AS Economics (Micro)

Chapter 1:Basic Economic Ideas and Resource Allocation

Basic economic problem: limited resources to satisfy unlimited human wants

Scarcity

Limited /Finite Wants are

Resources unlimited
FOPs are scarce

Note: Needs are limited. Needs are basic essentials of life, without which one cannot survive.
These are few, e.g. water, food, clothing etc. Wants are non-essentials, which keep on increasing
as previous wants are satisfied.

Factors of Production: (scarce resources used to produce goods/services)

Land: Natural resources used to produce goods and services e.g oil, land, gas. REWARD: RENT

Labor: Physical and mental efforts to produce goods and services. REWARD: WAGES

Capital: Manmade resources used to produce goods and services e.g tools, machine. REWARD:
INTEREST
used to
produce goods/services shareholders
risk production
owners
Enterprise: risk-taking and decision-making ability. REWARD: PROFIT eg , is
A factor that combines all other Fo to produce goods without enterprise ,
not
possible
.

REWARD means the payments different FOP’s are required to be given in order for them to
participate in productive activity.

Factor Mobility: How easily a resource can be moved from one productive activity to another

Geographic Mobility: refers to the ease with which a resource can move from one place to
another

Occupational Mobility: refers to the ease with which a resource can be used for alternative jobs
or purposes

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Why are some FOPs more mobile than others?

Many workers and capital are occupationally immobile due to certain characteristics, eg
specialization in certain skills/jobs. However, capital is geographically mobile as it can be moved
from one place to another. Workers are occupationally immobile as well, as family ties and
residence in a city discourage workers to move to other places. Land is also geographically
immobile, though it is occupationally mobile.

FOP How can FOP’s quantity increase? How can FOP’s quality increase?

-688GtIn rents leads to increased

-decrease -Fertilizers and better land
willingness to supply land management to improve soil
Land
-new discovery of natural resources -use organic farming methods to
improve quality of crops, dairy goods

-increase in wages will increase -Training and education

supply of labor
Labor -Healthcare
-increase in population/ immigration
-improved health care

-increased production of capital -Advances in technology

goods
Capital -modern equipment
-increase in interest payments which
increases willingness to supply

-increase in price so that profits -better training courses for would-be

increase entrepreneurs
Enterprise
-fall in cost of production - more and better business advice and
support for entrepreneurs

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Opportunity Cost

Next best alternative forgone.

Scarcity Choice OC

Consumer’s OC Rs 1000

Thani
Match
OC of watching Match is Movie that is forgone (consumer)

aaixm→aks
Producer’s OC

100-7150 70-750

*
OC of producing extra Chairs is÷
x number of Tables forgone
-

Worker’s OC

A worker producer 50 sandwiches each day, and sells them at $2 a day. If she takes a
holiday, the opportunity cost of that holiday will be $100 of income forgone.

OC of taking a holiday is $100 of income forgone

of$10m
Budget
Govt’s OC

→
Sehgal Highway
OOC of spending of a school’s construction is the spending on a highway forgone

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 Production Possibility Curve (PPC)

The Production Possibility Curve (PPC) is a curve that illustrates the maximum possible output
that an economy can produce, assuming (i) there are only TWO goods, (ii) all resources are used,
i.e. all resources are fully employed, (iii) all resources are being used efficiently and (iv)
technology and resources are fixed

capital a

Slope of PPC
goods
( K)
Slope of PPCdownward sloping due
It is always -
Goetz

to scarcity and thus trade-off.

> cough
Shape of PPC

K^ R N Red a
shoe

v
d
t
¥
v
> →→
s → → >
e Black shoe
a

Outward Bending Inward bending Straight line

As OC increases As OC decreases As OC is constant

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 Perfect VS Imperfect Mobility of Resources (Homogeneity VS Non Homogeneity)

Perfect mobility of resources (homogeneity) is a concept that shows how resources have the same
level of usage and productivity between two goods. So if resources are transferred from one good
to another, their productivity remains the same, and hence opportunity cost remains constant. This
is because both the goods are very similar to each other, e.g. black shoe and red show.
ee

Imperfect mobility of resources (non-homogeneity) is a concept that shows how resources do not
have the same level of usage and productivity between two different goods. This is because most
resources are specialist resources, more adept at producing one type of good than another. So if
we look at an example, tractors and fertilizers are roses specialist resources, while metals and
machines are guns specialist resources. If one of these is transferred to the production of the other
goods, their productivity will fall and there will be a change in opportunity cost.

