Economics Unit 3 AOS 1

Microeconomics is the study of the economic behaviour of individual consumers and businesses. It studies their choices, the motives behind the choices, and the consequences of these choices.

A latin term meaning "all else equal". This means that other factors that might affect a certain economic scenario are kept constant, such that the effects of one factor can be properly analysed.

In the real world, a variety of factors often influence a scenario.

The assumption that an economic agent will consider all relevant economic information, weighing up the potential costs and benefits and picking the overall most beneficial option.

Often agents don't have access to perfect information and hence do not correctly analyse the circumstances.

Utility maximisers

Profit maximisers

Assumes that consumers will make decisions and purchase certain goods and services in an attempt to maximise their personal satisfaction and gain (utility. Assumes that producers will make decisions designed to maximise their profits.

The assumption that the consumption of each additional unit of a good or service does not generate the same decree of utility/satisfaction as the previous unit. The more an item is consumed, the less utility the person enjoys per additional item.

The economic problem wherein although we have unlimited wants and needs, the resources available to us (land, labor, and capital) are limited, and hence cannot fulfill our needs and wants.

That our needs and wants can never be satisfied and are hence infinite.

The basic economic problem.

All economies face the problem of relative scarcity. As a result, individuals , business and governments must make a decision as to where they allocate their resources. These choices, in turn, have consequences and economics studies both the decisions behind the choices and the consequences of these choices.

A need is a good or service that is necessary for a person's survival.

Food/water, clothing, shelter. However, as society evolves, other goods and services such as telecommunications, electricity and healthcare could be considered needs.

A good of service that is not necessary for a person's survival but the consumption of which is highly desirable and add's to a person's quality of life.

Cars and televisions

Refer to the three main categories of scarce resources that are used as inputs to produce goods and services.

Natural resources/land, labour and capital.

These are naturally occuring inputs and include raw materials and land. All production depends on these natural resources.

This refers to the human contribution in the production process whether it be physical, mental or both.

There are many resources that have been made by combining natural resources and labour, to produce a more sophisticated good. These capital goods are made with the intent of aiding future production generally by increasing efficiency.

That of entrepreneurship (enterprise). Refers to the skills of individuals who combine resources to produce goods and services. Owners of every small or medium sized business in existence is included as they are responsible for running the allocation of resources and use entrepreneurial skill to achieve this.

The value of the second best alternative foregone when a person makes a decision.

Our time is finite and hence scarce, as are our physical resources. We only have 24 hours in a day, and must decide how we allocate our time. By allocating our time and resources to one pursuit, we are intrinsically sacrificing our ability to allocate our time to the second-best alternative.

The value and benefits of the foregone choice, not the choice itself.

A market is any type of arrangement (physical or otherwise) where potential buyers and potential sellers come together to determine the price and quantity of a good or service, in a process of exchange.

A market is the main instrument through which scarce resources are allocated in Australia. It is responsible for answering the three main economic questions of what to produce, how to produce, and for whom to produce.'

Goods and services sold

Factors of production are sold in these.

Interest rates are determined here.

Foreign monetary exchange rates are determined here.

The buying and selling of shares occurs here.

A theoretical market in which buyers and sellers are so numerous and well informed with perfect information (and hence competition is so great) that monopoly is absent and market prices cannot be manipulated.

Many buyers and sellers, homogenous products, ease of exit and entry into market, buyers and sellers operate with full information, buyers and sellers act rationally, little to no government intervention, producers make zero profit.

This ensures that each economic agent acts independently of the market, such that no individual buyer or seller how the power to influence the price of the product.

All products on the market are homogenous, meaning they are identical and offer identical benefits. As a result they are easily substitutable for each other.

This means there are low set up costs in the industry, which means if new profit making opportunities come into being, then new entrants can seek to capture a share of the market.
Moreover, the resources of suppliers are mobile (allowing for easy exit and entry) and will be allocated to those areas of production that generate the greatest profit.

This means that all buyers and sellers know about the price of all available products.

Both the buyer and the seller seek to maximise their own wellbeing. The supplier seeks to maximise profit whilst the consumer seeks to maximise utility

Government plays a minor or non-existent role in the allocation of resources

Due to the possession of perfect information and homogenous products, profits are driven to 0 in the long term. Producers then seek to simply satisfy the needs and wants of consumers. Included in this concept is the idea that goods are SOLD AT THE LOWEST PRICE POSSIBLE.

The Law of Demand states that there is an inverse relationship between price and quantity demanded. That is, when price increases, quantity demanded decreases, and conversely, when price decreases, quantity demanded increases.

Quantity demand decreases

Quantity demanded increases.

Refers to when quantity demanded increases, due to a decrease in the price of a good/service. This results in a downward motion along the demand curve.

Refers to when quantity demanded decreases, due to an increase in the price of the good/service. This results in an upward movement along the demand curve.

Refers to when the ability and willingness of consumers to buy a product increases, due to non-price determinants of demand. As a result, demand as a whole increases. This results in a shift of the demand curve to the right.

