Microeconomics – F851 OCR.
The Reasons for Individuals, Organisations & Societies having to Make
Choices
The economic problem is there are scarce resources in relation to unlimited wants. (2 mark definition)
The four factors of production are; land, labour, capital and enterprise.
Specialisation can be used to address the problem of scarcity in the sense; as regions specialise, more
output can be produced, meeting more wants. Surpluses can be traded (creating dependency).
Opportunity cost is the cost of the next best alternative forgone. (2 mark definition)
The PPC/PPF/PTC shows the maximum combination of goods. As you produce more of one good, the
opportunity cost is the other good. Convex shape. Economic growth will shift curve outwards.
Competitive Markets & How They Work
A competitive market is a market that operates through the laws of supply & demand.
Consumer surplus: the difference Producer surplus: the difference
between the price that customers are between the price that suppliers are
willing to pay, & the price that they willing to sell at, & the price actually
actually pay. charged.
Factors effecting demand; price, price of substitutes & compliments, income, advertising, tastes/trends,
addictiveness
Movement up the curve [expansion of supply] means a higher price, movement down the curve
[contraction of supply] means lower price.
Factors effecting supply; changes in costs, legislation
%ΔQD/S
Price elasticity of demand/supply; how responsive demand/supply is to a change in price. /%ΔP
%ΔQD
Income elasticity of demand; how responsive demand is to a change in income. YED = /%ΔY
Cross elasticity of demand; how responsive demand for one product is to a change in price of another.
%ΔQD of GOOD A
/%ΔP of GOOD B; positive for substitutes, negative for compliments. Higher the number, the
stronger the relationship.
Factors effecting PED; addictiveness, proportion of real/disposable income, availability of substitutes
Business relevance of elasticity; set a price, ways to increase revenue (inelastic – lower price and vice versa),
luxury/normal good/inferior good (-YED)/necessity, as income rises demand for normal goods increase, set
pricing structures (bundling), however only estimates (inaccurate data leads to inaccurate elasticity co-
efficient)
Market equilibrium = where demand meets supply.
Market Failure & Government Intervention
Markets fail when there is a misallocation of scarce resources in the market. Economic efficiency isn’t being
met. Due to: +/- externalities, de/merit goods, information failure, public goods
Negative/positive externalities are costs/benefits imposed upon a third party who aren’t directly involved
in a decision making process
Externalities & market failure: consumers/producers fail to take into account the full social costs of their
actions; therefore there will be over/under-production/consumption. This represents a misallocation of
scarce resources as too many/too few are being devoted to the production of these goods . Thus, there is
allocative efficiency.
Internalising the externalities: making the externality part of the price. Eg. Externalising the externality of
petrol.. tax the good (to the level of welfare loss), this will successfully internalise the externality.
Socials costs/benefits: the total cost/benefit arising from a particular decision
Private costs/benefits: the costs/benefits that accrue to an individual/firm
External costs/benefits: social costs/benefits exceed private costs/benefits. Costs/benefits upon the third
party.
+/- externalities: | Merit/demerit goods:
Divergence between private/social costs/benefits Due to a lack of information
Not reflected in price People do not perceive full costs/benefits
Over/under produced and consumed Over/under produced and consumed
External costs = neg. externality & vice versa
Both lead to a misallocation of scarce resources. The free market will lead to either too much/too little
production. Allocative inefficiency. MARKET FAILURE.
Information failure: lack of how good/bad a product or service is for you, hence insufficient demand will be
registered in the free market. Demand is below optimum level – the market has failed.
Merit good: positive externalities. People do not perceive the full benefits. Under-consumed. Eg. Education.
Demerit good: negative externalities. People do not perceive the full costs. Over-consumed. Eg. Cigs.
Public good: non-excludable (cannot stop being provided to everyone). Non-rival (if one person consumes it,
it doesn’t stop other people). Eg. Streetlighting.
Quasi-public: kinda public, but not fully. Eg. Beach – can get crowded (rival).
Public goods and market failure: not provided at all. Free riding (people want to benefit from other people
purchasing the good). There is however demand. Free market doesn’t guarantee production.
Why do governments intervene?: to achieve economic efficiency & the achieve a fair or equitable
distribution of resources in the economy.
Method of intervention: Advantages: Disadvantages:
Indirect taxation – ∑ Deter demand as price increases ∑ In order to prevent government failure,
taxing firms who ∑ Firms are forced to reduce supply, the tax must equal external cost
produce demerit goods. solving over-production ∑ Tax can be inflationary and reduce real
De-merit goods are ∑ Costs of production are raised, shifting GDP
overproduced the supply curve ∑ Restricts economics growth –
(imperfect information) ∑ Reduces firm’s profit margin – stop unemployment
so production needs to producing the good if it gets too low? ∑ Inelastic demand products can increase
decrease to social ∑ Allocative efficiency price to pass the cost onto customers
optimum. ∑ Internalises the externality & thus (polluter doesn’t pay)
correct the misallocation of resources ∑ Relocate abroad (tax-less)
∑ Taxes on necessities may be regressive
Subsidies – subsidising ∑ Control inflation rates ∑ Opportunity cost of dishing out money
production of merit ∑ Boost living standards of some groups to groups
goods. Payment to ∑ Encourage consumption of merit ∑ Which groups should receive the
producers to decrease goods with positive externalities subsidy? – fairness + equity
their costs & increase ∑ Increase social benefits ∑ Alternatives – income support through
output ∑ Improve under-consumption of merit tax system
goods to create allocative efficiency ∑ People may not benefit from subsidy –
∑ Boost employment of LT unemployed yield no satisfaction
Regulation ∑ Restrict amount of –ext produced ∑ Not always enforceable
∑ Fine companies – lots of money ∑ Need evidence to prove breaking of law
Polluter permits ∑ Tradable between firms ∑ Monopoly can buy them all out
∑ Encourages less pollution if firms have ∑ Encourage businesses to travel
an incentive to make money elsewhere
∑ Limits amount of neg ext (pollution)
State provision of public ∑ Ensures provision ∑ Expensive for govt
goods ∑ Meets demand ∑ No profit motive; not as efficient
Provision of information ∑ Correct level of demand would be ∑ Must ensure information is
registered correct/suitable/cheap or free
∑
Definitions (other):
Allocative efficiency: is achieved when the value consumers place on a good or service (reflected in the
price they are willing to pay) equals the cost of the resources used up in production. Condition required is
that price = marginal cost. When this condition is satisfied, total economic welfare is maximised. When you
get goods that have negative externalities, the market price is not reflective of the true social costs. So if
allocative efficiency was truly achieved, the price of the goods with negative externalities would be the
private costs + the social costs (ie the damage caused to a third party, e.g. the environment). Things are
being produced that people want.
Economies of scale: is when costs fall in the long run due to an increased scale of operation. Examples
included; bulk buying materials, division of labour, technological advancements
Pareto efficiency: where it is not possible to make someone in society better off without making someone
else worse off
Productive efficiency: where production is at the possible cost. Using the least amount of scarce resources
to produce a product.
