Theme 1: Introduction to markets and market failure
1.1 Nature of Economics
1.1.1 Economics as a social science
Microeconomics examines decisions made by economic agent – separated into two broad areas:
markets and market failure
Micro Economics Macro Economics
Individuals Economy of a country
Firms Global Economy
Individual Markets
a) Thinking like an economist: the process of developing models in economics, including the need
to make assumptions
Social science (broadest sense) – study of society and the manner in which people behave and
influence the world around us – seeks to explain human behaviour through models
Economic model seeks to explain how people will generally behave in certain circumstances
These models are used to predict patterns of future behaviour by considering how one variable
(government policy) can influence another variable (smoking habits)
b) The use of the ceteris paribus assumption in building models
Ceteris Paribus – All other things being equal
c) The inability in economics to make scientific experiments
Important character in economics is behaving rationally (taking account of all available information
and making a decision accordingly) and irrationally (opposite) – this debate is explored by
behavioural economics – uses both economics and psychology to try and explain human actions
Most sciences allow for laboratory testing, social sciences are different as economic agents like
households and firms make decisions against backdrop of constant changes in mood, perception
and finances
Economists unable to emulate laboratory conditions so they make ceteris paribus assumption –
allows them to generalise economic predictions (can weaken it too as everything else isn’t actually
equal)
1
,1.1.2 Positive and normative economic statements
a) Distinction between positive and normative economic statements
Statement 1: Michael Gove’s decision to abandon January exams will lead to a fall in the average
grade at A-level. (Positive)
Statement 2: Michael Gove’s decision to abandon January exams should be reversed. (Normative)
Positive Statements Normative Statements
Objective Subjective
Verifiable (Can be tested) – Most important indicator Non Verifiable (Cannot be tested)
of a positive statement.
Aren’t necessarily true – but can be tested for truth Based on a value judgement (‘opinion’ cannot be
used
Statement Positive or Why?
Normative
The Government should target poverty by Normative Subjective statement – non verifiable and based on
switching to means-tested benefits. the value judgement of the person writing the
statement
A rise in the sterling exchange rate should lead to Positive Objective statement based on the fact that increased
a decrease in the rate of inflation. sterling exchange rates cause a decreased rate of
inflation and it comes from an objective level.
The National Minimum Wage should be raised Normative It is subjective on the persons value judgement on
from £5 per hour for all workers. what workers should earn and it is non verifiable.
The Introduction of a London Congestion Charge is Positive It is an objective statement which can be verified
unlikely to change motorists’ behaviour when through proof of motorists’ behaviour not changing.
deciding whether or not to use their car at peak
times.
The Bank of England should cut interest rates to Normative The person is using their own value judgement in
stimulate recovery in manufacturing order to test a non verifiable outcome.
A reduction in income taxes for low income Positive This statement can be verified and this is based on
families will improve the incentive to work and fact.
therefore reduce unemployment
The Government should abolish inheritance tax Normative Clearly based on a value judgement
The European Single Currency ought to lead to a Positive It is verifiable and it is based on fact
reduction in pure differentials between the UK and
other European countries.
A rise in the price of petrol will lead to an increase Positive It is verifiable and based on previous experiences we
in the demand for rail transport know this is true.
The Government should extend the principle that Normative It is based on the value judgement of the person who
patients should pay for many of the health has written this statement.
treatments they receive under the NHS
Ignoring Brexit vote would be outrage Normative
If UK votes leave in Brexit, pound sterling will likely Positive
tumble
b) The role of value judgements in influencing economic decision making and policy
Value judgments can influence economic decision making and policy. Different economists make
different judgments from same statistic – E.g. rate of inflation can give rise to different conclusions
2
,1.1.3 The economic problem
a) The problem of scarcity – where there are unlimited wants and finite resources
Difference between needs and wants
Less of what we need than what we want
“Needs refer to the minimum that is required for an individual in order to survive. They often tend
to include food, water and shelter and are used to measure poverty”
“Wants refer to the desires by individuals of the consumption of goods and services. Economists
believe that individual wants are unlimited”
The Basic Economic Problem
“We have unlimited wants for limited resources – scarcity exists”
3
,b) The distinction between renewable and non-renewable resources
An economy converts inputs or factors of production into output (goods and services)
Factors of Production: Land
Includes land where natural resources are found (like oil and fertile soil), land where goods are
produced and land that factories or shops are built on. Sea would also come under this category.
