Reasons for individuals, organisations and societies having to make choices:
Economics = The study of how to allocate scarce resources in the most effective way
World has scarce resources AKA FINITE RESOURCES. The economic problem is how to allocate scarce resources among alternative uses, and as a result a choice has to be made resulting in an OPPOTUNITY COST(cost of the next best alternative, which is forgone when a choice is made)
Household = A group of people whose spending decisions are connected.
Central purpose of economic activity is to produce goods and services to provide what we need and what we want as individuals, households and firms. If we are able to organise a system that meets needs and wants then we would see an overall increase in economic welfare for citizens.
Micro economics = The study of how households and firms make decisions in markets
Macro economics = The study of issues that affect economies as a whole
Economic Problem = Finite resource, infinite wants, therefore a choice has to be made leading to an opportunity cost
Every purchase adds to consumption, and is the biggest concept in economics as it helps determine growth and success of an economy.
Consumption = The final purchase of goods and services by individuals
4 Factors of production:
The resources available in the economy are known as FACTORS OF PRODUCTION:
-LAND = Natural(includes minerals, oil, coal, water, land)
-LABOUR = Quality of education increases value and productivity of labour force
-CAPITAL = Physical resources, man mad aid for production(Machines, buildings)
-ENTREPRENEURSHIP = Organise production and take risks
Factor endowment = refers to the stock of factors of production
Scarcity = A situation where they’re insufficient resources to meet needs
Choice = The selection of appropriate alternatives
Economic systems and the role of the market:
Economic system = the way in which production is organised in a country or group of countries
Problem of all economies is scarce resources. In an economy the government has to make decisions on; 1)What goods +Services to produce. 2)How good +Services are produces. 3)Who should receive these goods +services.
Three types of economic systems are;
l System where most resources are state owned and allocated centrally
l Government has central control over decisions
l Production targets are set
l Production Controlled by state
l Objective is to achieve high rate of growth
l System where resources are allocated through the market and price mechanism
l However finite resources can be exploited
l Government has little or no involvement
l Households and firms are buyers and sellers
l System where resources are allocated through the market and direct public sector involvement
l Both private and public sector responsible for allocation of resources
l Past 20 years, trend has been one of privatisation
Production possibility curve(PPC):
PPC = this shows the maximum quantities of different combinations of output to two products, given current resources and the state of technology
In an economy it is determined by:
1.Quantity of resources
2.2.Quantity of resources
3.Developed countries have extensive availability of factors of production, while developing countries have limited availability.
Developed economy = an economy with a high level of income per head
Developing economy = an economy with a low level of income a day
Shift left indicates a decrease in productive capacity. A shift right shows an increase in productive capacity.
Factors that cause ppc to shift right:
l More resources available e.g labour and capital
l Technological advances
Factors that cause ppc to shift inwards:
l Change in economy: Economic shock - recession
l A fall in factors of production e.g emigration
Productive potential = maximum output that an economy is capable of producing
Economic growth = a change in productive potential of an economy
Market = where buyers and sellers meet to trade or exchange products. Buyers demand the goods from the market whilst supply to the market.
Characteristics of a market:
l Physical place/mechanism, where buyers and sellers can meet
l Willingness to trade/exchange goods and services
l Products bought and sold/command a price
l Price reflects what seller and buyer are willing to buy and sell products for
l Intention of sellers and buyers determines price in any system of market situation
Sub-Market = a recognised or distinguished part of a market. AKA a market segment.
Notional Demand = Desire for a product
Effective Demand = willingness and ability to buy a product
Demand =quantity of a product that consumers are willing and able to purchase at various prices over a period of time
Law of demand states the higher the price, the lower the quantity demanded. Price and quantity have an inverse relationship.(there can be a contraction or an extension in demand)
Demand Curve = relationship between quantity demanded and price of a product
Movement along curve = response to a change in the price level of a product
Consumer Surplus = the extra amount that consumers are willing and able to pay for a product or service above what is actually paid.
Consumer surplus can be new and old as price of a product or service changes.
Changes in demand due to a non-price factors:
l Tastes and fashions = good/bad publicity
l Consumer income = RDI - more spending power on normal goods
l Price of other products:
n Substitutes - creates competition
n Complements have a direct relationship
Normal good = goods for which a rise in income leads to an increase in demand
Inferior foods = goods for which a rise in income leads to a fall in demand
Substitutes = a competing good
Complements = goods for which there is joint demand
RDI = income after tax, state benefits added and adjusted to inflation
DI = income after tax, state benefits have been added
Theory of Supply:
Supply = quantity of a product that a producer is willing and able to supple to the market at a given price in a given period of time
Law of supply is; price of a commodity rises, produces expand their supply to the market
Supply schedule = the data used to draw up the supply curve of a product
Producer Surplus = the difference between the price a producer is willing to accept and what is actually paid.
Producer surplus, objective of all firms and producers is to maximise profits.
