AS chapter 3 summary

Definitions:
- Productive efficiency: where production takes place using the least amount of scarce resources.
- Economic efficiency: Where both allocative (demand based) productive efficiency are achieved.
- Inefficiency: Any situation where economic efficiency is not achieved.
- Free market mechanism: The system by which the marke forces of demand and supply determine prices and decisions made by consumers and firms. If the free market mechanism fails to achieve economic efficiency there is market failure.
- Information failure: A lack of information resulting in consumers and producers making decisions that do not maximise welfare. (E.G. sigarettes, alcohol) Result of: misleading packaging; persuasive advertising resulting in consumption levels that are not in the best interest of consumers.)
- Asymmetric information: Information not equally shared between two parties. (E.G. Health care, Environment(we know few about pollution), consumer purchases(bad deals))
- Costs and benefits.
There are three types of costs and benefits.

1) Private costs and benefits; these are experienced by the people who are directly involved in the decision to take a particular action. E.G. Take the case of an airport expansion. The private costs are the development costs are paid by the owners of the airport. The private benefits in this case are the revenue received by the airport’s owners and the pleasure that is gained by the additional passengers as a result of being able to travel by air from that extended airport.
- Private costs : The costs incurred by those taking a particular action.
- Private benefits: the benefits directly accruing to those taking a particular action.

2) External costs and external benefits; These are consequence of externalities that arise from a particular action. In the case of the airport expansion, people who live on the flight path of the airport will experience additional noise pollution problems. An external benefit could be if some flights transfer to the expanded airport elsewhere, resulting in less noise pollution for those people who live on the flight path of that airport.
- External costs: The costs that are the consequence of externalities to third parties.
- External benefits: The benefits that accrue as a consequence of externalities to third parties.

3) Social costs and social benefits; these are the total costs and benefits incurred by or accruing to society as a result of a particular action. By definition, the definition, they consist of private costs and benefits and any external costs and benefits that arise.
- Social costs: The total costs of a particular action
- Social benefits: The total benefits of a particular action
- Externalities consisting of:1) Negative externalities, E.G. Air pollution while driving; Illegal dumping of waste; chewing gum and binge drinking (damage or pollution caused by drunk people)
2) Positive externalities, E.G. Inoculations against flu; crossrail ( London’s transport project); Education and training.

- Merit goods: These have more private benefits than their consumers actually realise. (E.G. inoculations. ) Merit goods tends to have positive externalities. Information failure! People don’t know enough about the positive externalities.
- Demerit goods: their consumption is more harmful than is actually realised. (E.G. the excessive consumption of alcohol.) Demerit goods tend to have negative externalities. Information failure! People do not know it’s that harmful.
- Public goods: Goods that are collectively consumed and have the characteristics of non-excludability and non-rivalry. Public goods are goods that most people would like to have but are not affordable in the free market. (E.G. street lightning, Fire service) Public goods have the defining characteristics:
- Non-excludability: Situation existing where individual consumers cannot be excluded from consumption. All people use the service, like police. Not everyone is paying for it indirectly through taxes ( eg foreign visitors) but are receiving the service, this group is freeriding.
- Non-rivalry: Situation existing where consumption by one person does not affect the consumption of all others.
- Quasi-public goods: Goods having some but not all of the characteristics of a public good. (toll-roads)

Government interventions to correct market failure:

- Negative externalities. Government intervenes by charging or giving information. (E.G. the ‘bin it’ campaign for chewing gun) Same for Demerit goods.
- Positive externalities. Government intervenes mostly by giving more information, avoiding information failure. Same for Merit goods.

- Public goods: Goods that are collectively consumed and have the characteristics of non-excludability and non-rivalry. The defining characters of the public goods are:
1) Methods that involve some manipulation of the market mechanism – subsidies, indirect taxation and the provision of information.
2) Non-market methods – direct provision and various forms of regulation and control.
- Direct tax: One that taxes the income of people and firms and that cannot be avoided. (E.G. Income tax)
- Indirect tax: a tax levied on goods and services. (E.G. VAT.. Mostly used to discourage the production and consumption of demerit goods.)
With indirect taxes the government tries to make the polluter pay, this way the external cost is internalized to the producer. This is the polluter pays principle, there are four main problems that occur when applying this principle:
1) There are problems in determining the exact amount of tax, since it is invariably difficult to estimate the cost of the negative externality.
2) Producers may not always pay the full amount of the tax. They might charge the consumer for the tax they have to pay.
3) The PED for most demerit goods tends to be inelastic, so by making the price higher the demand won’t fall that much.
4) Better quality information for consumers might also be used to further reduce consumption.

