Unit 1 - AS Microeconomics

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Scarcity, choice and oppurtunity cost

  • Scarcity. These are resources that are limited. We need to make choices about to use and distrbute them.
  • Non-renewable resources. These are natural resources that are finite and scarce. Once used, they cannot be replaced. Eg: Coal, Oil, Precious Metals and Gas - all finite.
  • Renewable resources. Resources that can be replenished. Eg: Wind, Water, Wood, Fish.
  • Semi-renewable resources. There are resources that are renewable, but if they're over-consumed they can become extinct. E.g. Farmland, if we over-farm and use extensive quanitites of chemicals = soil erosion.
  • Economic good. A good that has a benefit to society, also some degree of scarcity.
  • Free good. A good that has a benefit to society, but is available in a unlimited quanity. No oppurtunity cost of consuming it.
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Scarcity and Choice

  • Because of scarcity and unlimited wants, we need to make choices.
  • As an individual we need to decide how to use our limited income to purchase goods and services.
  • Governments also have scarce resources (limited tax income).
  • They need to make decisions about how to use tax revenue. increasing governement spending on the NHS = less potential for spending elsewhere.

The fundamental economic problem

  • Is the issue of scarcity, and how best to produce and distribute these finite resources, to satisfy all human wants and needs.
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Opportunity Cost

Def. The next best alternative forgone.

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Production Possibility Frontiers (PPF)

PPF - Shows the maximum output that an economy can produce if the economy is maximising the use of its resources and operating efficiently.

Causes of long-run economic growth

A shift PPF to the right can be caused by:

  • Discovering raw materials. (e.g., discovering oil fields) 
  • The increase in the size of the workforce. (e.g., immigration) 
  • The increase in capital stock. (e.g., investment in new machines, factories)
  • The increase in labour productivity. (e.g., due to better-educated workers or workers becoming more motivated 
  • Improvements in technology which increase labour productivity. 

Negative economic growth

  • Declining population
  • Firms closing down and stopping production
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Choice between consumer and capital goods

Choice between Consumer and Capital goods 

  • Consumer goods. Goods that we can use and enjoy. The things we buy in shops like food, clothes etc. 
  • Capital goods. These are goods that are used in the productive process - for example, a machine. Capital goods involve investment in increasing productive capacity.

If a PPF curve shifts to the right

  • See an improvement in technology relating to capital goods, but not consumer goods. Therefore, we can produce more capital goods relative to consumer goods.


  • Occurs when a country or firm concentrates on producing a particular good or service. 
  • Countries will specialise in producing goods where they have a comparative advantage. Eg, Japan specialises in producing high-tech electronic goods. Cuba specialises in producing sugar.

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Division of Labour

Division of labour

  • Occurs when workers concentrate on different tasks within a firm.
  • Rather than try to master all aspects of production, some workers will specialise at a particular job.

Productivity of Labour

  • This is defined, as the output per worker, per period.
  • Specialisation may enable, an increase in overall productivity because specialised workers can become more efficient.

Advantages of specialisation in the production of goods

  • Division of labour gives workers time to gain skills for one particular job. Overall, they need less time to be trained.
  • With specialisation and the division of labour, firms can be more efficient when producing on a large scale; it enables economies of scale and lower average costs.
  • The division of labour makes a big production task manageable by spreading the workout.
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Problems of specialisation

Problems of Specialisation

  • Can make jobs highly specialised and repetitive, leading to boredom and possible diseconomies of scale. 
  • On an assembly line, if one person is absent, the whole production may slow down, if other people can't cover the job. Therefore - needs to be more flexibility.

Advantages of specialisation in trade

  • World trade is highly specialised. The growth of world trade = higher living standards, a greater choice of goods, and more competition.
  • Specialisation = countries don't have to produce every good they need - can be impractical for small countries.
  • Countries can make use of their best resource. Eg Low Labour costs in India & China or Advanced Technology in Germany.
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Problem in trade

Problems of specialisation in trade

  • Concentrating on producing a small number of goods can make an economy vulnerable. Eg, if sugar prices fall, countries that rely on sugar exports will see a fall in income. 
  • It may impede development if countries stick to producing primary products, which have a low-income elasticity of demand.


  • A Product market refers to - how a good is bought and sold. Eg, Farmers (producers) sell potatoes at the market and the consumers buy them).
  • The market will determine the price and quantity sold.


  • Firms and consumers are rational.
  • This means - they try to maximise their economic welfare, & make decisions to enable this.
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  • This is: how much benefit the people get from consuming a certain good.
  • E.g. if we get high utility from eating at a restaurant, we will be willing to pay a large amount of money. 
  • Assume that customers wish to maximise their utility. Eg, they will spend money on goods only if they believe, the utility gained is greater or equal to the cost. 


