Economics Revision Notes 2021-2022 Term 2

• Economics for 2021-2022, term 2 revision notes

Three Basic Economic Problems

• What to produce: the types and quantities of goods
• How to produce: the methods of production
• For whom to produce: how to distribute goods to society

Methods of Tackling Economic Problems

• Traditional economy: problems solved by customs/traditions
• Planned economy: problems solved by government plans/commands
• Market economy: problems solved by the price mechanism

How Traditional Economy Solves Economic Problems

• What to produce: typically produces similar goods as their ancestors
• How to produce: follows the ways of their ancestors
• For whom to produce: people follow their customs/traditions to allocate goods and assets

How Planned Economy Solves Economic Problems

• What to produce: the government decides what and what quantity to produce
• How to produce: production units follow the government's instructions
• For whom to produce: government decides how to distribute outputs

How Market Economy Solves Economic Problems

• What to produce: when the price of a good increases, new producers are attracted and goods will be produced more
• How to produce: producers use production methods that minimize costs
• For whom to produce: those willing and able to pay the market price get the goods

Price Mechanism

• Market prices are used as signals to guide resource allocation
• If consumers want more products, they are willing to pay more
• Increased prices encourage firms to produce more goods for increased profit

Functions of Prices

• Rationing function distributes goods to users with the highest value of the goods
• Only those who are willing and able to pay market price can get the goods
• Allocative function allocates resources in markets
• Prices transmit market information, like consumer preferences, to producers
• Higher prices act as an incentive for producers to increase output

Mixed Economies

• Most societies are mixed economies
• They use all three methods to tackle basic economic problems

Private Property Rights

• Exclusive right to use: the owner can exclude others from using the property
• Exclusive right to receive income: the owner has the exclusive right to receive income generated by the property
• Right to transfer: the owner can transfer the property to other people

Importance of Private Property Rights in a Market Economy

• Well-defined, protected private property rights are required for the price mechanism to function
• Without private property rights, people will use non-price methods to allocate resources

Demand

• Demand combines the willingness and ability to buy a good, supported by purchasing power
• Demand curve reflects how much of a good a consumer is willing and able to buy at certain prices
• Demand is only the quantity a consumer plans to buy, regardless of the actual quantity the consumer buys
• *ceteris paribus means other factors remain constant

Law of Demand

• As the price of a good increases, the quantity demanded decreases, ceteris paribus
• The market demand curve is downward sloping, so price and quantity demanded are inversely related

Supply

• Supply combines the willingness and ability to sell a good
• Supply curve shows the quantity of a good a producer is willing and able to sell/produce at all prices
• Supply is only the quantity a producer plans to sell, not necessarily the actual quantity
• *ceteris paribus means other factors remain constant

Law of Supply

• The higher the price of a good, the higher the quantity supplied, ceteris paribus
• The market supply curve is upward sloping, meaning price and quantity supplied are positively related

Market Equilibrium

• Equilibrium price is reached when the quantity demanded equals the quantity supplied
• There is no tendency for the price to change at equilibrium
• The equilibrium price is the intersection point on the supply and demand curve

Market Disequilibrium

• Excess demand occurs if the price is set below the equilibrium price, leading to a greater quantity demanded than supplied
• Excess demand results in a shortage
• With excess demand, some consumers will pay more to get goods
• When price increases, quantity supplied increases and quantity demanded decreases until the equilibrium price is reached
• Excess supply occurs if the price is set above the equilibrium price, leading to a greater quantity supplied than demanded
• Excess supply leads to a surplus
• With excess supply, some sellers will sell their goods at a lower price
• When price decreases, quantity supplied decreases and quantity demand increases until the equilibrium price is reached

Change in Demand

• Demand for a good changes when factors other than price changes influence demand
• A change in demand is represented by a shift of the entire demand curve

Factors that Cause a Change in Demand

• Change in income will impact the demand for normal and inferior goods
• As income increases, so does the demand for normal goods (positively related)
• As income increases, the demand for inferior goods decreases (negatively related)
• Change in the price of related goods will impact demand
• When the price of a substitute increases, demand increases (positively related)
• *Substitute goods satisfy similar wants or needs
• When the price of a complement decreases, demand increases (negatively related)
  • *Complement goods are used together to satisfy wants or needs
• Demand for a product increases the derived demand for the factors of production of that product
• Change in taste, fashion, weather, or government policy can impact demand
• Consumers expecting a price increase can impact demand

Change in Supply

• Supply of a good changes when factors other than the price changes influence supply
• A change in supply is represented by a shift of the entire supply curve

Factors that Cause a Change in Supply

• Change in the cost of production, like rent or wages: when it decreases, supply increases
• Change in the price of a good in joint supply: when it increases, supply increases
• *Joint supply involves two goods when one good is a by-product of another good
• Change in the price of a good in competitive supply: when it decreases, supply increases
• *Competitive supply involves two goods that require similar inputs to produce
• Change in taxes/subsidies impacts supply
• When the tax on the producer of a good increases, supply decreases
• When the subsidy to the producer of a good increases, supply increases
• Improved technology will increase supply
• Producers expecting a future price decrease will increase supply