- Subsidy: A payment, usually from government, to encourage production or consumption. A subsidy is designed to keep prices down while increasing production and consumption. Makes the supply curve move to the right. (EG payments to train-operating companies to operate franchised services, payments to local bus companies to run loss-making services in rural areas, university education )
- Governments do not only correct market failure by using the price mechanism(making demand increase or fall by decreasing or increasing price) but also in the form of regulations, standards and legal controls. E.G. :

1) Environmental – legislation relating to the emission of pollutants into the atmosphere, for the handling, storage and disposal of chemicals, noise levels from pop concert.
2) Transport – legislation governing the compulsory use of seat belts, the construction and use of motor vehicles.
3) Professional – regulations relating to the qualifications of doctors, dentists and nurses, academic qualifications and those for lawyers and accountants.
4) Use of demerit goods – restrictions on the scale of tobacco products and alcohol, various types of dangerous drugs.

- Tradable permits: a permit that allows the owner to emit a certain amount of pollution and that, if unused or only partially used, can be sold to another polluter.
The price of the permits are being determined by the market, the quantity supplied is being set by the government. When there are more firms that want to pollute, demand will increase for the tradable permits which will make the price go up.

AS chapter 2 summary.

Definitions:

- Market: Where or when buyers and sellers meet to trade or exchange products. Markets use the price system, which reflects the price suppliers wish to sell their products for and the price buyers are willing to pay for it.
- Sub-market: A recognized or distinguishable part of a market. Also known as a market segment.
- Demand: The quantity of a product that consumers are able and willing to purchase at various prices over a period of time. This splits up to two things:

1) Notional demand: The desire for a product. (= want, will always be there)
2) Effective demand: The willingness and ability to buy a product. If you want the product, are you actually willing to pay the price for it? Demand mostly refers to effective demand.
- Ceteris paribus (assumption): Leaving all the other things out. (everything is fixed except for the thing you’re looking at.
- Demand schedule: Data used to draw the Demand curve. ( as shown below.)



Note: The move from the price of $400,- to $200,- is called a movement along the demand curve. The move upwards along the demand curve ( from $200,- to $400,-) is called an extension in demand. And a move downwards(from $400,- to $200,-) is referred to as a contraction of demand.
Also note: The shape of the demand curve isn’t always straight, it can also be curved.

There are three non-price factors affecting demand which are:
1) Consumer Income (causing income elasticity)
2) The prices of other goods (causing cross-elasticity)
3) Tastes and fashion

- Consumer surplus: The extra amount that a consumer is willing to pay for a product above the price that is actually paid.



Imagine this demand curve shows the demand(per month) for the cinema. If the price is $2,- the demand will be 4 times per month. However, the demand for a price of $3,- would have been 2 times. The person who goes 4 times per month would have been prepared to pay $3,- for the first two visits each. The consumer surplus of the first two visits will therefore be $2,-. The total consumer surplus at a price of $2,- is the total colored area, the total consumer surplus at the price of $3,- is the light-gray colored area.

- Total revenue = Price*Quantity = area under curve.
- Disposable income: Income after tax on income have been deducted and state benefits have been added. (= spendable income)
- Real disposable income: Inflation corrected disposable income.
- Normal goods: Normal goods are goods for which an increase of income results in an increase in demand
- Inferior goods: goods for which an increase of income will lead to a fall in demand.
- Substitutes: Competing goods. (apples and banana’s)
- Complements: Goods for which there is joint demand. ( Printer and cartridge )
- Change in demand: This is where a change in a non-price factor leads to an increase or decrease in demand for a product. This makes the demand line shift!

Summary of demand line shifts.

Demand line shifts to the RIGHT(more demand @ same price) if there is:
1) An increase in consumer income.
2) A rise in the price of substitutes.
3) A fall in the price of complements
4) A positive change in tastes and fashion
Demand line shifts to the LEFT(less demand @ same price) if there is:
1) A fall in consumer income
2) A fall in the price of substitutes
3) A rise in the price of complements
4) A positive change in tastes and fashion.