Diagrammaticalthe
illustration
of imperfect
vent
mobility on
page
is Of
Nate The slope
: -

Actual Growth VS Potential Growth

Actual growth is when more output is made by employing existing and unemployed resources
more efficiently (i.e. decrease in unemployment leads to an increase in efficiency)

Potential growth is when potential output which the economy can produce grows. In such a case,
an economy’s productive capacity increases through an increase in the quantity and quality of
FOP’s

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 Perfect
Resources (
us
Imperfect Motility of
Homogeneity Non
vs -

homogeneity
poses Resort

¥:÷¥
÷

ʳᵗʰ
; ② marries }"

⑦ Tractors

: -
when 0C

productivity is↑
oÉÉams
the
Note : -

slope of PPC is O≤

Y = 100 -20€> 0C

Roses
¥É%f:-o
② )
(slopeAPP
= too -

Gung 0C
?⃝
 Actual Growth Potential Growth
➢ This is when an economy’s RGDP, or ➢ This is when an economy’s potential to
actual output rises. produce/capacity increases

➢ This causes unemployment to fall, and ➢ This occurs due an increase in quantity
output to rise and/or quality of FoPs

➢ This is shown by a movement towards ➢ This is shown by a shift outward shift in

the PPC. PPC

K
K

C
C

Causes of a shift in PPC:

1) Increase in the quantity of FOPs

For Example; increase in population, decrease in school leaving age, increase in retirement
positive
age. capital stock/net
" investment increase, increase in discovery of natural resources.
GI
NI =
Dep
-
.

+ 13 = 20 -

2) Increase in the quality of FOPs

For Example; Increase in training, increase in education, increase in technology and

^
innovation + R & D K

→TqualityoÉ
•
B
--
•
- -- --

q it
÷:*;
LR
-

3) Reallocation of Resources - - - -
A

> c
←

- Away from primary sector to tertiary sector production ( Profits Skill and efficiency
of FOPs Quality of FOPs
- Away from consumer to capital goods → of Fo PRQuantity .

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 - Towards those goods in which an economy has comparative advantage.

Types of Shifts
Ka

Parallel: When entire economy

grows

E
K ^

Pivotal: When one industry grows

>
C
Intersecting: When one industry K n
rises and the other industry
declines

s
>
c

Uses and Limitations of PPC

The PPC represents both microeconomic (the study of economics in segments) and
macroeconomic (the study of economy as a whole) issues. Occflooentrac
is 50K
K n
forgone
A
100

Microeconomic issues: i.
5¥ ✓
•
B

-The basic economic problem i.e scarcity, choice and opportunity cost →

200 300 {
K
-Productive efficiency • B
9
•

A
c

However, the PPC does not show the microeconomic issues of:

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 omfg Éo%
%
ÉÉÉ¥É
÷%&iÉ;§
÷ ÷¥÷ ÷
( ⇐

5
¥ :{¥:&
-The provision of merit (eg education and healthcare) and public goods ( eg national defence, light
houses etc)

-Externalities ( eg noise, pollution and congestion) ÷

-Competition
^

Macroeconomic issues: ATB

•

>c
-Actual growth (an increase in real GDP) by a movement of the point of production from below
PPC to on the PPC

-Potential growth (an increase in potential GDP) by an outward shift of the PPC

-Employment and unemployment in the economy

However, PPC does not show the macroeconomic issues of:

- Rate of inflation (Persistent rise in general price level)

- Balance of payments (Transactions of one country with the rest of the world)
- Even distribution of income

Economic Structure

Refers to the way in which an economy consists of various sectors i.e. Primary, Secondary and
Tertiary

1) Primary sector: consists of agriculture, fishing and activities such as mining and oil
extraction
2) Secondary sector: includes manufacturing activities that are found in an economy such as
food processing, textiles and clothing, iron and steel production, vehicle manufacturing etc
3) Tertiary sector: service sector that covers a diverse range of activities such as retailing,
transport, logistics, banking etc
4) Quaternary sector: relatively new term to denote the knowledge based part of the
economy- especially the provision of information. Typical examples are scientific research
and product development, computing and ICT.

Positive VS Normative Statements

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 Positive Statements are based on facts or established principles. These statements can be tested
and verified from the information available. They can also be used in construction and explanation
of theories and concepts in economics.

