Theme 1

• Scarcity


  The shortage of resources in relation to the quantity of human wants
• The basic economic problem is scarcity. Wants are unlimited and resources are finite, so choices have to be made. Resources have to be used and distributed optimally.
• Opportunity cost


  The value of the next best alternative forgone
• Opportunity cost is important to economic agents, such as consumers, producers and governments.
• Profit maximisation


  Profit is the difference between total revenue (TR) and total cost (TC). Firms break even when TR = TC. Profit maximisation occurs where marginal cost (MC) = marginal revenue (MR). Profits increase when MR > MC, and decrease when MC > MR.

  
• Reasons for profit maximisation


  • Provides greater wages and dividends for entrepreneurs
  • Retained profits are a cheap source of finance, which saves paying high interest rates on loans
  • In the short run, the interests of the owners or shareholders are most important, since they aim to maximise their gain from the company
  • Provides a stable price and output in the long run, as consumers do not like rapid price changes
• Sales maximisation


  Firm aims to sell as much of their goods and services as possible without making a loss. This is where average costs (AC) = average revenue (AR).
• Satisficing


  A firm is profit satisficing when it is earning just enough profits to keep its shareholders happy. This occurs where there is a divorce of ownership and control.
• Survival


  Some firms, particularly new firms entering competitive markets, might aim to simply survive in the market. This is a short term view.
• Market share


  Helps increase the chance of surviving in the market, and it can be achieved by maximising sales.
• Market share


  • Amazon aimed to increase their market share in the e-reader market, by trying to sell as many Kindles as possible. They did this at a loss in the short run, but they gained customer loyalty and now they are a leading e-reader producer.
• Cost efficiency


  The more cost efficient a firm is, the lower its average costs. This gives the firm a competitive advantage, since they can afford to charge consumers lower prices.
• Return on investment (ROI)


  The reward for taking risks by making investments. The higher the ROI, the more attractive the investment is.
• Employee welfare


  Some firms might try and ensure their employees are well looked-after. When employees are happy, they are more likely to be productive and do a good job.
• Employee welfare


  • Google is renowned for their employee perks such as on-site physicians and travel insurance.
• Customer satisfaction


  Firms might aim to increase their competitiveness by improving their quality and increasing their customer satisfaction. This could be achieved through innovation.
• Social objectives


  Some firms might focus on social welfare and their Corporate Social Responsibility (CSR). They might take responsibility for consequences on the environment and aim to maximise social welfare.
• Private costs


  Producers are concerned with private costs of production e.g. rent, cost of machinery and labour, insurance, transport, raw materials
• Social costs


  Private costs plus external costs
• External costs


  Shown by the vertical distance between marginal social costs (MSC) and marginal private costs (MPC)
• External costs increase


  Disproportionately with increased output
• Private benefit


  Consumers are concerned with the private benefit derived from the consumption of a good, determined by the price the consumer is prepared to pay
• Social benefit


  Private benefits plus external benefits
• External benefits


  Shown by the difference between private and social benefits
• External benefits increase


  Disproportionately as output increases
• External costs occur when a good is being produced or consumed, such as pollution
• The market equilibrium, where supply = demand at a certain price, ignores negative externalities, leading to over-provision and under-pricing
• With negative externalities, MSC>MPC of supply. At the free market equilibrium, there are an excess of social costs over benefits at the output between Q1 and Qe
• The output where social costs > private benefits is known as the area of deadweight welfare loss
• The market fails to account for the negative externalities that occur from the consumption of this good, which would reduce welfare in society if it was left to the free market
• An example of an external benefit from the production or consumption of a good or service could be the decline of diseases and the healthier lives of consumers through vaccination programmes
• Since consumers and producers do not account for external benefits, they are underprovided and under consumed in the free market, where MSB>MPB. This leads to market failure
• The triangle in the diagram shows the excess of social benefits over costs. It is the area of welfare gain
• Social optimum position


  Where MSC = MSB and it is the point of maximum welfare
• Market failure occurs when the free market fails to allocate resources to the best interests of society, so there is an inefficient allocation of scarce resources
• Economic and social welfare is not maximised where there is market failure
• Externalities


  The cost or benefit a third party receives from an economic transaction outside of the market mechanism
• Public goods


  Non-excludable and non-rival, underprovided in a free market because of the free-rider problem
• Public goods are missing from the free market, but they offer benefits to society e.g. street lights, flood control systems
• The non-excludable nature of public goods gives rise to the free-rider problem, where people who do not pay for the good still receive benefits from it