unit 3 AOS 1

Question 1

relative scarcity

Answer 1

• the basic economic problem, refers to the idea that peoples needs and wants are unlimited, relative to the limited amount of resources available to satisfy these needs and wants, therefore producers need to make decisions about how to use resources efficiently to maximise consumer satisfaction & LS

Question 2

resources/ factors of production

Answer 2

the inputs used in the production of g & s
- land: found in the natural environment- rivers, forests, oceans
- labour: the human skill & talent used in production- employees such as mechanic, doctor, teacher
- capital: physical equipment & machinery used in production of other g & s- roads, factories, tools, computers

Question 3

opportunity cost

Answer 3

the benefits lost when forgoing production in one area, and choosing to allocate scarce resources to their next most productive use
> occurs due to relative scarcity, must make decisions about how to allocate scarce resources in order to maximise society satisfaction
> can be illustrated on the PPF

Question 4

the three basic economic questions

Answer 4

1. what and how much to produce
   > type and quantity of each good or service to produce with limited resources available in order to maximise consumer satisfaction
2. how to produce
   > producing in the most most efficient way –> cheapest & most profitable
3. for whom to produce
   > how a nations goods, services & incomes will be shared

Question 5

economic efficiency

Answer 5

means that resources are used to produce g&s that best satisfy wants, needs & wellbeing
- allocative: resources are allocated to areas of production that maximise satisfaction of society’s wants and needs
- productive/ technical: firms using lowest cost production method. maximise output per unit of input
- dynamic: resources are quickly allocated in response to changing needs & tastes. the speed of change from one point to another
- intertemporal: balance between spending on current consumption vs saving for future consumption, immediate wants vs those of future generations, enviro sustainability

Question 6

non-price conditions affecting price changes in a market

Answer 6

• if there are more buyers and fewer sellers, price rises
• if there are fewer buyers more sellers, price falls

Question 7

conditions of a free & perfectly competitive market

Answer 7

strong comp between sellers & between buyers
- consumer sovereignty
> consumers dictate how resources are allocated
- firms have no market power or control over prices
> many firms producing the same product, therefore they are price takers (unable to influence prices)
- ease of entry or exit
> firms can easily reallocate their resources, meaning they can enter or leave a market easily. barriers to entry are limited
- products are homogenous
- resources are mobile
> resources can easily be used from one use to another in response to relative prices and profits
- behaviour is rational and includes profit maximisation
> selling at highest possible price, buying at lowest
- there is perfect knowledge of the market

Question 8

relative prices & profits

Answer 8

prices: the price of one good or service compared to another
profits: level of profit gained from producing one good or service compared to another
> relative prices give an indication of relative profits and influence how firms allocate their resources

Question 9

the law of demand

Answer 9

states that the quantity of a particular good or service that buyers are prepared to purchase varies inversely with the change in price
> as price rises, demand falls (contracts) and vice versa

Question 10

theories explaining the law of demand

Answer 10

• the income effect: when the good or service becomes more expensive, fewer people have the income to afford to buy it, so demand contracts
• the substitution effect: when the good or service becomes more expensive & less affordable, buyers look for cheaper alternatives, so demand contracts

Question 11

movement along vs shift of the demand curve

Answer 11

• movement: caused only by a change in price, movement from one point to another.
  > movement upwards = rise in price
  > movement downwards = fall in price
• shift: non-price factors cause buyers to purchase more or less of a good or service
  > increase in factors= shift outwards to the right

Question 12

non-price factors affecting the demand curve

Answer 12

cause a shift of the whole curve
- changes in disposable income
- consumer confidence
- changes in demographics & population size
- changes in preferences and tastes
- changes in interest rates on borrowed money
- changes in the price of substitutes
- changes in the price of complementary g & s

Question 13

the law of supply

Answer 13

states that the quantity of a good or service produced varies directly with the change in price
> as price rises, suppliers are more willing to produce (expansion) and vice versa

Question 14

theories explaining the law of supply

Answer 14

• the profit motive: a higher selling price in the market, while other factors like production costs remain unchanged, usually means an increase in sales revenue, encouraging firms to expand supply
• consideration of opportunity costs: the opportunity costs of producing another g or s, making it more profitable to reallocate resources away from other uses to increase output, expanding supply
  > not in SD

Question 15

movement along vs shift of supply curve

Answer 15

• movement: only caused by change in price
• shift: due to changes in non-price supply side conditions
  > stronger conditions = increase supply
  > weaker conditions = decrease supply

Question 16

effects of changes in supply & demand on equilibrium price & quantity traded

Answer 16

changed in non-price demand and supply conditions cause the lines to shift, resulting in new equilibriums
- increased demand = increase in equilibrium price & quantity & vice versa
- increased supply (shift inwards & right) = decreased equilibrium price & increased equilibrium quantity
- decreased supply (shift outwards & left) = increased equilibrium price & decreased equilibrium quantity

Question 17

non-price factors affecting the supply curve

Answer 17

shift the supply line to the left or right
- changes in costs of production
- changes in technology & productivity
- changes in climatic conditions
- changes in the number of suppliers

