have enough disposable income the demand goes down.
• Addiction: Negative externality goods like cigarettes cause addiction which makes demand inelastic as people will pay whatever price to purchase it
• Time period: If a production for a product takes long the demand will go down making it elastic however if the production is fast the demand is increased making it inelastic.

Price elasticity of Demand along with price elasticity of supply help determine the effects of the introducing indirect taxes and subsidies.

When a elastic goods price increases the firms have to take on the cost as if they shift the cost to consumers, the consumers will look for alternatives e.g cereal

When a inelastic goods price increases the firms can shift the costs to consumers as people will buy it no matter what e.g necessities like water.

Producer burden is higher in elastic goods as they take on the costs

Consumer burden is higher in inelastic goods as they shift cost to consumers

• For an elastic demand curve. A decrease in price leads to a increase in revenue and an increase in price leads to decrease in revenue
• For an inelastic demand curve. A decrease in price leads to a decrease in revenue and an increase in price leads to an increase in revenue
• For unit elastic curve, a change in price does not affect total revenue

Supply is the quantity of a good or service that the producer is able and willing to give.

PES= %change in quantity supplied / %change in price

Factors that shift the supply curve: PSSST

• Productivity: higher productivity causes an outward shift in supply as average costs fall
• Stocks: if goods can be stored e.g phones then firms can stock and supply easily. if goods are perishable e.g foods firms cannot hold stock for long supply is inelastic.
• Spare capacity: if the firm is at full capacity there is no way of increasing supply unless they expand. if there are spare resources then supply can be increased quickly
• Substitutability of Factors of Production: if labour and capital are mobile, supply is elastic as its easier to allocate supply where its needed e.g a worker can transfer skills from one task to another.
• Time: in short run, supply is inelastic as producers cannot quickly supply. in long run supply is elastic as all factors of production are variable.

Equilibrium price and quantity:

Excess demand:

When demand is greater than supply. P2 is below P1. There is a shortage of supply in the market causing prices to go up. This causes firms to create more supply for the high prices which will cause demand to level out and reach a new equilibrium.

Excess supply:

When supply is greater than demand. P2 is greater than P1. There is low demand therefore causing firms to reduce their prices to try sell their goods.

New market equilibriums:

When demand (PIRATES) or supply (PINTSWC) shift new market equilibriums are made. 

Functions of price mechanism:

Price mechanism determines the market price. Resources are allocated in places where there is high demand or a shortage of supply.

3 Functions of Price Mechanism:

• Signalling = Price acts as a signal to consumers and firms entering the market. High price signals that the market is profitable. However, consumers will reduce the demand causing price to lower and meet a new equilibrium.
• Incentive = High prices will encourage firms to enter the market because its profitable.
• Rationing: High prices will aim to reduce excess demand and discourage consumer spending. e.g plane tickets might rise as seats are sold because the spaces are running out.

Consumer surplus: the difference between the price the consumer is willing to pay and the price they actually pay. Consumer surplus is above P1 and below D1.

An increase in consumer surplus is the area above P2 and D2

A decrease in consumer surplus is the area above P2 and S2

Producer surplus: The difference between the price ther producer is willing to charge and the price they actually charge.

Indirect taxes are imposed by government to increase production costs for producers, reducing supply and increasing demand and price.

Two types of indirect taxes:

• Ad valorem tax are percentages e.g VAT. Main indirect tax in the UK
• Specific tax are set per unit e.g 58p per litre duty on unleaded petrol

If demand is inelastic gov revenue from tax is higher than elastic. e.g the duty on tobacco raises a lot of government revenue as addiction leads to the good being inelastic.

Taxes could be regressive, so they impact low income earners and fixed incomes the most.

Taxes could be inflationary.

A subsidy is a payment from the government to a producer to lower their cost of production and encourage to produce more.

Subsidies shift supply outwards and lower price level.

Effects of subsidies:

• increase output and lower price for consumers -> helpful for low income earners
• increase employment rate, workers recieve training through apprenticeship schemes and lower cost of employing workers.
• reduce inequality in society
• help boost demand during economic decline
• could be government failure if subsidy is inefficient
• tax payers money is used in subsidy so there is no direct benefit

Consumer subsidy -> affect demand

Producer subsidy -> affect supply by lowering cost of production

Market Failure

1.3.1 ---1.3.4

Market failure occurs when the free market fails to allocate resources to societies best interest causing inefficient allocation of resource.

Economic and social welfare is not maxmised

Types of market failure:

• Externalities = an externality is a cost or benefit a third party recieves from economic transaction. In other words the spill over effect of production of consumption of a good or service.
• The under provision of public goods = public goods are non excludable and non rival, underprovided in a free market because of free rider problem
• Information gaps = assumed that consumers and producers have perfect information when making economic decisions. Untrue as perfect information doesnt exist

An externality is a cost or benefit a third party recieves from a economic transaction also known as spill over effect.

Positive externality: positive benefits towards society e.g education as workers are trained

Negative externality: negative effect on society e.g factories create pollution which is harmful for us.

