unit 1 notes

Question 1

Basic economic problem

Answer 1

The economic problem is that there is too much demand for too few goods as a result of human greed and competing wants. Not all wants can be satisfied.
Human wants are unlimited and resources (land,labour,capital,enterprise) are finite (scarce)
The problem is universal and permanent; affecting both developed and developing countries.
Because of the basic economic problem, choices have to be made
Opportunity cost is the cost of giving up the next best alternative.
The purpose of economics is to help advise the best use of resources in order to make goods and services that will satisfy as many people as possible

Question 2

Scarcity vs shortages

Answer 2

Scarcity: OC arises as there are insufficient resources to supply consumers (or firms or governments) with everything they want, forcing them to make choices. This is called an OC
(scarcity is the basic economic problem)

Shortages: insufficient resources to supply consumers with what they demand at a particular time. (i.e.) what they are willing and able to pay. A shortage can be controlled through price movements.

Question 3

How to reduce scarcity

Answer 3

Finding new resources, for example new oil reserves
Specialisation, in order to improve efficient use of scarce resources
Alternative resources, for example switching from fossil fuels to wind energy
Encouraging immigration, to increase supply of labour

Question 4

Resources

Answer 4

Land - all the natural resources of earth.
Examples: fish in the sea, oil, rocks, metals e.t.c.
The reward for land is ‘rent’
labour - all the human mental and physical effort that goes into production.
Examples: cleaners, teachers, bricklayers
The reward for labour is ‘wages’

Capital - all the equipment, machinery and buildings that is not used for its own sake but for the contribution it makes to production
Examples; desks, chairs, lorries, machinery
The ‘price’ for capital is ‘interest’

Enterprise - the skills needed to organise other resources into some form of production.
The return for enterprise is ‘profit’

Question 5

Economic Goods

Answer 5

Goods with an opportunity cost
Scarce resources are used up in the production of economic goods
Example: A television

Question 6

Free Goods

Answer 6

Goods in plentiful supply, enough to satisfy the want of everyone
They have no opportunity cost
Example: Air

Question 7

Choices

Answer 7

Governments make choices to maximise social welfare
Businesses make choices to maximise profits
Individuals make choices to maximise satisfaction

Question 8

Effective demand

Answer 8

is when consumers have enough money to buy goods and services at various prices

Question 9

Individual demand

Answer 9

Is the demand of just one consumer

Question 10

market/aggregate demand

Answer 10

the total demand for a product from all its consumers

Question 11

Derived demand

Answer 11

when a product is demanded due to it being part of the production process of other products e.g. demand for garden sheds generates demand for timber.

Question 12

Non price factors - shifts in demand curve

Answer 12

tastes/preferences: a change in tastes in favour of the product will lead to more demand and will cause the demand curve to shift to the right etc

Disposable income: an increase in disposable income will provide people with more financial freedom to purchase more units of a good

Substitute goods: a change in the price on one product will lead to change in demand for substitute products. For example if there’s a fall in the price of chicken, people will switch to chicken from beef and so chicken will be in higher demand.

Complementary goods: products that are often bought together, e.g. jam and scones. If a price fall for jam goes down then there will also increase demand in scones.
Unrelated goods: if products are unrelated, then a change in the price of one product will have no effect upon the demand for the other product.

Question 13

3 reasons why the demand curve slopes downwards(need definitions)

Answer 13

The Diminishing Marginal Utility Effect – as consumers increase consumption of a good or service they experience the law of diminishing marginal utility. As their satisfaction falls after each marginal unit they are prepared to pay less to consume more.

The Substitution Effect – as the price rises then the marginal utility per £ of the last unit consumed falls. A rational consumer would therefore switch consumption to a substitute product that offered greater utility at a cheaper price i.e. one which they view as better value for money.

The Income Effect – as the price rises then a person’s real income (i.e. their buying power) falls so they are no longer able to buy the same quantity. Demand for the product then falls.

Question 14

Explain 3 reasons why the demand curve for some goods slopes upwards from left to right

Answer 14

Giffen/essential goods (ID) as low income consumers may cancel consumption of other goods and use their income to buy more of these essential goods (EXP) (1)

Veblen/ostentatious goods (ID) as some consumers will demand more as they wish to demonstrate their wealth (EXP) (1)

speculative demand (ID) results in consumers buying more of a good as they think it will be worth more in the future (EXP) (1)

Question 15

Movements in demand curve (contraction/extension)

Answer 15

A change in price leads to a change in quantity demanded (a movement along the demand curve).

