Professional Documents
Culture Documents
1
2018 - 2019 THE MARKET SYSTEM
Revision Book
ECONOMICS
IGCSE
1. THE ECONOMIC PROBLEM
a) finite resources
" needs are basic requirements for human survival, they are limited
" wants correspond to desires (fashion, obsolescence…) they are infinite (= unlimited)
C) OPPORTUNITY COST
" when making choices, people give up certain opportunities when resources are scarce
" the benefits of the opportunities that have been given up are the opportunity cost
" a PPC shows the different combinations of two goods that can be produced if all
resources in an economy are fully used up
" it shows the maximum quantities of goods that can be produced with all available
resources
×B
E
×
D
×
CAPITAL GOODS
CAPITAL GOODS
2
E) FACTORS THAT IMPACT GROWTH
Growth corresponds to an increase in the production level of in a country. This can come from:
LIMITS
resource depletion, climate change, political instability, emigration, restriction in public services
(healthcare, education…)
2. ECONOMIC ASSUMPTIONS
When making decisions, economists assume that consumers will always choose the option that
gives them the greatest benefit (= satisfaction). Consumers may choose:
LIMITS
difficulty to calculate benefit /price, habits preventing consumers to switch to a better option
(brand loyalty), peer pressure, lack of information
When business owners make decisions, they are expected to choose the option that gives the
best financial results. Businesses take decisions that enable:
LIMITS
inefficient organisation when taking decisions, alternative objectives (purpose, ethics,
reputation…), lack of information
3
3. THE DEMAND CURVE
A) EFFECTIVE DEMAND
Demand is the amount of a good that will be bought at given prices over a period of time.
Effective demand is the amount that will be bought considering what consumers can afford.
The demand curve represents all the combinations of prices and quantities bought on a graph.
9 the demand curve is downward sloping as there is an inverse relationship between
price and quantity bought: consumers are willing / able to buy more as prices
decrease
9 at different prices, there is a movement along the demand curve
PRICE
DEMAND CURVE
MOVEMENT ALONG THE CURVE
P
=> change in
demand following a
change in price
P’ => downward
sloping curve
Q Q’ QUANTITY
For prices remaining unchanged, there may be other factors that lead to an increase or
decrease in the quantity demanded.
9 the entire demand curve shifts to the right (increase) or to the left (decrease)
PRICE
DEMAND CURVE
SHIFT IN THE CURVE
D’’ D D’
Q’’ Q Q’ QUANTITY
4
B) ADVERTISING / TRENDS / FASHION
Businesses try to influence demand for their products, determining trends and fashions.
9 more advertising is likely to lead to an increase in demand
C) INCOME
D) PRICE OF SUBSTITUTES
Goods that are substitutes can replace each other.
9 when the price of a substitute falls, demand for a good is likely to increase as
consumers prefer the cheapest option
E) PRICE OF COMPLEMENTS
F) DEMOGRAPHIC CHANGES
5
5. THE SUPPLY CURVE
A) SUPPLY
Supply is the amount of a good that sellers are willing to sell at any given prices over a period of
time.
The supply curve represents all the combinations of prices and quantities sold on a graph.
9 the supply curve is upward sloping as there is a proportionate relationship between
price and quantity businesses are willing to sell more as prices increase because
profit expectations improve
9 at different prices, there is a movement along the supply curve
PRICE
SUPPLY CURVE
MOVEMENT ALONG THE CURVE
S
P’ => change in supply
following a change
in price
Q Q’ QUANTITY
C) FIXED SUPPLY
Supply is fixed when it is impossible to adjust the quantity supplied when prices change.
9 as the quantity sold remains unchanged whatever the price level, the supply curve is
vertical
PRICE
FIXED SUPPLY
P’ => no change in
supply following a
change in price
Q QUANTITY
6
6. FACTORS THAT MAY SHIFT THE SUPPLY CURVE
For prices remaining unchanged, there may be other factors that lead to an increase or
decrease in the quantity supplied.
9 the entire supply curve shifts to the right (increase) or to the left (decrease)
PRICE
SUPPLY CURVE
SHIFT IN THE CURVE
S’’ S S’
Q’’ Q Q’ QUANTITY
B) COSTS OF PRODUCTION
The businesses incur costs when they pay for rents, wages, raw materials, energy, machinery…
9 when production costs rise, profit expectations fall
9 businesses reduce supply as they seek better opportunities in other markets
9 production costs may rise when resources become scarce
C) TAXES
Taxes are considered to increase production costs and make profit expectations fall.