Refers to when the ability and willingness of consumers to buy a product decreases, due to non-price determinants of demand. As a result, demand as a whole decreases. This results in a shift of the demand curve to the left.

Tastes and preferences, disposable income, complements, substitutes, interest rates, consumer confidence, population.

Refers to what goods and services are currently considered desirable or popular in society.
This popularity may be cause by fashion merit, health benefits or cultural connotations.
If a product becomes more popular in the eyes of consumers, the demand for the product increases. Conversely if popularity decreases, demand decreases.

The amount of net income an individual or household has available to spend, save or invest, after income tax is deducted. This income is received for their contribution to production
For normal goods and services, an increase in income will lead to an increase in demand, as people have greater ability to purchase products. The inverse also applies.

Complementary goods are those that are often consumed together (Eg: Phones and Phone Chargers).
If the price of a complementary good increases, demand for the original good decreases, as less consumers are able to purchase and consume the goods are together. If the price of a complementary good decreases, demand for the original product increases, as more consumers are now able to consume the products together.

Substitute products are those that offer near-identical benefits and utility to the original product- they are homogenous products (Eg: Butter and Margarine).
If the price of a substitute good or service goes up, the demand for the original product increases, as it offers similar benefits for a lower price. Conversely, if the price of substitutes goes down, the demand for the original product decreases.

Interest rates are the return on money that has been saved, and the cost on money that has been borrowed.
Interest rates affect both the willingness and ability of consumers to consume.

The future economic expectations of consumers in relation to employment and income.
If consumers have high consumer confidence, they believe their income and economic condition will improve, and hence will be more willing to spend money now, increasing demand.
Conversely, if they believe their economic condition will worsen, they will be less willing to spend money now, decreasing demand.

When population increases, demand for most goods usually increases, as there are more buyers in the market, demanding these needs and services. The inverse also applies. A decline in population leads to a decline in demand, as there are no longer as many consumers.

High interest rates encourage people to save (to gain return), instead of spend. This decreases demand.
Low interest rates encourage people to spend, as there is not much point in saving. This increases demand.

High interest rates increase the payments due on existing loans, leaving people with less discretionary income and less able to consumer, hence decreasing demand.
Low interest rates decrease the payments due on existing loans, leaving people with more discretionary income, and a greater ability to consume, hence increasing demand.

The Law of Supply states that there is a positive relationship between price and quantity supplied. That is, when price increases, quantity supplied increases, and conversely, when price decreases, quantity supplied decreases.

Quantity supplied increases

Quantity supplied decreases.

Refers to when quantity supplied increases, due to an increase in the price of the good/service. This results in an upward movement along the supply curve.

Refers to when quantity supplied decreases, due to a decrease in the price of the good/service. This results in a downward movement along the supply curve.

Refers to when the ability and willingness of suppliers to produce a product increases, due to non-price determinants of supply. As a result, supply as a whole increases. This results in a shift of the supply curve to the right.

Refers to when the ability and willingness of suppliers to produce a product decreases, due to non-price determinants of supply. As a result, supply as a whole decreases. This results in a shift of the supply curve to the left.

Affected by the level of the profitability of the product. The more profitable, the greater the willingness to produce.

Availability of resources, cost of production and efficiency/productivity.

Refers to the quantity and type of resources available to producers. A lower amount of available resources decreases supply, whilst more resources increases supply. Factors that affect availability of resources include:
Climate and availability of Raw Materials

Refers to the cost of inputs in the manufacturing process, such as wages, taxes and raw materials. An increase in the cost of production, will lead to a lesser ability to supply, and hence decrease supply. A decrease in the cost of production, will lead to a greater ability to supply, and hence increase supply.

Government subsidies, government taxes, wages, cost of raw materials, interest rates, capital expenses.

Payments made to improve capital assets like machinery. Decrease supply short term but increases it in long term.

Efficiency refers to the maximisation of a firm's resources such that it maximises output and minimises waste. If efficiency increases, the ability of the firm to supply will increase, and hence supply will increase. If efficiency decreases, the ability of the firm to supply will decrease, and hence supply will decrease.

Productivity (Units of output per unit of input)
Technology and Technological Advancements
Climate (sometimes can affect the production process)
Other disruptions to the production process, such as acts of terrorism.

The efficient point where quantity supplied is equal to quantity demanded. Equilibrium is the point were the most efficient allocation of resources occurs. There is no shortage or surplus of the good or shortage, and the market is said to be cleared. No other point will yield higher living standards.

Equilibrium price increases and quantity traded increases.

Equilibrium price decreases and quantity traded decreases.

Equilibrium price decreases and quantity traded increases.

Equilibrium price increases and quantity traded decreases.

A market will always try to return to equilibrium, when a non-price factor shifts the supply and/or demand curve, changing the equilibrium price, and resulting in a surplus or a shortage. The process by which the market returns to equilibrium is known as the market mechanism.

1. State the position of the market and why it is in disequilibrium. 2. State who changes the price, how this occurs and why. 3. State what the adjustment in quantity demanded and quantity supplied is.

