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A-Level Economics > A-Level Economics A: Chains of Reasoning PAPER 1 > Flashcards

A-Level Economics A: Chains of Reasoning PAPER 1 Flashcards

1
Q

1.1.1 Economics as a social science

Q. Explain what is meant by ceteris paribus.

A
  1. Ceteris paribus translates to ‘all other things remaining equal.’
  2. Assuming ceteris paribus allows us to simplify economics and understand how something like a higher price will affect demand whilst ignoring other factors that may complicate the outcome.
  3. The concept is important in economics since, in the real world, it is usually hard to isolate every variable.
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2
Q

1.1.1 Economics as a social science

Q. Explain why some people argue economics is a science.

A
  1. Economics is considered a science due to the field having a strong foundation in maths and testing hypotheses.
  2. Economics is noteworthy for its early and widespread adoption of formal mathematics in its theoretical development and of statistical method to applied research.
  3. Most models used in Economics assume that all things remain equal (Ceteris paribus) thus allowing them to focus on the particular changes in the economy that will take place as a result of policy changes and models.
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3
Q

1.1.1 Economics as a social science

Q. Explain why some people argue economics isn’t a science.

A
  1. Critics argue economics isn’t a science to a lack of testable hypotheses and the ability to achieve consensus.
  2. The argument is based on the fact that controlled experiments cannot be performed in laboratories.
  3. Fields like chemistry, on the other hand, offer the ability for chemists to test a hypothesis and evaluate those results.
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4
Q

1.2.2 Demand

Q. Discuss the conditions, such as population, that cause demand to shift.

A
  1. If a population rises, demand for all products is likely to increase.
  2. This is because if there are more people in the economy, there are more people who will want goods and services in the economy.
  3. As a result, the demand curve will expand from the left to the right.
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5
Q

1.2.2 Demand

Q. Discuss the conditions, such as income, that cause demand to shift.

A
  1. If income increases, demand increases.
  2. This is because an increase in disposable income enables consumers to afford more goods and services.
  3. Since demand represents the ability and willingness to buy a good at a given price, more income gives them the ability to buy a good at that price. Hence, the demand curve will expand from the left to the right.
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6
Q

1.2.2 Demand

Q. Discuss the conditions, such as the economic cycle, that cause demand to shift.

A
  1. In a recession, people will cut back their spending regardless of income.
  2. This is usually because of the fear of losing their job during uncertain times. This means they will take risk-averse approaches such as reducing their spending.
  3. Since demand represents the willingness to buy a good at a given price, the demand curve will shift toward the left and contract.
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7
Q

1.2.2 Demand

Q. Discuss the conditions, such as substitutes, that cause demand to shift.

A
  1. An increase in the price of substitutes will increase demand for other products similar to the substitute.
  2. This is because if a good is an alternative that could be used for the same purpose. Rational consumers will likely choose the cheaper alternative since they are identical.
  3. As a result, the demand curve for the alternative to the substitute will rise.
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8
Q

1.2.2 Demand

Q. Explain why bans on advertising for a certain industry may result in a decrease in revenue for that industry. (supply and demand diagram)

A
  1. Advertising is used by firms in hopes of increasing brand loyalty for their goods.
  2. Successful advertising should convince consumers that a firm’s goods and services are better than the competition.
  3. This can result in higher spending on advertised goods and services and therefore demand.
  4. A ban on advertisements for those certain goods would mean therefore lead to less demand for the firm’s product, which translates to a loss in potential revenue for that industry.
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9
Q

1.2.2 Demand

Q. Explain what is diminishing marginal utility.

A

The law of diminishing marginal utility explains that as a person consumes an item or a product, the satisfaction or utility that they derive from the product wanes as they consume more and more of that product.

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10
Q

1.2.2 Demand

Q. Explain why the demand curve slopes downwards. (diminishing marginal utility)

A
  1. The law of diminishing marginal utility states if more of a good is consumed, there is less satisfaction derived from the good.
  2. This means that more consumers are less willing to pay high prices at high quantities due to the fall in satisfaction.
  3. This explains why demand slopes downward, showing the inverse relationship between price and quantity.
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11
Q

1.2.2 Demand

Q. Explain how the price mechanism responds to excess supply in a free market.

A
  1. A free market is one where the price of the good or service is determined by the demand from consumers and the supply from producers.
  2. When there is excess supply within a market, it means that there is too much of the good or service being produced.
  3. Excess supply causes an increase in stock and associated costs. Facing higher costs forces producers to sell more. For this reason, they lower the selling price to stimulate demand and avoid further increases in inventories.
  4. Lower price drives consumers to buy more. Gradually, demand rises, and supply decreases. This process continues until the market reaches a new equilibrium, where the quantity supplied is equal to the quantity demanded.
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12
Q

1.2.3 Price, income and cross elasticities of demand

Explain what is a normal good.

