Economics of the Market

Demand

(sometimes called effective demand) is the quantity of a good or service which consumers are willing and able to buy at a particular price in a certain period of time.

Changes in Demand Conditions

- A rise in demand (D curve shifts to the right) leads to a rise in equilibrium price and in the quantity exchanged in the market. - A fall in demand (D curve shifts to the left) leads to a fall in equilibrium price and in the quantity exchanged

Changes in Supply Conditions

- An increase in supply (S curve shifts to the right) leads to a fall in equilibrium price and a rise in the quantity exchanged. - A fall in supply (S curve shifts to the left) leads to a rise in equilibrium price and a fall in the quantity exchanged.

Determinants of Price elasticity of demand

- Availability of close substitutes - How widely defined a good or service is - Whether it is a habit forming or additive good - Whether it is something that we buy regularly out of necessity e.g. milk or bread - Whether we have to buy now or whether we can postpone the purchase - Proportion of disposable income involved

Effect of increased output on Marginal and average costs`

- Average fixed cost falls. This is because total fixed cost is the same amount regardless of the volume of output. Total fixed cost is being spread over an ever-larger output. - Average variable cost falls until a certain output is reached and then it rises. It falls because of improving efficiency and increasing returns. It rises because of inefficiency efficiency and diminishing returns. - Average cost falls while average variable cost and average fixed cost are falling. Average cost then rises when the increases in average variable cost exceed the falls in average fixed cost. - Marginal cost is the change in total cost resulting from a one unit change in output.

Reasons for choice

- Because of scarcity which is the basic economic problem - Resources are finite - Human wants are unlimited - This is the result of human greed and competing wants - We cannot have everything we want so we are forced to make choices - Each choice will involve a sacrifice, an opportunity cost.

Benefits of Free Market Mechanism

- Buyers are free to purchase any commodity which they like and in whatever amounts. - Allocative efficiency - producing what people want and the price people prepared to pay - The seller of a good or its producer can also produce whichever product they want to and also increase the capacity of any individual commodity depending upon the forces of the market. - Producers are free to undertake the risks and rewards (profits) associated with increases in production. - The decision of what to produce, for whom to produce and in what quantities is taken by the market forces and not determined by the state. - Innovation and productive efficiency are greater as profits can be made - Prices also have the function to allocate and distribute a country's resources. - In a perfect world, the free market leads to complete efficiency by bringing about the optimal distribution of a country's resources.

Determinants of supply

- Changes in profit: As producers are motivated by profit, anything which increases profit will increase supply and anything which reduces profit will reduce supply. - Costs of production such as wages, the costs of raw materials used in the production process and commodities such as oil. - Prices of other goods e.g. a farmer may resources away from supplying one product, e.g. milk, to supplying more of another, e.g. wheat, in response to a fall in the price of milk - Government intervention via a tax or subsidy - Increases in productivity; - The weather, especially if the good is produced in the agricultural sector.

Advantages of Government Intervention

- Corrects market failure: lack of public goods & merit goods, reduce de-merit goods, prevent inequality, prevent dominant monopolies, prevent negative externalities, generate positive externalities - more information in the 'Market Failure' Topic. - A subsidy could result in lower prices and greater quantities available for consumers (e.g. agricultural goods) - Min wage encourages people into work stimulating the labour market - Min wage helps prevent exploitation - Quota helps sustainability - Should help narrow the gap between rich and poor (higher wages and lower prices for example) - Taxes can deter consumption/supply of demerit goods - Taxes raise revenue for the government

Exceptions to the Law of Demand

- Goods of prestige or ostentation i.e Veblen Goods e.g. the demand for certain brands of jeans, training shoes or cars may rise as their price rises. - Assumption of link between price and quality - consumers may equate a rise in the price of a product as meaning that its quality has improved. - Expectation of future price rises, e.g. speculators may react to a rise in the price of shares by buying more, expecting them to rise even further. - Giffen goods - Giffen, a nineteenth-century economist, observed that during the Irish potato famine, the demand for potatoes rose as their price rose. This was because living standards were so low that most people spent nearly all their income on potatoes, a filling food, so that when the price rose they had so little money to buy meat, etc., that they bought more potatoes. This effect can apply to any basic foodstuff in conditions of poverty. The demand curve in any of the above situations will slope upwards but note that above a certain price it will resume its normal shape, as the income effect will reduce people's ability to buy the product.