Factor of Production: Labour
Human input into production process – labour referred to as human capital (skills that individuals
possess). Workforce of economy
Factors of Production: Capital
Refers to machinery, technology, transport and infrastructure used to produce goods and service –
stock of (physical) capital increases through investment
Factor of production: Entrepreneurship
Refers to individual that organises and manages land, labour and capital in order to produce goods
and services – they take risks in order to make profit
Land Labour Capital Entrepreneurship
University University land, campus Professors Books, projectors, Dean
of Oxford library etc.
Starbucks Coffee fields, factories, Employees, Transportation of CEO
store location and factory coffee, coffee
coffee beans workers machines
Payments Rent Wages Interest Profit
Resources are limited – only a fixed amount of land, people, machinery and managerial expertise at
any point in time
If an economy increases their resource stock by developing their own factors or stealing someone
else’s – resources available will always be outstripped by wants and needs of the population
Resources can be divided into renewable and non-renewable:
Renewable resources include wind and tidal power – the use of these resources doesn’t reduce
amount available in future – use is regarded as sustainable
Non-renewable resources include fossil fuels and wood – fixed supply of these resources and once
used up, no more available – use is regarded as unsustainable. But, some of these resources can be
replenished if used in a sustainable way. This reduces production and consumption in the long run
4
,c) The importance of opportunity costs to economic agents (consumers, producers and
government)
Economic agents (governments, firms and individuals) are forced to make choices or decisions.
3 main decisions to make:
• What to produce?
• How to produce it?
• For whom to produce it for?
Decisions for these economic agents
Households Firms Government
Bills Profit Trading
Basic necessities Employees (wage, sackings) Healthcare
Mortgages Budgeting employees Safe spending
Insurance Defence
Opportunity cost is important to economic agents (consumers, producers and governments)
Opportunity cost is the value of the next best alternative that is forgone
Cannot do both because of finite resources, so choice is made for where resources are best spent
Producers (Firms) Consumers ( Households) Governments
Producers have to choose between Households allocate Government have to choose
hiring extra staff and investing in a limited income between between spending more on NHS
new machine consumption of different and spending more on
goods and services, and education.
They must decide how best they consider when to use
should use their space, capital, their time for leisure, for Governments must set priorities
financial budgets and the goodwill of study or for work for spending and legislation
their staff
If you were to study Economics at AS level, it means you cannot study French, Politics, Biology or
whatever your other fourth choice would’ve been. If you were torn between Economics and Biology
then the opportunity cost of opting for Economics is all the pleasure and knowledge you would’ve
derived from opting for Biology
5
,1.1.4 Production possibility frontiers
a) The use of production possibility frontiers to depict:
Economic growth or decline
The maximum productive potential of an economy
In most simplistic economy – we assume there are only 2 produced goods, a raft and food
PPF shows maximum potential output of an economy when all its resources are fully employed
Opportunity cost (through marginal analysis)
In diagram beside – an increase in production of
butter from A to B implies the maximum output of
drums falls from C to D. So, the opportunity cost of
AB more butter is CD fewer drums. As economy
produces higher levels of butter, the opportunity
cost of drums rises.