- Supply: The quantity of a product that producers are willing and able to provide at different market prices over a period of time.
- Profit: The difference between the total revenue of a producer and total costs.

To make profit, firms have to apply the various factors of production. Let’s take mobile phones for example, you’ll need:
1) Capital: The assembly of components and parts.
2) Labour: Employing skilled labour.
3) Land: Producing at a suitable location.
4) Entrepreneurs: Having the business skills and contacts to survive.

- Supply schedule: the data used to draw up the supply curve of a product.
- Supply curve: This shows the relationship between the quantity supplied and the price of a product.
The supply curve looks like:



- Producer surplus: the difference between the price a producer is willing to accept and what is actually paid.
The producer surplus is the gray part in the picture below. P is the market price, producers are willing to supply from the price P,1. Everything they get ‘extra’ is the producer surplus.



There are some other factor affecting supply such as:
1) Costs of production: E.G. oil prices go up, increase of labour prices but also positive effects such as improving technology.
2) Size and nature of the industry, monopolistic companies can easily charge more for their goods if oil prices go up.
3) Government policy, increase in taxes.
4) Other factors, like the weather ruining the Caribbean’s banana’s.

- Change in supply: occurs when a change in a non-price influence leads to an increase or decrease in the willingness of a producer to supply a product. This makes the supply line shift!

Summary of supply line shifts.

Demand line shifts to the RIGHT(more supply @ same price) if there is:
1) A fall in raw material costs.
2) An improvement in labour efficiency.
3) A reduction in the rate of indirect taxation
4) A positive technological advance.
Demand line shifts to the LEFT(less supply @ same price) if there is:
1) An increase in cost of raw materials
2) An increase in labour costs.
3) An increase in the rate of indirect taxation
4) A failed technological advance.

- Price: The amount of money that is paid for a given amount of a particular good or service.
- Equilibrium price/ Clearing price: The price where demand and supply are equal.
- Equilibrium quantity: The quantity that is demanded and supplied at the equilibrium price.
- Disequilibrium: Any position in the market where demand and supply are not equal.
- Surplus: An excess of supply over demand
- Shortage: And excess of demand over supply.

Market pricing in free market will look like:



Note: Pe = price equilibrium , Qe = quantity equilibrium
Demand and supply curves may shift; causing new equilibria. Therefore, a shift from the demand curve to the right will make the Pe an Qe rise. Also, both can be shifted simultaneously (supply-line shift to the left and demand line shift to the left) causing lower Qe but the same Pe.

Elasticities.

- Price Elasticity of Demand(PED) is something used in microeconomics to see how much a change in price affects the demand.

The formula for PED = %change Demand/ %change price
Since changes in price and demand nearly always move in opposite direction economists mostly don't bother to put in the '-' sign.

There can be 4 outcomes of this formula:

1) PED= 0, the demand is perfectly elastic. The graph will show a vertical line.
2) PED is between 0 and 1,inelastic. The graph will show a steep line.
3) PED=1, demand is unit elastic, 15% increase in price will make demand fall for 15%.
4) PED is greater than 1, demand is elastic. The graph will show a (nearly) flat line.

In case of outcome 2 and 4 producers will be able to raise the total revenues by using the PED.



The situation shown on the left shows a relatively inelastic demand. In the picture it shows that a move from P1 to P2 caused the move from Q1 to Q2. However, due to the inelasticity of this good the move from P1 to P2 is way bigger than the move from Q1 to Q2. That's why the total revenues are increased going from situation 1 to situation 2.( Dark area shows total revenues in situation 1, light area shows total revenues in situation 2)
So for an inelastic environment producers should increase prices to make total revenues increase.

The situation shown on the right shows a relatively elastic demand. In the picture it shows that a move from P1 to P2 caused the move from Q1 to Q2. However, due to the elasticity of this good the move from P1 to P2 is way smaller than the move from Q1 to Q2. That's why the total revenues increase going from situation 1 to situation 2.( Dark area shows total revenues in situation 1, light area shows total revenues in situation 2)
So for an elastic environment producers should decrease prices to make total revenues increase.