Capital

- Industrial capital is used by firms, e.g. factories, offices, plant and machinery, tools, vehicles. - Social capital belongs to the whole community, e.g. schools, hospitals, roads. - Private capital belongs to individuals, e.g. houses. - Financial capital is money waiting to be used to buy capital goods. When capital goods are bought this is called investment. (Note the difference between saving and investment!)

Free market advantages and negatives

- No role for the government - All scarce resources are owned by private individuals - Scarce resources are allocated based upon the rationing, signalling and incentive functions only - Consumers aim to maximise utility and producers aim to maximise profit - 'Consumer sovereignty' exists i.e. the 'consumer is king' so what they demand at various prices has to be considered by the producers. - The market mechanism is 'guided by an invisible hand'

The Short Run Law of Diminishing Returns

- Returns is a name given to what a producer gets back in output when she/he employs more of a factor of production, e.g. returns to labour means the output gained when more workers are employed. - In deciding what output is the most efficient to produce in the short run a firm needs to consider the law of diminishing returns. - In the short run, increasing returns occurred as each variable factor (labour) was able to specialise using capital (fixed factor). This efficient use of fixed and variable factors led to increased output and falling AC. The law of diminishing returns explains that short run average cost will ultimately rise because adding more variable factors to one fixed factor eventually reduces productivity. Average costs will begin to rise overall as even though AFC falls continuously, AVC continues to rise because of the rising wage costs combined with falling productivity. Continuing to add variable factors will not increase efficiency beyond the optimum point. - For example, adding even more workers to the one machine may increase output a bit more. However, the wages of the added workers who make such a small contribution to output will force up average costs. - The solution is usually to expand to new premises or to buy more machines. This can only happen in the long-run when all factors can be varied.

Government interference

- Setting a minimum price - Setting a maximum price - Imposing tax - Giving a subsidy

SRAC LRAC differences

- The law of diminishing marginal returns explains the impact on output and average costs resulting from an increase in the variable factor only e.g. increasing the number of workers you have. - You are constrained in the short run and will have a fixed factor which cannot be changed! - The law of returns to scale explains the impact on output and average costs when you increase the scale of your organisation e.g. you increase both fixed and variable factors. - You have no constraints in the long run.

Price Mechanism and Allocation of Resources

- The price mechanism should help the economy to allocate resources more efficiently. - An efficient allocation of resources is desirable given that they are scarce. - The price mechanism refers to how the price will send the signal/incentive to producers to decide how to allocate scarce resources to maximise their profit and to consumers on how to spend their income to maximise utility.

Negatives of the free market Mechanism

- This generally harms people living below the poverty line or those in the low income group. It is impossible for them to pay high prices in cases of demand shortage and thus the free market model is not a viable option in developing countries which has a large number of poor. - Under-provision of merit goods like education, health, housing... so the poor will be deprived of the merit goods. In this way the rich becomes richer and the poor becomes poorer. - Non provision of public goods (bus stops, gardens, street lighting, army, police, fire services) important requirements for public goods not provided since it is not profitable to produce as consumers are not directly willing to pay for them - Over consumption of demerit goods(drugs, cigarettes, alcohol) if consumers have a preference for these goods, then they will be provided given that they are profitable to produce. - Social cost ignored. Private firm ignore negative externalities (air, water and noise pollution, road conditions.) - Wastage of resources as consumer may get what they want but not what is good for them. - Social injustice - increases in inequality - Economic instability

Disadvantages of Government Intervention

- Using taxation to increase price could result in some businesses passing on the higher costs to consumers. Some forms of taxation can be regressive. This may have inflationary consequences. Some businesses may also have to make workers redundant to compensate for higher costs elsewhere. We lose international competitiveness. - Using subsidies to reduce prices could lead to higher taxes from consumers to pay for this system. - Consumers get no say in what gets subsidised. - Using maximum prices can result in excess demand. If the excess demand is not met by existing producers then it could result in a black market for the product. Low prices can make a business unprofitable. - Using minimum prices can result in excess supply which could lead to wasted resources as producers try to exploit the situation.

