Edexcel A-level Economics Paper 1

Perfect solution

Economics
Answer
The study of the allocation of scarce resources.

Economic Goods
Answer
Resources that are scarce.

Short Run
Answer
A time period where at least one factor of production is fixed.

Long Run
Answer
A time period where all factors of production are variable.

Productivity
Answer
The output per unit of input.

The Economic Problem

Answer
Resources are scarce but wants are infinite.

Scarcity
Ans:
The world's resources are limited, there are only limited amounts of land, water, oil,
food, etc..
Therefore, resources are scarce.

Free Goods
Answer
Goods that are unlimited in supply and therefore have no opportunity cost.

Economic Agents
Answer
Consumer, Business and Governments.
Agents involved in Economic transactions.

Production Possibility Frontier

Answer
The maximum potential output of a combination of goods an economy can achieve
when all its resources are fully and efficiently employed, given the level of technology.

Opportunity Cost
Answer
The next best alternative foregone.

Economic Growth
Answer
Increase an economy's productive potential.

Capital Goods
Answer
Goods intended for use in production, rather than by consumers.

Consumer Goods
Answer
Goods designed for use by final consumers.

Renewable Resources
Answer
A resource whose stock level can be replenished naturally over a period of time.

Non-renewable Resources
Answer
A resource whose stock level decreases over time as it is consumed.

Ceteris Paribus
Answer
'All other things (factors) remaining the same'
The assumption that all other variables within a model remain constant whilst the
change is being considered.

Positive Statement
Answer
A statement based on facts which can be tested as true or false and are value-free.

Normative Statement
Answer
A statement based on value judgements which cannot be tested as true or false.

Adam Smith
Answer
The Father of Economics;
- The Invisible Hand (workings of the Price Mechanism)
- Specialisation
- Division of Labour

Division of Labour
Answer
Specialisation of workers on specific tasks in the production process.

Specialisation
Answer
The process of breaking down the production process into steps and then each worker
is assigned a step. This would then increase labour productivity (Output per Worker).

Barter
Answer
An exchange of goods/services for other goods/services.
- Does not involve money.
- Double coincidence of wants.
Money
Answer
Anything which is acceptable to a wide number of people and organisations as payment
for goods and services.

Free Market Economy

Answer
Where all resources are privately owned and allocated via the price mechanism. There
is minimal government intervention.

Command Economy
Answer
Where there is public ownership of resources and these are allocated by the
government.

Mixed Economy
Answer
Where some resources are owned and allocated by the private sector and some by the
public sector.

Market
Answer
A channel where goods and services are exchanged.

Utility
Answer
The capacity of a good or service to satisfy some human want.

Rational Decision Making

Answer
Where consumers allocate their expenditure on goods and services to maximize utility,
and producers allocate their resources to maximize profits.

Demand
Answer
The quantity of goods or services that will be bought at any given price over a period of
time.

Demand Curve
Answer
Shows the quantity of a good or service that would be bought over a range of different
price levels in a given period of time.
Slopes downward - Price and Quantity have an inverse (negative) relationship.
Marginal Utility
Answer
The additional satisfaction that a consumer gains for consuming one additional unit of a
product.

Diminishing Marginal Utility

Answer
As successive units of a good are consumed, the utility gained from each extra unit will
fall.

% Change
Answer
y2 - y1 / y1 × 100

Price Elasticity of Demand (PED)

Answer
The responsiveness of demand to changes in price.
The value is always negative.
% ∆QD / % ∆P × 100

Unitary Price Elasticity (Ped)

Answer
Ped = 1
Perfectly Price Inelastic (Ped)
Answer
Ped = 0

Price Inelastic (Ped)

Answer
Ped is < 1

Perfectly Price Elastic (Ped)

Answer
Ped = ∞

Price Elastic (Ped)

Answer
Ped is > 1

Total Revenue
Answer
Price × Quantity

Income Elasticity of Demand (YED)

Answer
The responsiveness of demand to changes in income.
%∆QD / %∆Y × 100
Negative - Inferior Good (Y increases, QD decreases)
Positive - Normal Good (Y increases, QD increases).

Negative Income Elasticity of Demand

Answer
Inferior Good (As income increases, QD decreases)

Positive Income Elasticity of Demand

Answer
Normal Good (As income increases, QD increases)

Cross Price Elasticity of Demand (XED)

Ans:
The responsiveness of demand for one good to changes in the price of a related good.
(Either substitutes or complements).