- Price Elasticity of Supply (PES) measures the relationship between the change in quantity supplied and change in price.
The formula for PES = %change quantity supplied / %change price

There can be 4 outcomes for this formula:

1)PES = 0, supply is perfectly inelastic.
2)PES is bigger than 1, the supply is price elastic. Producers can increase output without a rise in cost or a time delay.
3)PES is less than 1, the supply is price inelastic. Firms find it hard to change production in a given time period.
4)PES = infinity. Supply is perfectly elastic following a change in demand.

There are four main factors that influence the PES, those are:

1) Spare production capacity.
If there is spare production capacity the business is able to increase the output without a rise in costs and therefore supply will be elastic in response to demand. This happens mostly during recession because there is plenty of spare labour and capital resources available.
2) Stocks of finished products and components.
If stocks are on a high level, businesses are more able to respond to a change in demand quickly. Therefore the businesses with big stocks will be elastic in response to demand, and businesses with small stocks will be inelastic in response to change in demand.
3) The ease and cost of factor substitution.
If labour and capital can easily be switched businesses are more able to respond to a changing demand, those business are elastic in response to change in demand.
4) Time period involved in the production process.For many agricultural products there are time lags in the production process which means that elasticity of supply is very low.

I stated companies that have a relatively elastic demand would be able to increase their total revenues by lowering their price. However, knowing this, there is just one thing to mention. To be able to respond to the higher demand companies will have to be elastic in response to demand. Companies are able to influence this and become more elastic by increasing stocks and increasing production capacity. However, companies won’t be able to fully influence this. That’s why the most companies have a non-linear supply curve.



- Income elasticity of demand(YED): Measures how responsive demand is following a change in income.
Formula: %change demand / %change income; a positive outcome of the income elasticity’s shows the good is a normal good.

There may be two outcomes:

1) Outcome smaller than 1: Good is income inelastic; inferior good.( goods for which an increase in income leads to a fall in demand)
2) Outcome greater than 1: Good is income elastic; normal good.

- Cross elasticity of demand(XED): Measures the responsiveness of demand for one product following a change in the price of another related product.
Formula: %change demand product A / %change price product B

There may be three outcomes:

1) Outcome positive: Products are substitutes. (E.G. Mercedes and Renault)
2) Outcome negative: Products are complements. (E.G. printer and cartridge)
3) Outcome 0: Products don’t have any particular relationship ( E.G. paper and airline tickets)

Chapter one AS economics summary

Definitions:
- Economics: The study of how to allocate scarce resources in the most efficient way, divided in microeconomics( the study of how households and firms make decisions in markets) and macroeconomics. (the study of issues that affect economies as a whole)
- Household: Group of people whose spending decisions are connected.
- Model: A simplified view of reality that is used by economists as a means of explaining economic relationships.
- Factor of production: The resource inputs that are available in an economy for the production of goods and services. Land, Capital, Labor and entrepreneurship.
- Factor endowment: The stock of factors of production.
- Production: The output of goods and services.
- Goods : tangible products such as cars, food and washing machines.
- Services: Intangible products, such as banking, beauty therapy and insurance.
- Land: natural resources in an economy
- Capital: man-made aids to production.
- Entrepreneurship: Management.
- Labour: The quantity and quality of human resources.
- Division of Labour: The specialisation of labour where the production process is broken down into separate tasks. One part producing half-fabricate, other part making final product (perhaps in other countries, improving transport.)
- Opportunity cost : The cost of the next best alternative which is foregone when a choice is made. So if I buy a DVD of 5 pounds I will not be able to buy two sandwiches with the total of price of 5 pounds. The opportunity cost for the DVD is two sandwiches.
- Want: anything you would like, irrespective of whether you have the recourses to buy it.
- Scarcity: A situation where there are insufficient resources to meet all wants. (There is always scarcity)
- Specialisation: The concentration by a worker or workers, firm region or whole economy on a narrow range of goods and services. Specialisation has a wide range of benefits:
1) An increase in the output of goods and services when compared to circumstances where each country provides itself with everything it needs. Globally, this has had an important bearing on raising living standards, since there is more output from a particular volume of resources.
2) A widening range of goods that are available in an economy. Like the Caribbean selling banana’s because of the climate. (Oil-exporting countries!)
3) Exchange between developed and developing countries. This is often influenced by the factors of production. For example: China has been able to grow because of the high export. The high export was the result of the cheap labour in China.