9 when taxes increase, businesses reduce supply
9 this may reduce the production of dangerous / polluting products
D) SUBSIDIES
Subsidies are grants given by the government to businesses in order to encourage the
production of goods.
9 businesses use subsidies to pay off part of their production costs
9 as production costs decrease, profit expectations rise and businesses increase supply
E) CHANGES IN TECHNOLOGY
New technologies increase efficiency in businesses and enable to increase production levels and
thereby supply.
7
F) NATURAL FACTORS
Unfavourable weather conditions or natural disasters may harm the production of goods
(agriculture, transportation…) and reduce supply.
7. MARKET EQUILIBRIUM
A) EQUILIBRIUM PRICE
The equilibrium price of a good is set exactly where the quantity demanded by buyers equals
the quantity supplied by sellers.
PRICE
EQUILIBRIUM
PE
QE QUANTITY
Total revenue is the amount generated from the sales of output (=production).
9 it necessarily equals the amount buyers have spent, the total expenditure.
TR = P × Q = TOTAL EXPENDITURE
PRICE
TOTAL REVENUE
PE
QE QUANTITY
8
C) SHIFTS IN DEMAND AND SUPPLY
The shifts of the demand or the supply curve lead to a new equilibrium with a new equilibrium
price and equilibrium quantity.
a) shortages
PRICE PRICE
INCREASE IN DEMAND DECREASE IN SUPPLY
S S’
S
P’
P P’
P
D’
D D
Q Q’ QUANTITY Q’ Q QUANTITY
b) gluts
PRICE PRICE
DECREASE IN DEMAND INCREASE IN SUPPLY
S S
S’
P’ P
P’
D
D’ D
Q’ Q QUANTITY Q Q’ QUANTITY
9
D) EXCESS DEMAND AND EXCESS SUPPLY
a) excess demand
If the price charged for a good is below the equilibrium price, demand will be superior to supply
as buyers can afford larger quantities and businesses produce less due to lower profit
expectations.
9 there is excess demand
9 shortages push prices up to the equilibrium level
PRICE
EXCESS DEMAND
PE
QS QE QD QUANTITY
QD > QS
excess demand
b) excess supply
If the price charged for a good is above the equilibrium price, supply will be superior to demand
as firms are encouraged to sell larger quantities as profit expectations have improved but
buyers cannot afford as much.
9 there is excess supply
9 gluts push prices down to the equilibrium level
PRICE
EXCESS SUPPLY
PE
QD QE QS QUANTITY
QS > QD
excess supply
10
8. PRICE ELASTICITY OF DEMAND (PED)
A) DEFINITION
Price elasticity of demand (PED) measures the responsiveness of demand to a change in price: it
analyses how significantly the quantity demanded changes if the price changes.
% CHANGE IN DEMAND
PED =
% CHANGE IN PRICE
PED < -1
If demand changes more than proportionately to the price, demand is elastic. Buyers react
significantly to a change in price.
PRICE
PRICE ELASTIC DEMAND
Q Q’ QUANTITY
PED -> -¥
Demand is perfectly elastic if buyers purchase as much as possible at a given price and nothing
at all at any other price.
PRICE
PERFECTLY ELASTIC DEMAND
Q Q’ QUANTITY
11
-1 < PED < 0
If demand hardly changes after a change in price, demand is inelastic. Buyers hardly change the
quantity they buy after a change in price.
PRICE
PRICE ELASTIC DEMAND
Q Q’ QUANTITY
PED = 0
Demand is perfectly inelastic if a change in price leads to no change at all in the quantity
demanded at all.
PRICE
PRICE INELASTIC DEMAND
Q QUANTITY
a) availability of substitutes
Consumers are likely to switch to the cheapest option when they consider that two goods
can easily replace each other. If a good has substitutes, demand will be elastic. Time
increases the possibility of finding substitutes and raises elasticity.
b) degree of necessity
Consumers buy more or less the same quantities of goods that consider to be necessities
(= goods essential to their lives), even if prices change. If the degree of necessity they attach
to a good is high, they will hardly change the amount they buy and demand will be inelastic.
12
c) proportion of income spent on a good
If consumers spend a high proportion of their income on a good, they will react more
significantly to a change in price as it will impact their budget. Demand will be elastic.