A
  1. A normal goods are goods whose demand show a direct relationship with a consumers income.
  2. This means that the demand for normal goods increases alongside with the expansion of consumers income.
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13
Q

1.2.3 Price, income and cross elasticities of demand

Explain what is a luxury good.

A
  1. A luxury good is characterised by high-income elasticity of demand, the responsiveness of demand to a change in income.
  2. This means when an increase in demand causes a bigger percentage increase in demand (in comparison with normal goods).
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14
Q

1.2.3 Price, income and cross elasticities of demand

Explain what is an inferior good.

A
  1. A inferior good is characterised by low-income elasticity of demand, the responsiveness of demand to a change in income.
  2. This means an increase in income causes a fall in demand.
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15
Q

1.2.3 Price, income and cross elasticities of demand

Q. Explain what is a substitute good.

A
  1. A substitute in economics refers to a product that consumers see as essentially the same to another product.
  2. Substitutes are characterised by a positive cross elasticity of demand, the percentage change in quantity demand for a good after the change in the price of another.
  3. This means if the price of one good increases, then demand for the substitute is likely to rise due to this positive cross elasticity of demand.
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16
Q

1.2.3 Price, income and cross elasticities of demand

Q. Explain what is a complementary good.

A
  1. Complementary goods are products which are used together.
  2. Complementary goods are characterised by a negative cross elasticity of demand, the percentage change in quantity demand for a good after the change in the price of another.
  3. This means If the price of one good increases, demand for both complementary goods will fall.
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17
Q

1.2.3 Price, income and cross elasticities of demand

[POINT: TIME]

Q. Examine two possible reasons for the change in price elasticity of demand for a good over time.

A
  1. The price elasticity of demand varies directly with the time period.
  2. This means the elasticity for a shorter time period is always low or it can be even inelastic.
  3. The reason stated for this is the redundant human nature to change habits. We generally stick to a commodity and respond very late to the price changes.
  4. However, the elasticity of demand is high over a longer time period as our habit changes over time. We can substitute the original product if its price changes in the long run.
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18
Q

1.2.3 Price, income and cross elasticities of demand

[POINT: SUBSTITUTES]

Q. Examine two possible reasons for the change in price elasticity of demand for a good over time.

A
  1. If a product has a lot of substitutes, people will switch to other products when prices go up.
  2. Therefore, the price elasticity of demand will be elastic.
  3. Similarly, if a market loses the availability of substitutes, the demand curve will remain inelastic.
  4. As a result, people will still have to buy that good if there are no alternatives.
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19
Q

1.2.3 Price, income and cross elasticities of demand

[POINT: FALL IN PROFITS]
[FACTOR: NECESSITY]

Q. Assess the likely effects on inelastic (demand) good retailers if the consumption of that good becomes more elastic.

A
  1. If a good is a demand inelastic when a change in price occurs, there is a small change in demand.
  2. A factor in why these goods are inelastic is due to their sense of necessity, the need to keep buying regardless of price.
  3. However, if consumer behaviour changes its perception of necessities (such as tobacco products) the good will becomes more elastic.
  4. On the retailer’s end, they can no longer charge higher prices based on elasticity since the price now affects a greater percentage change in demand.
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20
Q

1.2.3 Price, income and cross elasticities of demand

[CB: FALL IN PROFITS]
[FACTOR: NECESSITY/ADDICTIVENESS]

Q. Assess the likely effects on inelastic (demand) good retailers if the consumption of that good becomes more elastic.

A
  1. However, there are other factors that help retain product elasticity such as addictiveness.
  2. This means retailers can continue to charge higher prices based on their good’s addictive properties.
  3. Because of these properties, it leads to consumers treating those goods as necessary for their own purposes.
  4. As a result, retailers can still charge prices based on elasticity to some degree.
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21
Q

1.2.3 Price, income and cross elasticities of demand

[POINT: FALL IN PROFITS]
[FACTOR: SUBSTITUTES]