When prices INCREASE – there is a CONTRACTION of the demand curve i.e. less is demanded

When prices DECREASE – there is an EXTENSION of the demand curve i.e. more is demanded

Question 16

A change in price will lead to a movement along the supply curve, ceteris paribus because of the profit motive.

Answer 16

.

Question 17

3 reasons why the supply curve slopes upwards

Answer 17

The profit motive: when the market price rises (for example an increase in consumer demand), it becomes more profitable for businesses to increase their output

Production and costs: when output expands, a firm’s production costs rise, therefore a higher price is needed to justify the extra output and cover these extra costs of production

New entrants coming into the market: higher prices may create an incentive for other businesses to enter the market leading to an increase in supply.

Question 18

Movement in supply curve (extension/contraction)

Answer 18

The increase in price motivates the producer to sell more due to the profit motive i.e. there is an extension in supply. The producer in this situation will allocate (divert) more resources towards this product in order to fully profit from selling this product.

The decrease in price motivates the producer to sell less due to the lack of profit motive i.e. there is a contraction in supply. A producer in this situation will allocate (transfer) their resources to make other, more profitable products, instead.

Question 19

Shifts in the supply curve

Answer 19

A change in a non price determinant will shift the supply for example;
Input prices
Technology
weather

Question 20

Subsidies

Answer 20

subsidies are payments made to producers from the government in order to make the product cheaper to produce or cheaper to consume
For example, farmers are given subsidies in order to support their incomes and make the production of agricultural goods more profitable (otherwise farming communities may go into further decline with further job losses). This increases supply.

Question 21

barriers/inhibitors that may make geographical ,mobility less of an option

Answer 21

Transport cost 
Family connections
Cost of accommodation
Language 
Good schools

Question 22

The mixed market economy

Answer 22

The mixed market economic system is the means adopted by all economies though the ratio of public to private ownership may differ depending on the political party in power.

Question 23

The nature of a market

Answer 23

A market is a place buyers and sellers meet in rider to exchange gift or services for money
A market is made up of producers and consumers of a particular product
E.g. The market for CDs consists of all the people willing to produce and sell CDs and all the people willing to buy CDs.

Question 24

ELASTIC or INELASTIC?

Answer 24

ELASTIC - % change in demand > % change in price

INELASTIC - % change in demand < % change in price

example
Elastic if price increase by 10 percent and demand decreases by more than 10 percent
Inelastic if price increases by 10 percent and demand decreases less than 10 percent

Question 25

Determinants of PED

Answer 25

If the good has a number of close substitutes demand for it will be more elastic. (1 mark) This is because consumers will be more likely to switch to another good when the price goes up.(1 development mark) eg branded toothpaste etc. (1 development mark)

If the good is a necessity, demand will be less elastic. (1 mark) e.g. bread or milk. (1 development mark)

If a small proportion of income is spent on the product demand will be relatively inelastic (1 mark) This is because changes in price are less likely to be noticed. (1 development mark) eg crisps.
(1 development mark)

If the goods are purchased frequently demand for it will be more inelastic.

Question 26

How the price mechanism helps to allocate scarce resources:

Answer 26

Rationing – prices serve to ration scarce resources when demand outstrips supplyWhenever resources are particularly scarce, demand exceeds supply and prices are driven up. The effect of this is to discourage demand and conserve resources. The greater the scarcity, the higher the price and the more the resource is conserved.
(individuals)

Signalling – prices adjust to demonstrate where resources are required, and where they are not (i.e. high price smart phone versus lower priced tablets) (firms)
Price changes send contrasting messages to consumers and producers about whether to enter or leave a market.
Rising prices give a signal to consumers to reduce demand and they give a signal to potential producers to enter a market.
Conversely, falling prices give a positive message to consumers to buy while sending a negative signal to producers to leave a market.
For example, a rise in the market price of’ smartphones sends a signal to potential manufacturers to enter this market, and perhaps leave another one.

