IGCSE ECONOMICS 1. The Basic Economic Problem

IGCSE ECONOMICS 1. The Basic Economic Problem

1.1 Nature of the economic problem Problem: an economy's finite resources are insufficient to satisfy all human wants & needs Finite resources can't meet infinite wants Decide the best allocation of resources for society as a whole Resources: Inputs available for production of g/s Economic goods: scarce resources that have opportunity costs (eg. clothing, food) A sacrifice must be made to obtain it (eg. money, effort) Scarce resources: factors of production that are limited in supply Free goods: an abundant resource that has no opportunity cost (eg. seawater, sunlight) No sacrifice must be made in order attain it Purpose of economic activity Produce goods & service to provide for wants & needs Become more efficient to maximise economic welfare & satisfaction Identify what goods should be produced & how/for whom they should be produced Economic activity isn't just production for recorded monetary gain Includes DIY, subsistence farming, charity work, barter & illegal trade

1.2 Factors of production Known as inputs Building blocks used to produce output (g/s) Eg. Creating a farm Farmland (land) Farmer's physical labour (labour) Tools used- shovels, tractors, ploughs etc. (capital) Sale of the products in exchange for money; profit (enterprise) Land All natural resources & premises Eg. coal, water, forests, minerals, oil etc. Fixed supply Quality Soil type, fertility, weather etc. Mobility Some are geographically immobile; others are difficult (not impossible) Many types of land have changed their use (occupational mobility) Reward: rent Labour All human resources (mental & physical efforts of labourers) Eg. farming (physical efforts), lawyer (thinking skills) etc. Supply Number of workers available Number of hours they work Influenced by population size, no. of years of schooling, retirement age, structure of population etc. Quality Skill, education & qualification of labour Mobility High occupational mobility (ability to change jobs) Geographic mobility (ability to move to a place for a job) Reward: wages Capital Capital good: Human made good used in production of other g/s Eg. hammers, computers, delivery vans, conveyor belts etc.

 Becomes obsolete (replaced by more modern versions) Supply

Demand for g/s Success of business Quality No. of good quality products that can be produced using the given capital Mobility Depends on nature/use of capital

Eg. office building is geographically immobile but occupationally mobile Occupational mobility (machine can be used for several industries) Reward: interest Enterprise Ability to take risks & run a business venture/firm Organise all other factors of production & makes the necessary decisions Risks: failure, losses, bankruptcy, rival producing better product, costs rising Eg. earning a profit out of a sale of a product/service Supply Entrepreneurial skill (risk-taking, innovation, effective communication etc.) Education Corporate taxes If taxes on profits are too high, no one will want to start a business Quality How well it is able to satisfy & expand demand in the economy in cost-effective Mobility Highly mobile (geographically & occupationally) Reward: profit 1.3 Opportunity Cost Next best alternative that is forgone when making an economic decision Cost of goods measured in terms of what must be sacrificed for other goods Real cost of any economic decision Main groups in the economy Consumers Workers Producers Govt Financial institutions Eg. Govt. could spend on 2 options: build a school or a hospital Decides to build a hospital Opportunity cost: education the children could have received 1.4 Production Possibility Curve (PPC) A curve showing the maximum output of two types of products that can be produced at a given time using all the resources available to their maximum potential All points on PPC shows maximum production efficiency given the resources currently available Not possible to achieve output levels outside the PPC Shows economic problem, opportunity cost, employment, specialisation & economic growth Position of points Inside PPC Inefficient use of existing resources compared with what is possible (A) Indicates under-utilised assets, unemployment On the PPC Efficient (B, D, C) Outside PPC Impossible (X) Shifts along the PPC reflect an opportunity cost Outward shift (right) higher production possibility = efficiency New technology

 New resources (gold discovery) Increases supply of labour (birth rate, migration) Improved labour force (education, training) Better use of labour (division of labour & specialisation) More entrepreneurism Inward shift (left) lower production possibility = inefficiency Natural disasters (ruined infrastructure, loss of population) Low investment in new technologies (causes productivity to fall over time) Running out of resources (particularly non-renewables eg. oil/water) Opportunity cost is measured along the curve in terms of the sacrifice in the quantity of one good when you choose to allocate more resources to an alternative good