Normative Statements are based on opinions and cannot be tested or verified because they are
not meant to relate to a particular point, or they can be regarded as generalized statements. These
statements usually include words like:
-Should be/ought to be/need - - - -
-

-Desirable/undesirable/correct / incorrect
-Fair/ unfair
- Good/better/best/bad/worse
-Harmful/beneficial
-Welfare/happiness/well-being/standard of living

Classification of Goods and Services

u→vˢ_ Economic
Goods
Free Goods
-

donotrequireanyscaree
Fopsto
them
produce
_

regurePsto
produce .
:O 0C >◦

→
-

06=0
air
eg sunlight ,

✓
Private goods -

pubhegoods → Demerit
Tv Consumer GyÑtaM↓erit
goods goods goods
pure Quasi
those
goodssatisfy
made to
-
that make
e) Sfo failure 1) Info failure
ueent
Goods that have thee
goods 2)
-

Goods that 2) meat

-

consumer wants
2 characteristics upto which .
+
↓
certain limit beyond tweaked overvalued
havemynduaahhe.ge a

they become
enclndabled
rivalry
in
non -

the entirety
rivalrous -

egputhipaihs etc
,

highways
.

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Free Rider problem . (LGS Gulberg A levels 2020-22)

Private goods: these are goods that have two characteristics.
1. Excludability: this means that people can be stopped from consuming these goods.
The most common method used for excludability is price. By charging a price for a
private good, producers make this product available only for those who can afford it,
and exclude those who can’t afford.
2. Rivalry: this means that there is a rivalry for the consumption of these goods. If one
person consumes these goods, the benefit from this good’s consumption for the other
person will fall as a result. Again, rivalry in these goods are mostly created through
market price. If some consumers start to demand a private good more and more, this
will create a shortage for other consumers who might also want to consume the good,
and that shortage will increase the price of the good, lower consumers’ affordability
to buy the good and hence lower their benefit from the good’s consumption.

It is because of these reasons that private goods are profitable, as by charging

prices, producers of these goods only sell these goods to those who can afford, and
profitable prices, and hence these goods are supplied in a market economy.

Private goods are of four types:

- Consumer goods: these are goods that are used to satisfy consumer wants. They can
be durable (long lasting with multiple uses e.g. cars, houses etc), and non-durable
(which are depleted after 1-2 uses, e.g. food, drinks etc)
- Capital goods: these are goods that are used to produce other goods and services,
and hence increase an economy’s capacity, e.g. machines, equipment etc.

produced bysector gout

the
Note : -
All
public goods are

( public sector ,
but NOT ALL public goods
public goods eg public
schools
/hospitals
.

are
 MERIT GOODS DE- MERIT GOODS

-Eg Education and Healthcare -Eg Cigarettes and Drugs

- Very beneficial for society BUT people -Very harmful for society BUT people

Undervalue these goods over value these goods

1) Information failure 1) Information failure

Actual Benefit>Perceived Benefit Actual Benefit<Perceived Benefit

2) Positive Externalities 2) Negative Externalities

-Benefits to 3rd party greater hence - Cost to 3rd party greater as person directly

undervalued since-_#€iwolued
original owner is involved does not pay full cost. Hence

do Not benefited
• fully overvalued

-Private sector under produces due to Private sector overproduces as profit

Low profit incentives. Only produce for incentives are HIGH.

those who can afford.

-Govt produces for the rest

SB =P Bt EB

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 Public Goods:

These are the goods that have 2 distinct characteristics:

1) Non-excludability: It means that no one can be stopped from consuming these goods if
they are available to the society.
2) Non exhaustibility or Non Rivalrous: it means that if anyone consumes these goods, the
benefit from the good will not exhaust for anyone else who wants to consume as well.

Due to these 2 characteristics, public goods experience the Free Rider Problem ie people
consume these goods without paying for them. As a result, these products are not
profitable for the private sector to produce. Hence these goods are only produced by the
government. Eg lighthouse, street lights Sober
and parks

Private Goods:
These goods are bought and consumed for their own benefit. These are both Excludable and
Rivalrous.
The 2 unique types of private goods are Merit and De - Merit Goods.

Merit Goods:
These are goods whose consumption is considered to be highly desirable for the welfare of the
general public. There are 2 characteristics of merit goods:
1) Their actual private benefits are greater than their perceived benefits (AB>PB) as people
undervalue these goods causing Information Failure
2) They create Positive Externalities ie the benefits of such goods are enjoyed by the 3rd party. As
the total benefits are divided among those directly involved in their production/consumption
(private benefits and to 3rd party), those directly involved in their production undervalue these
goods.
Due to these 2 factors , merit goods are low on profitability and hence are under produced.
Note: merit goods are overpriced in the market economy, as private sector only offers to those who can afford
De-merit Goods:
These are goods whose consumption is considered harmful for the welfare of the general public.
There are 2 characteristics of De-merit goods:

1) Their Actual Benefit is less than the Perceived Benefit (AB<PB) as people undervalue them
causing Information Failure

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 -
Public Goods i

be
① Non
eacladabihty
no one can
-
: .

stopped from consuming

them .

② Non -

rivalry : .
no one 's
benefit
derived
from consuming
them
falls if
other them
people start to consume .