Incentives – when the price of a product rises, quantity supplied increased (i.e. if oil prices increases, supply will increase) (firms)
An incentive is something that motivates a producer or consumer to follow a course of action or to change behaviour.
Higher prices provide an incentive to existing producers to supply more because they provide the possibility of more revenue and increased profits.
The incentive function of a price rise is associated with an extension of supply along the existing supply curve.

Question 27

The free market mechanism

Answer 27

No role for the government
All scarce resources are owned by private individuals
Scarce resources are allocated based upon the rationing, signalling and incentive functions only
Consumers aim to maximise utility and producers aim to maximise profit
The market mechanism is ‘guided by an invisible hand’

Question 28

Benefits of the free market mechanism

Answer 28

Buyers are free to purchase any commodity which they like and in whatever amounts.
Allocative efficiency – producing what people want and the price people prepared to pay
The seller of a good or its producer can also produce whichever product they want to and also increase the capacity of any individual commodity depending upon the forces of the market.
Producers are free to undertake the risks and rewards (profits) associated with increases in production.

Question 29

Drawbacks of the free market mechanism

Answer 29

Over consumption of demerit goods(drugs, cigarettes, alcohol) if consumers have a preference for these goods, then they will be provided given that they are profitable to produce.
Social cost ignored. Private firms ignore negative externalities(air, water and noise pollution, road conditions.)
Wastage of resources as consumers may get what they want but not what is good for them.

Question 30

Government Intervention in the Market Mechanism

Answer 30

There are several ways in which the government can intervene including:
Subsidising production
Taxing production
Placing a quota on production

Question 31

Barriers to entry

Answer 31

Capital costs are fixed, one-time expenses incurred on the purchase of land, buildings, construction, and equipment used in the production of goods or in the rendering of services. In other words, it is the total cost needed to bring a project to a commercially operable status.

        Sunk costs  A sunk cost refers to a cost that has already occurred and has no potential for recovery in the future. For example, your rent, marketing campaign expenses or money spent on new equipment can be considered sunk costs. A sunk cost can also be referred to as a past cost

Economies of scale
in microeconomics, economies of scale are the cost advantages that enterprises obtain due to their scale of operation, with cost per unit of output decreasing with increasing scale

Legal barriers
Barriers to entry are the legal, technological, or market forces that discourage or prevent potential competitors from entering a market. … One is natural monopoly, where the barriers to entry are something other than legal prohibition. The other is legal monopoly, where laws prohibit (or severely limit) competition.

Limit pricing
A limit price is a price, or pricing strategy, where products are sold by a supplier at a price low enough to make it unprofitable for other players to enter the market. It is used by monopolists to discourage entry into a market, and is illegal in many countries

Question 32

Perfect competition

Answer 32

The product that is sold is homogeneous - e.g. each product sold by each firm is identical and are perfect substitutes. There is no differentiation so customers can buy the same product everywhere

Freedom of entry and exit - firms should be able to establish themselves quickly and easily with no costs to exit the industry i.e. no barriers to exit/entry

A large number of small buyers & sellers – therefore no one firm can have any influence on price over another and each firm acts independently – each firm is a price-taker i.e. they charge the market equilibrium price

Perfect information – both buyers and sellers must clearly know about market prices, product quality and cost conditions. Consumers can easily switch between competing firms.

Question 33

Monopoly definition

Answer 33

A situation in which a single company owns all or nearly all of the market for a given type of product or service

A monopolist has the power to determine either:
The price at which he will sell his product
The quantity at which he wishes to sell

The monopolist cannot determine both

The monopolists power depends upon:
- the availability of close substitutes
The power to restrict new firms entering the market

Question 34

Merit goods

Answer 34

Goods that would be under consumed and underprovided if left to private individuals, we need a government to make decisions on how much we need to consume and when
Examples: NHS and Education

Question 35

Public goods -

Answer 35

In economics, a public good is a good that is both non-excludable and non-rivalrous, in that individuals cannot be excluded from use or could benefit from without paying for it, and where use by one individual does not reduce availability to others or the good can be used simultaneously by more than one person.
Example: street lighting
Paid through taxation

Question 36

Government intervention

Answer 36

Tax goods/services which have negative externalities e.g. cigarettes (i.e. make to polluter pay) to reduce demand for them

Subsidies can be provided by the government to increase supply of certain goods which would be unprofitable without government intervention. These are heavily used in the agriculture sector which helps farmers make profit.