Price Inelastic Demand and Revenue ?

1. Revenue lost when price is increased for a product which is price inelastic. 2. Revenue gained when price is increased for a product which is price inelastic. Conclusion: revenue gained is greater than revenue lost so price increases are beneficial when product is price inelastic. E.g. if petrol was to increase to £1.50 per litre from £1.10 per litre, the increased revenue from the higher selling price would more than compensate for the slight loss in customers who choose to drive less. 3. Revenue lost when price is decreased for a product which is price elastic. 4. Revenue gained when price is decreased for a product which is price elastic. Conclusion: revenue gained is greater than revenue lost so a price decrease is beneficial when product is price elastic.. E.g. if Netflix were to lower their subscription of £6 to only £2 per month, the huge increase in customers would more than compensate for the lower selling price.

Costs of Production

A fall in the cost of any factor of production will lead to an increase in supply. A change in a tax or subsidy will change the costs of production. An increase in tax can cause an increase in costs of production. This gives the firm 2 choices: 1. Pass the extra cost onto consumers through higher prices though they will become uncompetitive and consumers may decide to shop elsewhere. 2. Absorb the cost themselves though they may not make enough profit for it to be worthwhile staying in business. Many firms will choose to leave the industry therefore decreasing supply. Subsidies are payments made to producers from the government in order to make the product cheaper to produce or cheaper to consume. For example, farmers are given subsidies in order to support their incomes and make the production of agricultural goods more profitable (otherwise farming communities may go into further decline with further job losses). This increases supply.

Scarce Goods

Also called economic goods, are those which have a price i.e. something has to be sacrificed to obtain them hence there is an opportunity cost attached to consuming them. e.g. A car.

Effects of Maximum Price

An example of a maximum price would be the NHS dentist check-up fees set by the Government. A maximum price is usually set on products which the Government deem to be essential and they do not wish low income families to be excluded from consuming the product or service. The maximum price is set below the market equilibrium. The effect is usually a contraction is supply, as producers will earn less profit selling the produce combined with an extension in demand as the product is now cheaper and more affordable. This causes excess demand.

Effects of minimum Price

An example of a minimum price would be the minimum wage that is set by the government. The minimum wage rate is set above the market equilibrium i.e. the rate at which employers would wish to pay and demand labour at (demand for labour) and the rate at which workers would be prepared to accept (the rate that they will supply their labour at). The result is that at higher wages more labour is supplied (i.e. more people are willing to work) than are demanded (i.e. less businesses are willing to take on employees at such higher rates which increase their costs). This causes unemployment i.e. an excess supply of labour compared to the level of demand set by employers.

Diminishing Marginal utility

As a person consumes more of a good or service in a certain period of time, the utility gained from each extra unit (the marginal utility (MU)) decreases. Total utility will continue to increase, although at a decreasing rate, until a maximum is reached. At this point there is no further satisfaction to be gained from consuming more of the product. Marginal utility will be zero.

The Marginal Utility Effect

As consumers increase consumption of a good or service they experience the law of diminishing marginal utility. As their satisfaction falls after each marginal unit they are prepared to pay less to consume more. Hence, it is only as price falls that we buy more.

The Income Effect

As the price of a good rises then a person's real income (i.e. their buying power) falls. They are not able to buy the same quantity. Demand for the product then falls.

The Substitution Effect

As the price rises then the marginal utility per pound of the last unit consumed falls. A rational consumer would therefore switch consumption to a substitute product that offered greater utility at a cheaper price i.e. one which they view as better value for money. Therefore, at high prices we switch to substitutes and at low prices we switch from substitutes.