2. The Allocation of resources 2.1 Microeconomics & Macroeconomics Microeconomics: study of individual markets Deals with individual firms, consumers, & markets making individual decisions within the economy Eg. effect of a price change on the demand/supply of a good Macroeconomics: study of the entire economy as a whole Deals with aggregates (total supply/demand for g/s in an economy at a particular time) Eg. level of inflation, national spending, national output, economic development etc. Decisions are made by govt in managing the economy as a whole 2.2 Role of markets in allocating resources Resource allocation: the way in which markets decide what goods & services to provide, how to produce them & who to produce them for Price mechanism Prices respond to shortages & surpluses Price rises: consumers ration Reduces amount they are willing/able to buy Tells producers there is excess supply in the market Gives suppliers incentive to decrease supply Shortages causes price to rise Surpluses causes prices to fall Market system Any place where buyers & sellers meet to exchange goods & services G/s are bought/sold in a market at an equilibrium price Producers produce goods that consumers demand the most Market equilibrium Demand = supply for a good Demand changes (eg. income rises: people can afford more goods) Supply changes (eg. weather impacts supply (drought) = decrease in crops) Market is more likely to be in state of disequilibrium than equilibrium Demand & supply constantly change Mixed economy Decisions are made by a combination of the govt & the private sector (market) Eg. USA, India, China, Singapore, Japan etc. 2.3 Demand Want & willingness of consumers to buy a good or services at a given price Effective demand: willingness to buy is backed by the ability to pay for the purchase Quantity demand: effective demand for a particular g/s Eg. Want a phone but don't have the money to buy (demand) Have the money to buy (effective demand) Individual demand: demand from one customer Market demand: total (aggregate) demand; sum of all individual demands of consumers

 Demand curve Shows effective demand Law of demand Increased price = decreased demand Decreased price = increased demand Slopes down from left to right Demand increases as price falls (vice versa) Movements are due to change in price Price rise = contraction along demand curve (less demand) Price falls = extension along demand curve (more demand) Reasons for shifts Consumer incomes Increased income = people can afford more Eg. bicycle replaced by motorcycle Tax on incomes (more/less disposable income) Rise/fall in the price of substitute (eg. tea & coffee) Rise in the price of complements (eg. printers & ink cartridge) Two products used/consumed together As demand for 1 product increases, demand for other product increases Successful/unsuccessful advertising Weather Legislation Age distribution Fashion/trends Demand varies depending on age group Eg. trainers are more popular amongst young people Majority of population is young people = high demand Example: Diagram X: Decreased price (80 to 60) = increased demand (300 to 500) Extension in demand from A to B Increase in price (60 to 80) = decrease in demand (500 to 300) Contraction in demand from B to A Diagram Y: Increased demand (500 to 600) Increased demand due to changes in other factors (excluding price) causes shift to the right (A to B) Diagram Z: Reduced demand (500 to 400) without change in price Fall in demand for a product due to changes in other factors (excluding price) causes shift to the left (A to B)

2.4 Supply Want & willingness of producers to supply a g/s at given price Quality supplied: amount of g/s producers are willing to make & supply Market supply: amount of g/s all producers supplying the product are willing to supply Supply curve Slopes down from right to left

 Higher supply = increase in price Shows relationship between the amount offered for sale & the price Law of supply

Increased price = increased supply Decreased prices = decreased supply Movements are due to change in price Increase in price = extension in supply (increase in quantity supplied) Decrease in price = contraction in supply (reduced quantity supplied) Reasons for shifts Change in costs of production (COP)

Producers can produce & supply products cheaply COP rises = supply falls Changes in quantity of resources available Resources rise = supply rises (vice versa) Technological changes (higher productivity/output) Profitability of other products Producers might shift to producing more profitable products (reduces

supply of initial product) Joint supply

When a product is made as a by-product of another

Weather Regulation/bureaucracy Increased number of producers in the market Example Diagram X:

Increased price (60 to 80) = increased supply (500 to 700) Decreased supply due to changes in price (without

changes in other factors) causes a contraction in supply Diagram Y: Increased supply without change in price (S to S1)

Due to changes in other factors (excluding price)

Decreased supply without change in price (S to S2) Due to changes in other factories (excluding price)

2.5 Price determination Market equilibrium price: price at which the demand & supply curve meet Equilibrium quantity: quality demanded or supplied at the equilibrium price Marginal benefit = marginal cost Movements to a new equilibrium Increased demand (demand curve shifts right) Increased supply (supply curve shifts right) Market disequilibrium Disequilibrium price: price at which market demand & supply curves don't meet

2.6 Price changes Causes: change in supply/demand Consequences

Effect on equilibrium market price Effect on equilibrium market quantity

Demand shifts to the right Increase

Increase

Demand shifts to left

Decrease

Decrease

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