% ∆ inQD of Good A/ % ∆ in Price of Good B × 100

Negative Value - Complements (The 2 goods are in Joint Demand; as the Price of Good
A increases the Demand of Good B decreases).
Positive Value - Substitutes (The 2 goods are in Competitive Demand; as the Price of
Good A increases, the Demand of Good B increases.)

Negative Cross Price Elasticity of Demand

Answer
Complements (As the Price of one good increases, the Demand for the second good
decreases)
The 2 goods are in Joint Demand.

Positive Cross Price Elasticity of Demand

Answer
Substitutes (As the Price of one good increases, the Demand for the second good
increases)
The 2 goods are in Competitive Demand.

Supply
Answer
The quantity of a good or service that firms are willing to sell at a given price over a
given period of time.

Supply Curve
Answer
Shows the quantity of a good or service that firms are willing to sell to a market over a
range of different price levels in a given period of time.
An upward sloping curve - Price and Supply have a direct relationship.
Price Elasticity of Supply
Answer
The responsiveness of supply to changes in price.
Pes = %∆QS / %∆P

Equilibrium Price
Answer
The price at which the Quantity Demanded and Quantity Supplied are equal, ceteris
paribis. "Market Clearing Price"

Excess Supply
Answer
Where the QS exceeds the QD for a good at the current market price.
QS > QD
Excess Demand
Answer
When the QD exceeds the QS for a good at the current market price.
QD > QS

Adam Smith's Invisible Hand

Answer
A hidden hand of the market operating in a competitive market through the pursuit of
self-interest allocated resources in society's best interest.
Price Mechanism
Answer
The use of market forces to allocate resources in order to solve the economic problem
of what, how, and for whom to produce.
The interaction of demand and supply to determine the market clearing price.

Consumer Surplus
Answer
The difference between how much buyers are prepared to pay for a good and what they
actually pay.
It is represented by the area under the demand curve above the ruling market price.
Producer Surplus
Answer
The difference between the market price which firms receive and the price at which they
are prepared to supply.
It is represented by the area below the ruling market price and above the supply curve.

Tax Incidence when Demand is Inelastic

Answer
Consumer Tax Burden > Producer's Tax Burden

Tax Incidence when Demand is elastic

Answer
Consumer Tax Burden < Producer's Tax Burden

Tax Incidence when Supply is Inelastic

Answer
Consumer Tax Burden < Producer's Tax Burden

Tax Incidence when Supply is elastic

Answer
Consumer Tax Burden > Producer's Tax Burden
Direct Taxes
Ans:
Tax paid on incomes or profits.
Example; Income Tax and Corporation Tax.

Indirect Taxes
Answer
A tax levied on the purchase of goods and services. It includes both specific and Ad
Valorem taxes.
Its shown by an inward shift of the supply curve.

Specific Tax
Answer
The amount of tax levied does not change with the value of the goods but with the
amount or volume of goods purchased (Excise Duties)
- Parallel to the 1st Supply Curve
Ad Valorem Tax
Answer
Tax levied increases in proportion to the value of the tax base. (VAT)
- Steeper Gradient relative to the original Supply Curve.

Incidence of Tax
Answer
The distribution of the tax paid between consumers and producers.
Consumer Tax
Answer
Below the new EQ and above the original EQ.
Producer Tax
Answer
Below the original EQ and above the original supply curve.
Subsidy
Answer
A government grant to firms, which reduces production costs and encourages an
increase in output.
Its shown as an outward shift of the Supply Curve.

Market Failure
Answer
A misallocation of resources caused by the Market Mechanism.

Reasons for Market Failure

Answer
- Missing Markets ( Merit Goods and Public Goods)
- Lack of Competition in the market.
- Externalities
- Imperfect Market Information
- Factor Immobility
- Inequality

Demerit Goods
Answer
A good which is over provided by the Market Mechanism and tends to yield more costs
to individuals than they realize.
Examples; Tobacco, Drugs, Alcohol, etc..

Externalities
Answer
The costs or benefits that are external to an exchange. They are 3rd party effects
ignored by the Market Mechanism.
Consumption Externality
Answer
An external cost or benefit arising from a consumption activity.

Production Externality
Answer
An external effect of production, which neither harms nor benefits the person or firm
controlling the production.

External Costs
Answer
Negative 3rd Party effects that are excluded from the Market Mechanism.

Private Costs
Answer
Cost internal to a market transaction, which are therefore taken into account by the
Market Mechanism.

Social Costs
Answer
External Costs + Private Costs.

External Benefits
Answer
Positive 3rd Party effects that are excluded from the Market Mechanism.

Private Benefits
Answer
Benefits internal to a market transaction, which are therefore taken into account by the
Market Mechanism.