A change in price leading to a change in the quantity demanded will impact the total revenue
(TR) collected by firms on their sales.
If demand is elastic, a change in price will lead to a more than proportionate change in the
quantity demanded (= quantity sold).
" an increase in price will lead to a more than proportionate fall in the quantity
demanded
9 TR will fall
" a decrease in price will lead to a more than proportionate rise in the quantity
demanded
9 TR will rise
If demand is inelastic, a change in price will lead to a less than proportionate change in the
quantity demand (= quantity sold).
an increase in price will lead to a less than proportionate fall in the quantity demanded
9 TR will rise
a decrease in price will lead to a less than proportionate rise in the quantity demanded
9 TR will fall
13
9. PRICE ELASTICITY OF SUPPLY (PES)
A) DEFINITION
Price elasticity of supply (PES) measures the responsiveness of supply to a change in price: it
analyses how significantly the quantity supplied changes if the price changes.
% CHANGE IN SUPPLY
PES =
% CHANGE IN PRICE
PES > 1
If supply changes more than proportionately than the price, supply is elastic. Sellers react
significantly to a change in price as their profit expectations change.
PRICE
PRICE ELASTIC SUPPLY
Q Q’ QUANTITY
PES -> ¥
Supply is perfectly elastic if businesses supply as much as possible at a given price and nothing
at all at any other price.
PRICE
PERFECTLY ELASTIC SUPPLY
Q Q’ QUANTITY
14
0 < PES < 1
If supply hardly changes to a change in price, supply is inelastic. Businesses hardly change the
quantity they sell after a change in price.
PRICE
PRICE INELASTIC SUPPLY
S
=> a change in price
leads to a significant
P change in supply
0 < PES < 1
P’
Q Q’ QUANTITY
PED = 0
Supply is perfectly elastic if a change in price leads to no change in the quantity sold at all.
PRICE
PERFECTLY PRICE INELASTIC SUPPLY
Q QUANTITY
Producers can only adjust their production level to changes in prices if the resources they
need are available. If resources can be easily sourced, supply will be elastic.
Producers can easily respond to changes in prices if they have stocks of unsold goods they
can immediately bring to the market. The ability of keeping stocks increases elasticity of
supply.
Producers cannot increase their production levels if they have already reached full capacity
(= all resources being used at maximum). Supply will be inelastic. Spare capacity increases
elasticity.
15
10. INCOME ELASTICITY OF DEMAND (IED)
A) DEFINITION
% CHANGE IN DEMAND
IED =
% CHANGE IN INCOME
IED > 0
IED < 0
If demand changes more than proportionately than the income, demand is income elastic.
Buyers react significantly to a change in income as they can afford more luxuries.
If demand changes less than proportionately than the income, demand is income inelastic.
Buyers hardly react to a change in price as they buy necessities.
Businesses try to anticipate demand in order to adjust the quantity to produce and supply:
16
D) IED AND GOVERNMENT
a) taxes
The government chooses to tax goods with price inelastic demand: demand will hardly be
impacted by the rise in price and the tax revenue will be important
LIMIT
the government will avoid to tax necessities
b) subsidies
The government chooses to subsidies goods with price elastic supply as they want these
goods to be produced in large quantities
LIMIT
producers may not pass on the fall in production costs to consumers by lowering their prices
A) DEFINITIONS
An economic system is a system that attempts to solve the economic problem: decisions about
what to produce, how to produce, for whom to produce.
In the private sector, goods and services are produced by individuals or group of individuals and
supplied in a market where they are sold/bought.
In the public sector, government organisations produce and supply goods and services that are
partly or entirely financed by taxes.
Markets determine resource allocation as businesses will use the resources to produce goods
and services that will be demanded in the market. But sometimes, resources are wasted due to
inefficiency. There is market failure because of:
a) externalities
The cost to society has not been completely considered when the good was produced.
SOLUTION
government regulation, taxes
17
b) lack of competition
If there is no competition, businesses can charge high prices and they are likely to be more
careless about waste of resources as they can charge high prices
SOLUTION
government preventing excessive growth of firms
c) missing markets
Some goods are likely to be underprovided by the private sector because profit expectations
would not be attractive enough.