Specialisation isn’t without risks. For example:
1) Countries that have specialized in E.G. oil might have a problem when oil runs out. (Dubai)
2) De-industrialisation. Because of specialization E.G. the British textile industry has moved to low-wage companies like China. This resulted in a huge amount of job-losses.
3) Bad weather, if the Caribbean focus on banana’s and the crops get wiped out because of bad weather they will be in some serious problems.
4) The taste of consumers might change, asking for other goods which will make the demand for you specialized good drop.

- Exchange: The process by which goods and services are traded. The trades can be internal (domestic) and external (international).
- Productivity: Output, or production of a good or service, per worker.
- Developed economy: an economy with a high level of income per head
- Developing economy: an economy with a relatively low level of income per head.
- Productive potential: the maximum output that an economy is capable of producing.
- Economic system: the way in which production is organised in a country or group of countries.

The basic economic problem: the fact that resources are scarce in relation to wants that are unlimited leading to choices having to be made.



Production possibility curve.

The production possibility curve shows how resources are allocated. It shows the maximum quantities of different combinations of output of two products, given current resources and the state of technology.
To explain this model we need to imagine the economy just produces two goods, say: cars and TV’s . It is also assumed that these two industries use all of the economy’s current resources. Sometimes the production possibility curve is called the production possibility frontier, since it draws a type of boundary between what can and cannot be produced.

CARS TV’s
1000 0
800 400
600 800
400 1200
200 1600
0 2000

Also involves opportunity cost: The opportunity cost of making 200 cars is 400 TV’s.

In the example of the cars and TV’s, there are two extremes: producing 1000 cars and producing 2000 TV’s.



Point A and B are on the PPC and are important since they are indicative of an efficient allocation of resources. Point C, however, shows an inefficient allocation of resources because there are less cars and tv’s produced than it could from the resources available. Point D isn’t a possible outcome because this point indicates there are more resources being used than there are resources available.
The graph also indicates there is a trade-off involved. A trade off is the calculation involved in deciding on whether to give up one good for another. If we choose to make more tv’s, we’ll produce less cars.

PPC will move outwards because of:
- Increase in technology; this leads to an over-time increase of productive capacity. (because of higher efficiency)
- More resources, we will be able to produce more because the amount of resources increases. ( With fixed efficiency)
- Economic growth; causes increase of productive capacity due to an increase of capital.

The PPC will move inwards when the productive capacity decreases.

The problems of developing countries in relation to the PPC.
If we look at a PPC for capital goods and consumer goods the problem for the developing countries is that they have a relatively high population in relation to the GDP. Therefore, there is a relatively high demand for consumer goods and there are relatively a lot of consumer goods produced. However, due to the steepness of the line near the extreme of consumer goods a small decline in the production of consumer goods will make the production of capital goods increase significantly.



However, to ensure economic growth in the future capital goods are very important because this will make the productive potential increase.
The choice is always between meeting the current needs and wants of the people(by producing consumer goods) and insuring economic growth. (by producing capital goods)


Economic market systems and the role of the market.


Scarcity involves the choice of governments and organizations to choose:
- What goods and services are to be produced;
- How these goods and services are produced and
- Who should receive these goods and services (allocation)

There are three main types of economic systems:
-Market economy: An economic system whereby resources are allocated through the market forces of demand and supply. Decisions on how resources are allocated are made by millions of people and firms. Price and free operation of the price system are central to the way in which resources are allocated.



-Command economy or centrally planned economy: An economic system in which resources are state owned and allocated by the state.
In the command economy the government has a central role in all decision made like: what to produce, how to produce and for whom the produced goods are. Also, prices of essential items and wages are controlled.
The market does not have a substantive role in the allocation of resources.
Also, in the command economy the government will try to move the PPC more to the capital goods as it would have been in the free market system to ensure future economic growth.
-Mixed economy: an economic system in which resources are allocated through a mixture of the market and direct public sector involvement.
Mostly in mixed-economy the most important companies involving E.G. oil; gas; electricity would have been government owned. However, the last 20 years there has been the trend of privatisation. Those companies are becoming private companies.
Worldwide there has been a move from government-owned companies to privatisation, which mostly caused an extra flow of money to the countries involved due to additional foreign investments. (China, command economy to mixed)