Q. Assess the likely effects on inelastic (demand) good retailers if the consumption of that good becomes more elastic.

A
  1. If a good is a demand inelastic when a change in price occurs, there is a small change in demand.
  2. A factor in why these goods are inelastic is due to the availability of substitutes, people will have to buy a good if there are no alternatives.
  3. However, if a market gains more substitutes, then the price elasticity of demand will be more elastic.
  4. Retailers who now face competition from other retailers can no longer charge higher prices based on elasticity.
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22
Q

1.2.3 Price, income and cross elasticities of demand

[CB: FALL IN PROFITS]
[FACTOR: BRAND LOYALTY]

Q. Assess the likely effects on inelastic (demand) good retailers if the consumption of that good becomes more elastic.

A
  1. However, there are other factors that help retain product elasticity such as brand loyalty.
  2. The attraction of brand loyalty makes demand more inelastic.
  3. This is because there is less time for consumers to think about what to buy and they can safely guarantee minimum standards.
  4. As a result, regardless of new substitutes changing elasticity, it can be argued that brand loyalty can still help enable retailers to charge higher prices to some degree.
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23
Q

1.2.4 Supply

Q. Explain how the price mechanism responds to excess supply in a free market.

A
  1. When there is excess supply within a market, it means that there is too much of the good or service being produced.
  2. This will be corrected by a contraction in supply, along the supply curve, and an extension in demand, along the demand curve.
  3. Demand will continue to extend and supply continue to contract until a new equilibrium price and quantity are reached and demand and supply are equal.
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24
Q

1.2.4 Supply

Q. Explain what is the price elasticity of supply.

A
  1. Price elasticity of supply measures the responsiveness of quantity supplied to a change in price.
  2. PES is measured by the percentage change in quantity supplied divided by the percentage change in price.
  3. Therefore, inelastic supply refers to a change in price that causes a smaller proportional change in quantity supply whilst elastic supply refers to a change in price that causes a bigger proportional change in supply.
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25
Q

1.2.4 Supply

Q. Discuss the conditions, such as cost of production, that cause supply to shift.

A
  1. If the cost of production rises for businesses but their selling price remains the same, they will make less money.
  2. As a result, they will put up their prices in order to avoid making losses.
  3. As a result, less is supplied at each price, meaning the supply curve will shift to the left. The opposite is true if costs go down.
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26
Q

1.2.4 Supply

Q. Discuss the conditions, such as technology that cause supply to shift.

A
  1. If the technology improves for a business, this will lead to a fall in production costs.
  2. This is because new tech increases the productive efficiency of a firm.
  3. As a result, firms will lower prices or produce more goods at the same price, so the curve will shift to the right. The opposite is also true.
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27
Q

1.2.4 Supply

Q. Discuss the conditions, such as taxes that cause supply to shift.

A
  1. If there are taxes, the cost of production rises for businesses. If the selling price remains the same, they will make less money.
  2. As a result, they will put up their prices in order to avoid making losses.
  3. As a result, less is supplied at each price, meaning the supply curve will shift to the left. The opposite is true if costs go down.
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28
Q

1.2.4 Supply

Q. Discuss the conditions, such as subsidies that cause supply to shift.

A
  1. If there are subsidies, the cost of production falls for businesses.
  2. As a result, firms will put lower their prices in order to since they have increased supply.
  3. As a result, more is supplied at each price, meaning the supply curve will shift to the right.
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29
Q

1.2.5 Elasticity of supply

Q. Explain the importance of elastic supply in terms of market forces.

A
  1. If firms find it easy to increase supply, then supply will be more elastic, and an increase in price will lead to a bigger percentage change in supply.
  2. If supply is price elastic, an increase in demand will cause only a small rise in price, but a significant increase in demand as shown by the diagram.
  3. Because of this fact, firms will wish to try and make supply more elastic so they can respond to increased demand. This is because a high PES makes the firm more competitive than its rivals and it allows the firm to generate more revenue and profits.
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30
Q

1.2.5 Elasticity of supply

Q. Explain the importance of inelastic supply in terms of market forces.

A
  1. Inelastic supply will lead to a smaller percentage change in supply.
  2. If supply is price inelastic, an increase in demand will cause a large rise in price but only a small increase in demand.
  3. If supply is inelastic, it invariably causes prices to be more volatile as shown by the graph.
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31
Q