  • This is the amount of money a firm gains after subtracting costs from its total revenue. 
  • Profit = Total Revenue - Total Costs.
  • We assume firms wish to maximise profit. 
  • This might involve cutting costs and/or selling profitable goods.
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  • The individual demand curve illustrates the price people are willing to pay for a particularly quantity of a good
  • The market demand curve illustrates the price consumers in the whole economy are willing to pay

A shift to the right in the demand curve

  • An increase in disposable income, such as higher wages and lower taxes giving consumers more spending power.
  • An increase in the quality of the good. For example, mobile phones are now more versatile and powerful, making them more attractive.
  • Advertising increases brand loyalty to goods and increase demand.
  • A fall in the price of complements. For example, a lower price for Apple apps will increase demand for Apple iPhones.
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Supply - The supply curve refers to the quantity of a good that the producer plans to sell in the market.

Why supply curve slopes upwards

  • As price increases, firms have an incentive to supply more.
  • At a higher price, they get extra revenue, from selling the goods.
  • As output rises, firms usually have higher marginal costs in the short run - it is more costly to increase output.
  • Firms require higher prices to encourage more supply.
  • Firms react to market prices in competetive markets. If a farmer tried to sell his produce above the market price, he wouldn't be able to sell.
  • Firms are price takers.
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Shifts in the supply curve

An increase in supply occurs - shift to the right.

  • Decrease in costs of production. Businesses can supply more at each price. Lower costs could be due to lower wages/lower raw material costs.
  • Increase in the number of producers will cause and increase in supply.
  • Expansion in the capacity of existing firms, e.g. investment to extend the size of a factory.
  • Increase in the supply of a complementary good, e.g. beef & leather.
  • Favourable climatic conditions, are very importatnt for agricultural products, e.g. good weather will give a good harvest.
  • Improvements in technology, e.g. computers and internet enables more to be produced for a lower cost.
  • Lower taxes on the good, e.g. lower petrol tax.
  • Government subsidies on the good.
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Market Equilibrium

Market Equilibrium - refers to how supply and demand interact to set the market price and the amount of goods sold.

  • Market equilibrium occurs when supply = demand, there is no tendency for the price to change.

Excess Demand

  • If the price is below equilibrium, demand is greater than supply = causes a shortage.
  • Consumers want to buy more, firms will put up prices and supply more.
  • As price rises, there will be movement along the demand curve and less will be demanded. 
  • Prices will rise until supply equals demand.
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Excess Supply

Excess Supply

  • If the price is above equilibrium, supply is greater than demand - causing a surplus.
  • To sell the unsold goods, firms reduce their price and reduce supply.
  • The lower prices, encourages more demand.

Impact of increase in demand

  • If consumers saw an increase in income, we would see an increase in demand for goods like TV's; the demand curve would shift to the right.
  • There would be a shortage, but the higher demand would cause the price to rise and suppliers to supply more.
  • In the long term - high prices may encourage firms to enter the market and the supply curve will shift to the right
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Impact of fall in supply in long term

Impact of fall in supply in long term

  • If the price of oil increased, it may start to make it profitable to produce oil from new places, such as Alaska and Antartic.
  • Previously it was too costly to produce oil from there, but the higher price may make it worthwhile.
  • If the price of oil rises, in the long-term people may respond to higher prices by switching to other forms of transport which doesn't use petrol.
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Factors that could explain a fall in the price of

The demand for coffee could fall because of:

  • Lower incomes mean that consumers cannot afford to buy as much.
  • Coffee becomes less fashionable.
  • A fall in the number of coffee shops.
  • Health concerns about caffeine.

The supply of coffee could increase because of:

  • An increase in the number of suppliers or countries producing coffee.
  • Lower costs of production. E.g. lower wage rates in coffee-producing countries.
  • Government subsidies. E.g. Latin American countries may wish to subsidise the coffee farmers. 
  • Higher labour productivity in producing coffee, which will decrease the costs of production.
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Consumer Surplus

Consumer Surplus - is the difference between the price that consumers pay and the price that they would be willing to pay.

E.g. if a book costs £10, but the demand curve shows t hat they would have paid £16, the consumer surplus is £6. 

  • Consumer surplus tends to be higher when markets are competitive and prices are low. 
  • Consumer and producer surplus will be maximised in a free market where price is determined by supply and demand.
  • A monopoly that can set higher prices will be able to reduce consumer surplus

E.g. peak train fares are an attempt to charge higher prices to those commuters willing to pay the higher price - and capture consumer surplus. 

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Producer surplus

Producer surplus - the difference between the price suppliers receive and the price that they would have been willing to supply the good at.

E.g. if the market price is £10, and their supply curve shows that they would have supplied it at £8, they have a produce surplus of £2.