Private cost: costs to economic agents involved directly in economic transaction. Producers concerned with private cost of production e.g rent, cost of machinery, wages in labour.

Social costs: private cost + external cost = cost to society. Marginal Social Cost (MSC) is the cost society pays for the production of another unit.  Marginal Private Cost (MPC) is the change in producers total cost brought about by the production of an additional good/service.

Private benefit: benefit the individual or firm recieves from a transaction

Social benefit: private benefits + external benefits = society benefits

Social optimum position: MSC = MSB -> maximum welfare achieved

External costs:

• external costs occur from consumption or production of a negative good e.g pollution
• shown by the verticle distance from MSC to MPC (welfare loss)
• market fails to notice the negative externalities that occur from the consumption of the good, reduces welfare in society

External benefits:

• shown by the verticle distance from MSB to MPB (welfare gain)
• underconsumed leading to a market failure
• e.g the decline of dieseases, healthier lives through vaccination

Government policies for negative externalities:

Indirect taxes: reduce the quantity of demerit goods consumed. Increase price of good to reduce purchase. The tax helps internalise the externality in other words polluter pays for damage.

Subsidies: encourage the consumption of merit good as its a social benefit.

Regulation: to enforce less consumption of a good. Bans and fines given to people breaching the rules and using harmful goods however, risk of black market creation.

Provide the good directly: the government could provide public goods that are underprovided in free markets e.g education funding

Provide information: no information failure so firms and consumers and producers make informed rational decisions.

Personal carbon permits: tradeable permits so firms and consumers pollute up to a limit.

Public goods offer benefits to society e.g street lights

Non excludable - by consuming the good someone else isnt prevented from consuming the good too.

Non rival - benefit other people and the good does not diminish if more people consume.

Free rider problem - unfair where some consumers can recieve the same satisfaction as someone who paid or purchased the good or service e.g a person using their friends netflix account is a free rider example.

Private goods are rival and excludable e.g a chocolate bar can only be consumed by one consumer.

Quasi (non pure) public goods have characteristics of public and private goods.

Public goods are underprovided because its difficult to measure the value consumers get from a public good, hard to put a price on the good. Consumers undervalue the benefit, pay less for the good

Symmetric information: the consumer and producer have perfect market information to make their decision. Efficiently allocate resources

Asymmetric information: leads to market failure where there is unequal knowledge between producer and consumer. e.g car dealer might know a fault but the consumer wont know the fault with a car.

Firms could exploit consumers as they have the knowledge in most of the economic transcation. May over charge consumers for a "special package".

Asymmetric information links to principal agent problem (Y2 micro)

Asymmetric information leads to moral hazards as the party with superior knowledge in the deal benefits themselves which automatically disadvantages the other group with less knowledge.

Government Intervention

1.4.1 --- 1.4.2

Government intervenes to correct market failure. e.g subsidies for underprovided sectors like education healthcare.

Indirect tax + Subsidies used in gov intervention.

Maximum and Minimum Prices:

Maximum price set to increase the consumption and production of a good where it is encouraged to consumer. So the good does not become too expensive and consumers can afford.

Minimum price to discourage the consumption or production of the good. National minimum wage is an example of minimum price.

Tradeable pollution permits: limit the amount a firm can pollute as its a negative externality. Permits can be traded, allowed to buy and sell permits.

Adv & Disadv of Tradeable pollution permits:

Advantages:

• Should benefit society as there is a limit, encourage firms to use greener production methods.
• Tax money raised from the revenue of permits, use on improving green technology
• If a firm exceeds pollution limit they have to purchase more permits, raises revenue.

Disadvantages:

• Inelastic good firms might pass the higher costs of production to consumers
• Expensive for government to monitor
• Permits can create a barrier to enter the market especially for potential firms.

State provision of public goods:

Gov could provide public goods which are underprovided e.g education. External benefits. Merit goo, increasing consumption could make yeild positive externality.

Provision of information:

Government can make sure theres no information failure, consumers and producers have equal knowledge, fair trade.

Regulation:

Government could use laws to ban consumers from consuming a negative externality good. e.g you cant smoke till your 18. Firms which fail to follow rules could face heavy fines. Help increase revenue for government. 

• Indirect taxes = ad valorem (VAT) or Specific taxes (fuel duty)

• Subsidies = payment from government to producer lower cost of production

• Maximum: encourage consumption of that good, affordable

• Minimum: discourage consumption of good, expensive

• Tradeable Pollution permits: limit pollution per firm

• State provision of public goods: subsidy for underprovided goods e.g education

• Provision of information: symmetric information

• Regulation: use laws, bans and fines for comsuming goods

Governments can fail when they intervene in the market. Could make market failure worse. Net welfare loss to society.

Causes of Government Failure:

• Distortion of price signals = government might end up subsidising an industry thats failing.

• Unintended consequences = Government failure could cause unexpected consequence, not part of the plan.

• Excessive administrative costs: Government has to consider whether the policy is good value for money

• Information gaps: some policies may happen without perfect information. However is impractical for governments to gain every bit of information.