1.2.5 Elasticity of supply

Q. Discuss the conditions, such as time, that affect the price elasticity of supply.

A
  1. In economics, the short term is the period of time when at least one factor of production is fixed and the long term is when all factors are variable.
  2. This means PES will be relatively inelastic due to being restricted by the factors of production.
  3. In the long term, they can increase production, meaning that PES will be more elastic. Hence why the longer the period of time the has to increase production, the more elastic the curve will be.
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32
Q

1.2.5 Elasticity of supply

Q. Discuss the conditions, such as ease of factor substitution, that affect the price elasticity of supply.

A
  1. If the nature of the product is the ability to substitute a product factor used to produce a product for another production function, supply will be elastic.
  2. This is because if capital and labour resources can easily be switched, the production process is more flexible.
  3. Therefore, the increased replacement capacity of the production of a product will mean supply elasticity is high. The opposite is also true.
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33
Q

1.2.5 Elasticity of supply

Q. Discuss the conditions, such as barriers of entry, that affect the price elasticity of supply.

A
  1. Large costs of start-up equipment could make it difficult to improve a firm’s price elasticity of supply.
  2. Firms can increase their PES by investing in spare capacity, improving efficiency, or paying workers overtime.
  3. However, improvements in these areas cost money, putting start-ups and firms with low economies of scale at a disadvantage.
34
Q

1.2.6 Price determination

Q. Explain what happens when the price is set higher than the equilibrium.

A
  1. If the price was set above the equilibrium. The price at which the product is then supplied would be greater than the demand and therefore leading to a surplus in supply.
  2. Therefore firms would reduce prices and supply less.
  3. This would encourage more demand and therefore the surplus will be eliminated. The new market will then be in a state of equilibrium.
35
Q

1.2.6 Price determination

Q. Explain what happens when the price is set lower than the equilibrium.

A
  1. In the diagram, the price is below the equilibrium. At this price, demand would be greater than the supply.
  2. Therefore there is a shortage. If there is a shortage, firms will put up prices and supply more. As price rises, there will be a movement along the demand curve and less will be demanded.
  3. Therefore the price will rise until there is no shortage and the market is in equilibrium.
36
Q

1.2.7 Price mechanism

Q. Explain the rationing function.

A
  1. Whenever resources are scarce, demand will likely exceed supply, driving prices up.
  2. This implies some people will no longer be able to afford to buy products at the increased price.
  3. Due to the rationing function, the limited resources are rationed and are allocated to the people able to afford the products and value them most highly.
37
Q

1.2.7 Price mechanism

Q. Explain the signalling function.

A
  1. The price mechanism acts as a signal where resources should be used.
  2. When prices rise, producers move resources in the manufacture of that product.
  3. The change in price indicates to suppliers and consumers that market conditions have changed so they should change the quantity bought/sold. When equilibrium moves, output equilibrium moves with it.
38
Q

1.2.7 Price mechanism

Q. Explain the incentive function.

A
  1. An incentive is something that motivates a producer or consumer to follow a course of action or to change behaviour.
  2. Higher prices provide an incentive to existing producers to supply more because they provide the possibility of increased revenue and profits. Low prices act as an incentive for consumers to buy more of a good.
  3. As a result the price mechanism encourages people to behave a certain way.
39
Q

1.2.7 Price mechanism

Q. Discuss how a local market, how will disruption impact consumers.

A
  1. In the example of British supermarkets, fewer imports from other countries mean there are fewer goods supplied by supermarkets.
  2. Due to the contraction in the supply of food, the price of food rises.
  3. This rations off excess demand so that only consumers who value the food most highly buy them (example of the rationing function).
40
Q

1.2.7 Price mechanism

Q. Discuss how in a national market, how will disruption impact consumers.

A
41
Q

1.3.1 Types of market failure

Q. Explain how market failure causes a loss in social welfare.

A
42
Q

1.3.1 Types of market failure

[POINT: ]

Q. Assess the benefits of governments intervening in market failures?

A
  1. The monopoly pricing creates a deadweight loss because the firm forgoes transactions with the consumers.
  2. Monopolies are then inefficient and less innovative over time because they do not have to compete with other producers in a marketplace.
  3. By restricting output in an attempt to maximize profit. Without the presence of market competitors it can be challenging for a monopoly to self-regulate and remain competitive over time.
  4. In the case of monopolies or firms with monopoly power, abuse of power can lead to market failure.
43
Q

1.3.1 Types of market failure

[POINT: OVERCOMING EXTERNALITIES]