Suppliers, seeking to maximise profits, will increase prices. As prices increases, consumers will drop out of the market or consumers will bid up the price.
MARKET FORCES APPLY UPWARDS PRESSURE.
As price increases, the quantity demanded contracts and the quantity supplied expands, until the new equilibrium quantity is reached.

Suppliers, seeking to get rid of excess stock, as it makes no profit sitting there, will decrease prices. As price decreases, more consumers are able to consume, increasing quantity demanded.
MARKET FORCES APPLY DOWNWARDS PRESSURE
As price decreases, the quantity demanded expands, and the quantity supplied contracts, until the new equilibrium quantity is reached.

1. Outline (give detail) about the factor. "Set the scene"
2. Demand or Supply Factor
3. Increase or Decrease- EFFECT ON WILLINGNESS AND ABILITY
4. Shift Curve Left or Right
5. At the original price, there is a surplus/shortage
6. Market forces put pressure on price and quantity to adjust to the new equilibrium.
Say word for word, unless they ask for more detail. If they ask for more detail, refer to how the surplus or shortage is solved, (Stage 2 of Market Mechanism)
7. Movement along the supply and demand curves (contractions and expansions in quantity demanded/supplied.
Stage 3 of Market Mechanism
8. Overall impact on equilibrium price and equilibrium quantity

The price of one market (A) (good) compared to another (B).

Initially markets are equal. Change in one market causes the price of that market to increase or decrease. This results in a change of relative price.

Price of market A good/Price of market B good.

Profit is equal in both markets.

They act as price signals. These signals tell suppliers which market is more profitable, which market has greater demand ( a shortage)

When relative price changes due to a shortage, suppliers realise there is a gap in the market to fill and hence reallocate resources to it, reaching the new equilibrium quantity.

Resources are reallocated to A (as the price (and hence profit) of A is increasing)

Resources are reallocated to B (as the price (and hence profit) of B is increasing)

Before suppliers change their resource allocation, they need to investigate the price signals. It is important that suppliers are not receiving "false signals" and acting upon these.

Actions based on these signals would result in an inefficient allocation of resources, as the signals do not actually represent the changing needs of wants. (i.e. there is actually no shortage in a market, but by reallocating resources there, you have created a shortage in the market you took the resources from).

Inflation / Inflationary Pressure
This causes prices of all goods to rise, and it is important that suppliers don't interpret this as a change in relative price (i.e. an accurate price signal)

When no false signals are acted upon, the market mechanism allows society to achieve allocative and technical efficiency, as resources are being allocated to the needs and wants of society, and relatively cheapest inputs are used
As a result, THE GOODS AND SERVICES THAT SOCIETY WANTS AND NEEDS ARE PRODUCED AT THE LOWEST POSSIBLE PRICE.

Relative price is the price of one market (A) compared to another (B). A change in relative price acts as a signal to producers (suppliers). They must investigate these changes to ensure they are driven by changes to demand or supply, rather than 'false' price pressures such as inflation. An increase in relative price from one period to another indicates that there is a shortage within market A (relative to market B). Therefore suppliers look to reallocate their resources from market B into market A to capitalise on greater profit opportunities and hence rectify the shortage. As this reallocation of resources was based on society's changing needs and wants (indicated in the prices signals), this will result in an efficient allocation of resources, whereby no other allocation of resources will yield higher living standards, opportunity cost is minimised and utility is maximised.

In society, some people earn a relatively higher wage than others. In turn, this gives higher income earners a greater ability to access goods and services than lower income.
These higher income earners can access not only a wider range of products, but also a higher quantity of products This means that, through the price mechanism, resources may be allocated towards the needs and wants of wealthy people in society, as they are more able and willing to pay higher prices (and suppliers seek to capitalize on this willingness and ability). As a result of this, poorer households will have to go without some of these needs and wants - inequitable distribution of resources.

When the price of one input in the manufacturing process (factor of production) increases relative to the price of another, firms may be influenced to change the way in which they produce their goods or service. Suppliers seek to maximise profits, and this is in part achieved by minimising costs. Therefore, suppliers will utilize more relatively cheaper substitute inputs or a different combination of factors of production.
Over time, as firms continually seek to minimize costs by choosing the relatively cheapest substitute inputs, productivity increases, until the point of technical efficiency is reached. At this point, productivity is maximized and average costs are minimized.
So, by observing the price signals set about by changes in relative price from one period to another, firms can utilize the inputs that yield the lowest average cost (and still produce the product), such that they will eventually achieve the most technically efficient means of production.

Living standards are a measure of the quality of life and can be viewed as an indicator of society's happiness. Living standards are divided into two main categories. Material living standards and non-material living standards.

Those factors that relate to the quantity and variety of goods and services which a housed is able to afford and can access. These are considered "measurable" is usually measured in GDP per capita (per person)

Those intangible factors that contribute to our quality of life, yet are difficult to measure. These include: Personal safety, political stability, level of social interaction, equality, health.

