The PPC can be shifted outwards when economic growth takes place, due to

technological advancements or an increase in the quality or quantity of

resources in the economy
Once it has shifted outwards, the point Y becomes achievable (and thus the
total output of the economy increases, the reason for economic growth)
If an economy decides to move from point A to point B, an opportunity cost is
involved
While more of Product B is being produced the economy is sacrificing the
opportunity to produce some units of Product A, the opportunity cost
Thus, the PPC is also sometimes called an opportunity cost curve
5 Evaluate the implications of particular courses of action in terms of opportunity
cost
Look at it from these perspectives
o Individual
o Producer
o Government
An individual A might decide to purchase a car, but the opportunity cost to
this decision could be the long holiday with his family that he had been
wanting for quite some while now
A jam producer might decide to move a few of its resources from producing
apricot jam to the production of mixed fruit jam, in which case, while the
output of mixed fruit jam will increase, the opportunity cost will be the loss in
the production of apricot jam
A government might decide to move some of its revenue from subsidising
university students to healthcare, in which case, the healthcare facilities will
probably become better, but the opportunity cost to the government of this
choice will be the loss in subsidy to university students
UNIT 2 The allocation of resources: how the market work; market failure
1 Describe the allocation of resources in market and mixed economic systems
There are three questions which every economy needs to answer
o What to produce?
o How to produce?
o For whom to produce?
In a market economic system, goods and services are freely exchanged
The three questions are answered by the buyers and sellers when they trade in
different goods and services
All the resources are privately owned by firms or people
All these private firms aim for profit
What to produce Since firms aim to make profits, they will move the scarce
resources from the production of goods and services which consumers do not
demand, into the production of those goods and services which they do
demand
Therefore, only those goods and services will be produced which are
demanded for by the consumer.
3 Describe the causes of change in demand and supply conditions and analyse such
changes to show effects in the market
Demand shifts are caused due to various reasons
1. Changes in consumers incomes A rise in incomes will cause an increase
in demand whereas a fall in incomes will cause the demand to fall. The precise
nature of the relationship between incomes and demand will depend upon the
product considered and the levels of consumer income spent on the product. A
rise in incomes might not increase a demand for necessities such as salt or a
cheap product such as newspapers. However, it will cause an increase in the
demand for products such as air travel or taxis. Moreover, some goods are
inferior in nature, which means that as incomes go up, the demand for these
goods decreases. For example, as incomes increase the demand for
matchsticks might decrease as more people are now able to afford the more
expensive option, which is, a lighter.
2. Changes in taxes on incomes Disposable income refer to the amount of
income a consumer has left to spend or save after taxes have been deducted
from it. An increase in taxation rates will mean people have less disposable
income, so the demand will fall. A decrease in taxation rates means higher
disposable incomes, and thus a greater demand.
3. The price and availability of other goods and services Some goods are
complementary in nature since they are in joint demand, that is, to gain utility
out of one of them, the other is required as well. For example, car and petrol or
bread and butter. If the price of a complement of a product falls, the demand
for the complement will rise, and this in turn, will cause the demand for the
actual good to rise as well. Some goods are said to be substitutes, since the
purchase of one can replace the want for the other good or service, in other
words, they give the same utility to consumers. For example, butter is a close
substitute of margarine, and the same can be said for tea and coffee. If the
price of the substitute of a good falls, the demand for the substitute will rise,
and this in turn, will cause the demand for the actual good to fall, as
consumers who previously bought the actual good will switch over to the
substitute, since it is available to them cheaper, and yet, serves the same
purpose as the actual good.
4. Changes in tastes, habits and fashions Consumer tastes and fashion keep
changing, since they may get bored of the old products, and demand for
newer, more innovative products. For example, clothing fashion changes in a
small period of time, and so does hairstyle fashions and so on. A successful
advertising campaign may also increase the demand for the advertised good
and shift its demand outwards.
5. Population Changes An increase in population will increase the demand
for almost all goods and services since the consumer base of the economy is
increasing (so market or aggregate demand is increasing). Change in the
structure of the population will also change demand of certain goods and
services. For example, if the Birth Rate increases and there are more young
infants the demand for formula milk, diapers, nappies etc. will increase, while
at the same time, if the elderly population increases, the demand for walking
sticks, healthcare, spectacles etc. will increase.
6. Other factors such as weather (more demand for ice creams in the summer,
woollen clothes in the winter), advertising etc. to name a few.
There are various factors that affect supply as well
1. Changes in the cost of factors of production This is the biggest
determinant of supply since it includes wages for labour, rent for land, interest
for capital and so on. A rise in the cost of production will cause the profit
margins of the business to decrease, causing a decrease in profits for the
company. For example, the labourers could demand a higher wage, or the raw
materials could become more expensive. Producers in such a situation will
tend to cut back their spending on labour and raw materials, and thus will be
less willing to supply as much of the particular product as they did previously.
Taxes and subsidies by the government can also increase or decrease the cost
of production, and thus affect supply.