Equilibrium Price

At this price: - Quantity demanded by consumers is the same as quantity supplied by suppliers. - The market is cleared, i.e. there will be no unsatisfied customers (shortages) and there will be no unsold supplies (surpluses). This is why the equilibrium price is also called the market clearing price. - The price will not change unless there is a change in demand or supply conditions.

Choice

Because of the problem of scarcity it follows that choices have to be made. Consumers must choose what to buy out of their limited incomes. Producers must choose what to produce with their limited resources. Governments must choose what services to provide out of their limited tax revenues.

Economic Goods

Consumer Goods and Capital Goods

Theory of Demand

Consumers gain satisfaction from consuming goods and services. Economists call this satisfaction utility. The utility gained from consuming a product is difficult to measure accurately but three possible ways of measuring it are by noting: 1 - How people react when they are consuming 2 - How much of the product people consume 3 - The price that people are willing to pay for it. Note that none of these measures is totally reliable, but the third is the most commonly used.

Enterprise

Enterprise refers to the decision making and risk taking of entrepreneurs. The entrepreneur decides how many of each factor is to be used, how they are to be combined to make the most profit and how the work should be done. He or she also bears the risks caused by business uncertainties. An entrepreneur is an organiser and a risk taker.

Opportunity Cost

Every choice involves a sacrifice. This is the sacrifice of the next best alternative choice. For a consumer this is the cost of choosing a product, is the next item on his/her scale of preference.

External Economies of scale

External economies of scale are the improvements in productivity which a firm gains from the growth of its industry.

Costs of Production

Fixed and Variable costs

Average Fixed Cost

Fixed cost/Output

Price Elasticity

Goods & Services will have either ELASTIC or INELASTIC price elasticity of demand. ELASTIC - if the demand for a product is VERY RESPONSIVE to changes in price i.e. if price increases by 10%, demand decreases by an amount GREATER than 10% INELASTIC - if the demand for a product is NOT VERY RESPONSIVE to changes in price i.e. if price increases by 10%, demand decreases by an amount LESS than 10%

Capital Goods

Goods that are used for the production of more goods e.g. machinery.

Consumer Goods

Goods that are used up by consumers for the satisfaction they give e.g. a new pair of jeans.

External Diseconomies of scale

Growth of firms in an area may lead to extra costs for those firms. They can also be thought of as consequences arising from the over-concentration of industry they could be considered external diseconomies. This is because they add to costs and problems faced by firms and their employees. - Labour shortage as firms compete for the best workers/graduates they have to offer higher wages and salaries which leads to higher costs of production. - Raw material shortage as firms compete for scarce resources they have to pay higher prices which leads to higher costs of production. - Congestion leads to higher transport costs More business, more travel, more congestion, more money.

The Incentive Function

Higher prices act as an incentive to raise output because the supplier stands to make a better profit. Conversely, lower prices act as a disincentive to reduce output because the supplier stands to make a lower profit. Therefore, the price is an incentive to allocate more resources towards expanding supply beyond its current level.

Supply output differences

In a particular period, output may be greater than supply, i.e. stocks are being increased, or output may be greater than supply, i.e. stocks are being run down. Stocks may be built up in readiness for unexpected or urgent orders, or to even out the need for seasonal fluctuations of output, e.g. fireworks, ice cream.

Production in the long run returns to scale

In the long run all factors of production are variable. A firm is able to change its capacity, up or down. Changing capacity is also called changing the scale of its operations or changing its size. The long run is made up of all the individual short runs. Each time a firm experiences short run diminishing returns and solves the problem of rising costs by increasing the number of fixed factors, e.g. buying new capital, the firm is having an impact on its long run costs of production.

Economies of scale types

Internal and External Economies of Scale

Internal economies of Scale

Internal economies of scale are the improvements in productivity as the firm grows in size.