The price mechanism (and by extension relative price) enables suppliers to produce the goods and services that society needs and wants, at the lowest possible price (as the price mechanism helps to achieve technical efficiency). This efficient allocation of resources is such that the needs, wants and wellbeing of society are maximised, bettering material living standards.

The market mechanism is one such that each economic agent seeks benefit only for themselves. This means that it can be quite ruthless
If you don't possess valued skills and knowledge, your relative income will be low, leading to inequitable income distribution.
This lack of equality can then lead to social unrest. An economy that focuses entirely on reducing average production costs and improving technical efficiency can lead to unemployment, particularly if new machinery (capital) is cheaper than hiring a labor force. This reduces the feeling of job security, as well as consumer confidence. Moreover, if resources are inequitably allocated to suit the needs of the rich over the poor, inequality will widen leading to increasing crime rates, social unrest etc. Deterioration of living standards occurs.

The responsiveness of quantity demanded to changes in price.

PED = % Quantity Demand / % Price

Perfectly inelastic

Relatively inelastic

Unit elastic

Relatively elastic

Percetly elastic

Perfect elasticity of demand only occurs when perfect substitutes exist. Therefore, a perfectly competitive market is perfectly elastic.

Elastic. A small change in price leads to a relatively large change in quantity demanded.

Inelastic. A large change in price leads to a relatively small change in quantity demanded.

Price elasticity of demand is important for businesses and governments.

By knowing the PED of their product, businesses can determine whether a planned change in price will lead to increase or decrease in revenue.

Where the goods they sell have a relatively low PED. This means that any percentage price increase will result in a relatively smaller percentage decrease in quantity demanded, increasing revenue.

If supply increases through a shock to the market, the price of the product will drop but the quantity demanded of the product will only increase by a relatively small amount, resulting in loss of revenue.

Non-Price Determinant that effects supply or demand within the market

They utilise PED to determine the potential revenue that a tax on a good may generate. Governments often tax the production of inelastic goods like cigarettes generating tax revenue.

Tax on the production or sale of a godo at the moment of manufacture.

They pass this tax on to their consumers. As the good is inelastic, the increase in price will decrease quantity demanded by a relatively smaller amount allowing cigarette manufacturers to generate a sizeable revenue, and keep producing the product.

If the good were elastic and the charges were passed on to consumers, quantity demanded would decrease by a relatively large proportion to the price. As a result, not only would the company have a large decrease in revenue, but the tax would be ineffective in generating large amounts of tax revenue, as large numbers of people would be unwilling to purchase more.

Whilst lots of tax revenue is generated by the government, the actual impact on quantity demanded is relatively small, and doesn't do much to stop the levels of smoking.

Before the price increase, households are consuming the amount of the good or service that is necessary for them to survive/function in society.
Price Increases
The necessity of the good or service has not decreased, and as a result, consumers must consume similar amounts of it to survive. Therefore quantity demanded decreases only by a relatively small amount.
As consumers must continue to purchase similar amounts of the product at a higher price, a greater proportion of their disposable income is now used to pay for the necessity. As a result, the amount of discretionary household income decreases.

Before the price decrease, households are consuming the amount of the good or service that is necessary for them to survive/function in society.
Price Decreases
The necessity of the good or service has not increased, and as a result, consumers continue to consume similar amounts of it. Therefore the quantity demanded only increases by a relatively small amount.
As, for most households, the price of the product has decreased, but consumption has increased minimally (or not at all), the overall cost of consuming the necessity is now lower, and hence takes up a smaller proportion of the household's disposable income. As a result, the amount of discretionary household income increases.

The responsiveness of quantity supplied to changes in price.

% change in quantity supplied / % change in price

Perfectly inelastic

relatively inelastic (Low)

Unit elastic

Relatively elastic (HIGH)

Perfectly elastic.

Elastic: A small change in price leads to a relatively large change in quantity supplied.

Inelastic: A large change in price leads to a relatively small change in quantity supplied.

Economic viability of a business and ability to respond to changing price signals.

Often, having elastic supply, and being to able to quickly adjust their quantity supplied if a price increases or decreases is very beneficial and results in higher revenue.

The greater the elasticity of the product, the quicker suppliers can adjust their quantity supplied to respond to price signals.

A Lower PES. Primary products such as fruit and mining are in this category.

The advent of digital servies have created streaming services and other similar concepts that allow virtually any number of consumers to simultaneously utilise the service. Hence the PES is effectively infinite (horizontal supply curve)

PES is about responsiveness of quantity supplied to changes in price, but these price changes are usually brought about by shifts in demand. Hence, we also observe the sensitivity of quantity supplied to changes in demand.

SPLAT

The number of other goods that offer similar or identical utility and benefits to the original product. A product with many substitutes will have to be more elastic whilst a good with few or no substitutes will be more inelastic.

The percentage amount of consumers' disposable income that the purchase of the product takes up. The greater the proportion of income required to purchase a good or service, the more elastic the PED of that product. this is because a 10% rise in a more expensive good is more costly than a 10% rise in a less expensive good.

How critical a good or service is for a person's survival and wellbeing.