2. Changes in the price of other goods and services Price acts as a signal for
producers to move their factors of production to and from production of
different goods and services. In a free market, resources will be allocated to
the production of those goods and services which are the most profitable to
produce. So, if the price of a product falls, profits reduce, and producers move
their resources from producing this good (thus, causing a fall in supply) to
other, more profitable goods (thus, causing an increase in supply).
3. Technological advancements This could mean improvement in the
performance of machines, labour force or better production methods, better
management, quality control etc. Technological advancements, generally,
reduce the cost of production of goods and services, and thus producers
become more willing to produce larger quantities of such goods and services.
Moreover, with technological advancements, efficiency increases, and thus the
output increases, increasing supply of the good.
4. Business optimism and expectations If producers fear that an economic
downturn might be around the bend, they will move their resources to the
production of those goods and services which they believe are going to be
least affected by the recession. For example, expensive cars and holidays often
fare badly during recessions whereas necessities such as bread and butter do
not get affected by much. However, if an economy is recovering, producers
will move their resources into new markets, such as cars, theme parks and so
on, causing an increase in supply for these goods and services.
5. Global factors such as sudden climatic changes, trade sanctions, wars,
political instability, natural disasters etc. can all affect supply.
4 Define price elasticity of demand and supply and perform simple calculations
PED is the responsiveness of demand to a change in price of a particular good
or service.
PES is the responsiveness of supply to a change in the price of a particular
good or service.
PED and PES can be perfectly inelastic (PED = 0), perfectly elastic (infinity),
relatively inelastic (<1), relatively elastic (>1), or unitary elastic (1)
PED PES
5 Demonstrate the usefulness of price elasticity in particular situations, such as in
relation to revenue changes, consumer expenditure
There are various factors that affect PED
1. The number of substitutes If there are many substitutes for a certain
product, the demand for it is likely to be price elastic, since with even a small
change in price, many consumers will prefer to purchase one of the other
substitutes (and thus, there is big fall in quantity demanded). If there are not
many substitutes, the demand is likely to be price inelastic.
2. The period of time If the price of a good or service increases, consumers
will start searching for cheaper substitutes. The longer the time they have, the
more likely they are to find such substitutes. Thus, while in the short run
demand for most products will be price inelastic, in the long run, demand will
become price elastic in most cases.
3. The proportion of income spent on the good or service Goods which cost
very little, and form a small part of consumer expenditure, will be likely to
have an inelastic demand since even if the price does rise by a large amount, it
will only take a little bit extra out of a consumer's income, and thus the
quantity demanded will fall only by a small margin. At the same time, if a
product is very costly, it will have an elastic demand, since even a small rise in
price will mean that consumers will have to spend a lot more, and thus they
may cut their demand (so, quantity demanded falls by a lot)
There are various factors that affect PES
1. Time The supply at any one moment will be fixed since it takes time for
producers to increase their production and procur the required raw materials,
labour etcetera. In this case, the supply will be a straight vertical line, showing
it is perfectly inelastic. In the short run, the supply can be increased by some
amount by employing more labour or by allowing overtime work. This will
only increase the supply slightly since other factors such as capital and land
are fixed in the short run, and thus will limit the increase in supply. The supply
in this case will be relatively inelastic. In the long run, firms can obtain more
of all factors of production and thus increase supply greatly (price elastic)
2. The availability of resources A firm wishing to expand its output needs to
employ more of the factors of production, such as land, labour and enterprise.
If an economy is already operating at its peak efficiency and no resources are
unemployed, firms will find it hard to increase their output. Thus, the supply
of most goods and services in such an economy will be price inelastic.
However, if there is widespresd unemployment of resources such as land or
labour, firms can easily employ more factors of production and increase their
output, making supply of most products in such an economy price elastic.
Effect of PED on total revenue For a product with inelastic demand, an
increase in price will cause a much smaller decrease in quanity demanded.
Total revenue is the price times the quantity, so the total ervenue will increase.
For a product with elastic demand, with an increase in price there will be a
much larger decrease in quantity demanded. Once again, since total revenue is
price into quantity, the total revenue of the firm will fall. Thus, with the
knowledge of the PED of the products they sell, firms can decide whether to
raise or reduce their prices. If the product they sell has an inelastic demand,
they should probably increase the price, whereas if the demand is price elastic,
they should reduce the price as far as possible.
Effect of PED on consumer expenditure Same effect as total revenue since
consumer expenditure too is price into quantity. For example, if an individual
purchases 20 bars of Mars chocolate at SGD 2.00 each, his/her expenditure
will be 20 x 2 = SGD 40
6 Evaluate the merits of the market system
There are many adavantages to the free market system
1. The free market system encourages comepetition and thus, many firms
operate at the same time trying to fulfil consumer wants and gaining a profit at
the same time. With more firms, producing varying products, consumers have
a wide variety of goods and services to choose from to meet their demands.
The quality if these goods and services will also be very good since firms
know that if they compromise on the quality of their product, consumers will
simply move to their competitors, and they will be left without any business.
2. All firms in the market are trying to make profits and thus they will all try
and get a wider consumer base than the other competitors. To do this, firms
will try and sell their product at the cheapest possible price and thus, gain
consumer support and create a brand name. A firm knows that if it charges too
highly, the consumers will not but their products and instead move over to
their competitors products, leaving them without any business.