Internal Diseconomies of scale

It may appear to be very beneficial for a firm to grow to a large size so that it may exploit its economies of scale. However, some firms become too large and this can cause inefficiency: production slows down and costs rise. This is caused by diseconomies of scale. -Poor communication in a large firm with a long chain of command. Mistakes are made or information is slow to be processed - costs rise. - Alienation: Working in a highly specialised assembly line can be very boring, if workers become de motivated. Demotivated workers generate less output and costs rise. - Lack of control: when there is a large number of workers it is easier to escape with not working very hard because it is more difficult for managers to notice shirking. This leads to lower average output and costs rise.

Factors of Production

Land, Labour, Capital and Enterprise

Importance of Price Elasticity

Much of the importance of PED stems from its influence on TR. Firms will want to know how their TR will change when they change their price - this will help them to decide whether to increase or decrease their price. The government will also want to know how TR will change if they change the rate of tax on expenditure, e.g. VAT. The purpose of expenditure taxes is to raise revenue for the government, but taxes such as VAT raise the price of goods. This explains the high level of tax on tobacco, alcohol and petrol. The government will raise most revenue if sales do not fall much as the result of increasing tax. This means they would be wiser to put tax up when price elasticity is low.

Calculating Price Elasticity

PED = Percentage change in QUANTITY DEMANDED Divided by Percentage change in PRICE

Price affecting supply

Price. As the price of a product rises its supply rises (ceteris paribus). This is because: (a) existing producers are willing to supply more as they earn a higher profit per unit and, (b) new firms enter the market as it now becomes profitable for less efficient firms to produce.

The signalling function

Prices perform a signalling function as they adjust to demonstrate where resources are required, and where they are not. If prices are rising (or falling) because of high (low) demand from consumers, this is a signal to suppliers to expand (reduce) production to meet the higher (lower) demand. This is a signal to allocate more (less) resources towards making this product.

The rationing Function

Prices serve to ration scarce resources when demand in a market outstrips supply. When there is a shortage, the price is bid up leaving only those with the willingness and ability to pay to purchase the product. When prices rise, consumers allocate fewer resources towards products which they cannot afford and are not necessities.

Supply

Quantity Demanded < Quantity Supplied = Excess supply Effect - Price will fall to the equilibrium so that the supplier is not left with unsold stock which is a waste of resources.

Equilibrium

Quantity Demanded = Quantity Supplied = Equal price point Effect - Price remains constant as this is the market clearing price with no unsold stock or excess demand

A shortage

Quantity Demanded > Quantity Supplied = Excess Demand Effect - Price will rise to the equilibrium mainly because of the supplier's profit motive

Effects of Subsidy on Supply

Subsidies are grants paid by the government to suppliers. A subsidy has the effect of reducing the costs of production therefore they influence SUPPLY not demand. A subsidy will shift the SUPPLY CURVE TO THE RIGHT.

Supply

Supply is the quantity of a good or service that firms are able and willing to supply at a certain price over a certain period of time.

Effects of Tax on Supply

The government is able to influence market prices by means of taxes and subsidies. In the UK the most familiar tax on goods and services is VAT (value added tax). Taxes can also come in the form of customs and excise duties. Taxes represent an increase in the cost of production therefore they influence SUPPLY not demand. Income tax will influence demand only. Taxes on goods and services will shift a SUPPLY CURVE TO THE LEFT. Some suppliers may be forced to leave the industry if they are not in a position to pass on higher costs to the consumer.

Rational consumers

The idea that consumers achieve maximum satisfaction when they spend their money in a way which gives the best value for their money or maximises their utility.

External Economies of scale

The lowering of a firm's costs due to external factors. External economies of scale will increase the productivity of an entire industry, geographical area or economy. The external factors are outside the control of a particular company, and encompass positive externalities that reduce the firm's costs. - Lower training costs - training facilities, colleges, universities etc. may provide the skills that you need from your employees rather than you training each worker e.g. ICT and language specialist courses. - Ancillary services (complementary services such as transport, material production, delivery services, machinery repairs businesses) may locate themselves nearby - Greater co-operation amongst firms e.g. locating in London beside finance, legal, creative companies means all the services you need are close together which is efficient. - Purpose built infrastructure such as communication networks (broadband) and transportation links may be provided by the local authority to tempt business to a location and this saves them money e.g. Edinburgh Park and the Gyle.