Q. Assess the benefits of governments intervening in market failures?

A
  1. Government interventions such as taxation can help reduce negative externalities.
  2. A tax would increase the private cost of the consumption of the good with negative externalities.
  3. In theory this will cause output to contract towards the social efficiency.
  4. Furthermore, taxation will increase the government’s revenue, allowing it to finance further efforts to reduce the impacts of negative externalities.
44
Q

1.3.1 Types of market failure

[CB: OVERCOMING EXTERNALITIES]

Q. Assess the benefits of governments intervening in market failures?

A
  1. However, taxation can distort consumer behaviour.
  2. Because taxes artificially raise prices, it encourages evasion.
  3. This means that the government loses on tax revenues and doesn’t succeed in reducing demand for negative externalities.
45
Q

1.3.1 Types of market failure

[POINT: REDUCE MONOPOLY POWER]

Q. Assess the benefits of governments intervening in market failures?

A
  1. If a monopolist can gain a foothold in a market (high market share), can set higher prices. The monopoly prices higher than a competitive market and restricts output, which does not maximise welfare for consumers.
  2. Through price capping, the regulator can set prices lower than what is set.
  3. Prices are lower, so there is greater consumer welfare, alongside lower production costs.
  4. There will also be improvements in productive efficiency since firms now can only increase profits by decreasing costs.
46
Q

1.3.1 Types of market failure

[CB: REDUCE MONOPOLY POWER]

Q. Assess the benefits of governments intervening in market failures?

A
  1. Disadvantages of price capping include distortion of price mechanism.
  2. Price sends signals within markets as to the balance of demand and supply.
  3. Artificially altering the price can send the wrong signals to the market.
47
Q

1.3.2 Externalities

Q. Explain one measure government could use to reduce the impacts of negative externalities.

A
  1. Indirect taxes are taxes levied on goods and services rather than on income or profits.
  2. Taxes are put on goods with negative externalities to increase their price. This is done to reduce the external costs of externalities.
  3. As a result, it moves production closer to being socially optimum.
48
Q

1.3.2 Externalities

Q. Explain what a negative production externality is.

A
  1. Negative externalities of production occur when social costs are greater than private costs.
  2. The market left to operate freely will ignore the external costs involved in producing a good. It will produce where MPB=MPC, the market equilibrium, at Q1P1.
  3. At Q1, the costs to the society are higher than the benefits to society resulting in the loss of welfare equal to the shaded area.
  4. As highlighted by the shaded region, there is a net welfare loss.
49
Q

1.3.2 Externalities

Q. Explain what a negative consumption externality is.

A
  1. Negative externalities of consumption occur when social benefit is less than private benefit.
  2. In a free market, we get Q1 output. But at this output, the social marginal cost is greater than the social marginal benefit.
  3. Social efficiency occurs at a lower output (Q2). where social marginal benefit = social marginal cost.
50
Q

1.3.2 Externalities

Q. Explain what is social efficiency.

A
  1. In a free market, consumers ignore the external costs of consumption.
  2. Social efficiency occurs at an output where Marginal Social Benefit (MSB) = Marginal Social Cost (MSC).
  3. If the output is reduced from Q1 to Q2, society is in a better position. At Q2, the marginal social cost = the marginal social benefit. This is said to be socially efficient
51
Q

1.3.2 Externalities

[POINT: ENABLES GREATER SOCIAL EFFICIENCY]

Q. Assess the likely benefits of an increased subsidy on positive externalities.

A
  1. In a free market, there is an under consumption of goods with positive externalities.
  2. To increase consumption and production, the government can offer a subsidy to reduce the price and increase quantity.
  3. The supply curve should expand, decreasing prices.
  4. The output will then be socially efficient because Social marginal cost (SMC) equals Social marginal benefit (SMB).
52
Q

1.3.2 Externalities

[CB: ENABLES GREATER SOCIAL EFFICIENCY]

Q. Assess the likely benefits of an increased subsidy on positive externalities.

A
  1. However, the cost will have to be met through taxation.
  2. Some taxation, e.g. income tax, may reduce incentives to work.
  3. The most efficient way to raise revenue for subsidising positive externalities would be to tax goods with negative externalities, however this may not always be the case.
53
Q

1.4.1 Government intervention in markets

Q. Explain how public goods create the free-rider problem.

A
  1. Public goods are non-excludable and non-rivalrous, meaning people cant be stopped from consuming a good and benefits from a good or service does not reduce the amount available to others.

2.

