Revision For Feb Mocks Paper 1 Flashcards
What is Opportunity Cost?
The benefits lost from pursuing the next best alternative.
What is the function of the PPF?
It shows the maximum possible combinations of captial and consumer goods that the economy can produce with its current resources and technology.
What is specialisation?
Specialisation is the production of a limited range of goods by a company/individual/country which means that trade is essential as it is the only way they are able to acccess all that they need.
What is division of labour?
When labour becomes specialised in a particular part of the production process.
What did Adam Smith believe about specialisation/division of labour?
They can increase labour productivity, allowing firms to increase efficiency and lower their costs of production.
Advantages of specialisation and the division of labour in organising production
The division of labour enables labour productivity to be increased.
Workers more skilled at their jobs, so maybe higher quality of goods and services.
It is more cost effective to develop specialist tools, improving speed or quality.
Time is not wasted moving between jobs and getting out tools etc.
Workers only need to be trained to do one specific task, rather than many, saving time and money.
Disadvantages of specialisation and the division of labour in organising production
One task can be boring, poor quality of work - can be solved with playing music.
Reduction of craftmanship and a more standardised product because of mechanisation.
If for some reason production in one process is delayed, every other task has to stop until that problem is solved.
Not a lot of training leaves the workforce prone to structual unemployment.
Advantages in specialising in the production of goods and services to trade
Countries specialise in producing those goods where they have a lower opportunity cost, and so they are relatively best at producing.
This helps boost their economy, and there is greater output globally.
Disadvantages in specialising in the production of goods and services to trade
Countries may become over-dependent on one particular export - developing economies specialise in farming, and the economy suffers if crops fail due to weather.
Other countries specialise in non-renewable resources and these could run out, which will result in a huge loss of income for that country. It will also mean the loss of these resources.
High interdependence, will cause problems if trade is prevented through examples such as war.
Some say that increased specialisation means there will be more competition to cut costs and therefore wages will fall, but this is not necessarily true.
What are the functions of money?
Medium of exchange - the problem with bartering was that both parties would need to want the good the other party offers.
A measure of value
A store of value - can keep its value for a long time, unlike fruits for example
A method for deferred payment - money can allow debts to be created.
Assumptions of rational economic decision making
Consumers aim to maximise utility
Firms aim to maximise profit
Government aim to maximise social welfare
What can cause a shift in demand? (8)
Population
Income
Related goods - if a substitute good price falls, then the demand for the original good may fall.
Advertising
Taste/fashion
Expectations (use oil crisis in UK)
Seasons
Government legislation
What is diminishing marginal utility?
By assumption that people act rationally in purchasing the good:
The satisfaction derived from the consumption of an additional unit of a good will decrease as more of a good is consumed, assuming the consumption of all other goods remains constant.
Factors influencing PED (5)
Availability of substitutes
Time (the longer the time, the easier it will be for a person to find an alternative supplier)
Necessity (if needed, inelastic)
How large of a % of total expenditure
Addictive
Significance of PED with tax
Determines the effects of the imposition of indirect taxes and subsidies.
The more elastic the demand curve, the lower the incidence of tax on the consumer.
YED - Values for Inferior, Normal and Luxary goods
Inferior - YED<0 (Inelastic, as necessity)
Normal - YED>0 (Inelastic, as necessity)
Luxury - YED>1 (Elastic)
Significance of YED
Important for businesses to know how their sales will be affected by changes in the income of the population.
It may have an impact on the type of goods that a firm produces.
Cross elasticity of demand
%change in quanitity demanded of A / %change in price of B
Factors that cause a shift in supply (8)
Costs of production
Price of other goods (if price of beef rises, man will kill cows, less production of milk)
Weather (agricultural goods)
Technology
Goals of the supplier (if supply motivated by helping society, not profit)
Government legislation (can increase production costs)
Taxes and subsidies
Producer cartels
Factors affecting PES (5)
Time
Stockpile of goods (if a business has a stockpile of goods, when the price goes up, they’ll use the stockpiles up, supply is elastic)
Availability of factors of production (labour may need skills/training to increase production)
Ease of entry into the market
Availability of substitutes (car models as substitues)
The price mechanism
Rationing - when prices increase, people will no longer be able to buy the product and others may no longer have the desire to buy the good. Limited resources can be rationed and allocated t the people who can afford them and those who value them most highly.
