A-Level Economics A: Chains of Reasoning PAPER 1 Flashcards

Question

1.2.4 Supply Q. Discuss the conditions, such as cost of production, that cause supply to shift.

Answer 1

1. If the cost of production rises for businesses but their selling price remains the same, they will make less money. 2. As a result, they will put up their prices in order to avoid making losses. 3. As a result, less is supplied at each price, meaning the supply curve will shift to the left. The opposite is true if costs go down.

Answer 2

1. If the technology improves for a business, this will lead to a fall in production costs. 2. This is because new tech increases the productive efficiency of a firm. 3. As a result, firms will lower prices or produce more goods at the same price, so the curve will shift to the right. The opposite is also true.

Answer 3

1. If there are taxes, the cost of production rises for businesses. If the selling price remains the same, they will make less money. 2. As a result, they will put up their prices in order to avoid making losses. 3. As a result, less is supplied at each price, meaning the supply curve will shift to the left. The opposite is true if costs go down.

Answer 4

1. If there are subsidies, the cost of production falls for businesses. 2. As a result, firms will put lower their prices in order to since they have increased supply. 3. As a result, more is supplied at each price, meaning the supply curve will shift to the right.

Answer 5

1. If firms find it easy to increase supply, then supply will be more elastic, and an increase in price will lead to a bigger percentage change in supply. 2. If supply is price elastic, an increase in demand will cause only a small rise in price, but a significant increase in demand as shown by the diagram. 3. Because of this fact, firms will wish to try and make supply more elastic so they can respond to increased demand. This is because a high PES makes the firm more competitive than its rivals and it allows the firm to generate more revenue and profits.

Answer 6

1. Inelastic supply will lead to a smaller percentage change in supply. 2. If supply is price inelastic, an increase in demand will cause a large rise in price but only a small increase in demand. 3. If supply is inelastic, it invariably causes prices to be more volatile as shown by the graph.

Answer 7

1. In economics, the short term is the period of time when at least one factor of production is fixed and the long term is when all factors are variable. 2. This means PES will be relatively inelastic due to being restricted by the factors of production. 3. In the long term, they can increase production, meaning that PES will be more elastic. Hence why the longer the period of time the has to increase production, the more elastic the curve will be.

Answer 8

1. If the nature of the product is the ability to substitute a product factor used to produce a product for another production function, supply will be elastic. 2. This is because if capital and labour resources can easily be switched, the production process is more flexible. 3. Therefore, the increased replacement capacity of the production of a product will mean supply elasticity is high. The opposite is also true.

Answer 9

1. Large costs of start-up equipment could make it difficult to improve a firm's price elasticity of supply. 2. Firms can increase their PES by investing in spare capacity, improving efficiency, or paying workers overtime. 3. However, improvements in these areas cost money, putting start-ups and firms with low economies of scale at a disadvantage.

Answer 10

1. If the price was set above the equilibrium. The price at which the product is then supplied would be greater than the demand and therefore leading to a surplus in supply. 2. Therefore firms would reduce prices and supply less. 3. This would encourage more demand and therefore the surplus will be eliminated. The new market will then be in a state of equilibrium.

Answer 11

1. In the diagram, the price is below the equilibrium. At this price, demand would be greater than the supply. 2. Therefore there is a shortage. If there is a shortage, firms will put up prices and supply more. As price rises, there will be a movement along the demand curve and less will be demanded. 3. Therefore the price will rise until there is no shortage and the market is in equilibrium.

Answer 12

1. Whenever resources are scarce, demand will likely exceed supply, driving prices up. 2. This implies some people will no longer be able to afford to buy products at the increased price. 3. Due to the rationing function, the limited resources are rationed and are allocated to the people able to afford the products and value them most highly.

Answer 13

1. The price mechanism acts as a signal where resources should be used. 2. When prices rise, producers move resources in the manufacture of that product. 3. The change in price indicates to suppliers and consumers that market conditions have changed so they should change the quantity bought/sold. When equilibrium moves, output equilibrium moves with it.

Answer 14

1. An incentive is something that motivates a producer or consumer to follow a course of action or to change behaviour. 2. Higher prices provide an incentive to existing producers to supply more because they provide the possibility of increased revenue and profits. Low prices act as an incentive for consumers to buy more of a good. 3. As a result the price mechanism encourages people to behave a certain way.

Answer 15

1. In the example of British supermarkets, fewer imports from other countries mean there are fewer goods supplied by supermarkets. 2. Due to the contraction in the supply of food, the price of food rises. 3. This rations off excess demand so that only consumers who value the food most highly buy them (example of the rationing function).