54
Q

1.4.1 Government intervention in markets

Q. Explain how public goods create the free-rider problem.

A
  1. Public goods are non-excludable and non-rivalrous, meaning people cant be stopped from consuming a good and benefits from a good or service does not reduce the amount available to others.
  2. The free rider problem will occur when people can benefit from a good/service without paying anything towards it.
55
Q

1.4.1 Government intervention in markets

Q. Explain how public goods create the free-rider problem.

A
  1. Public goods are non-excludable and non-rivalrous, meaning people cant be stopped from consuming a good and benefits from a good or service does not reduce the amount available to others.
  2. The free rider problem will occur when people can benefit from a good/service without paying anything towards it.
  3. Because of this, there is a danger that, in a free market, the good will be under-provided or not provided at all.
56
Q

1.4.1 Government intervention in markets

Q. Explain maximum prices.

A
  1. Occurs when a government sets a legal limit on the price of a good or service with the aim of reducing prices below equilibrium.
  2. When the maximum price is set below equilibrium, will cause excess demand.
  3. Excess Demand occurs when the Price of a good is lower than the Equilibrium Price, meaning more consumers will want to buy the good than suppliers are willing to sell.
57
Q

1.4.1 Government intervention in markets

Q. Explain minimum prices.

A
  1. A minimum price is a legally imposed price at which the price of the good cannot go below.
  2. When the minimum price is set above equilibrium, will cause excess demand.
  3. Excess supply occurs when the market supply of a commodity is greater than the market demand for it, thus causing its market price to fall.
58
Q

1.4.1 Government intervention in markets

[POINT: PROVIDES MARKET INCENTIVE]

Assess the benefits of tradable pollution permits for reducing the impact of negative externalities.

A
  1. If firms produce carbon as a side-effect of production, it is classed as a negative externality. Pollution permits are a method to try and reduce output to a more socially efficient level by providing firms with a market incentive.
  2. Pollution permits involve giving firms a legal right to pollute a certain amount.
  3. The high polluters have to buy more permits, which increases their costs, and makes them less competitive and less profitable. The low polluters receive extra revenue from selling their surplus permits, which makes them more competitive and more profitable.
  4. This creates a market for pollution permits with the price set by demand and supply. The aim of pollution permits is to provide market incentives for firms to reduce pollution and reduce the external costs associated with it.
59
Q

1.4.1 Government intervention in markets

[CB: PROVIDES MARKET INCENTIVE]

Assess the benefits of tradable pollution permits for reducing the impact of negative externalities.

A
  1. In practice, it can be difficult to implement. It is difficult to know how many permits to give out.
  2. If the government is too generous, there will be little pollution reduction.
  3. If the government is too strict in implementing permits, firms may complain that it adversely affects output because they can not get enough permits, harming business productivity.
60
Q

1.4.1 Government intervention in markets

[POINT: TAXATION]

Assess the benefits of tradable pollution permits for reducing the impact of negative externalities.

A
  1. The idea of a tax is to make consumers and producers pay the full social cost of producing pollution.
  2. In this case, if a tax were implemented, the social marginal cost (SMC) of producing the good is greater than the private marginal cost (PMC).
  3. The tax shifts the supply curve to S2 and therefore, consumers are forced to pay the full social marginal cost.
  4. This reduces the quantity consumed to Q2, which is the socially efficient outcome (because SMC=SMB).
61
Q

1.4.1 Government intervention in markets

[CB: TAXATION]

Assess the benefits of tradable pollution permits for reducing the impact of negative externalities.

A
  1. Increased tax can create an incentive for firms and consumers to switch to less fuel-intensive engines. However, the main draw is that it is dependent on demand elasticity.
  2. If demand was quite inelastic, an increase in tax may do little to reduce demand and only marginally reduce the amount of pollution.
  3. This very much is the case for fuel since it is classed as a necessity, meaning regardless of the price it is needed for daily procedures.
62
Q

1.4.1 Government intervention in markets

Q. Explain why reducing a price cap may result in excess demand.

A
  1. A price cap is a government-imposed limit on the price charged for a product.
  2. When the price is set below equilibrium, this will cause excess demand.
  3. Excess demand occurs when the price of a good is lower than the equilibrium, meaning more consumers will want to buy the good than suppliers are willing to sell.
63
Q

1.4.1 Government intervention in markets

[POINT: INDIRECT TAXES]