Optimum output in the short run

The optimum output is the output where the firm would be technically efficient. At this output, average cost is at its lowest.

The Short Run

The period of time when at least one factor of production is fixed e.g. a fixed number of machines, skilled workers or size of building. All other costs will be variable.

The Long Run

The period of time when the capacity of the firm can be increased or decreased. No factors of production are fixed. The fixed factor could be land and/or capital, making you unable to extend your shop or factory in the short-run. It might involve choosing a new location, talking to architects, obtaining planning permission, dealing with building delays. Land and capital are quite often fixed factors in the short-run. If you are running the National Health Service and it takes six years to train doctors, you may regard labour as a fixed factor in the short-run. There can be more than one fixed factor, but in the short-run there is at least one factor of production that is fixed and restraining your expansion.

Fixed costs

These are costs which remain the same within a range of output and they are incurred even when there is no output e.g. rent, loan repayments and insurance.

Variable costs

These are costs which vary with output and are zero when output is zero e.g. packaging costs and raw materials used in the production process.

Free Goods

These are those goods of which there is enough to satisfy everyones wants. e.g. fresh air, sea water. These goods have no cost.

Free Market

This Market is on where: - There are no barriers to firms competing with each other - The price is set in the market by the total demand and supply; firms have to accept this, i.e. they are price takers not price makers - There is no government intervention.

Internal economies of Scale

This can be grouped under the following headings: -Technical economies of scale occur when a large business can afford to invest in large scale capital intensive production. As this allows them to produce a greater output allowing their costs can be spread over greater output. This keeps their LRAC lower than a smaller firm. - Financial economies of scale occur when a large business is offered a lower interest rates than a smaller firm as they are perceived as being less risky. As the interest rate is low, it keeps their costs of production lower than a smaller business. - Marketing economies of scale are achieved when a large business can pay for a large scale marketing campaign and spread the cost of this campaign over their large output of goods and services. As this only adds a small extra cost to each unit of output it does not prevent them from being uncompetitive whilst generating extra sales. - R&D economies of scale can be achieved if a business can invest in greater research. This research may help them to develop more effective methods of production or cheaper materials allowing them to lower their average costs. - Purchasing economies of scale can be achieved through being able to bulk-buy. If large orders are placed a supplier may offer a bulk discount which lowers average costs. - Managerial economies of scale can be achieved through employing specialist managers. These specialists/experts may be able to find ways to improve the efficiency of a business and lower their average costs.

Opportunity cost for the Producer

This is aiming to maximise profit with limited revenue, the opportunity cost of producing a good is the next most profitable product which could have been produced with the resources used.

Opportunity cost for the Consumer

This is aiming to maximise utility with limited income, the opportunity cost of consuming one product is the satisfaction they could have gained from consuming another.

Economic Efficiency

This is an economic state in which every resource is optimally allocated to serve each person in the best way (i.e. maximise the most wants in society) whilst minimising waste and inefficiency.

Market

This is formed when buyers and sellers of a good, service or resource come in contact with each other in order to agree to exchange at the equilibrium price.

The Basic Economic Problem

This is scarcity. In economics scarcity means that there are not enough resources to produce all the goods and services which consumers want. Scarcity arises because human wants for goods and services are unlimited, due to human greed, but the resources (land, labour capital and enterprise) required to produce them are finite.

Individual or Firms Supply

This is the quantity of the good that the firm is willing and able to supply at a certain price.

Total cost

This is the sum of fixed costs and variable costs.

Total Revenue

This is the total money earned from selling output, i.e. quantity sold X price per unit.

Total utility

This is the total of the marginal utilities gained from each unit consumed.

Market Supply

This is the total quantity of the good that all firms in the market would be willing and able to supply.

Utility

This is the total satisfaction gained from consuming a product in a period of time.

