OCR AS Economics Module 1 Revision Notes – The Reasons for

Individuals, Organisations and Societies Having to Make Choices

What is Economics?

 One can’t have everything one wants – resources are scarce but one’s wants are unlimited
 Choices therefore have to be made, and that’s what economics is all about- choices and
decision making

 It’s not easy to split economics problems into discrete sets of ‘macroeconomics’ and
‘microeconomics’, as complex inter-relationships come into play.

The Basic Economic Problem

 The resources available to an economy are known as the factors of production

 Factors of production are the mean by which an economy produces a whole range of goods
and services to meet the needs of its population
 The four factors of production are:
o Land – Natural resources.
 E.g. oil, rivers, minerals. Also can be attractive touristic things like the sun,
sea, sand, etc.
o Labour – The human resource in an economy.
 Quantity and quality of an economy’s labour are important factors
o Capital – A form of physical resource that covers anything that’s regarded as a man-
made aid for production.
 Capital is combined with land and labour to produce goods that are required
by the population.
 E.g. factories, offices, machinery, IT, transport, roads, electricity, etc.
o Entrepreneurship – A particular form of human capital.
 Firstly, it refers to enterprise whereby the other factors of production are
organized to produce goods and services
 It also refers to entrepreneurs and people willing to take risks

Factors of Scarce Goods and The Basic Economic Problem

Production Resources Services Available

Choices Made Goods and

Wants (Consumers, Firms &
Applying Services Produced
Government)
Opportunity Cost and Consumed
  The quality of an economy is based on factor endowments – Poor factor endowments, poor
economy
 Factor endowment alone isn’t the only ‘factor’ the determines the quality of an economy

 The factors of production are scarce, but consumers’ wants are unlimited
 We all want things, whether it be food and shelter or a new TV
 Wants are different and are of greater or less priority for everyone – scale of preferences
 This means that we have to choose what we want based on what’s available - due to scarcity
(we can’t have it all!)
 When making choices, economists consider possible alternatives – opportunity cost

Specialisation and Exchange

 The problem of scarcity can be addressed through specialisation

 Specialisation is where workers, firms, regions or economies concentrate on a particular task
 It is trade that allows specialisation to take place, as this allows the specialised entity to
trade their services or products for things they’re not producing
 Trade can either be internal (domestic) or external (international)

Specialisation offers benefits like:

 An increase in the output of goods and services compared to unspecialised entities.

o This has caused living standards to rise, since there is a greater output from a
particular volume of resources
 A widening of the range of goods that are available in an economy
 Exchange between developed and developing economies.
o Trade allows for expert-led growth

Specialisation does have risks:

 If a country has finite resources like copper or oil, then when these run out, the economy
is likely to suffer (unless it’s invested its revenues for the future)
 De-industrialisation - loss of jobs due to cheaper labour elsewhere
 Bad weather can wipe out a whole years’ crops
 Consumer needs and wants may change, leaving a country’s exports in a vulnerable
position
 Because the world’s economies rely on each other due to specialisation, if political
disruption were to happen, it would have an adverse effect on the specialised economy

 Trade permits countries to specialise in products that they are able to produce efficiently
 This is due to different economies having different factors of production and factor
endowment – some countries will be rich in oil or copper; others may have a good
climate.

Division of Labour
  As a result of the division of labour, productivity increases, as an employee can undertake
one part of the production process
 A result of the division of labour is that the produce of such a process is very price
competitive
 However, the work is often monotonous and the quality of the product is usually poor.

Production Possibility Curves

 Production possibility curves show how resources should be allocated

 In an economy, what is produced us determined by the quantity and quality of available
resources – factor endowment
 These factors of production therefore determine an economy’s production possibilities
 A production possibility curve shows the maximum level of output of the two goods that can
be produced

 It is most efficient and productive to produce ‘on the curve’

(points A and B)
o This is because the economy will be getting all it can
Quantity of Cars Produced

from the resources and technology available

 Point C is inefficient, as the economy is producing less than it
can from the resources available.
1000 D
o This also represents any other point inside the curve
A
750
 Point D is outside the PPC, and is not a possible outcome as
B
there are not enough resources to satisfy this level of
500
production
o Point D, therefore, shows a position of scarcity
250 C
 Production possibility curves can also be used to
show opportunity cost.
500 1000 1500 2000 o For example, when an economy
Quantity of TVs produced
reallocates its factors or production from
point A to B, 350 cars are being given up to get 650 more televisions
 If the economy is producing at point A, the opportunity cost of producing 650 more
televisions is 350 cars.

 The shape of the curve is also important

o When the economy is devoting most of its resources to produce TVs, the curve is
relatively steep.
 This means that in order to produce more televisions, an increasing amount
of productive capacity for making cars needs to be sacrificed.

 PPCs can also be used to show what is known as ‘trade-off’

o If it is decided that more televisions should be produced, the trade-off is that less
cars can be produced.
  The extent of any trade-off can be shown from the production possibility curve.