Necessities will have a lower PED as consumers have less choice (fewer substitutes) when purchasing these products as they require if for survival. Therefore, increases in price will result in relatively smaller decreases in quantity demanded.

Luxury goods are items of discretionary spending. Therefore they can be foregone more easily and this makes the PED of these goods high. (elastic). Therefore a small increase in price will result in a relatively large decrease in quantity demanded, as more consumers forego this non-essential item.

A subset of the decree of necessity, addiction can turn a seemingly discretionary item into one with a very inelastic demand curve. If people are addicted to a product, many of them will continue to purchase it even if the price increases.

The length of time over which the consumption of a product is being measured. The PED for a product becomes more elastic in the long term compared to the short term.

In the short term, consumer behaviour is inelastic due to habitual consumption. Consumers will not initially notice an increase in price or will not be incentivised engou to seek out a viable substitute. However, in the long term, consumers will notice these price changes and their behaviour will follow a more elastic demand curve.

DEP

The length of time required to produce a product. When firms receive price signals that allocating resources to a certain part of production is more profitable they will increase their supply of this product. However, this is not an instant process. Products with a long production period tend to be inelastic as it is difficult for suppliers to instantly produce more product to satisfy demand. Product with a short production period tend to be elastic, as producers can quickly produce more of a product to satisfy changes in demand.

The PES of inelastic goods will increase, as firms will be able to better respond to changing price signals. For producers of inelastic products, if a change in price is seen to be relatively permanent, they will eventually be able to largely alter their supply.

Producers will desire to determine whether these prices signals are cyclical or structural in their nature.

Spare capacity refers to factors of production of a firm that are being unemployed or underemployed. The greater the spare capacity of a firm, the greater their ability to increase their supply in response to a change in price. The closer a firm operates to their productive capacity, the harder it iwll be to increase their supply.

It will be very hard to expand their operations and PES is relatively low.

Through investment in more efficient capital resources, or training of labour resources.

The ability of a product to be stored, while still maintaining its quality. If a good is very durable, then producers can respond to changing prices more easily by accessing the inventory that has been stored. Thus, the more durable, the more elastic (higher PES) the good has.

Refers to an allocation of resources where the following stipulations are met: Opportunity cost is minimised (no better use of resources.) NOs surplus or shortage exists (market is cleared). Utility and satisfaction is maximised. No other allocation of resources will yield higher living standards of society.

At the equilibrium point. Occurs when the four types of economic efficiency are maximised.

Allocative efficiency, technical (productive efficiency), dynamic efficiency, inter-temporal efficiency.

Resources are allocated in such a way that society's needs, wants and living standards (well-being) are maximised. Resources are allocated in the most efficient way from society's point of view.

The good or service is produced up to the point where the last unit produced a marginal benefit equal to the marginal cost of producing. At the point of allocative efficiency, no resources are wasted, and it is impossible to make someone's life better, without making another person's life worse.

It is dependent on the values of a society.

Occurs at the point where minimal inputs are used to produce maximum outputs (i.e. at the point where it is not possible to increase output, without first increasing inputs (resources)). The production process is at its most efficient point.
At this point productivity is at a maximum and average costs are at a minimum.

All points on the PPF are considered technically efficient as all resources are being fully employed and utilised efficiency.

Only one point on the PPF will be considered allocative efficient- this will occur when resource allocation resource maximises society's wellbeing.

Refers to how quickly an economy can reallocate resources in response to changes in the market (supply and demand), to achieve allocative efficiency. In turn, this depends on how quickly an economy can reallocate its resources from one activity to another.

Movie theatres cannot really reallocate their cinemas if not a lot of people are going.

Government deregulation of markets and removal of subsidies creates clearer price signals helping to increase dynamic efficiency.

Prices are seen as sticky. This leads to the needs and wants of society not being quickly met.

This focuses on balancing the allocation of resources between present and future demand.
Observes how we manage resources now, and whether they will be able to satisfy future needs and wants.
Moreover, it looks at the balance between consumption and savings over a large period of time. Current investment translates into future consumption.

If an economy can generate goods at lower cost, then technical efficiency is likely to be achieved. Hence, more goods and services can be attained to maximise fulfilment of society's needs and wants, improving allocative efficiency.

If an economy is technically efficient, but it is cheaply producing goods and services nobody wants, then allocative efficiency will not be reached.

A dynamically efficient society is filled with businesses capable of quickly responding to society's changing needs and wants, increasing allocative efficiency.

Government subsidises for solar panels will improve inter-temporal efficiency, by creating sources of renewable energy. However, it is one of the most inefficient ways to decrease greenhouse gases, so it will not maximise society's current level of wellbeing, and hence allocative efficiency will not be maximised.

Refers to the way that key factors of production are assigned to different areas of production.

Relative scarcity. a limited amount of resources means that we have to choose what causes we allocate factors of production to.

The three basic economic questions.

What to produce? How to produce? For whom to produce?

What goods and services will we use our resources to produce.

What combination of resources will we use to produce the goods and services.

Who gets to consume the resources available to us, within these goods and services.