Signalling - when prices rise, producers move resources into manufacturing that product.
Incentive - Buyers realise the more money they have, they are able to buy more products. Low prices act as an incentive to consumers to buy more of a good, and producers to sell more of a good.
Ad valorem tax with example
Tax payable increases in proportion to the value of the good. The tax is the percentage of the cost of the good, for example VAT.
Specific tax with example
Amount is added to the price of a good (not proportional), and based on amount bought rather than the value of the good.
For example, excise duty on alcohol, tobacco and petrol.
4 reasons why consumers don’t always act rationally
Influences of other people, social norms, bias.
Influence of habitual behaviour.
Consumer weakness at computation (consumers aren’t willing or able to make comparisons between prices so they will buy more expensive goods than needed)
Brand loyalty
3 types of market failure
Externalities
Under-provision of public goods
Information gaps
How can the government intervene to ensure the market considers the external costs and benefits? (5)
Indirect taxes and subsidies - Taxes put on goods with negative externalities, subsidies on goods with positive externalities. Internalising the externality.
Tradable pollution permits - Allows firms to produce up to a certain amount of pollution, trading amongst firms, gives them the choice.
Provision of the good - The government may provide the good through taxation revenue - healthcare and education.
Provision of information - Some externalities are associated with information gaps, the government can provide information to help people make informed decisions and acknowledge external costs.
Regulation - Banning advertising of smoking, for example.
Characteristics of public goods
Non-rivalrous (one person’s use of the good doesn’t stop someone else from using it)
Non-excludable (you cannot stop someone from accessing the good and someone cannot chose not to access the good)
What is the free rider problem?
People who do not pay for a public good still receive benefits from it, so the private sector will under provide the good as they cannot make a profit.
How can advertising lead to information gaps?
It’s designed to change attitudes of the consumers to encourage them to buy the good. It could cause them to think the benefits are greater than they actually are.
Why do information gaps lead to market failure?
There is a misallocation of resources because people do not buy things that maximise their welfare. Economic agents are unable to make rational decisions due to the information gap.
What is the principle-agent problem?
When the goals of the principle (the person who gains from the decision) are different from the agents (those making deicisons on behalf of the principle).
Example: Education. Child is principle, and the agents are parents/govts. The child has imperfect information as they do not see the benefits of education and so therefore will devote too few resources to education, if allowed.
Advantages of indirect taxation to address externalities (2)
Internalises the externality - the market now produces at the social optimum position and social welfare is maximised.
It raises govt revenue, which could be used to solve the externality in other ways such as through education.
Disadvantages of indirect taxation to address externalities (6)
It is difficult to know the size of the externality, and so it is difficult to target the tax - the govt suffers from imperfect information when setting the tax.
There could be conflict between the govt goal of raising revenue and solving the externality, which makes setting the tax difficult.
It could lead to the creation of a black market.
If demand for the good is inelastic, then the tax will be ineffective at reducing output.
Taxes are politically unpopular, and so govts may be reluctant to introduce them.
They are regressive, meaning that the poor spend a larger proportion of their income on indirect taxes than the rich do.
Advantages of subsidies to address externalities (2)
Society reaches the social optimum output and welfare is maximised
They can have other positive impacts, such as encouraging small businesses, bringing about equality and encouraging exports.
Disadvantages of subsidies to address externalities (4)
The govt has to spend a lot of money, high opportunity cost.
As with taxes, theya re difficult to target since the exact size of the externality is unknown.
Subsidies can cause producers to become inefficient, especially if they are in place for a long time.
Once introduced, subsidies are difficult to remove.
Advantages of minimum/maximum prices (2)
They can be set where MSB=MSC, so allow for some consideration of externalities, and so help to increase social welfare.
A minimum price will ensure that goods are affrodable, whilst a maximum price will ensure that producers get a fair price. Both of these are able to reduce poverty and can increase equity/equality.
Disadvantages of minimum/maximum prices (3)
There is a distortion of price signals and this causes excess supply/demand.