,
Free Ides Problem
pay for
them
willing
to
.

No one is

Not
footplate for put
u
sector

put sector NOT produce

qloes U

Grout provides them for All .

eg streetlights lighthouses ,
2) They create Negative Externalities; costs to the 3rd party which aren’t payed by those directly
involved in production of de-merit goods. Due to this, they overvalue these goods eg drugs and
cigarettes.
_EMl
p @roduced
Due to these 2 characteristics, de-merit goods are high on profitability and hence are overpriced.

Note: de-merit goods are underpriced, due to the fact that they are overvalued

Basic Economic Questions

There are 3 questions in resource allocation:

1) What to produce? Private sector produces those goods which make profits. Government
produces basic necessities
2) How to produce? In a way that satisfies maximum wants and in the most cost efficient way
3) For whom to produce? Private sector uses Price Mechanism to produce goods for those who
can afford. Government uses Rationing for the underprivileged.

Economic Systems

A system by which an economy allocates its scarce resources in production of various goods and
services to satisfy the needs and wants of the society.

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 Free Planned/
FEATURES MARKET COMMAND MIXED ECONOMY
ECONOMY ECONOMY

Ownership of Property Private Ownership Government Private and

ownership Public
ownership

Motive or Objective Profit Collective social Private sector:

maximization welfare Profit
maximization

Public sector:

Social welfare

Allocative Mechanism Price mechanism Rationing Private Sector:

through demand Mechanism Price
and supply through quotas Mechanism
and central
planning Public Sector:
Rationing
Mechanism

Freedom of Choice YES NO Private sector:

regarding YES
production/consumption
Public sector:
NO

Competition Yes No Private sector:

YES

Public sector:
NO

Role of government in Minimum govt All economic and The govt limits
resource allocation intervention in non economic its role to the
economic affairs affairs are within provision of
the control of the necessary goods
govt and services and
regulate private
sector for social
welfare

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 Quality of goods and High quality Usually poor Private sector:
services quality High quality

Public sector:
Low quality

Response to changes in Quick response to Slow or no Private sector:

demand changes in response Quick response
consumer
preferences Public sector:
Slow response
( consumer
Sovereignty
Merit goods eg Under production Socially optimum Private sector
education and welfare and under under produces
consumption whereas rest is
supplied
through govt
provision

Public goods eg street Non marketable, and Provides public goods The public sector
lighting and national defence therefore missing through govt provides public goods
expenditure

De merit goods eg cigarettes
and drugs
Over production and Fewer or no demerit Govt discourages
over consumption goods consumption by
applying taxes and
imposing legislative
actions

Distribution of income and Unequal distribution Even distribution Progressive taxation

wealth and welfare
payments to the poor
reduce disparity

Useless duplication of goods Yes No May occur in the

and services private sector but not
public sector

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Rationing mechanism: it is a method by which the govt allocates resources
through the quota system.

- Govt decides to produce necessities and hence resources are allocated to those
necessities
- Govt creates quotas so that everyone can be provided with the necessities in an
equal manner
- This leads to inefficiency as it results in long queues and time wastage, and also
leads to shortages
- However, it lowers income inequality
Free market economy: Pros and cons

Mixed economy (Govt intervention): Pros and cons

Difficulties faced by Transition Economies

1) Fall in GDP and output due to the fact that private sector had no prior experience since
the government used to organize business industries.
2) High rate of unemployment as government is no longer controlling industries. Hence
private sector looks to cut costs by laying off inefficient staff
3) Rise in informal sector to avoid government taxes
4) High inflation: price mechanism results in comparatively higher prices than rationing
mechanism.
5) Unequal distribution of income between the rich and poor
6) Merit goods under produced, demerit goods overproduced and public goods are not
produced
7) Negative externalities

Government can help negate these problems through intervention and ensure assets are
distributed equally, impose progressive taxes, introduce public sector enterprises side by
side, subsidize merit goods and tax demerit goods to reduce consumption.

Advantages of transition economies (from command to free market)

1) Good quality products available for consumers which improves living standards
2) Rise in GDP in the future due to higher efficiency and profit motive
3) Greater exports and hence BoP surplus due to good quality
4) Greater consumer choice
5) Fall in cost push inflation in the future due to higher efficiency
6) Better wages for skilled workers which

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What is Ceteris Paribus?

It means holding all other factors constant. So if we assume that one factor
that changes PPC is changing, we assume all other factors are held
constant and unchanged.

Important time periods in microeconomics

supply Ichang tyan ↓

supply changed
change easily /shutdown
minimally enpansion
takes place
-
e- b/w Physical &
DifferenceHuman →
capital
A-