Should everyone get a fair share of the nations' resources? Should access to key resources that improve opportunity be available to all?

No market power, prices determined by market mechanism. Firms are price takers (not price makers). Technical efficiency is achieved as there is incentive to be as efficient as possible to offer lower prices. Allocative efficiency is achieved as consumers hence have more purchasing power and are hence able to purchase more of the goods and services they desire, maximising their wellbeing and increasing allocative efficiency.

Producers cannot compete on the quality of a product, and can instead only compete on price. Technical efficiency occurs as there is an incentive to be as efficient as possible to be able to offer lower prices. Allocative efficiency occurs as when prices decrease, consumers have more purchasing power and hence purchase more goods they desire, maximising their wellbeing.

Dynamic efficiency occurs as this allows for fluid movement of resources between competing uses and markets, increasing dynamic efficiency. Allocative efficiency occurs as producers are able to respond to respond to changes in consumers needs and wants (consumer sovereignty), maximising consumer's needs and wants.

Allocative efficiency: Consumers make rational decisions in order to increase living standards (Eg: By purchasing the cheapest products). Technical efficiency: Producers can be a productive as possible, as they know the perfect way to produce, maximising technical efficiency. Inter-temporal efficiency: Encourages sustainable use of resources, with little to no wastage. Producers efficiently use current resources, and are aware of the most sustainable combination, preserving resources for future use.

A situation that occurs when there is inefficient allocation of society's resources, such that this current allocation of resources does not maximise living standards.

An efficient system in which no allocation of given goods can be made without making at least one individual or group worse off

there is an over allocation of the production of some goods, and an under allocation of resources to other goods relative to the allocation that would maximise welfare and living standards.

Main one! Resources are misallocated, producing goods and services that are less wanted/desired by consumers. This is a problem, as these resources could be put to better use, by making products that consumers value more highly, hence maximising their living standards.

Businesses are not maximising output from their given factor inputs. This is a problem, as the lost output, caused by inefficient production, could have been used to satisfy society's needs and wants.

Exists when there is an over-allocation of resources to current consumption/demand, relative to future use. This is problematic, as this trend is not sustainable, and will result in a lower availability of resources in the future (and hence a lower ability to satisfy demand).

Our resources are not mobile enough to be reallocated between products, in response to an over-allocation or under-allocation. This is a problem, as, when demand changes, producers may be 'forced' to continue to produce non-desirable (and hence not as profitable goods), as they are unable to reallocate resources.

A public good is a good or service that is both non-excludable and non-rivalrous

A supplier cannot prevent a person from consuming the product even if they have not paid.

Consumption by one person does not lead to a reduction in the amount available for others.

Streetlights, lighthouses, police force.

The market will tend to under-allocate resources to those goods where the producer cannot charge all users. Therefore, there is a shortage of these under-allocated resources.
However, profit-seeking suppliers will be reluctant to enter this market, as they won't be able to cover costs. Hence nobody comes in to rectify the shortage.
As a result, producers will allocate resources to other, more profitable uses. As a result, society misses out on the opportunity to consume the valuable product, and its associated benefits.

A free rider is a person who receives the benefit from a public good, but does not pay for it. Instead they rely on other members of society to pay for the good or service and provide incentive for suppliers to provide.

The under-allocation of resources to the production of the desired public good means that allocative efficiency is not achieved (as the needs and wants of society are not being maximally satisfied).

Asymmetric information, public goods, externalities, common across good.

The government intervenes in two major forms: Government subsidies and direct government provision.

A direct cash payment (or low/no interest loans), subsidised costs (Eg: tax-free petrol) or other grants. These are designed to provide enough income to the supplier, to make the production of the good enticing.

The government takes full responsibility for the provision of the public good. By entering the market as a provider, they alter (rectify) the allocation of resources, making it more optimal.

An externality arises when a person is involved in a transaction that affects the wellbeing of a third-party, who is not involved in the transaction. There are two types of externalities:

Third party receives a benefit (positive impact) from the production.consumption of the product.

The third party receives a cost (negative impact) from the production/consumption of the product.

In production or in consumption.

Occurs when production activities undertaken by suppliers impose costs on society. Private costs < social costs. Hence the production is beneficial for the individual but significantly more detrimental to society as a whole.

Occurs when the consumption of goods by consumers imposes costs on other members of society. Social benefits < private benefits. Hence individual receives benefit from consumption and society receives miniscule benefits from it.

Pollution of factories into the air and waterways.
Costs to the ecosystem of intensive pesticides.
Damage to ocean beds and ecosystems caused by intensive fishing.

Smoking of cigarettes leads to second-hand smoke inhalation.
The drinking of excessive alcohol, which can result in car crashes or violence.
Loud music (noise pollution), such as parties late in the night that keep neighbours awake.

All negative externalities will lead to an over-allocation of resources to these socially undesirable products (pollution, noise, smoking), as ideally, there we would be none of these products in existence. Hence too many resources are allocated to the production/consumption of the relevant good or services, living standards are not maximised and the socially optimal allocation of resources is not achieved.

they will attempt to reduce the demand or supply of a product to ensure more socially optimal levels of production occur. This can occur through government regulation, indirect tax, subsidies and government advertising.