In diagram beside – increases in butter of AB and
BC causes different responses in terms of the
number of drums foregone; although AB and BC
are identical changes, CD is smaller than DE
6
,Efficient or inefficient allocation of resources
PPFs can be curved in nature due to law of diminishing marginal returns – due to opportunity cost
Shape is explained by changes in trade-off between two goods as an economy specialises
production in one industry
Factors of production in an economy are better suited to one industry than another, so when the
output of one industry (butter) approaches its maximum the extra land, labour and capital used will
be taken from the other industry (drums)
Resources are less efficient at producing butter than they were at making drums, so increase in
butter production is lower than the fall in drums
So as output of a good approaches maximum level – opportunity cost of any extra output will
increase
Law of DMR: As you add more units to the production of a good or service, its output will increase
at a decreasing rate (graph)
Possible and unobtainable production
Inefficient: Not all factors of production are being fully employed or utilised (no opportunity cost)
Efficiency: All factors of production are being employed or utilised to their full potential
Unattainable: Given the factors of production that we have available
7
,b) The distinction between movements along and shifts in production possibility curves,
considering the possible causes for such changes
Production Possibility Frontier shifts
PPF can depict economic growth or decline
Economic growth shown by an outward shift in PPF
An increase in quality and quantity of resources and factors of production causes productive
potential of the economy to increase – economic growth
Firm (Micro) Economy (Macro)
Employs more workers/ offers training to Population growth/immigration and improved
existing workers education system
Buys more machinery and equipment/ buys Greater investment by firms into machinery/
better quality machinery and equipment better technology
Expands its offices or site
Economic decline shown by an inward shift in PPF
A decrease in quality and quantity of resources and factors of production causes productive
potential of the economy to decrease – economic decline
Shifting PPF curve uses either more/less resources or resources of a greater/lesser quality
Reduces opportunity cost of producing either capital or consumer goods, since more goods can be
produced overall
Movement along
Movement along PPF uses same number and state of resources
E.g. shifts production from fewer consumer goods to more capital goods – incurs opportunity cost
c) The distinction between capital and consumer goods
Capital good – any good deployed to help increase future production – most common capital
goods are property, plant and equipment, or PP&E.
Consumer goods – any goods that aren’t capital goods; goods used by consumers – no future
productive use
8
,1.1.5 Specialisation and the division of labour
a) Specialisation and the division of labour: reference to Adam Smith
Specialisation refers to individuals, firms or an economy deciding to focus on the production of one
good or part of a good – It generally increases productivity
Division of labour refers to the process of splitting up the production process and allocating each
task to a different worker
b) The advantages and disadvantages of specialisation and the division of labour in organising
production
c) The advantages and disadvantages of specialising in the production of goods and services to
trade
Advantages Disadvantages
Individual By repeating tasks you should become Monotony of tasks after doing it
better and more experienced, increasing repeatedly, could become less productive
productivity and output
Structural unemployment due to lack of
You will receive a minimum range of flexibility to undertake different roles
skills to undertake the tasks within firm and alternative career paths
Firm Output of firm should increase and cost Staff turnover high due to monotonous
per unit should fall as factors of nature of the job
production are put to their most
productive use Difficult to co-ordinate products on as the
firm expands
Training costs and time for firm reduced
as workers only have to learn one trade
Changes in consumer demand may leave
Firms can invest in capital goods – may specialised firms with unwanted output
only be relevant to their own industry, and thus unprofitable capital and labour
further increasing labour productivity
d) The functions of money (as a medium of exchange, a measure of value, a store of value, a
method of deferred payment)
Store of value Measure of Value/ Medium of exchange Standard of deferred
Unit of account payment
Money can be spent or Money is a Money allows Refers to expressing
saved (value of it can be standardised unit of consumers and of the value of a debt
retrieved at a later date) measurement of the producers to i.e. if people borrow
individuals may decide to value of a good or exchange goods and today, they can pay
save it in order to service and allows us services in a back their loan in
smooth spending over to compare the value conventional way to future in a way that’s
time. Minus inflation it of a good or service avoid the double acceptable to the
keeps the same value for and transactions are coincidence of wants. person who made the
years easier for different It makes transactions loan.