Social Benefits
Answer
External Benefits + Private Benefits.

Market Equilibrium Level

Answer
Marginal Private Costs (MPC) = Marginal Private Benefits (MPB)

Social Optimum Level

Answer
Marginal Social Costs (MSC) = Marginal Social Benefits (MSB)
This is where society should be.
Welfare Loss
Answer
The excess of social costs over social benefits for a given output.
A situation where MSB is ≠ to MSC and society does not achieve maximum utility.

Welfare Gain
Answer
The excess of social benefits over social costs.

Negative Production Externality

Positive Consumption Externality

Internalising the Externality
Answer
Eliminating the externality by bringing it back into the framework of the Market
Mechanism.
= Creating a market for the Externality.
Examples; Tradable Pollution Permits, Extending Property Rights, Taxes, Regulation,
etc..

Public Goods
Answer
Those goods that have non-rivalry and non-excludability by their consumption.
Non Rivalry; Consumption of goods by one person does not reduce the amount
available for consumption by another.
Non-Excludable; Once provided, no person can be excluded from benefiting.
Examples; Defense, Police Service, Street Lighting, Judiciary and Prison Service.

Private Goods
Answer
Those goods that have rivalry and excludability in their consumption.

Free Rider Problem

Answer
If left to the free market, public goods would not be adequately provided for.
The market fails because firms cannot withhold the goods and services from people
who refuse to pay.

Information Gaps
Answer
Where consumers, producers or the government have insufficient knowledge to make
rational economic decisions.
Symmetric Information
Answer
Where consumers and producers have access to the same information about a good or
service in a market.

Asymmetric Information
Answer
Where consumers and producers have unequal access to information about a good or
service in the market.

Maximum Price
Answer
A ceiling price set by the government on a good or service, above which it cannot rise. It
may be enforced through government legislation.

Minimum Price
Answer
A floor price set by the government on a good or service, below which it cannot fall. It
may be enforced through government legislation.
Guaranteed Minimum Price
Answer
Where the surplus output created is purchased by a government agency at the
minimum price. The main aim of such a scheme is to protect producer incomes.

Tradable Pollution Permits

Answer
Pollution permits that can be bought and sold in a market. They are an attempt to solve
the problem pf pollution by creating a market for it.

Extending Property Rights

Answer
Water companies are given the right to charge companies which dump waste into the
rivers or the sea.
A way of internalising the externality.

Regulation
Answer
Government rules in markets to influence the behaviors of consumers and producers.

Government Failure
Answer
When government intervention leads to an inefficient allocation of resources and a net
welfare loss.
Distortion of Price Signals
Answer
The actions of government which distort the operation of the price mechanism and so
misallocates resources.

Law of Unintended Consequences

Answer
The actions of government, producer or consumers will always have effects that are
unintended or unanticipated.

Administration Costs
Answer
The costs which arise in the formulation, monitoring and enforcing of government
measures to correct market failure.

Government Information Gaps

Answer
The govt. has insufficient information to make rational economic decisions.

Backwards vertical integration

Answer
a joining together into one firm of two or more firms where the purchaser merges
with/takes over one or more of its suppliers

Conglomerate integration
Answer
a joining together into one firm of two or more firms producing unrelated products

Demerger
Answer
when a firm splits into two or more independent businesses

Divorce of ownership from control

Answer
when managers and directors of a business are different from the owners of a business
(the shareholders)

Forward vertical integration

Answer
a joining together into one firm of two or more firms where the supplier merges
with/takes over one or more of its buyers

Horizontal integration
Ans:
a joining together of two firms in the same industry at the same stage of production
Niche market
Ans:
a small segment of a larger market

Merger/integration
Answer
the joining together of two or more firms under common ownership

Not-for-profit organisations
Answer
organisations that do not aim to make a profit; rather, they use any profit or surplus they
generate to support their aims (eg. a charity)

Organic or internal growth

Answer
a firm increasing its size through investment in capital equipment/an increased labour
force

Private sector organisations

Ans:
organisations owned by individuals or companies rather than the state

Public sector organisations

Answer
organisations owned and controlled by the state

Synergy
Answer
when two or more activities/firms put together can lead to greater outcomes than the
sum of the individual parts

Vertical integration
Answer
a joining together into one firm of two or more firms in the same industry at different
stages of production

Average revenue
Answer
the average receipts per unit sold // TR÷Q

Marginal revenue
Answer
the addition to total revenue of an extra unit sold // ΔTR÷ΔQ
Total revenue
Answer
the total amount of money received from the sale of any given quantity of output // AR*Q

Average product
Answer
the quantity of output per unit of factor input // total product÷level of output

Law of diminishing marginal returns

Answer
if increasing quantities of a variable input are combined with a fixed input, eventually the
marginal product and then the average product of that variable input will decline.