The government can use the law to control the levels of production or consumption of undesirable goods/services.

Can make production unprofitable, decreasing supply and/or when passed on to consumers, makes them unwilling or unable to consume the undesirable product.

By subsidising the production of more socially desirable goods, the government can draw supply away from certain areas.

By advertising the adverse nature of a product, governments can reduce demand for it. (Eg: Cigarette Adverts)

Occurs when the production activities undertaken by suppliers impose benefits on society. This means that the costs to the firm are greater than the costs to society such that consumers and society will extract utility for a good without necessarily paying for it(producers much shoulder this cost).

Research and development by a firm results in new technology, but this may be accessed by other firms and members of society, meaning the firm cannot extract the full benefits of the research and development.

Occurs when the consumption of goods by consumers incurs benefits for others. Social benefits > Private benefits. This means that the individual will receive some benefit but the mass benefit to society will be significantly more.

Vaccinations. By getting a vaccination, you are protecting yourself from the disease, and stopping yourself from infecting others.
Education. Education benefits individuals (Eg: Increased earning capacity). However, society also benefits, as the labour force is more productive, unemployment is lower, and crime rates are usually lower.

is lower than socially optimal, as not everyone wants them, despite the benefits (Eg: Not everyone wants vaccines)

All positive externalities will lead to an under-allocation of resources to these socially desirable products, as we can never have enough of them. There are always more people to vaccinate or educate.
Therefore too few resources are allocated to the production/consumption of the relevant good/service and the socially optimal allocation of resources is not achieved, as living standards are not maximised.

The government attempts to increase demand or supply of the product to ensure more socially optimal levels of production occur. This can be through government regulation, subsidies, direct provision and advertising.

o Using the law to make certain positive activities mandatory, such as compulsory education between the ages of 5 and 16, or the "No Jab, No Play" policy, wherein children had to be vaccinated to go to pre-school.

Subsiding the production of these socially desirable goods, such that more are available to society.

The government physically provides the product to its citizens.

The government advertises the benefits of a socially beneficial product in order to increase demand for it.

These are goods/ resources that are NOT owned by anyone, and therefore do not have a market price. They are non-excludable and rivalrous

Anyone can utilise the resource without having to pay for them in a market. No-one can be stopped from accessing the resource.

Consumption of hte resource by one person leads to a reduction in the amount available for others.

Fish in the ocean and trees in the forest.

Common access resources SPECIFICALLY limit inter-temporal efficiency. This is because these resources go against sustainable development. Current Consumption is too great, meaning that future demand will not be able to be satisfied. A lack of balance exists.

Lack of excludability leads to excessive consumption of the good, as each person, seeking to maximise their own utility (consumers) or profit (producers), consumes the good with disregard to the consumption needs of future generations.
Overconsumption of resources now
Therefore, future access to these resources will be limited by these current choices, resulting in inter-temporal inefficiency.

Regulation, indirect tax and subsidies.

Laws and permits increase the exculdability of these goods.

Levied on the consumption of these common access goods. It uses relative prices to change production methods. When the price of one method of production rises relative to other methods, then producers will reallocate resources to the cheaper more profitable option.

Can be used to encourage the use and development of alternate, more sustainable technologies, or to attract producers of a certain good (Eg: Fishermen) away from the production of fish to that of a more sustainable alternative.

A market transaction where one party has access to more (knows more) information than the other. There is a lack of perfect information.

adverse selection; moral hazard

Consumers will tend to withhold information about adverse behaviours in order to get cheap insurance. The insurance is sold below fair value which results in increase in average premium for all consumers. Low risk consumers may determine that health care is not worth it and drop out of market. Increases firm's average costs, increasing average premiums further. As a result health insurance providers may drop out of market and there is not an underallocation of resources towards the private health insurance sector. Society needs and wants no maximised.

When economic agents adjust their behaviour to one that is less efficient or favourable from society's point of view.

Consumers, relatively protected against the risk of loss, may act more recklessly. For example, they might take less preventative methods to stop their car being stolen, as they know they will be reimbursed. Or they may buy more health services than necessary, as they have health insurance.
Both of these reflect an inefficient allocation of resources, as with more 'favourable' behaviour, neither circumstance would have occurred, and resources would not have been wasted on it.

Seller withholds information from buyer. Hence product sold at price that is above fair value. This leads to adverse selection.

Where the seller knows more than the product than the buyer, such that the consumer may purchase adversely, instead of purchasing other, more beneficial allocations, increasing demand, leading to an over-allocation of resources to the production of this misleading good.

if a weight loss product is ineffective, but consumers still purchase it, as suppliers have more information, and advertise the product as effective, then there is an over-allocation of resources to a misleading, ineffective product that doesn't maximise the needs and wants of society.

If a mutually beneficial transaction does not take place in the second hand car market, and the car is actually a 'lemon', then the consumer might now only demand new cars, meaning fewer cars are sold second-hand, and there is an over-allocation of resources to the production of new cars. A more efficient allocation could be achieved by selling more used cars.