3. Firms are all looking to maximise profits, so they will not only try and
increase revenue, but also decrease costs as far as possible. To do so, they will
use the most cost-effective method of production, with more machinery and
newer technology, thus resources get used to the fullest. In other words, the
immense competition in a free market economy ensures maximum efficiency
and productivity.
4. A free market responds quickly to consumer's wants and demands since it is
completely controlled by the market forces of demand and supply. A high
demand for a certain good or service, increases its price, which is a signal for
producers to move their scarce resources into the production of this good,
increasing supply, and thus meeting the demands of the consumers.
7 Describe the concept of market failure and explain the reasons for its occurrence
Market failure takes place when the allocation of resources by a free market
economy is not efficient, that is, an economy is not operating at Pareto
optimal, and there is some amount of allocative inefficiency. The community
surplus is not maximisesd, and from societal point-of-view producer surplus is
not equal to community surplus.
There are various ways in which market failure can take place
1. Can lead to widespread unemployment Since profit is the man aim of
firms in a market economy, they will only employ factors of production if it is
profitable to do so. If a profitable use cannot be found, the factor of production
will be unemployed. Labour is just another factor of production, so if, a firm
decides that some labour is not required or that capital-intensive technology is
more profitable, they will make labour redundant. This can cause widespread
unemployment in the economy. Widespread unemployment in an economy
can mean that more people are living in relative or absolute poverty, so the
disparity in income between the upper classes and the less well-to-do is
increases, another sign of market failure.
2. The free market can fail to provide certain goods and services Certain
goods, such as public goods, may not be provided by the firms in a free market
since these goods are enjoyed by all, but no one is ready to pay for them, such
as street lighting, defence, army etcetera. Since it is not profitable to produce
suchgoods the firms in a free market will not.
3. The free market can tend to under-produce certain important products
Merit goods are those which provide positive externalities such as healthcare
and education. Such goods have to be produces in bulk, since everyone should
have acess to them, but the profit motive of firms may mean that they do not
produce such goods altogether or they produce in such little quantities, that the
price of them are so high, that the less well-to-do cannot afford them.
However, this is wrong since everyone should have access to such goods.
4. The free market may encourage the consumption of harmful goods
Demerit goods are those which produce negative externalities when consumed
such as drugs. Thus, they should either be banned or their production and
consumption restricted. Some consumers may, however, wish to purchase
such goods and have the ability to pay for them, and firms in the free market
will supply them since it is profitable to do so. Such drugs ar eharmful not
only for the consumer, but also for society in general.
5. The social effects of production may be ignored Since private firms have
the main aim of making profits they only look at the private costs and benefits.
Many a times, the social costs are neglected. The main social cost of
production is pollution air pollution as well as noise pollution. Air pollution
can cause problems such as respiratory ailness for members of society and also
destroy the natural environment, while noise pollution can be quite irritating.
6. The market system allcates more goods and services to those consumers
who have more money than others The upper classes, who have more
money, will demand for more goods and services than those less well-to-do,
and will have the ability to pay for them (money). While for them there is a
wide variety of choice, the unemployed or the elderly will have much less
freedom of choice, since firms will not produce for those who are poor, and
incur loss on such production.
7. Formation of natural monopolies Markets may be unable to control a
monopoly from abusing its powers. If a producer manages to become the
biggest or perhaps, the only producer in the entire industry, it becomes a
monopoly. A monopoly can charge consumers exorbitant prices since it is,
after all, the only producer and there is no competition to worry about. It can
also ensure that no newcomers enter the industry by undercutting them, that is,
charging prices that are lower than what the new firm can hope to charge, and
then, once the firm has exited the market, hiking prices greatly once again.
Monopolies, due to the lack of competition, have no incentive to be efficient,
and thus, allocatie and productive ineffiency will exist in a monopoly, another
big sign of a market failure.
8. Information asymmetry This occurs when one party in a transaction has
more or better information than the other. Such a situation can create an
imbalance in power between the parties in a transaction causing transactions to
go awry, a market failure in its worst form.
8 Define private and social costs and benefits, and discuss conflicts of interest in
relation to these costs and benefits in the short term and long term through studies of
the following issues: conserving resources versus using resources; public expenditure
versus private expenditure
Private Costs The costs of setting up and running a business as well as the
costs to the consumers of purchasing goods and services to satisfy wants
Private Benefits The monetary benefits (such as profits) for firms when they
sell their products, and the benefits a consumer gets from purchasing goods
and services
External Costs The costs that the external stakeholders (society, in general)
have to bear due to the firms activity
External Benefits The benefits to the external stakeholders (society, in
general) due to the activity of firm
Social Costs The total cost paid for by the society due to the activities of a
firm
Social Benefits The total benefit arising due to the production of goods and
services by a firm
Social Costs = Private Costs + Social Costs
Social Benefits = Private Benefits + Social Benefits
If the social costs of an economic activity are greater than the social benefits,
then the activity is harming society more than benefiting it. On the other hand,
if the social benefits are greater than the social costs, the economic activity is
benefiting society, and should go on to do so.