Alevel Economics Revision

Basic economic ideas and resources allocation

Factors of Production

Land: Natural resources

    - Payment: Rent

Labor: Human resources

    - Payment: Wage

Capital: The manufactured stock of tools and other resources which are used in production in products

    - Payment: Interest

Enterprise: Personal initiative to combine resources in making profit

    - Payment: Profit

Basic Economic Questions

What to produce?

Because enterprise cannot produce everything, so we need to decide what to produce and in what quantities.

How to produce?

We need to consider how resources are used so that the best outcome arises. Consider how we can get the maximum use out the resources available to us. For exmaple: Labor or Capital intensive.

For whom to produce?

We cannot satisfy all the wants of the poplation, decision have to be taken concerning how many of each person's wants are to be satisfied.

Specialization

- the process by which individuals, firms and economies concentrate on producing those products where they have an advantage over others.

Division of labor

The concentration of large numbers of workers within very large production units allowed the process of production to be broken down into a series of tasks.

Pros

- Increase in output

- Reduces average cost of production

- Time saving

Cons

- Mechanical repetition will reduce worker's operation capacity

- Immobility of labor

- Increase in interdependent

From Basic Economic Problem to Three Basic Economic Questions

1. Basic economic problem (Scarcity)

2. Resources need to be allocated in most efficient way

3. Economies need to answer the Three Basic Economic Questions

By answering the Three Basic Economic Questions, is the process of allcating resources

Market Economy

In market economy, market mechanism works best: decisions on price and quantity are made on the basis of demand and supply alone.

Advantages

- Consumer sovereignty

- Incentive workers and firms to be efficient

- Lack of bureaucracy

Disadvantages

- Inequitable distribution of income

- Risk of unemployment of resources

- Under/Over consumption of merit/demerit good

- Lack of provision of public good

- Information failure

Planned economy

Resource allocation decisions are taken by a central body

Advantages

- Full employment of resources

- Avoidance of wasteful duplication

- An equitable distribution of resources

- Provision of merit/public good

- Discourage demerit goods

- Long term planning and support vulnerable groups

Disadvantages

- Slow responses to changes in consumer demand

- Likely to have bureaucracy

- Lack of incentives

Production Possibility Curve

A simple representaiton fo the maximum level of output that an economy can achieve when using its existing resources in full.

Factors of influence

- Quantity and quality of resources

- Techonology

- Productivity

- New raw materials

- Wars

- Natural disasters

Private goods VS Public goods

Excludability: It is possible to exclude some people from using a private good. Normally done through charging a price.

Rivalry: The consumption by one person reduces the availability for others.

Private Sector Firms will not have any incentive to produce public goods because of Free Rider Problem.

Merit & Demerit

External benefits: Benefits that are received by third parties not involved in the action.

The problem of under consumption of merit goods and over consumption of demerit goods arises from: Information failure

To encourage merit goods, government may

- Provide it for free

- Subsides

- Set maximum price

- Provide information (Education)

To encourage Demerit good, government may

- Ban them

- Impose taxes (Supply shift to left)

- Set minimum price

- Provide information (Education)

The price system and the microeconomy

Cause of shift in Demand

- Income / ability to pay

- Price and availability of related products

- Fashion, tastes

- Population size

- weather

- Expectation to future

Cause of shift in Supply

- Cost of production

- Size and nature of the industry

- Chaneg in price of otehr products

- Government policy

- Expectation to future

Price elasticity of demand

A numerical measure of the responsiveness of the quantity demanded for a product following a change in the price of that product.

PED = % change in QD / % Change in Price

PEDa = 0.2, Less than 1, Relatively inelastic.

PEDb = 2, more than 1, Relatively elastic

Factors affecting PED

- The range and attractiveness of substitutes

- Times

- The relative expense of the product

Income elasticity of demand

A numerical measure of the responsiveness of the quantity demanded following a change in income.

YED = % change in QD / % change in Y

YED is Positive => Normal Goods

YED is Negative => Inferior Goods

YED is Positive & > 1 => Luxury Good

YED is Positive & Close to Zero => Necessity

E.g.: YED of A = 1 % decrease in demand / 2% increase in income

     = - 0.5 (Inferior good - Inelastic response)

Cross elasticity of demand 

A numerical measure of the responsiveness of the quantity demanded for o.ne product following a change in the price of another related product

XED = % change in QD of Good A / % change in Price of Good B

XED is Positive => Substitutes

XED is Negative => Complements

Price elasticity of Supply

A numerical measure of the responsiveness of the quantity supplied for a product following a change in the price of that product.

PES = % change in QS / % Change in Price

Factors affecting PES:

- The ease with which businesses can accumulate or reduce stocks of goods

- The ease with which businesses can increase production

- Time

Functions of Money

- Rationing

- Signaling & transmission of preference

- Provision of incentives

Government microeconomic intervention

Three types of intervention

- Regulation

- Financial intervention

- Provision

Impact of Direct & Indirect tax

- Disincentive to work => AS decrease (Direct tax)

- High rate of corporation tax discourage entrepreneurs from investment (Direct tax)

- Redistribution of income (Direct tax)

- Imposes more tax burden on the poor (Indirect tax)

- Raise price and cause inflation  (Indirect tax)

- Less disincentive to work than direct taxes

 

Transfer payment

- Old pension

- housing allowance 

- Coupons

- Child benefits

The macroeconomy

Circular flow of income