REVISON ALL

• Microeconomics


  Study of individual markets
• Macroeconomics


  Study of aggregates (total goods market) and topics like economic growth, inflation, unemployment and balance of payments
• The economic problem


  • Scarce (limited) resources and infinite (unlimited) wants
  • Economic agents (households, firms and government) have to make choices
  • Opportunity cost - loss of the next best alternative
• Positive statement


  Can be tested using evidence to prove if they are right or wrong
• Normative statement


  Opinions that cannot be proved or disproved
• Three basic economic questions

  • What to produce (which goods and services to make)
  • How to produce (what combination of factors of production to use)
  • For whom to produce (how goods should be distributed to people in society)
• Command economy


  • Government answers the 3 basic economic questions
  • Resources allocated through planning process
  • Goods and services distributed fairly equally
  • Motivation is the common good
  • Public ownership
  • No competition and limited choice
  • Centralised decision making
• benefits of command economy

  • Creates a "Welfare State"
  • Essential services at low prices
  • Very little unemployment
  • Equality of income
  • Protect the environment
• Weaknesses of command economy


  • Difficult to plan and forecast accurately
  • Huge government subsidies to keep prices low
  • Over-staffing and workers have little incentive to work hard
  • Lack of investment leading to out-of-date machinery and inefficient production
  • Little choice of goods
  • Shortages in the shops
  • Black markets appearing
  • Environmental costs
• Free Market economy

  • Market mechanism (supply and demand) to decide on 3 basic questions
  • Those with the most spending power are allocated the most resources
  • Free enterprise (producers are free to sell what they want and consumers free to buy what they want)
  • Private property (land and capital)
  • Self-interest is the main motivation (profit motive for firms and welfare maximisation for consumers)
  • Competition and choice
  • Decentralised decision making
• Mixed economy


  A combination of a market economy and state intervention
• Production Possibility Frontier (PPF)


  • Shows the maximum potential output of an economy
  • A point on the curve shows efficient use of all resources
  • PPFs are usually drawn concave due to inequality of factors of production
  • A point inside the PPF indicates inefficient use of resources
  • Economic growth shifts the PPF outward
  • A leftward shift indicates a permanent loss of resources
• Market


  A place where buyers and sellers come together to exchange goods and services
• Price and demand


  Negative (inverse) relationship - as price rises, demand falls and vice versa
• Change in price


  Leads to a movement along the demand curve
• Change in other demand factors


  Causes a shift in the demand curve (outward for increase, inward for decrease)
• Marginal utility theory


  • Explains the downward sloping demand curve
  • Utility is a measure of satisfaction
  • Total utility is the total satisfaction
  • Marginal utility is the extra satisfaction from consuming one more unit
  • Marginal utility declines as more units are consumed
• Price and supply


  Positive relationship - as price rises, supply rises and vice versa
• Change in supply factors


  Causes a shift in the supply curve (downward for increase, upward for decrease)
• Price elasticity of demand (PED)


  • Responsiveness of demand to a change in price
  • Always negative
  • Less than 1 is price inelastic, greater than 1 is price elastic, 1 is unitary
• Factors affecting PED


  • Availability of close substitutes
  • Time horizon
  • Definition/breadth of market
  • Necessities versus luxuries
  • Proportion of income devoted to the good
• Income elasticity of demand (YED)


  • Responsiveness of demand to a change in income
  • Positive for normal goods, negative for inferior goods
  • Less than 1 is income inelastic, greater than 1 is income elastic
• Cross elasticity of demand


  • Responsiveness of quantity demanded of one good to a change in price of another
  • Positive for substitutes, negative for complements
  • Less than 1 is cross price inelastic, greater than 1 is cross price elastic
• Price elasticity of supply (PES)


  • How quickly firms can respond to a price change with an increase/decrease in supply
  • Factors: time horizon and level of spare capacity or stocks
• Price determination in the market system


  • Market equilibrium price is determined where quantity supplied meets quantity demanded
  • Market forces will drive any disequilibrium position back into equilibrium
• Inter-relationship between markets


  • Joint demand (complementary goods)
  • Competitive demand (substitute goods)
  • Derived demand (factors of production)
  • Joint supply (goods supplied together)
• Market failure


  • Scarce resources are not allocated to their most efficient use
  • Examples: excessive price fluctuations, over/under production of goods with externalities, lack of provision of public goods
  • Analysed through MSB/MSC diagrams
  • Negative externalities when MPB>MSB, positive externalities when MSB>MPB
  • Negative externalities when MPC>MSC, positive externalities when MSC>MPC
• Government intervention to address market failure


  • Regulation, education, information provision, "nudge" economics
  • Maximum prices (price ceilings)
  • Minimum prices (price floors)
  • Indirect taxes
• Government intervention can also fail (government failure)
• Adverse selection


  Mainly in the insurance market, where those most at risk are the most likely to take out a policy
• Moral hazard


  Where the costs of the risk taken by those agents making a decision are not paid by them, e.g. banking risk
• Market-based policies


  Policies used by governments to try and address market failure
• Market-based policies


  • Maximum Price (price ceiling or cap)
  • Minimum Price (price floor)
• Maximum Price (price ceiling or cap)


  Set by government to try and reduce the problem of too high a price. E.g. rent controls.
• Minimum Price (price floor)


  Set by government to try and reduce the problem of too low a price. E.g. National Minimum Wage.
• Problem of setting maximum or minimum prices


  Government failure (this occurs when government intervention to overcome market failure fails or makes things worse)
• Indirect taxes


  Imposed by government to try and reduce the overproduction of demerit goods through raising prices by increasing production costs for suppliers (shifting the supply curve to the right)
• Subsidies


  Used by government to increase the underproduction of merit goods in the market through lowering prices by reducing production costs for suppliers (shifting the supply curve to the left)
• Buffer stock policy


  Used by governments (e.g. the EU) to try and reduce excessive fluctuations in prices, mainly in agriculture. This occurs by government agencies setting up a minimum intervention price and guaranteeing to buy all unsold output, in a good harvest year, at this price. They then take this surplus supply out of the market, maintaining the intervention price and building up stocks for use when there is a bad harvest year. When a bad harvest does occur, these stocks are released onto the market, increasing supply and, again, maintaining the intervention price.
• Buffer stock policy


  • The CAP of the EU