things. easier to conduct
9
, 1.1.6 Free market economies, mixed economy and command economy
a) The distinction between free market, mixed and command economies: reference to Adam
Smith, Friedrich Hayek and Karl Marx
Free market Economy Mixed Economy Command/ Planned Economy
E.g. Singapore – although the E.g. UK, USA E.g. North Korea
state still has a role
Limited role of state – forces of Mixture of government Large role for state – owns
supply and demand lead to intervention and a market means of production
allocation of resources system
Market will regulate itself via Private ownership of means of State decides what is
invisible hand – decides what’s production with regulation produced, how it is produced
morally right from state and for whom to produce it for
(Economic Problem)
Associated with capitalism Association with capitalism Associated with Communism
(purest form) (real world form)
“Invisible hand” – metaphor for Allowing demand and supply to State will decide wages of
how, in a free market economy, influence prices creates workers and price of goods and
self-interested individuals incentives for entrepreneurs to services
operate through a system of innovate and compete
mutual interdependence to
promote the general benefit of
society at large
In some markets a value
judgement is made that partial
or total intervention is
required – typically in markets
of education, healthcare,
transport, law and order and
emergency services
10
1.1 Nature of Economics
1.1.1 Economics as a social science
Microeconomics examines decisions made by economic agent – separated into two broad areas:
markets and market failure
Micro Economics Macro Economics
Individuals Economy of a country
Firms Global Economy
Individual Markets
a) Thinking like an economist: the process of developing models in economics, including the need
to make assumptions
Social science (broadest sense) – study of society and the manner in which people behave and
influence the world around us – seeks to explain human behaviour through models
Economic model seeks to explain how people will generally behave in certain circumstances
These models are used to predict patterns of future behaviour by considering how one variable
(government policy) can influence another variable (smoking habits)
b) The use of the ceteris paribus assumption in building models
Ceteris Paribus – All other things being equal
c) The inability in economics to make scientific experiments
Important character in economics is behaving rationally (taking account of all available information
and making a decision accordingly) and irrationally (opposite) – this debate is explored by
behavioural economics – uses both economics and psychology to try and explain human actions
Most sciences allow for laboratory testing, social sciences are different as economic agents like
households and firms make decisions against backdrop of constant changes in mood, perception
and finances
Economists unable to emulate laboratory conditions so they make ceteris paribus assumption –
allows them to generalise economic predictions (can weaken it too as everything else isn’t actually
equal)
1
,1.1.2 Positive and normative economic statements
a) Distinction between positive and normative economic statements
Statement 1: Michael Gove’s decision to abandon January exams will lead to a fall in the average
grade at A-level. (Positive)
Statement 2: Michael Gove’s decision to abandon January exams should be reversed. (Normative)
Positive Statements Normative Statements
Objective Subjective
Verifiable (Can be tested) – Most important indicator Non Verifiable (Cannot be tested)
of a positive statement.
Aren’t necessarily true – but can be tested for truth Based on a value judgement (‘opinion’ cannot be
used
Statement Positive or Why?
Normative
The Government should target poverty by Normative Subjective statement – non verifiable and based on
switching to means-tested benefits. the value judgement of the person writing the
statement
A rise in the sterling exchange rate should lead to Positive Objective statement based on the fact that increased
a decrease in the rate of inflation. sterling exchange rates cause a decreased rate of
inflation and it comes from an objective level.
The National Minimum Wage should be raised Normative It is subjective on the persons value judgement on
from £5 per hour for all workers. what workers should earn and it is non verifiable.
The Introduction of a London Congestion Charge is Positive It is an objective statement which can be verified
unlikely to change motorists’ behaviour when through proof of motorists’ behaviour not changing.
deciding whether or not to use their car at peak
times.
The Bank of England should cut interest rates to Normative The person is using their own value judgement in
stimulate recovery in manufacturing order to test a non verifiable outcome.
A reduction in income taxes for low income Positive This statement can be verified and this is based on
families will improve the incentive to work and fact.
therefore reduce unemployment
The Government should abolish inheritance tax Normative Clearly based on a value judgement
The European Single Currency ought to lead to a Positive It is verifiable and it is based on fact
reduction in pure differentials between the UK and
other European countries.
A rise in the price of petrol will lead to an increase Positive It is verifiable and based on previous experiences we
in the demand for rail transport know this is true.
The Government should extend the principle that Normative It is based on the value judgement of the person who
patients should pay for many of the health has written this statement.
treatments they receive under the NHS
Ignoring Brexit vote would be outrage Normative
If UK votes leave in Brexit, pound sterling will likely Positive
tumble
b) The role of value judgements in influencing economic decision making and policy
Value judgments can influence economic decision making and policy. Different economists make
different judgments from same statistic – E.g. rate of inflation can give rise to different conclusions
2
,1.1.3 The economic problem
a) The problem of scarcity – where there are unlimited wants and finite resources
Difference between needs and wants
Less of what we need than what we want
“Needs refer to the minimum that is required for an individual in order to survive. They often tend
to include food, water and shelter and are used to measure poverty”
“Wants refer to the desires by individuals of the consumption of goods and services. Economists
believe that individual wants are unlimited”
The Basic Economic Problem
“We have unlimited wants for limited resources – scarcity exists”
3
,b) The distinction between renewable and non-renewable resources
An economy converts inputs or factors of production into output (goods and services)
Factors of Production: Land
Includes land where natural resources are found (like oil and fertile soil), land where goods are
produced and land that factories or shops are built on. Sea would also come under this category.