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Price elasticity of Demand - measures the responsiveness of demand to a change in price. 


Price elastic demand

  • Demand is price elastic if a change in price causes a bigger percentage change in demand.
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Characteristics of elastic demand

Characteristics of elastic demand

  • Luxury goods. Are sensitive to price because they represent a big percentage of disposable income, such as sports cars and foreign holidays.
  • Competitive markets. Goods that have many substitutes and a very competitive market will be elastic. E.g. if the price of Tesco bread increased, consumers could switch to several other varieties.
  • Frequently bought. With goods that are bought frequently, we are more likely to compare prices, and switch if necessary.
  • PED will be more than 1. (e.g. -3.0)


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Inelastic demand

  • Demand is price inelastic if a change in price leads to a smaller percentage change in Q.D.
  • PED will be less than -1 (e.g. -0.5)

E.g. of inelastic demand: if the price of tobacco increases 10% and demand falls 2%, the PED = -0.2

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Characteristics of inelastic goods

Characteristics of inelastic goods

  • Few substitutes. E.g. petrol and cigarettes have few close alternatives.
  • Necessities. E.g. if you have to drive to work, you need to buy petrol.
  • Addictive. If you are addicted, you will pay a higher price. E.g. cigarettes, coffee. 
  • Small percentage of income - means you don't worry if the price rises.
  • In the short term, demand is usually more inelastic because it takes more time for consumers to find and switch to alternatives. 


  • Demand for a good like coffee, is likely to be inelastic, as there a few subsitites to coffee. But demand for individual brands of coffee is likely to be more elastic, as there are substitiutes to Starbucks coffee (e.g. Costa).
  • Elasticity may change over time. In the short term, demand for petrol is inelastic, but over time people may be more willing to switch to alternatives, such as cycling to work, so that demand for petrol becomes more elastic with time. 
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Income elasticity of demand (YED)

Income elasticity of demand (YED) -  measures the responsiveness of demand to a change in income. 

  • YED for Mobile Phones = 20/5 = 4.0 (luxury good)
  • YED for Tesco Value Rice -2/5 = -0.4 (inferior good)

Types of good

  • Inferior good. This occurs when an increase in income leads to a fall in demand. Inferior goods will have a negative YED. E.g. clothes from charity shops & Tesco value rice. As your income increases, you buy better quality goods instead
  • Normal good. This occurs when an increase in income leads to an increase in demand for the good, therefore, YED>0. Most goods are normal goods.
  • Luxury good. Occurs when an increase in income causes a bigger percentage increase in demand, therefore, YED>1. Means demand is income elastic. E.g. jewellery & sports cars.
  • Income elastic. This means an increase in income leads to a smaller percentage increase in demand. Therefore 0>YED<1. 
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Importance of income elasticity of demand

Importance of income elasticity of demand

  • In a recession, with falling incomes, demand for luxury goods will fall significantly. Demand for inferior goods will increase.
  • Budget pound shops may do well with falling incomes. But luxury car sales will not.
  • Supermarkets may respond to a recession by supplying more 'inferior' goods and cutting back on luxury goods.
  • If incomes are rising, firms may seek to make their good more of a luxury good. E.g car manufacturers may add more luxury items to cars, such as air conditioning to take advantage of the rising incomes.
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Cross elasticity of demand

Cross elasticity of demand - measures how the demand for one good is affected by the price of another.

  • E.g. if the price of milk falls by 10%, demand for tea may increase by 1%. Therefore XED = (1/-10) = 0.1

Substitute goods. These are two goods that could be used as alternatives. With two substitute goods, XED will be positive.

  • Weak substitutes like tea and coffee will have a low XED. 
  • Tesco bread and Sainsburys bread are close substitutes, so XED is higher.

Complements goods. These are goods that are used together. Therefore, XED is negative.

  • E.g. If the price of DVD players fall, then there will be an increase in demand for DVD discs.

Unrelated goods. If the price of lamb increases, we would expect it to have no effect on the demand for beer or computers. If the price of lamb increased and demand changes for computers, it is just a coincidence and not related.

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Price elasticity of supply

Price elasticity of supply - measures the change in quantity supplied after a change in price. 


  • Inelastic supply means a change in price causes a smaller percentage change in supply    (PES <1). 
  • Perfectly inelastic means a change in price has no effect on supply. 

Supply could be inelastic for the following reasons: 

  • Operating close to full capacity. If firms are operating close to full capacity, it is difficult to increase supply.
  • Low levels of stocks; therefore, there are no surplus goods to sell.
  • In the short term, capital is fixed. Therefore, firms do not have time to build a bigger factory and increase supply. 
  • Difficult to employ factors of production, e.g. it may be difficult to find relevant skilled labour to increase output. 
  • With agricultural products; supply is inelastic in the short run because it takes, at least, six months to grow crops.