Q. Discuss ways in which government distort price signals through intervention in markets.

A
  1. A way in which price signals are distorted is through indirect tax. The effect Ad Valorem tax is to cause a pivotal shift in the supply curve.
  2. This is because the tax is a percentage of the unit cost of supplying the product.
  3. In the UK the standard VAT rate is 20%, meaning a good supplied for a cost of £50 will now cost $60 when a VAT of 20% is applied. If it were £400, the cost would be £470 when VAT is applied.
  4. Therefore, the absolute amount of the tax will go up as the market price increases.
64
Q

1.4.1 Government intervention in markets

[CB: INDIRECT TAXES]

Q. Discuss ways in which government distort price signals through intervention in markets.

A
  1. Some types of government intervention change price signals in the market and distort the free market mechanism.
  2. The price mechanism aims to allocate resources to their best use and where consumers want and value them most highly.
  3. By intervening, the government distorts the mechanism and so resources may be allocated inefficiently.
65
Q

1.4.1 Government intervention in markets

[POINT: SUBSIDIES]

Q. Discuss ways in which government distort price signals through intervention in markets.

A
  1. A government subsidy is paid to producers to encourage the firm’s output by lowering costs.
  2. The subsidy will expand the supply curve to the right.
  3. This leads to a lower market price.
  4. Due to the lowered price quantity demand increases.
66
Q

1.4.1 Government intervention in markets

[CB: SUBSIDIES]

Q. Discuss ways in which government distort price signals through intervention in markets.

A
  1. Some types of government intervention change price signals in the market and distort the free market mechanism.
  2. For example, subsidies keep farmers in employment when they cannot produce cheaply enough to be competitive.
  3. The result is that the government keeps them in business when they should close down and find an alternative use for their resources.
67
Q

1.4.1 Government intervention in markets

Q. Explain the negatives of a minimum price scheme.

A
  1. Minimum Price is a scheme to pay suppliers a guaranteed minimum price per unit to encourage supply. As there is a minimum price that the government or establishment will pay for the good, then the supplier won’t sell below that price.
  2. The line above the equilibrium is the minimum price, this set price decreases quantity demanded for the good.
  3. However, if the supply exceeds demand, there is a surplus.
  4. As a result of this, government expenditure has to be allocated to purchase the excess due to the misallocation of resources.
68
Q

1.4.1 Government intervention in markets

Q. Explain the negatives of a maximum price scheme.

A
  1. Leads to an imbalance in the market - maximum pricing will cause demand to outweigh supply.
  2. Even though consumers want to buy more at the lower market price, firms do not want to supply more because the price is lower than it used to be.
  3. As a result, the distortion means some consumers will be unable to get the product at all, hence the shortage.
69
Q

1.4.2 Government failure

Q. Explain the impacts of government failure on the public sector.

A
  1. Public sector failure occurs when government intervention in the economy leads to an inefficient allocation of resources and leads to an overall decline in economic welfare.
  2. This may occur due to a lack of profit incentive in the public sector.
  3. People working for the government may not have the same profit motive to cut costs, work hard, or increase efficiency.
  4. Therefore, this causes the government sector to be inefficient compared to the private sector.
70
Q

1.4.2 Government failure

Q. Explain how the government can overcome failure in the public sector.

A
  1. They could improve competition within public sector industries. This could be seen in what the Conservative government implemented in the 1980s.
  2. This is when firms bid for the right to run a service or gain a certain contract.
  3. Council services could still bid to run refuse collection. But, if a private company offers a better service, then they would lose out to the private sector.
  4. The argument is that the threat of competition creates incentives for the public sector to act like a private company and cut costs.
71
Q

1.4.2 Government failure

Q. Explain what are the problems with competitive tendering.

A
  1. The problem with competitive tendering is that the cheapest service may not be the best.
  2. A private company may offer to provide school meals for a cheap cost but at the expense of reducing the quality of food.
  3. Therefore, you reduce costs, but you have a decline in standards.
  4. A government body then needs to be responsible for checking standards of service.
72
Q

1.4.2 Government failure

[POINT: DISTORTION]
[EXAMPLE: HEALTHCARE]

Q. Discuss the likely consequences of government failure on consumers.

A
  1. Intervention through subsidisation or other interventions can result in a distortion of markets and signals.
  2. Taxes and subsidies on goods and services can artificially raise or lower prices and distort how markets work to allocate scarce resources.
  3. If prices are lowered, for example, it can be criticised that it encourages wasteful misuse or over-use of scarce resources.
  4. For example, free healthcare can result in doctors’ waiting rooms becoming become full of the malingerers and the so-called ‘worried well’. This can result in a waste of public resources and a denial of access to these services by those in genuine need, worsening the economic problem and consumer welfare.
73
Q

