Edexcel A Level Economics B 1.1 questions and answers

1.1.1 - The Economic Problem The basic economic problem Scarcity - unlimited wants and finite resources, so choices have to be made. Resources have to be used and distributed optimally. Scarcity refers to the shortage of resources in relation to the quantity of human wants. Scarcity Example For example, if you only have £1 and you go to a shop, you can buy either the chocolate bar or the packet of crisps. The scarcity of the resource (the money) means a choice has to be made between the chocolate and the crisps. Opportunity Cost Cost of the next best alternative use of money, time, or resources when one choice is made rather than another. In the £1 example, the opportunity cost of choosing the crisps is the chocolate bar. Example of opportunity cost If a car was bought for £15,000 and after 5 years the value depreciates by £5,000, the opportunity cost of keeping the car is £5,000 (which could have been gained by selling the car), regardless of the starting price. Who is opportunity cost important to and why? Opportunity cost is important to economic agents, such as consumers, producers and governments. For example, producers might have to choose between hiring extra staff and investing in a new machine. The government might have to choose between spending more on the NHS and spending more on education. They cannot do both because of finite resources, so a choice has to be made for where resources are best spent. Trade-off When looking at a balance between 2 choices, choosing more of one than the other. When producing goods, what does the economy need to consider? What to produce: determined by what the consumer prefers. Consumers tell producers what they prefer by demanding goods and using their 'spending votes' and demanding certain goods. How to produce it: producers seek profits and aim to minimise production costs. Positive Statements Testable as factual or false, normally based on observation or evidence. Normative Statements (AKA value judgements) Statements about the economy which depend on opinion and judgement. Often involve ideas on what should be done. 1.1.2 - Business Objectives Entrepreneurs Individuals who set up in business, accepting risks involved, taking decisions about what to produce and how, and working out how to market the product. Profit Maximisation Making as much profit as possible in a given time period. A firm profit maximises when they are operating at the price and output which derives the greatest profit. Profit maximisation occurs where marginal cost (MC) = marginal revenue (MR). In other words, each extra unit produced gives no extra loss or no extra revenue. Models that consider the traditional theory of the firm are based upon the assumption that firms aim to maximise profits. Profit is the difference between total revenue (TR) and total cost (TC). It is the reward that entrepreneurs yield when they take risks. Firms break even when TR = TC. Why do some firms choose to profit maximise? - It provides greater wages and dividends for entrepreneurs - Retained profits are a cheap source of finance, which saves paying high interest rates on loans - In the short run, the interests of the owners or shareholders are most important, since they aim to maximise their gain from the company. - Some firms might profit maximise in the long run since consumers do not like rapid price changes in the short run, so this will provide a stable price and output. Why are PLCs particularly keen to profit maximise? They could lose their shareholders if they do not receive a high dividend. They are more likely to have short run profit maximisation as an objective, because they need to keep their shareholders happy. Sales Maximisation When the firm aims to sell as much of their goods and services as possible without making a loss. Not-for-profit organisations might work at this output and price. This is where average costs = average revenue. Example of sales maximisation Amazon's Kindle launch: They sold as many Kindles as possible to gain market share, so they can earn more profits in the long run. It helps keep out and deter competitors. Satisficing Reaching a good enough profit level, without maximising. Survival Some firms, particularly new firms entering competitive markets, might aim to simply survive in the market. (Short term view.) Example of Surivival During periods of economic decline such as the 2008 financial crisis, when consumer spending plummets, firms might have survival as their objective, until there is economic growth again. Firms might aim to sell as much as possible to keep their market position, even if it is at a loss in the short run. Market Share A company's product sales as a percentage of total sales for that industry. This helps increase the chance of surviving in the market, and it can be achieved by maximising sales. Example of Market Share as an objective Amazon aimed to increase their market share in the e-reader market, by trying to sell as many Kindles as possible. They did this at a loss in the short run, but they gained customer loyalty and now they are a leading e-reader producer. Cost Efficiency The more cost efficient a firm is, the lower its average costs. This gives the firm a competitive advantage, since they can afford to charge consumers lower prices. Firms operating in competitive markets will need to be cost efficient to ensure they are not competed out of the market by more efficient producers. Social Objectives Some firms might focus on social welfare and their Corporate Social Responsibility (CSR). They might take responsibility for consequences on the environment and aim to maximise social welfare. Firms might try and perform more ethically, especially if they have a philanthropic owner. Employee Welfare Some firms might try and ensure their employees are well looked-after. When employees are happy, they are more likely to be productive and do a good job. It also increases loyalty towards the employer, so the employee is less likely to leave the job. Google is renowned for their employee perks such as on-site physicians and travel insurance. Customer Satisfaction Firms might aim to increase their competitiveness by improving their quality and increasing their customer satisfaction. Firms might consider improving their customer service or the quality of the good they produce. This could be achieved through innovation. If firms can gain a reputation for high quality goods, they could potentially charge higher prices, since consumers might be willing to pay more for them. 1.1.3 - Stakeholders Economic Agents General term to cover people and organisations involved in economic activity. (Primarily producers and consumers). Stakeholders A stakeholder is anyone with an interest in how a business is run. Shareholders (legal owners of a business) Shareholders want the firm to make a large profit, so the share price increases and the value of their dividend goes up. EXTERNAL Employees They aim for high wages and good working conditions. INTERNAL Consumers They want goods of a high quality and a low price. EXTERNAL Managers They want to earn large bonuses and salaries, as well as personal benefits, such as leisure time and company cars. INTERNAL