Answer 16

1. The monopoly pricing creates a deadweight loss because the firm forgoes transactions with the consumers. 2. Monopolies are then inefficient and less innovative over time because they do not have to compete with other producers in a marketplace. 3. By restricting output in an attempt to maximize profit. Without the presence of market competitors it can be challenging for a monopoly to self-regulate and remain competitive over time. 4. In the case of monopolies or firms with monopoly power, abuse of power can lead to market failure.

Answer 17

1. Government interventions such as taxation can help reduce negative externalities. 2. A tax would increase the private cost of the consumption of the good with negative externalities. 3. In theory this will cause output to contract towards the social efficiency. 4. Furthermore, taxation will increase the government's revenue, allowing it to finance further efforts to reduce the impacts of negative externalities.

Answer 18

1. However, taxation can distort consumer behaviour. 2. Because taxes artificially raise prices, it encourages evasion. 3. This means that the government loses on tax revenues and doesn’t succeed in reducing demand for negative externalities.

Answer 19

1. If a monopolist can gain a foothold in a market (high market share), can set higher prices. The monopoly prices higher than a competitive market and restricts output, which does not maximise welfare for consumers. 2. Through price capping, the regulator can set prices lower than what is set. 3. Prices are lower, so there is greater consumer welfare, alongside lower production costs. 4. There will also be improvements in productive efficiency since firms now can only increase profits by decreasing costs.

Answer 20

1. Disadvantages of price capping include distortion of price mechanism. 2. Price sends signals within markets as to the balance of demand and supply. 3. Artificially altering the price can send the wrong signals to the market.

Answer 21

1. Indirect taxes are taxes levied on goods and services rather than on income or profits. 2. Taxes are put on goods with negative externalities to increase their price. This is done to reduce the external costs of externalities. 3. As a result, it moves production closer to being socially optimum.

Answer 22

1. Negative externalities of production occur when social costs are greater than private costs. 2. The market left to operate freely will ignore the external costs involved in producing a good. It will produce where MPB=MPC, the market equilibrium, at Q1P1. 3. At Q1, the costs to the society are higher than the benefits to society resulting in the loss of welfare equal to the shaded area. 4. As highlighted by the shaded region, there is a net welfare loss.

Answer 23

1. Negative externalities of consumption occur when social benefit is less than private benefit. 2. In a free market, we get Q1 output. But at this output, the social marginal cost is greater than the social marginal benefit. 3. Social efficiency occurs at a lower output (Q2). where social marginal benefit = social marginal cost.

Answer 24

1. In a free market, consumers ignore the external costs of consumption. 2. Social efficiency occurs at an output where Marginal Social Benefit (MSB) = Marginal Social Cost (MSC). 3. If the output is reduced from Q1 to Q2, society is in a better position. At Q2, the marginal social cost = the marginal social benefit. This is said to be socially efficient

Answer 25

1. In a free market, there is an under consumption of goods with positive externalities. 2. To increase consumption and production, the government can offer a subsidy to reduce the price and increase quantity. 3. The supply curve should expand, decreasing prices. 4. The output will then be socially efficient because Social marginal cost (SMC) equals Social marginal benefit (SMB).

Answer 26

1. However, the cost will have to be met through taxation. 2. Some taxation, e.g. income tax, may reduce incentives to work. 3. The most efficient way to raise revenue for subsidising positive externalities would be to tax goods with negative externalities, however this may not always be the case.

Answer 27

1. Public goods are non-excludable and non-rivalrous, meaning people cant be stopped from consuming a good and benefits from a good or service does not reduce the amount available to others. 2.

Answer 28

1. Public goods are non-excludable and non-rivalrous, meaning people cant be stopped from consuming a good and benefits from a good or service does not reduce the amount available to others. 2. The free rider problem will occur when people can benefit from a good/service without paying anything towards it.

Answer 29

1. Public goods are non-excludable and non-rivalrous, meaning people cant be stopped from consuming a good and benefits from a good or service does not reduce the amount available to others. 2. The free rider problem will occur when people can benefit from a good/service without paying anything towards it. 3. Because of this, there is a danger that, in a free market, the good will be under-provided or not provided at all.

Answer 30

1. Occurs when a government sets a legal limit on the price of a good or service with the aim of reducing prices below equilibrium. 2. When the maximum price is set below equilibrium, will cause excess demand. 3. Excess Demand occurs when the Price of a good is lower than the Equilibrium Price, meaning more consumers will want to buy the good than suppliers are willing to sell.