 The curve shows an increase in the ability to produce TVs

 As more televisions are produced, the relative efficiency gain
Quantity of Cars Produced

increases
o Before, it could produce 400 cars and 1,650 TVs, it
can now produce 2,300 TVs for the same amount of
1000
cars
 This is because the productivity output per worker has
increased due to the technological advance in television
500
making

 The curve can shift entirely to the left or right

Quantity of Cars Produced

1000 2000 3000  This means that the productive capacity of the economy has
Quantity of TVs produced
changed
 A1100
shift to the right means that the productive capacity has
increased
1000
 A shift to the left means that the productive capacity has
900
decreased

Other
Increase
Decrease

1800 2000 2200

Quantity of TVs produced

Applications

 Production possibility curves can also be used to show the difficult choices that have to be
made by developing economies
o Such economies have low standards of living, expanding populations and little or no
economic potential
o As a result, scarce resources have to
be allocated to meet present needs at
Capital Goods

the expense of investing into the

economy to improve it in the later
years
Increase in  This is done by investing in
productive
potential capitalare
 Here, a lot of resources goods
being used for short term
consumer goods
o The only money being spent on capital goods is often
D
only to replace existing resources
C
 To raise economic potential, a greater proportion of
BA
resources should be devoted to capital goods to shift the
Consumer Goods curve outwards
 A small reduction in the amount of consumer goods
produced (B to A) would produce a greater relative increase
in the amount of capital goods (D to C)
 This would increase the potential for the economy’s
economic growth due to capital investment
 Capital Goods

 This is a similar situation to the previous curve

 However, this is applied to a command economy
o In such an economy, the production of consumer
Increase in goods is held down and resources are allocated for
productive
potential capital goods
D
o Current consumption is therefore being sacrificed for
consumer prosperity
C

B A

 To conclude, production possibility curves

Consumer Goods

are highly simplified models to show fundamental concepts like scarcity, choice and
opportunity cost

Economic Systems and the Role of the Market

 The choices that are made in an economy are determined by the economic system of a
particular country
o The three main types of economic system are the market economy, the mixed
economy, and the command economy
 The former soviet states switched from a command economy to a mixed
economy as the market now has an increasing role to play

The Market Economy

 In a market economy, resources are allocated through the forces of supply and demand;
through the price mechanism.
 Decisions are made by companies and firms with respect to how resources are allocated –
not the government
 Households and firms interact as buyers and sellers
 Price and the free operation of the price system are central to the way that resources are
allocated
 The market operates with little interference
  Prices and self interest of people and
The Market Economy businesses therefore act as a kind-of

Government
Excess
Excess of
of Supply
Supply Excess Supply in the market. Too much is being
from
The Price Mechanism produced compared to demand, resulting in
from Firms
Firms
Government
Government ‘keeps
‘keeps excess of goods
an
an eye’
eye’ on
on the
the
process
process To clear the excess of stocks quickly, the price is
Fall
Fall in
in Price
Price Increase
Increase in
in Price
Price reduced. A by-product of price reduction is that
firms that previously produced a good will no
longer be willing to do so, as there isn’t as much
Price money to be made
Households
Firms
Firms less
less Willing
Willing Increase
Increase in
in Supply
Supply
Firms
to
to Supply
Supply Mechanism
With less of a supply due to not as many firms
producing, the price will rise
More
More Firms
Firms now
now
Increase
Increase in
in Price
Price With the increase in price, firms may choose to re-
Willing
Willing to
to Supply
Supply enter the market

With more firms producing goods, there will be an

excess, and so the price will fall. Thus, the process
repeats
 In principle, the government should have no
‘barometer’ to the decisions that have to be made
direct involvement with the market economy or
the price mechanism
 The government is only there to ‘keep an eye’ on
firms and only interfere where processes don’t
provide the best allocation of resources
o Examples of interference are situations
like price regulation, to stop them being
unreasonably high
 As a result, the market economy is often an ideal,
as government regulations are nearly always
required due to the amoral nature of markets

The Command or Centrally Planned Economy

 Similar to the Market economy, it only really exists in theory

 The government has a central role in all decisions that are made
 Decision making is by planning boards, and production is controlled by the state
 What is available to consumers is determined through centralization

 The government and its organisations are responsible for the allocation of resources
 Production budgets are set for the main sectors of the economy such as agriculture and
manufacturing
 These targets are linked to planning from long term growth through an increase in
productive potential
 Prices of essential items and the determination of wages are controlled
 The state controls most productive resources
 The market doesn’t have much of a role with the allocation of resources

 In practise, government intervention is needed in any economy

  They find it necessary to control the workings of the market mechanism, usually due to
political reasons.
o E.g., the government usually needs to subsidise basic foodstuffs such as bread and
meat to keep prices low and fixed, so members of the public can buy them.
 A consequence of artificially low prices is excess demand relative to supply
 Private ownership of productive resources is often restricted to things like small shops,
restaurants and hair dressers.
 The aim is to achieve a high rate of growth

The Mixed Economy

 This is the most common economic system

 Both the private and public sector have a part in the allocation of resources
 Decisions involve interactions between firms, labour and the government, mainly through
the market mechanism
 There is private ownership of most resources, although public ownership does exist to
varying degrees
 The latest ‘trend’ in the last 20 years has been one of privatisation
o This is moving resources from the public to the private sector
 This has been the trend in many economies, including the UK and the EU
 The introduction of an increased emphasis on market forces has had problems
o Jobs in manufacturing plants in the UK have closed down due to cheaper locations
like south east Asia and eastern Europe offering cheaper labour

 Former states of the USSR have been changed from a near-command economy to a mixed
economy.
o This has resulted in a huge flow of foreign investment, especially in manufacturing
and retail sectors
 Private companies are being started in such economies, and former state owned companies
have been sold off to private owners, who have adopted it and made big profits

 In Asian ‘Tiger’ economies, some states such as Singapore have had a strong focus on letting
the market allocate resources.
 Free enterprise is encourage, and the rewards can be high
 Others, such as Malaysia, have placed more emphasis on central planning
 China’s phenomenal growth has been based on controlled management of the economy, but
with clear opportunities for foreign investors and domestic companies to influence the
allocation of resources.
 Korea

Republic
NorthKorea

CzechRepublic

Singapore
Singapore
Albania
Albania

Hungary
Hungary

France

USA
France

USA
UK
UK
North

Czech
Command
Command Economy
Economy Market
Market Economy
Economy

Weak Market Strong

Allocation of Resources

Strong Governmen Weak

t