Average Revenue

This is total revenue ÷ quantity sold. If a firm sells only one product then average revenue is the same as selling price If you only sell one type of product and it is priced at £100, then your average revenue is the price per item which is £100. If you sell one more unit, your marginal revenue will be the £100 you will add to total revenue. In these circumstances, price is the same as average revenue and marginal revenue. However, if you have to reduce your price to £95 in order to increase demand and sell more units then your average revenue will start falling. In these circumstances, your marginal revenue will fall faster than the average revenue.

Productive Efficiency

This is when all products are produced at the minimum unit cost i.e. when the fewest necessary resources are used to produce each product. Example -In building a bridge, using the least amount of steel while ensuring the bridge will not collapse. Building a bridge strong enough to take 1000-ton lorries would be wasting steel, which could be used for making other products.

Scarcity

This is when human wants for a product are great than its supply of the resource required in making the product, This is permanent and Universal.

Shortage

This is when there is insufficient resources to supply consumers with what they demand at a particular time (i.e what they are willing and able to pay for) A shortage can be controlled though price movements.

Ceteris paribus

This means other things remain unchanged, and is an assumption that is generally made in economic theory. Obviously in the real, non-theoretical world, many other factors would be changing all the time. As the price of a commodity goes up then there is a fall in the quantity which consumers are willing and able to buy. This happens for three main reasons: The Marginal Utility Effect, the Income effect and the Substitution effect.

Demand

This means what consumers want and can afford to buy. Therefore if there is enough of a product to meet the demand of those consumers who want and can afford to pay the prevailing price there is no shortage. However the product will remain scarce because of all those consumers who want the product but cannot afford the price.

Price Elasticity of Demand

This measures the responsiveness of demand to a change in price.

Economies of scale

This occur's when output rises faster than the size of the firm, i.e. when there are increasing returns to scale.

Land

This refers to all the gifts of nature and includes not only land itself, but also all the minerals in and on the land, the sea and everything in the sea, the air, sunlight, etc.

Labour

This refers to any human effort (manual or mental), which is directed to the production of goods or services.

Marginal Utility

This satisfaction gained from consuming an extra unit of a product.

Production Possibility curve

This shows the maximum combination of goods and services that can be produced given the present level of resources available in the current time period. This joins together all the possible maximum combinations of capital & consumer goods together - this maximum output is called the country's potential output.

The Law of Demand

This states that the demand for a product varies inversely with its price. The law of demand states that "the quantity demanded of a good will tend to increase if its price falls and decrease if its price rises - ceteris paribus."

Opportunity cost for the Government

Thos is aiming to maximise social welfare with limited tax revenue, the opportunity cost of providing a service is the next best service which it could have provided with the resources used.

Price elasticity and revenue

To calculate revenue, we multiply the selling price of the product by the number of units sold: Total revenue = P x Q Price changes will have a different effect on revenue for elastic and inelastic firms. If a product is price elastic a change in price will always lead to a more than proportionate change in quantity demanded regardless of whether the price has risen or fallen. If a product is price inelastic a change in price will always lead to a less than proportionate change in quantity demanded regardless of whether the price has risen or fallen.

Average cost

Total cost/Output Average cost is sometimes called unit cost. Average cost may also be calculated by Average fixed cost + Average variable cost

Average Variable Cost

Variable cost/Output

A Fully Efficient Economy

When Full Employment, Allocative Efficiency and Productive efficiency

Total Costs

When output increases in the short run then: - Fixed costs do not change. - Variable costs increase, but not necessarily at a constant rate. - Total costs increase at the same rate as variable costs

Allocative Efficiency

all resources are allocated (used) to produce only the goods & services that consumers actually want, at the price that reflects the value of those goods to society Example - One hundred bridges could be built over the Firth of Forth in Edinburgh in a technically efficient way, but this would be a wasteful use of resources if consumers do not want 100 bridges. The resources could have been used to make products which consumers want more.

Full Employment

when all resources are being used and there are no idle resources which result in lost output.