It is difficult for the govt to know where to set the prices, because of the difficulty of knowing the size of externalities and because it will have implications on the size of excess supply/demand.
Both can lead to the creation of black markets. Maximum prices may also lead to illegal bribes or discriminatory policies in allocating goods.
What is a buffer stock scheme?
Where both minimum and maximum prices are implemented at the same time. This is often the case with agricultural products whose prices fluctuate massively.
The govt will buy up excess supply when the equilibrium price is below minimum price and vice versa to sell.
This helps prevent price fluctuation and provides stability but causes inefficiency and places a large cost on the government. Often, prices remain below the minimum price since farmer produce as much as they can as they know the govt will buy whatever they produce at the minimum price.
Advantages of pollution permits (4)
Since the govt caps the number of permits, it is guaranteed that pollution will fall to the targets set by the govt, maximising social welfare.
The govt can raise revenue by selling permits and by fining firms who exceed their limits.
This encourages companies to use and invest in green technology.
Firms are able to make their own decisions about whether to cut pollution or buy more permits. This helps encourage efficiency.
Disadvantages of pollution permits (4)
This can be expensive to monitor and police, but it will only work if it is monitored well.
The govt needs to impose fines that are large enough to ensure firms follow the regulation.
It will raise costs for businesses, and it is likely that these higher costs will be passed onto consumers.
It may be difficult to know how many permits the govt should allow.
Advantages of state provision of public goods (4)
This corrects market failure by providing important goods which would otherwise not be provided. It will lead to improved social welfare.
It can help to bring about equality, by ensuring everyone has access to basic goods.
There will be benefits of the goods themselves, like for healthcare, helping the workforce, boosting economic growth?
By using competitive tenders, the government can ensure efficiency.
Disadvantages of state provision of goods (4)
This is expensive and represents a high opportunity cost for the govt.
The govt may produce the wrong combination of goods as consumers cannot indicate their preferences. Democracy aims to reduce this problem.
The govt may be inefficient at production since they have no incentive to cut costs.
Govt officials may suffer from corruption and conflicting objectives.
Advantages of government provision of information (2)
This helps consumers to act rationally, which allows the market to work properly.
It is best if the government uses this alongside other policies. For example, it can make demand more elastic in the long run and so help indirect taxes to become more effective at reducing output.
Disadvantages of provision of information (3)
This can be expensive for the govt to do, incurring an opportunity cost.
The government may have imperfect info themselves.
Consumers may not listen to the information provided due to irrational behaviour.
Advantages of government regulation (1)
This can ensure consideration of externalities, prevent exploitation of consumers and keep consumers fully informed. This will help to overcome market failure and maximise social welfare.
Disadvantages of regulation (5)
Laws may be expensive for the govt to monitor.
They don’t account for the different costs of following the laws for different companies.
The govt can suffer from regulatory capture.
Firms may pass on costs to the consumer in the form of higher prices.
Excessive regulation may reduce competition in a market and efficiency, by increasing bureaucracy and reducing innovation.
What is Government Failure?
When govt intervention in the market leads to a net welfare loss and a misallocation of resources.
The total social costs arising from the intervention are greater than the social benefit.
What can cause government failure? (4)
Distortion of price signals (can keep inefficient companies in business, max/min prices lead to excesses, price mechanism allocates resource to their best use/where consumers want).
Unintended consequences (consumers and producers may react to new policies in unexpected ways and so the policy doesn’t have the effect it should).
Excessive administration costs (afterwards, social costs may exceed social benefits once admin costs are taken into account)
Information gaps
Advantages of Organic growth (2)
Integration is expensive, time-consuming and high risk, with evidence suggesting that the long-term share price of the company falls following integration.
The firm is able to keep control over their business
Disadvantages of Organic growth (3)
Sometimes another firm has a market or an asset which the company would be unable to gain through organic growth. For example, integration would allow a European company expand into the Asian market which it has no expertise in.
Organic growth may be too slow for directors who wish to maximise their salaries.
It will be more difficult for firms to get new ideas.
Advantages of vertical integration (4)
There is increased potential for profit as the firm takes the potential profit from a larger part of the chain of production.
There will be less risks as suppliers do not have to worry about buyers not buying their goods and buyers do not have to worry about suppliers not supplying the goods.