Long run
Answer
the period of time when all factors of production can vary, as does the number of firms
in the market, but the level of technology remains constant

Marginal product
Answer
the addition to output produced by an extra unit of input // Δtotal output÷Δlevel of inputs

Returns to scale
Answer
the change in percentage output resulting from a percentage change in all the factors of
production

Short run
Ans:
the period of time in which at least one factor of production is fixed, as is the number of
firms in the market

Total product
Answer
the quantity of output measured in physical units produced by a given number of inputs
over a period of time

Very long run

Answer
the period of time in which all factors are variable, as is the number of firms in the
market, and the state of technology is variable

Average cost
Answer
the average cost of production per unit // AVC+AFC
Average fixed cost
Answer
TFC÷Q

Average variable cost

Answer
TVC÷Q

Diseconomies of scale
Answer
a rise in the long run average costs of a firm as production increases

Economic cost
Answer
the opportunity cost of an input into the production process

Economies of scale
Answer
a fall in long run average costs of production as output rises

External economies of scale

Answer
where the average cost of a firms production falls due to growth in the size of the
industry in which the firm operates

Fixed costs
Answer
costs which do not vary as the level of production changes

Imputed cost
Answer
an economic cost which a firm does not pay for with money to another firm, but is the
opportunity cost of the factors of production which the firm itself owns

Internal economies of scale

Answer
economies of scale which arise due to growth in the scale of production within a firm

Marginal cost
Answer
the cost of producing an extra unit of output

Minimum efficient scale (MES)

Answer
the lowest level of output at which long run average costs are minimized
Optimal level of production
Answer
the range of output over which long run average costs are lowest

Semi-variable costs
Answer
costs that contain within it a fixed and variable cost element

Total cost
Answer
the cost of producing at any given level of output // TFC+TVC

Total fixed cost

Answer
the value of the cost of production that does not vary with output

Total variable cost

Answer
the overall cost of factors of production that vary directly with output

Variable costs
Answer
costs which vary directly in proportion with output

Supernormal profit
Answer
profit above normal profit

Normal profit
Answer
the amount of profit required to keep all factors of production employed in their current
use in the long run (AKA Break-Even point)

Subnormal profit
Answer
profit below normal profit

Barriers to entry
Answer
factors which make it difficult/impossible for firms to enter an industry and compete with
existing producers

Barriers to exit
Ans:
factors which make it difficult/impossible for firms to leave a market and cease
production
Brand
Answer
a name, design, symbol or other feature that distinguishes a product from another and
makes it non-homogenous

Concentration ratio
Answer
the market share of the largest firms in the industry

Homogenous goods
Answer
identical goods made by different firms

Independence
Answer
where the actions of one firm has no significant impact on any other firms in the market

Interdependence
Answer
where the actions of one firm have an impact on other firms in the market

Limit pricing
Answer
when a firm sets a low enough pricing to deter new entrants into a market

Market concentration
Answer
the degree to which the output of a market is dominated by the largest firms

Market share
Answer
the proportion of sales in a market taken by a firm/group of firms

Market structure
Answer
the characteristics of a market that determine the behaviour of firms in the market

Natural monopoly
Answer
where economies of scale are so large relative to market demand that the dominant
producer will always enjoy lower costs of production than any competitors

Non-homogenous goods
Answer
goods that are similar but not identical, for example through use of branding
Perfect information
Answer
when all buyers are fully informed of all prices and quantities for sale, whilst producers
have equal information to production techniques

Product differentiation
Answer
aspects of a good/service that distinguish a product from its competition, for example
through packaging or marketing

Sunk costs
Answer
costs of production that are not recoverable if a firm leaves an industry

Uncertainty
Answer
a when one firm does not know how other firms will react if it changes strategy

Perfect competition
Answer
market structure where there are many buyers and sellers, freedom of entry and exit,
perfect knowledge and where all firms produce a homogenous product

Price taker
Answer
a firm with no control over market price and must accept the market price if it wants to
sell its product

Monopolistic competition
Answer
a market structure where a large number of small firms produce non-homogenous
products and where there are no barriers to entry

Monopolist
Answer
a firm that controls all the output in a market

Monopoly
Answer
a market structure where ine firm supplies all output in the market without facing
competition due to high barriers to entry

Price discrimination
Answer
charging different prices for the same good/service in different markets
Monopoly power
Answer
when firms are able to control the price they charge for their product