Factor of Production: Labour
Human input into production process – labour referred to as human capital (skills that individuals
possess). Workforce of economy
Factors of Production: Capital
Refers to machinery, technology, transport and infrastructure used to produce goods and service –
stock of (physical) capital increases through investment
Factor of production: Entrepreneurship
Refers to individual that organises and manages land, labour and capital in order to produce goods
and services – they take risks in order to make profit
Land Labour Capital Entrepreneurship
University University land, campus Professors Books, projectors, Dean
of Oxford library etc.
Starbucks Coffee fields, factories, Employees, Transportation of CEO
store location and factory coffee, coffee
coffee beans workers machines
Payments Rent Wages Interest Profit
Resources are limited – only a fixed amount of land, people, machinery and managerial expertise at
any point in time
If an economy increases their resource stock by developing their own factors or stealing someone
else’s – resources available will always be outstripped by wants and needs of the population
Resources can be divided into renewable and non-renewable:
Renewable resources include wind and tidal power – the use of these resources doesn’t reduce
amount available in future – use is regarded as sustainable
Non-renewable resources include fossil fuels and wood – fixed supply of these resources and once
used up, no more available – use is regarded as unsustainable. But, some of these resources can be
replenished if used in a sustainable way. This reduces production and consumption in the long run
4
,c) The importance of opportunity costs to economic agents (consumers, producers and
government)
Economic agents (governments, firms and individuals) are forced to make choices or decisions.
3 main decisions to make:
• What to produce?
• How to produce it?
• For whom to produce it for?
Decisions for these economic agents
Households Firms Government
Bills Profit Trading
Basic necessities Employees (wage, sackings) Healthcare
Mortgages Budgeting employees Safe spending
Insurance Defence
Opportunity cost is important to economic agents (consumers, producers and governments)
Opportunity cost is the value of the next best alternative that is forgone
Cannot do both because of finite resources, so choice is made for where resources are best spent
Producers (Firms) Consumers ( Households) Governments
Producers have to choose between Households allocate Government have to choose
hiring extra staff and investing in a limited income between between spending more on NHS
new machine consumption of different and spending more on
goods and services, and education.
They must decide how best they consider when to use
should use their space, capital, their time for leisure, for Governments must set priorities
financial budgets and the goodwill of study or for work for spending and legislation
their staff
If you were to study Economics at AS level, it means you cannot study French, Politics, Biology or
whatever your other fourth choice would’ve been. If you were torn between Economics and Biology
then the opportunity cost of opting for Economics is all the pleasure and knowledge you would’ve
derived from opting for Biology
5
,1.1.4 Production possibility frontiers
a) The use of production possibility frontiers to depict:
Economic growth or decline
The maximum productive potential of an economy
In most simplistic economy – we assume there are only 2 produced goods, a raft and food
PPF shows maximum potential output of an economy when all its resources are fully employed
Opportunity cost (through marginal analysis)
In diagram beside – an increase in production of
butter from A to B implies the maximum output of
drums falls from C to D. So, the opportunity cost of
AB more butter is CD fewer drums. As economy
produces higher levels of butter, the opportunity
cost of drums rises.