Question 18

price elasticity of demand

Answer 18

measures the responsiveness of the quantity demanded relative to the % change in price
> whether demand contracts a little or a lot due to price changes
- demand is relatively elastic: changes by a larger proportion than the change in price (line is flat)
- demand is of unit elasticity: change is same as price change
- demand is relatively inelastic: changes by a smaller proportion than the change in price (line is steep)

Question 19

factors affecting PED

Answer 19

• degree of necessity
  > necessities are inelastic, whereas luxury items are elastic
• availability of substitutes
  > items with lots of substitutes are more elastic than unique items
• proportion of income
  > items representing a higher proportion of income are more elastic than cheaper things
• time
  > demand is more elastic in the long-term than short, as time gives people a chance to find alternatives or change habits

Question 20

price elasticity of supply

Answer 20

measures the responsiveness of the quantity supplied to a change in price
- elastic supply: supply changes by a larger proportion than change in price (line is flat)
- inelastic supply: supply changes by a smaller proportion than the change in price (line is steep)
- supply is of unit elasticity: supply changes by same proportion as the change in price

Question 21

factors affecting PES

Answer 21

• availability of spare capacity
  > more elastic if levels of supply can be easily changed by moving resources between industries
• production/ time period
  > more difficult to expand supply in the short term following a price increase, more elastic long-term
• durability of goods
  > items that don’t deteriorate (minerals, wheat) are more elastic than those that cannot be stored or deteriorate quickly

Question 22

significance of price elasticity of demand & supply

Answer 22

1. the pricing policies of sellers
   > sellers can increase their prices if their products have no substitutes, increasing their profits as demand is inelastic
2. the raising of government revenue
   > govs can put heavy excise tax on products with inelastic demand to raise revenue

Question 23

role of relative prices in the allocation of resources

Answer 23

• businesses watch changes in relative price & make decisions about how to allocate their resources between competing uses to maximise profits
  > rise in relative prices means businesses need to allocate more resources to that area
  > fall in relative prices means businesses need to move resources and decrease production in that area

Question 24

role of free & competitive markets in promoting efficient allocation of resources & LS

Answer 24

• free and competitive markets determine relative prices, which alter relative profits and how businesses allocate their resources.
  > ensures resources are allocated efficiently, as firms will reallocate their resources in order to maximise satisfaction of wants and needs in order to maximise their profits
• improves LS by satisfying wants and needs
• business expansion = more jobs = more incomes = improved LS
• changes in relative prices affect incomes & purchasing power, impacting LS

Question 25

types of market failure

Answer 25

occurs when the operation of the price system involving the forces of demand and supply, do not allocate resources efficiently to maximise the general satisfaction of society’s needs and wants. - public goods - externalities - asymmetric information - common access resources

Question 26

public goods- type of market failure

Answer 26

goods and services that can be consumed collectively by an individual, without preventing others from accessing them > eg. defence, police, non-toll roads > those who do not pay cannot be easily excluded from gaining benefits, making it hard to make profits these are: 1. non-excludable: nobody can be refused access, leads to the free rider problem, as people can use without paying tax 2. non-rivalrous: one person using it does not prevent another from also using it & gaining benefit, because some people don't pay, insufficient resources will be allocated

Question 27

externalities- type of market failure

Answer 27

- extra costs (negative) or benefits (positive) to third parties as a result of production or consumption - negative externalities lead to misallocation of resources & damage to third parties - positive externalities lead to underallocation of resources

Question 28

asymmetric information- type of market failure

Answer 28

when one group in the market (usually sellers) has more knowledge than the others (usually buyers), which means rational choices cannot be made & society wellbeing is reduced

Question 29

common access resources- type of market failure

Answer 29

environmental natural inputs such as air, minerals, oceans and forests. non-excludable and free, but also rivalrous > survival of current and future generations is jeopardised when when these are overused (climate change, severe weather events)

Question 30

government intervention to address market failure

Answer 30

- indirect taxation > reduce negative externalities by raising the price of particular goods, changing decisions of buyers and sellers. cause them to reallocate resources to other areas of production eg. tax on alcohol - subsidies > reduce neg by encouraging consumers to change their behaviour & reduce consumption of products that cause negative externalities. eg. subsidies to encourage installation of solar panels > can also encourage producers to produce g&s with pos externalities - advertising > reduce asymmetric info & externalities, inform consumers so that they can make more effective choices - direct provision > directly providing goods and services - regulations

Question 31

one example of government intervention that unintentionally leads to a decrease in one type of efficiency

Answer 31

paying subsidies to the coal industry - encourages production, exports & employment - may unintentionally reduce allocative and intertemporal efficiency by: > increasing CO2 emissions, accelerating climate change & severe weather events, adding to negative externalities & lowering LS of future generations > creates a large opportunity cost > encourages overproduction & consumption of coal, taking resources away from more productive uses that would have greater society satisfaction, undermining allocative > satisfying immediate wants without taking future gens into account (intertemporal)