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Elastic supply

Elastic supply - this occurs when an increase in price leads to a bigger % increase in supply, therefore, PES > 1. 

  • On the left, price increases from 60-63 and Q increases 50 to 60. 
  • % change in Q = 10/50 = 20% 
  • % change in price = 3/60 = 5%
  • Therefore PES = 20/5 = 4.0 (elastic supply). 
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Elastic Supply

Elastic Supply

Supply could be elastic for the following reasons

  • If there is space capacity in the factory. 
  • If there are stocks available 
  • If it is easy to employ more factors of production.

Difference between long run and short run

  • In the short run, supply is more likely to be inelastic because the firm does not have the ability to increase the size of the factory. 
  • In the long run, supply can be more elastic as the firm can invest in more capacity and, therefore, increase supply.
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Elasticity calculation

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Market Failure

Market failure - occurs when there is an inefficient allocation of resources in a free market. Market failure implies there is a decline in producers/ consumer surplus and a net welfare loss. 

Market failure can occur for various reasons:

  • Externalities - a cost of benefit imposed on a third party, leading to under or over consumption.
  • Information asymmetries - lack of complete knowledge by one party. E.g. people may under-estimate the benefits of education (merit good) or underestimate the costs of smoking (demerit good).
  • Monopoly - when a firm has market power and can set higher prices. Monopolies may also be more inefficient because they face less competitive pressures. 
  • Immobilities - geographical immobilities occur when it is difficult to people or firms to move to another area. E.g. unemployed coal miners in Yorkshire find it difficult to move to London because of housing costs. Occupational immobilities occur when it is difficult for people to retrain and get skills in high-tech industries.
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Market Failure

Market failure reasons for occurrence ext.

  • Public Goods - goods that are non-rival and non-excludable. They tend to be underprovided or not provided in a free-market. E.g. law and order, national defence and street lighting. 
  • Merit and demerit goods - goods where we make decisions based on poor information.
  • Volatile prices - in agricultural markets, prices can be volatile causing problems for consumers and farmers.
  • Income inequality - in a free market, there could be widespread inequality with some unable to afford important services.
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Externalities and social efficiency

Social benefit - is the total benefit to society.

  • Social benefit = private benefit + external benefits.
  • Social marginal benefit (SMB) = the additional benefit to society of producing an extra unit.
  • SMB = PMB (Private Marginal Benefit) + XMB
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Externalities and social efficiency

Social Benefit

  • Social benefit is the total benefit to society.
  • Social benefit = private benefit + external benefits.
  • Social marginal benefit (SMB) = the additional benefit to society of producing and extra unit.
  • SMB = PMC + XMB 
    • SMB - Social Marginal Cost.
    • PMC - Private Marginal Cost.
    • XMC - External Marginal Cost.

Social cost

  • Social cost is the total cost to society.
  • Social cost = private cost + external costs.
  • Social marginal cost = private marginal cost + external marginal cost.
  • SMC = PMC + XMC
    • SMC - Social Marginal Cost.
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Negative Externality

Negative Externality - occurs when there is a cost imposed on a third party.

E.g. If a firm produces chemicals, the external cost is the pollution that causes damage to the river and the lost earnings for fishermen.

E.g. If you drive into a town centre, the negative externality is the congestion and pollution that affects other people in the town.

  • With a negative externality, the social marginal cost is greater than the private marginal cost.

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Negative consumption Externality

Negative externalities can also occur in consumption

  • E.g. if we drive inefficient petrol cars, the consumption of petrol causes excess C02 emissions and pollution. This is a cost to the rest of society. Other people will experience pollution and perhaps ill health because of our decision to drive. 
  • If we drink alcohol to excess, we may turn up late to work on Monday morning, leading to lower productivity and lower economic growth. 

     Diagram on the next Revision Card


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Negative Consumption Externality

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Positive Externality

Positive Externality - a positive externality in consumption occurs when there is a benefit to a third party from your consumption. 

E.g. if you cycle to work (rather than drive), other people benefit from reduced congestion and pollution.

Positive externality in production

  • When producing a good this causes a benefit to a third party.

E.g. if you keep bees, then a nearby apple farmer benefits because your bees help to pollinate his apple trees.

Diagram and explanation on next Revision Card

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Positive Externality

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Merit Good

Merit Good - occurs where people may underestimate or be unaware of the benefits of consuming a good.

E.g. students may underestimate the benefits of studying and, therefore, leave school early. Or people may be hesitant to get a vaccination from diseases.

  • Merit goods often have a positive externality
  • Merit goods are under-consumed in a free market.
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