Monopsony
Answer
when there is only one buyer in a market

Contestable market
Answer
a market with freedom of entry and where the costs of exit are low

Hit and run competition

Answer
when firms can enter a market at low cost attracted by high profits and then leave at low
cost when profits fall

Consumer sovereignty
Answer
exists when the economic system allocates resources totally according to consumer
preference

Cost-plus pricing
Answer
where firms fix a price for their products by adding a fixed percentage profit margin on
top of the long run average cost of production

Profit maximization
Answer
when profit is at its highest // MR=MC

Profit satisficing
Answer
making sufficient profit to satisfy the demands of owners eg. Shareholders

Revenue maximization
Answer
when revenue is at its highest // MR=0

Sales maximisation
Answer
when the volume of sales is at its highest // AR=AC

Allocative efficiency
Answer
where the goods produced satisfy consumer preferences and maximise their welfare
Dynamic efficiency
Answer
where investment reduces the long run average cost curve

Productive efficiency
Answer
production at the lowest average cost

X-inefficiency
Answer
inefficiency arising from a lack of competition

Creative destruction
Answer
where firms produce/create new products that replace existing products on the market

Multi-plant monopolist
Answer
the sole producer in an industry has multiple places of production which can be sold off
to create competition

Competitive tendering
Answer
introducing competition among private sector firms which put in bids for work contracted
out by public sector firms

Contracting out
Answer
getting private sector firms to produce goods and services then provided by the state

Deregulation
Ans:
the process of removing government controls from markets

Regulatory capture
Answer
when firms can influence to their advantage the market regulatory body

Nationalisation
Answer
the transfer of assets from the private to public sector

Privatization
Answer
the transfer of assets from the public to private sector
Elasticity of demand for labour
Answer
responsiveness of the quantity demanded of labour to changes in the price of labour //
Δ%Q or labour÷Δ%Wage rate

Marginal physical product

Answer
the physical addition to output of an extra unit of a variable factor of production

Marginal revenue product

Answer
the value of the physical addition to outputof an extra unit of a variable factor of
production

Total physical product

Answer
the total output of a given quantity of factors of production

Unit cost of labour

Answer
the cost of employing labour per unit of output

Activity rate
Answer
the proportion of any given population actually in the workforce

Economically active
Answer
the number of workers in the workforce either in a job or unemployed

Net migration
Answer
immigration-emigration

Population of working age

Answer
size of the population between school leaving age and the state retirement age

Labour force
Answer
those economically active and therefore in or seeking work

Workforce jobs
Answer
the number of workers in employment
Bilateral monopoly
Answer
when a single buyer faces a single seller in a market

Minimum wage
Answer
a legal minimum wage per hour that employers must pay their workers

Cartel
Answer
a formal agreement between firms to limit competition in order to maximise profits

Collusion
Answer
collective agreements, be it tacit or formal, between firms that restrict competition

collusive oligopoly
Answer
a market with a high concentration ratio where a few interdependent firms cooperate
(either formally or tacitly) to restrict competition

Concentrated market
Answer
a market with a high concentration ratio

Duopoly
Answer
a market with only two firms

Game theory
Answer
the analysis of situations in which players are interdependent

Market conduct
Answer
the behaviour of firms, eg. through pricing strategies, marketing, branding and collusion

Marketing mix
Ans:
different elements of a marketing strategy designed to increase demand

Non-collusive oligopoly
Answer
an oligopoly where firms compete amongst themselves and there is no collusion
Oligopoly
Answer
a market structure with a small number of interdependent firms

Overt collusion
Answer
agreements between firms to reduce competition eg. through forming cartels

Tacit collusion
Answer
when firms collude without any formal agreement eg. price leadership

Payoff matrix
Answer
a matrix showing the outcomes of a game for players given different possible strategies

Predatory pricing
Answer
a pricing strategy where a firm lowers its prices when a new entrant comes into a
market in order to force the competitor to leave the market, then raises prices again

Price agreement
Answer
a type of collusion where two or more firms agree to fix the prices of their products

Price follower
Answer
a firm which sets its price based on the price of the price leader

Price leadership
Answer
where a 'price leader' sets its own price and other firms set their own price in
relationship to that firm

Price war
Answer
a situation where several firms in a market repeatedly lower prices to outcompete other
firms

Prisoner's dilemma
Answer
a game where, given that neither player knows the strategy of the other, the dominant
strategy leads to a different result than the optimal outcome
Optimal outcome
Answer
the outcome that maximises utility

Dominant strategy
Ans:
the strategy that has the best outcome in light of the decisions of other players