With backward integrationm businesses can control the quality of supplies and ensure delivery is reliable, and prices will not be extreme.
Forward integration secures retail outlets and can restrict access to these outlets for competitors.
Disadvantages of vertical integration (1)
Firms may have no expertise in the industry they took over.
For example, a car manufacturing company would have deep knowledge of car manufacturing, but little knowledge of selling cars and vice versa.
Advantages of horizontal integration (3)
This helps to reduce competition as a competitor is taken out and increases market share, giving firms more power to influence markets.
Firms will be able to specialise and rationalise, reducing the areas of the businesses whch are duplicated.
The business is able to grow in a market where it already has expertise, more likely to be successful.
Disadvantages of horizontal integration (1)
Will increase risk for the business as if that particular market fails, they have nothing to fall back on. They are placing their all eggs in one basket.
Advantages of conglomerate integration (3)
Useful for firms where there may be no room for growth in the present market.
Range of products reduces risk for firms if a whole industry fails.
It will make it easier for each individual part of the business to expand than if they were on their own as finance can be easily obtained and mergers can be transferred from company to company within the firm.
Disadvantages of conglomerate integration (1)
Firms are going into markets in which they have no expertise, which can be damaging for the business.
Constraints of business growth (4)
Size of the market (not all businesses can mass produce and consumers will buy it all, niche markets)
Access to finance (retained profits and loans)
Owner objectives (some owners may be happy with their current profits and don’t want to take extra risks)
Regulation
William Baumol on revenue maximisation
He suggested managers are most interested in their level of revenue since this is what their salary depended on.
Even when their salary is not directly connected to sales revenue, they knew that a growth in revenue was always likely to be a positive for the business. It increases their prestige and is used as a justification to shareholders for managerial rewards.
A fall in revenue would be negative as it would not only reduce their salary but could signal the start of a downward spiral for the company. It could lead to a fall in staff and financial institutions may be worried and less willing to lend money.
As a result, many firms may aim to revenue maximise as long as they provide some profit for the owners.
At what point of the cost/revenue graph is revenue maximised?
MR=0
What did Robin Marris say about sales maximisation?
Managers aim to maximise the growth of their company above any other objective. This is because their salary may be linked to the size of the company.
It is often easier for people to judge the level of growth achieved rather than the level of profit. This will increase the prestige of the business.
Growth will also increase market share, and may push other firms out of business. It will enable a firm to have more market power and more power over prices.
This tends to be a short-term strategy, and in the long term firms are more likely to profit maximise.
At what point of the cost/revenue curve do you sales maximise?
AC=AR - the highest level of sales possible without making a loss.
They want to ensure sufficient returns to keep the owners happy, so will aim for normal profits.
What is satisficing?
Managers will make enough profit to keep owners happy whilst following other objectives and not profit maximising.
These ‘other’ objectives are likely to be their own benefits. for example, they may increase their own salaries, which increases costs and therefore decreases profit.
Managerial utility maximisation
Oliver Williamson said that managers will make decisions to maximise their own satisfaction. This will be dependent on their salary, the number of staff they control, their power over decision making and the other benefits they receive.
Definition + How to calculate marginal cost
The extra cost of producing one extra unit of a good
Change in total cost / Change in output
Diminishing marginal productivity or Law of Diminishing Returns
If a factor of production is fixed, this will affect the business if it decides to expand.
More workers can be added, and this will see an increase in production as machinery is used more efficiently.
However, it’ll get to the point where adding labour has less of an impact on the amount produced as they get in the way and have no machines to use.
Economies of scale relates to the short-run or the long-run?
Long-run
Why is the LRAC an ‘envelope’ for all associated SRAC curves?
The LRAC is either equal to or below the relevant SRAC curve.
The firm may initially be set up to produce a certain amount a day and have enough machinery to do so effectively.
They may become popular and need to produce more than that amount, and in the short run this will cause a rise in SRAC due to the law of diminishing marginal returns as some factors of production are fixed.
In the long run, all factors of production become variable and so the SRAC curve can be shifted, with the new SRAC curve being lower due to economies of scale.
What is the long run average cost curve?
It’s a boundary representing the minimum level of average costs attainable at any given level of output.