Answer 31

1. A minimum price is a legally imposed price at which the price of the good cannot go below. 2. When the minimum price is set above equilibrium, will cause excess demand. 3. Excess supply occurs when the market supply of a commodity is greater than the market demand for it, thus causing its market price to fall.

Answer 32

1. If firms produce carbon as a side-effect of production, it is classed as a negative externality. Pollution permits are a method to try and reduce output to a more socially efficient level by providing firms with a market incentive. 2. Pollution permits involve giving firms a legal right to pollute a certain amount. 3. The high polluters have to buy more permits, which increases their costs, and makes them less competitive and less profitable. The low polluters receive extra revenue from selling their surplus permits, which makes them more competitive and more profitable. 4. This creates a market for pollution permits with the price set by demand and supply. The aim of pollution permits is to provide market incentives for firms to reduce pollution and reduce the external costs associated with it.

Answer 33

1. In practice, it can be difficult to implement. It is difficult to know how many permits to give out. 2. If the government is too generous, there will be little pollution reduction. 3. If the government is too strict in implementing permits, firms may complain that it adversely affects output because they can not get enough permits, harming business productivity.

Answer 34

1. The idea of a tax is to make consumers and producers pay the full social cost of producing pollution. 2. In this case, if a tax were implemented, the social marginal cost (SMC) of producing the good is greater than the private marginal cost (PMC). 3. The tax shifts the supply curve to S2 and therefore, consumers are forced to pay the full social marginal cost. 4. This reduces the quantity consumed to Q2, which is the socially efficient outcome (because SMC=SMB).

Answer 35

1. Increased tax can create an incentive for firms and consumers to switch to less fuel-intensive engines. However, the main draw is that it is dependent on demand elasticity. 2. If demand was quite inelastic, an increase in tax may do little to reduce demand and only marginally reduce the amount of pollution. 3. This very much is the case for fuel since it is classed as a necessity, meaning regardless of the price it is needed for daily procedures.

Answer 36

1. A price cap is a government-imposed limit on the price charged for a product. 2. When the price is set below equilibrium, this will cause excess demand. 3. Excess demand occurs when the price of a good is lower than the equilibrium, meaning more consumers will want to buy the good than suppliers are willing to sell.

Answer 37

1. A way in which price signals are distorted is through indirect tax. The effect Ad Valorem tax is to cause a pivotal shift in the supply curve. 2. This is because the tax is a percentage of the unit cost of supplying the product. 3. In the UK the standard VAT rate is 20%, meaning a good supplied for a cost of £50 will now cost $60 when a VAT of 20% is applied. If it were £400, the cost would be £470 when VAT is applied. 4. Therefore, the absolute amount of the tax will go up as the market price increases.

Answer 38

1. Some types of government intervention change price signals in the market and distort the free market mechanism. 2. The price mechanism aims to allocate resources to their best use and where consumers want and value them most highly. 3. By intervening, the government distorts the mechanism and so resources may be allocated inefficiently.

Answer 39

1. A government subsidy is paid to producers to encourage the firm's output by lowering costs. 2. The subsidy will expand the supply curve to the right. 3. This leads to a lower market price. 4. Due to the lowered price quantity demand increases.

Answer 40

1. Some types of government intervention change price signals in the market and distort the free market mechanism. 2. For example, subsidies keep farmers in employment when they cannot produce cheaply enough to be competitive. 3. The result is that the government keeps them in business when they should close down and find an alternative use for their resources.

Answer 41

1. Minimum Price is a scheme to pay suppliers a guaranteed minimum price per unit to encourage supply. As there is a minimum price that the government or establishment will pay for the good, then the supplier won’t sell below that price. 2. The line above the equilibrium is the minimum price, this set price decreases quantity demanded for the good. 3. However, if the supply exceeds demand, there is a surplus. 4. As a result of this, government expenditure has to be allocated to purchase the excess due to the misallocation of resources.

Answer 42

1. Leads to an imbalance in the market - maximum pricing will cause demand to outweigh supply. 2. Even though consumers want to buy more at the lower market price, firms do not want to supply more because the price is lower than it used to be. 3. As a result, the distortion means some consumers will be unable to get the product at all, hence the shortage.

Answer 43

1. Public sector failure occurs when government intervention in the economy leads to an inefficient allocation of resources and leads to an overall decline in economic welfare. 2. This may occur due to a lack of profit incentive in the public sector. 3. People working for the government may not have the same profit motive to cut costs, work hard, or increase efficiency. 4. Therefore, this causes the government sector to be inefficient compared to the private sector.