SOLUTION
government providing goods financed by taxes
d) lack of information
Producers may be insufficiently informed about the costs of the resources they or the most
efficient production processes. Resources may get wasted. Consumers may not be well
enough informed about quality and prices
SOLUTION
obligation to label products, information campaigns
e) factor immobility
Producers can only achieve maximum efficiency when factors can be moved from the
production of one good to the production of another good.
SOLUTION
training
18
C) THE ROLE OF THE GOVERNMENT
a) public goods
" non-excludability
once a goods is provided, no consumer can be excluded from consuming it
" non-rivalry
when a good is consumed by a consumer, it does not prevent another consumer from
consuming it too
Therefore, public goods cannot to be properly charged and offer no profit expectations to
firms. They will not provide it at all. The government takes over their production and will use
tax revenue to finance them.
b) merit goods
Some goods may be provided by firms but at a high price as production costs are high. Only
a few consumers will be able to afford them. These goods are merit goods, they are
underprovided. The government can decide to produce or to subsidise them.
Businesses are owned and controlled by individuals or group of individuals. They can be sole
traders (one person) or grouped in partnerships or companies. Large companies are owned
by shareholders who brought money to the business and elect a board of directors to run
the businesses on their behalf.
Public organisations are owned and controlled by the government (central government
departments, local authorities, public corporations…). Their directors are elected or
appointed.
" survival (avoiding bankruptcy, the inability to pay the money owed)
" profit maximisation (profit will be distributed to shareholders under the form of
dividends)
" growth, market leadership
" social and environmental responsibility (consideration of stakeholders’ interests, those
who are impacted by the businesses’ activity: workers, clients, residents…)
19
b) in the public
F) TYPES OF ECONOMIES
" the role of the public sector is limited to providing a legal and monetary system as well as
policing and defence
" almost all goods and services are produced by the private sector
" price is set in the market by demand and supply
" the government takes all decisions about the production and the distribution of goods
" prices are set by the government
c) mixed economy
" goods are mainly produced by the private sector and producers adjust supply to demand
" competitive pressure ensures that goods are produced at the lowest price
" the government takes in charge public and merit goods
20
12. PRIVATISATION
A) DEFINITION
The government sells these industries to private investors who become the shareholders of
the newly formed business.
b) contracting out
Contracts are signed with private businesses to carry out a task previously supplied by a
government organisation.
D) CONSEQUENCE OF PRIVATISATION J / L
a) consumers J
Consumers try to buy the best quality at the lowest price and switch to the cheapest
product.
9 private businesses face competition (= rivalry from other businesses)
9 they will avoid waste and supply goods that match demand at the lowest price
LIMIT
In markets without competition, a business being the sole supplier can charge higher prices
as consumers find no substitutes.
21
b) workers L
When businesses are privatised, they are often restructured to reduce the costs and many
workers may be laid off in order to reduce the wages to pay.
LIMIT
Businesses lose experienced workers and efficiency or quality may decline.
c) businesses J
Investors are likely to invest in the business in order to introduce new technologies.
LIMIT
Investors may be averse to risk and only seek their share of profit.
d) government L
The government may find it difficult to control privatised industries when it comes to
limiting polluting activities or improving work conditions.
SOLUTION
New legislations may be passed.
22
13. EXTERNALITIES
a) private costs
Private costs are the costs registered and paid by firms when they produce goods and
services
External costs are spillover effects that impact third parties: individuals are impacted by
negative consequences coming from production decisions made by businesses.
c) social costs
a) private benefits
Private benefits are the benefits felt by consumers relating to the satisfaction of consuming
goods and services.
External benefits are spillover effects that impact third parties: individuals are impacted by
positive consequences coming from consumption decisions made by individuals.
c) social benefits
23
C) GOVERNMENT POLICIES TO DEAL WITH EXTERNALITIES
a) taxes
Taxes reduce the purchase of goods with negative externalities as their price increases.
LIMITS
The efficiency of the government intervention depends on price elasticity of demand of the
taxed goods.
b) subsidies
Subsidies increase the purchase of goods with positive externalities as their price decreases.
LIMITS
The efficiency of the government intervention depends on price elasticity of supply of the
taxed goods. Businesses may not pass on the decrease in production costs to the consumers.
The government may pass laws in order to forbid or limit activities with external costs and
fine businesses that do not comply.
LIMITS
There is an opportunity cost to tracking businesses that do not comply.
d) polluting permits
The government may decide to issue polluting permits that can be traded among firms if left
unused.
LIMIT
The government may find it difficult to set the maximum limit allowed.
24