Set quotas to limit over production that causing pollution or shortages

Ban certain activities e.g. smoking in bars and restaurants (command and control, techniques

Provides goods deemed necessary to the wellbeing of society such as public/merit goods.

Advertising (government warning of effects of tobacco on the people’s health)

Monopolies exist when one firm dominates a market. The government intervenes through the competition and market authority to control monopolies to ensure that prices are controlled by consumers.

Question 37

Consequences to government intervention

Answer 37

Using taxation to increase price could result in some businesses passing on the higher costs to consumers. Some forms of taxation can be regressive. This may have inflationary consequences. Some businesses may also have to make workers redundant to compensate for higher costs elsewhere. We lose international competitiveness.

Using subsidies to reduce prices could lead to higher taxes from consumers to pay for this system.

Consumers get no say in what gets subsidised.

Using maximum prices can result in excess demand. If the excess demand is not met by existing producers then it could result in a black market for the product. Low prices can make a business unprofitable. Using minimum prices can result in excess supply which could lead to wasted resources as producers try to exploit the situation.

Question 38

Explain the law of diminishing marginal returns.

Answer 38

as output increases the efficiency of production falls (ID) causing higher average costs (EXP) (1). If marginal costs are higher than average costs, then average cost is being pulled up (DEV) (1)

this occurs in the short run only (ID) when one factor of production is fixed (for example, capital) (EXP) (1)

as a variable factor is increased (for example, labour) (ID) eventually productivity starts to fall (EXP) (1). This is because the fixed factor is being ‘overworked’ (DEV) (1)

Question 39

stages of the business cycle

Answer 39

Boom/peak
GDP above the target/trend rate/highest level (1)
highest levels of consumer spending (1)
unemployment is lowest/full employment (1)

Slump/trough
GDP zero
lowest spending (1)
unemployment highest (1)

Recovery
GDP rising
consumers begin to spend more

Recession
two consecutive quarters of negative GDP/lowest (1)
consumer spending falling (1)

Question 40

describe the powers which have been devolved to the Scottish parliament from the UK government

Answer 40

Vary income tax (1 mark) by plus or minus 3 pence in the pound. (1 development mark)
 Collect Land and Buildings Transaction Tax replacing stamp duty. (1 mark)
 Control Scottish Landfill Tax to protect the environment. (1 mark)
 Control Air Passenger Duty for passengers flying out of UK. (1 mark)
 Determine the price of alcohol (1 mark) by setting minimum prices per unit of alcohol/not allowing happy hour/bulk buying

Question 41

Technical efficiency

Answer 41

Technical efficiency is achieved as producers produce at minimum unit cost, in other words, when the fewest necessary resources are used to produce each product. This is because they are profit maximising and given the degree of competition in a free market they will want to produce at a point where costs are minimized.
In the long run (because of the high degree of competition), firms are producing at the lowest point in the average cost curve. At this point the quantity of resources needed to produce one unit of a commodity are minimized (optimum output).
If all firms operated under these conditions it would follow that there would be an optimum allocation of resources and every commodity would be produced at a minimum cost per unit.
when technical efficiency is achieved
when products are produced at minimum unit cost, in other words when the fewest necessary resources are used to produce each product. Goods are being produced at minimum average cost and minimum opportunity cost. Technical efficiency therefore focuses how goods are produced.

In building a bridge, using the least amount of steel while ensuring the bridge will not collapse. Building a bridge strong enough to take 1000-ton lorries would be wasting steel, which could be used for making other products.

Question 42

Allocative efficiency

Answer 42

In a free market economic system, scarce resources are allocated through the price mechanism where the preferences and spending decisions of consumers and the supply decisions of businesses come together to determine equilibrium prices.
The free market works through price signals. When demand is high, the potential profit from supplying to a market rises, leading to an expansion in supply (output) to meet rising demand from consumers. In other words, the invisible hand of the market would allocate resources to everyone’s advantage.
All firms would be producing to consumers demand curves i.e. goods which people desire.

when allocative efficiency is achieved
when resources are allocated (used) to produce those goods and services which consumers most want. Economic efficiency therefore focuses on what goods are being produced.

One hundred bridges could be built over the River Clyde in Glasgow in a technically efficient way, but this would be a wasteful use of resources if consumers don’t want 100 bridges. The resources could have been used to make products which consumers want more.