Actions of consumers are less favourable from society's point of view, often leading to unnecessary using of resources. This decrease the efficiency of resource use, resulting in an inefficient allocation of resources, a market failure.
Moreover, the actions of consumers can lead to an under-allocation of desired goods (like insurance), resulting in a decrease in allocative efficiency.

Means that consumers purchase products at an above fair price, and hence these products do not maximise their living standards, as they are unaware of the ineffective nature of the products. Moreover, the resources used to produce these less desirable products could be used to make more beneficial products. Therefore the outcome does not maximise living standards for one of the parties.

Often, economic agents in the market (consumers or producers) will take action to gain the necessary information to make an informed decision. For example employee screening, independent reviews of products, altering terms of contract for insurance.

Government regulation, government advertising, subsidies.

Governments can use the law to protect consumers from misinformation that might be provided by sellers. They can use consumer law and medicare levy.

Australian Consumer Law makes it illegal for firms to engage in conduct that misleads or deceives consumers. This forces producers to reveal information about their products, such as ingredients and nutritional information. This brings the market close to perfect information, allowing consumers to better maximise their living standards, increasing allocative efficiency, and hence rectifying the market failure.

Governments also tax a Medicare Levy on those who do not have health insurance, and subsidise those who do. This ensures that more people purchase health insurance, bringing the market closer towards allocative efficiency

Consumers may be unaware of benefits associated with merit goods and demerit goods. This in itself is asymmetric information, as consumers are unaware of what products are best for their wellbeing. Increases allocative efficiency, as consumers know what they should purchase.

Products that enhance customer outcomes.

Products that are harmful to the consumer.

The government can provide subsidies to consumer information groups (as well as groups like documentary makers) to enhance the amount of reliable product information available to consumers

Define the market failure. Describe how it impacts the market (supply and demand - although with externalities it is more focussed on allocation of resources). Does this result in under-allocation or over-allocation of resources relative to the socially optimal level of resource allocation? Link to a definition of market failure.

1. Governmental Action
2. How it Works
3. How allocation has changed
4. Impact on "efficient allocation of resources"

The government set a minimum wage to ensure people aren't living below the poverty line and people are not exploited by workers. However, this resulted in a surplus of labour, increasing unemployment (under-allocation of labour resources).

The government intervenes in the labour market in an attempt to ensure workers receive a living wage and avoid poverty. They do this by introducing a minimum wage that acts as a price floor (lowest legal price labour can be purchased at), by selling the price of labour above the market equilibrium. This will mean that households will be willing to supply more labour, but the willingness of businesses to demand labour will have decreased, thus leading to a surplus in labour (Qs>Qd). The surplus of labour represents increased unemployment, which means that some of our labour resources are being under-utilised and not being used efficiently towards production, leading to a decrease in technical efficiency. Furthermore, higher unemployment reduces average incomes, thus people have lower access to goods and services. This leads to a decrease in material living standards and overall wellbeing, which results in a decrease in allocative efficiency. Therefore, the government intervention has made living standards worse, and propagated an inefficient allocation of resources.

The gain or satisfaction that customers receive from the consumption of a product. It helps determine our level of demand and guides our decisions as consumers.

Macroeconomics is the study of the behaviour and performance of the whole. It is concerned with economy-wide phenomena and their effects. Macroeconomics often builds upon the analysis of microeconomics in order to study the economy as a whole.

Refers to the stored goods that a supplier can readily access and sell, if the opportunity arises.

The absolute point at which society's resources are allocated in the most efficient way possible, such opportunity cost is minimised, no other allocation of resources leads to higher living standards and it is impossible to make someone better off without making another worse off.

A production possibility frontier is a diagram of the productive possibilities of an economy, and can be used to demonstrate opportunity cost.

It looks at the trade-off between producing two particular goods or services. In fact, the simplest PPF model assumes that an economy can only produce two goods.

The economy can achieve any point of production on the PPF. They have achieved technical efficiency.

Leads to inherent opportunity cost.

Not achievable with today's economy, highlighting the concept of relative scarcity.

Not allocating resources efficiently, so some resources are underemployed or unemoployed.

It would expands it's PPF, and increase the output of both goods.

This can be achieved through the discovery of new resources that can be used for production. It can also be achieved by developing more efficient production techniques, allowing more output to be generated with existing resource levels

Refers to resources that are very commonplace and readily available. Opposite of scarcity.

Resources such as water, that were once abundant are becoming increasingly scarce due to human mismanagement of resources.

1. Define relative prices. 2. Suppliers use these signals. 3. They investigate. 4. Increase in relative price shows an increase in demand. 5. Reallocate resources to market A.

Define one. Whereas. Define two. Overall difference.

The allocation of resources such that no other allocation will yield higher living standards and hence consumer needs and wants are maximised.

`the power of consumers to decide what gets produced

Difficult to achieve without government intervention. Economic agents are self-motivated meaning they act to maximse their own present utility.