1.4.2 Government failure

[CB: DISTORTION]
[EXAMPLE: HEALTHCARE]

Q. Discuss the likely consequences of government failure on consumers.

A
  1. However, merit goods are often under-consumed in a free market because people underestimate the personal benefits and/or ignore the external benefits.
  2. This leads to an underprovision of things like health care and education.
  3. Government intervention to provide free healthcare can lead to a significant improvement in the quality of life for everyone.
  4. Vaccination against a contagious disease clearly provides protection to the individual and yields a private benefit. There is also an external benefit to other individuals who aren’t protected since there is less spreading of the virus in society.
74
Q

1.4.2 Government failure

[POINT: PUBLIC SECTOR FAILURE]

Q. Discuss the likely consequences of government failure on consumers.

A
  1. A type of failure is the lack of incentives. Public sector failure occurs when government intervention in the economy leads to an inefficient allocation of resources and leads to an overall decline in economic welfare.
  2. This may occur due to a lack of profit incentive in the public sector.
  3. People working for the government may not have the same profit motive to cut costs, work hard, or increase efficiency.
  4. Therefore, this causes the public sector to be inefficient compared to the private sector, resulting in worsened goods/services for the consumer.
75
Q

1.4.2 Government failure

[CB: PUBLIC SECTOR FAILURE]

Q. Discuss the likely consequences of government failure on consumers.

A
  1. However, the public sector failures can be easily solved. Governments could improve competition within public sector industries. This could be seen in what the Conservative government implemented in the 1980s (competitive tendering).
  2. This is when firms bid for the right to run a service or gain a certain contract.
  3. Council services could still bid to run refuse collection. But, if a private company offers a better service, then they would lose out to the private sector.
  4. The argument is that the threat of competition creates incentives for the public sector to act like a private company and cut costs.
76
Q

3.1.2 Business growth

Q. Explain the principal-agent problem.

A
  1. The principal-agent problem can be linked to the theory of asymmetric information.
  2. In theory, the agent should maximise the benefits for those whom they are looking after but in practice, agents have the temptation to maximise their own benefits.
  3. The owners may want to maximise the returns on their investment so will want to short-run profit maximise. However, directors and managers are unlikely to want the same thing: as employees, they will want to maximise their own benefits.
77
Q

3.1.2 Business growth

[POINT: AVOID PRINCIPAL-AGENT PROBLEM]

Q. Discuss the reasons why some firms choose to stay small.

A
  1. In a large firm, owners have to delegate control to managers and workers who may not share the same motivation and goals of maximising the interests of the firm.
  2. Managers and workers may engage in profit-satisficing.
  3. This is where they do enough to keep owners happy but then maximise other objectives, such as sales maximisation.
78
Q

3.1.2 Business growth

[POINT: DIFFERING BUSINESS OBJECTIVES]

Q. Discuss the reasons why some firms choose to stay small.

A
  1. Not all firms aim at profit maximisation and increasing market share. Some owners may prefer a business that is manageable and easy to retain control.
  2. Expansion may involve listing on the stock exchange which makes you liable to shareholders.
  3. If people work in small firms, they may get more joy because they feel in control and have a close connection with customers.
  4. Therefore, they would prefer to keep the firm small and avoid spending their time on management and paperwork.
79
Q

3.1.2 Business growth

[POINT: LESS EFFICIENT]

Q. What are the disadvantages of small firms?

A
  1. Big firms can benefit from economies of scale in production and sell at a lower cost.
  2. Economies of scale help reduce the per-unit fixed cost. As a result of increased production, the fixed cost gets spread over more output than before.
  3. It also reduces per-unit variable costs. This occurs as the expanded scale of production increases the efficiency of the production process.
80
Q

3.1.2 Business growth

[POINT: LACK OF PURCHASING POWER]

Q. What are the disadvantages of small firms?

A
  1. Another way large corporations keep costs down is by negotiating for lower prices. Because of the large volume of material a producer is ordering, the vendor or supplier has an incentive to lower its price.
  2. It would be hard for a much smaller competitor to get the same deal.
  3. The lack of purchasing power affects then means the smaller firm has a higher cost of production than the bigger firm, decreasing its profitability.

A-Level Economics (14 decks)

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