A typical selling price would be P and at this price Q is the quantity supplied. Producer surplus is the shaded area above the supply curve but below P the producer is willing to sell are. At P1 the producer is not willing to supply
How the following factors affect supply:
1)Cost of production:
l Higher cost of production = less incentive to supply
l As cost increases quantity decreases
l As cost decreases quantity increases
2)Size and nature of the industry:
l If large its hard to compete in
l If small, producers can monopolise the market
l Minimum wage
l Natural disasters
Change in supply = occurs when a change in a non price influence, leads to an increase or decrease in the willingness for a producer to supply to the market
How prices are determined:
Price of a product determines if a company makes a profit or loss. It determines how much is supplied to the market and how much is demanded. Price equilibrium where demand and supply meet.
Price = the amount of money that is paid for a given amount of a product or service
Equilibrium quantity = quantity that is demanded and supplied at the equilibrium price
Price elastic = where the percentage change in the quantity demanded is sensitive to a change in price
Price inelastic = where the percentage change in the quantity demanded is insensitive to a change in price
Elasticity = the extent to which buyers and sellers respond to a change in market conditions
SO, what is it about?:
l Numerical estimate(could be inaccurate)
l Helps us understand the market and how its influenced
l Helps us understand how buyers and sellers will respond to a change in market conditions
l Helps us determine prices and to forecast sales revenue
Price Elasticity Demanded(PED):
PED = measures the responsiveness to the change in quantity demanded in response to a change in its price
Price elastic = >1
Price inelastic = <1
Exact proportionate = 1
Determinates of PED:
l Availability and closeness of substitutes
n Greater number and greater closeness to product = price elastic
l Relative expense of the product with respect to income
n Price of product small, increase, not much change in income, price inelastic
n Short term consumers find it difficult to alter spending habits, still buy-product if increase in price. Over time more consumers change buying habits as more people are educated meaning its price elastic.
Income Elasticity of Demand(YED):
YED = the responsiveness of demand to a change in income
Income elastic = >1
Income inelastic = <1
The signs +or - are essential of elasticity as it indicates whether there is an increase or decrease i the quantity demanded following a change in income.
Normal goods have a POSITIVE YED
Inferior goods have a NEGATIVE YED
Cross Elasticity of Demand(XED):
XED = measures the responsiveness of demand for one product following a change in the price of another related product.
If XED is negative they are complementary goods.
Substitutes have a POSITIVE XED
Complements have a NEGATIVE XED
If 0 = there is no relationship
Price Elasticity of Demand(PES):
PES = responsiveness of the quantity supplied of a product/service in response to a change in the price of the product/service
Given the nature of the suppliers objective of profit maximisation, it follows that the value of the elasticity of supply will always be positive.
0-1=Supply is inelastic
>1 =Elastic - producers are able to respond with a relatively large change in supply if prices rise
1 = Exactly proportional change in the quantity supplied
S1 = Proportional
S2 = Elastic
S3 = Inelastic
Determinates of PES:
1)Availability of stock:
l Buffer stock - quicker to put to market
n Profit maximisation
2)Availability of factors of production:
l Labour is elastic
l Machinery/capital is inelastic
n As there is a time line between the time the order was placed and its arrival
n And the time it takes to train people to use it
l This is where it takes time to adjust
An externality(spill over) occurs when those not directly involved in a particular decision are affected by the actions of others. People affected are known as THIRD PARTY.
Third party = those not directly involved in decision making
e.g smoking-family,people walk past, congestion-workplace, deliveries, residence affected by smog.
Merit goods = those that have more private benefits than their consumer actually realise. (Usually associated with positive externalities).
Demerit goods = their consumption is more harmful than is actually realised. (They are usually associated with negative externalities).
Encourage consumption of merit goods and discouraging consumption of demerit goods through, tax, subsidy, campaigns, restrictions.
Taxation = A tariff that increase the cost
Subsidy = A payment by governments to encourage production or consumption of a product
Permits = Allows owners to pollute
Regulations = Legislation and education
Positive externality = this exists where the social benefit of an activity exceeds the private benefit.
Diagram to show a positive externality. Price equals P and quantity sold is represented by Q. At this price the external benefits aren't taken into account.
Market failure = where the free market fails to achieve economic efficiency
Allocative efficiency = Where consumer satisfaction is maximised
Productive efficiency = when output is maximised from the least amount of scarce resources
Economic efficiency = where allocative and productive efficiency are achieve
Free market mechanism = the system by which the market forces of demand and supply determine prices and decisions are made by consumers and firms
Regulations = exams, age limits, speed limits, licences
If the market was left to the free market, undesirable outcomes would occur. The purpose of such controls are to override the workings of the market mechanism.
However legislation is difficult to manage, and is costly to enforce.
Size of fines may not deter companies from stopping its actions. If the producer benefits greatly from external costs, the risk of the action is worth it, especially if detection is low.