In diagram beside – increases in butter of AB and
BC causes different responses in terms of the
number of drums foregone; although AB and BC
are identical changes, CD is smaller than DE
6
,Efficient or inefficient allocation of resources
PPFs can be curved in nature due to law of diminishing marginal returns – due to opportunity cost
Shape is explained by changes in trade-off between two goods as an economy specialises
production in one industry
Factors of production in an economy are better suited to one industry than another, so when the
output of one industry (butter) approaches its maximum the extra land, labour and capital used will
be taken from the other industry (drums)
Resources are less efficient at producing butter than they were at making drums, so increase in
butter production is lower than the fall in drums
So as output of a good approaches maximum level – opportunity cost of any extra output will
increase
Law of DMR: As you add more units to the production of a good or service, its output will increase
at a decreasing rate (graph)
Possible and unobtainable production
Inefficient: Not all factors of production are being fully employed or utilised (no opportunity cost)
Efficiency: All factors of production are being employed or utilised to their full potential
Unattainable: Given the factors of production that we have available
7
,b) The distinction between movements along and shifts in production possibility curves,
considering the possible causes for such changes
Production Possibility Frontier shifts
PPF can depict economic growth or decline
Economic growth shown by an outward shift in PPF
An increase in quality and quantity of resources and factors of production causes productive
potential of the economy to increase – economic growth
Firm (Micro) Economy (Macro)
Employs more workers/ offers training to Population growth/immigration and improved
existing workers education system
Buys more machinery and equipment/ buys Greater investment by firms into machinery/
better quality machinery and equipment better technology
Expands its offices or site
Economic decline shown by an inward shift in PPF
A decrease in quality and quantity of resources and factors of production causes productive
potential of the economy to decrease – economic decline
Shifting PPF curve uses either more/less resources or resources of a greater/lesser quality
Reduces opportunity cost of producing either capital or consumer goods, since more goods can be
produced overall
Movement along
Movement along PPF uses same number and state of resources
E.g. shifts production from fewer consumer goods to more capital goods – incurs opportunity cost
c) The distinction between capital and consumer goods
Capital good – any good deployed to help increase future production – most common capital
goods are property, plant and equipment, or PP&E.
Consumer goods – any goods that aren’t capital goods; goods used by consumers – no future
productive use
8
,1.1.5 Specialisation and the division of labour
a) Specialisation and the division of labour: reference to Adam Smith
Specialisation refers to individuals, firms or an economy deciding to focus on the production of one
good or part of a good – It generally increases productivity
Division of labour refers to the process of splitting up the production process and allocating each
task to a different worker
b) The advantages and disadvantages of specialisation and the division of labour in organising
production
c) The advantages and disadvantages of specialising in the production of goods and services to
trade
Advantages Disadvantages
Individual By repeating tasks you should become Monotony of tasks after doing it
better and more experienced, increasing repeatedly, could become less productive
productivity and output
Structural unemployment due to lack of
You will receive a minimum range of flexibility to undertake different roles
skills to undertake the tasks within firm and alternative career paths
Firm Output of firm should increase and cost Staff turnover high due to monotonous
per unit should fall as factors of nature of the job
production are put to their most
productive use Difficult to co-ordinate products on as the
firm expands
Training costs and time for firm reduced
as workers only have to learn one trade
Changes in consumer demand may leave
Firms can invest in capital goods – may specialised firms with unwanted output
only be relevant to their own industry, and thus unprofitable capital and labour
further increasing labour productivity
d) The functions of money (as a medium of exchange, a measure of value, a store of value, a
method of deferred payment)
Store of value Measure of Value/ Medium of exchange Standard of deferred
Unit of account payment
Money can be spent or Money is a Money allows Refers to expressing
saved (value of it can be standardised unit of consumers and of the value of a debt
retrieved at a later date) measurement of the producers to i.e. if people borrow
individuals may decide to value of a good or exchange goods and today, they can pay
save it in order to service and allows us services in a back their loan in
smooth spending over to compare the value conventional way to future in a way that’s
time. Minus inflation it of a good or service avoid the double acceptable to the
keeps the same value for and transactions are coincidence of wants. person who made the
years easier for different It makes transactions loan.
things. easier to conduct
9
, 1.1.6 Free market economies, mixed economy and command economy
a) The distinction between free market, mixed and command economies: reference to Adam
Smith, Friedrich Hayek and Karl Marx
Free market Economy Mixed Economy Command/ Planned Economy
E.g. Singapore – although the E.g. UK, USA E.g. North Korea
state still has a role
Limited role of state – forces of Mixture of government Large role for state – owns
supply and demand lead to intervention and a market means of production
allocation of resources system
Market will regulate itself via Private ownership of means of State decides what is
invisible hand – decides what’s production with regulation produced, how it is produced
morally right from state and for whom to produce it for
(Economic Problem)
Associated with capitalism Association with capitalism Associated with Communism
(purest form) (real world form)
“Invisible hand” – metaphor for Allowing demand and supply to State will decide wages of
how, in a free market economy, influence prices creates workers and price of goods and
self-interested individuals incentives for entrepreneurs to services
operate through a system of innovate and compete
mutual interdependence to
promote the general benefit of
society at large
In some markets a value
judgement is made that partial
or total intervention is
required – typically in markets
of education, healthcare,
transport, law and order and
emergency services
10