Answer 44

1. They could improve competition within public sector industries. This could be seen in what the Conservative government implemented in the 1980s. 2. This is when firms bid for the right to run a service or gain a certain contract. 3. Council services could still bid to run refuse collection. But, if a private company offers a better service, then they would lose out to the private sector. 4. The argument is that the threat of competition creates incentives for the public sector to act like a private company and cut costs.

Answer 45

1. The problem with competitive tendering is that the cheapest service may not be the best. 2. A private company may offer to provide school meals for a cheap cost but at the expense of reducing the quality of food. 3. Therefore, you reduce costs, but you have a decline in standards. 4. A government body then needs to be responsible for checking standards of service.

Answer 46

1. Intervention through subsidisation or other interventions can result in a distortion of markets and signals. 2. Taxes and subsidies on goods and services can artificially raise or lower prices and distort how markets work to allocate scarce resources. 3. If prices are lowered, for example, it can be criticised that it encourages wasteful misuse or over-use of scarce resources. 4. For example, free healthcare can result in doctors’ waiting rooms becoming become full of the malingerers and the so-called ‘worried well’. This can result in a waste of public resources and a denial of access to these services by those in genuine need, worsening the economic problem and consumer welfare.

Answer 47

1. However, merit goods are often under-consumed in a free market because people underestimate the personal benefits and/or ignore the external benefits. 2. This leads to an underprovision of things like health care and education. 3. Government intervention to provide free healthcare can lead to a significant improvement in the quality of life for everyone. 4. Vaccination against a contagious disease clearly provides protection to the individual and yields a private benefit. There is also an external benefit to other individuals who aren't protected since there is less spreading of the virus in society.

Answer 48

1. A type of failure is the lack of incentives. Public sector failure occurs when government intervention in the economy leads to an inefficient allocation of resources and leads to an overall decline in economic welfare. 2. This may occur due to a lack of profit incentive in the public sector. 3. People working for the government may not have the same profit motive to cut costs, work hard, or increase efficiency. 4. Therefore, this causes the public sector to be inefficient compared to the private sector, resulting in worsened goods/services for the consumer.

Answer 49

1. However, the public sector failures can be easily solved. Governments could improve competition within public sector industries. This could be seen in what the Conservative government implemented in the 1980s (competitive tendering). 2. This is when firms bid for the right to run a service or gain a certain contract. 3. Council services could still bid to run refuse collection. But, if a private company offers a better service, then they would lose out to the private sector. 4. The argument is that the threat of competition creates incentives for the public sector to act like a private company and cut costs.

Answer 50

1. The principal-agent problem can be linked to the theory of asymmetric information. 2. In theory, the agent should maximise the benefits for those whom they are looking after but in practice, agents have the temptation to maximise their own benefits. 3. The owners may want to maximise the returns on their investment so will want to short-run profit maximise. However, directors and managers are unlikely to want the same thing: as employees, they will want to maximise their own benefits.

Answer 51

1. In a large firm, owners have to delegate control to managers and workers who may not share the same motivation and goals of maximising the interests of the firm. 2. Managers and workers may engage in profit-satisficing. 3. This is where they do enough to keep owners happy but then maximise other objectives, such as sales maximisation.

Answer 52

1. Not all firms aim at profit maximisation and increasing market share. Some owners may prefer a business that is manageable and easy to retain control. 2. Expansion may involve listing on the stock exchange which makes you liable to shareholders. 3. If people work in small firms, they may get more joy because they feel in control and have a close connection with customers. 4. Therefore, they would prefer to keep the firm small and avoid spending their time on management and paperwork.

Answer 53

1. Big firms can benefit from economies of scale in production and sell at a lower cost. 2. Economies of scale help reduce the per-unit fixed cost. As a result of increased production, the fixed cost gets spread over more output than before. 3. It also reduces per-unit variable costs. This occurs as the expanded scale of production increases the efficiency of the production process.

Answer 54

1. Another way large corporations keep costs down is by negotiating for lower prices. Because of the large volume of material a producer is ordering, the vendor or supplier has an incentive to lower its price. 2. It would be hard for a much smaller competitor to get the same deal. 3. The lack of purchasing power affects then means the smaller firm has a higher cost of production than the bigger firm, decreasing its profitability.

A-Level Economics A: Chains of Reasoning PAPER 1 Flashcards

(80 cards)