A2 Level Micro CIE Economics Notes for Data Response & Essay paper with predicted essay questions
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Module
A2 Level Microeconomics and Macroeconomics
Institution
CIE
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A2 Level Microeconomics and Macroeconomics
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A2 MICRO ESSAY NOTES
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,Market efficiency
1. Explain what is meant by an efficient use of resources and discuss whether efficiency can only
be achieved if governments are involved [20m]
Introduction
In a market economy, resources are allocated according to the price mechanism. The price mechanism is able
to allocate resource efficiently.
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Economic efficiency is where scarce resources are used in the most efficient way to produce maximum
output. Economic efficiency if basically achieved once two criteria are fulfilled: productive and allocative
efficiency.
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Productive efficiency is achieved when firms produced at an output where average cost is minimized
(minimum point of their average cost (AC) curve). All points on the PPC (production possibility curve) are
productive efficient.
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Allocative effect is achieved when consumer preferences are met. It occurs when Price equals marginal
cost (P=MC in diagram 3), where the price reflect the marginal benefit of the unit. It is also a situation where we
cannot make someone better off without making another person worse off. Only 1 point on the PPC curve
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is allocative efficient.
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If not specified, write on 2 market failure (demerit good/ negative externalities
and monopoly)
,Efficiency can be achieved without government intervention
1. In a market economy (where there is no government intervention), the price mechanism (interaction between
demand and supply) functions to allocate resources efficiently through rationing, is signaling and acting as
an incentive. As such, the market economy’s price mechanism is large able to achieve allocative efficiency
without government intervention.
- Diagram below shows an example of where productive and allocative efficiency in achieved in the long run
perfect competition model.
- In this model, firms are price takers, where goods and services are sold at market price determined by the
price mechanism.
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2. Productive efficiency can also be achieved in the free market through profit motive and competition.
- As all firms are privately owned, all producers will be motivated to ensure that the production process is as
efficient as possible (lower the average cost to each good produced is, the more profit firms will have)
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- When markets become more competitive, firms will have the incentive to invest in technology, undertake R&D
(research and development) and better capital equipments.
- This would lower production cost leading to productive efficiency
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3. There will also be a decrease in average cost as firms grows bigger and achieve economies of scale.
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- This occurs due to the fact that firm’s scale of operation increases so does its level of specialization, hence
overall efficiency.
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Resource effectiveness cannot be attained without government
However, the price mechanism may fail in circumstances due to market failures. Market failure occurs when
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there is a misallocation of resources in a free market. There is thus a justification of government
intervention.
1. Public goods
Public goods is a form a market failure as it exhibits the characteristics of non-rivalry and non-
excludability which leads to a free-rider problem.
- Due to non excludability in consumption, non-payer user cannot be excluded from consuming the goods.
Once it has been supplied, it is impossible to prevent others from consuming it for free.
- Hence firms will be unable to supply them for a profit.
, - Non-rivalry in consumption means that the supply of good is not depleted
by an additional use
- Hence marginal cost of producing the public good is zero, meaning price charged for the
good must also be zero based on the condition for allocative efficiency where
P=MC (price equals marginal cost)
Therefore there is market failure as the private market fails to allocate resources to produce public goods.
2. Demerit goods / Negative externalities
- Demerit goods are over consumed and overproduced because most of these goods are addictive, relatively
cheap and available to the public.
- There are adverse effects associated with these goods, and without government intervention, these products will bring
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more negative externalities to the consumer than the individual is aware of.
- Negative externalities occur when a third party is affected by the decision made by others (e.g. The second hand
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smoke (negative externality) from someone smoking a cigarette (demerit good) will affected others around them.)
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- An example is cigarettes. Free market point is at X where MPB=MPC as firms only consider their private costs and
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benefits when producing. External costs including pollutants is not taken into account in the free market.
- Socially efficient output is at Y where MSC=MSB.
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Methods used to correct negative externalities:
a) Indirect taxes are used to discourage production as it increases price and shifts supply to the left to meet the socially
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efficient level of production. Indirect tax also provides incentive to seek out emission free methods such as solar power.
Less emission means less tax hence lower cost and higher profit.
b) Pollution permit are issues by the Emissions Trading Scheme where firms are given a certain number of permits to
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pollute over a given time period. If a firm emits low level of pollution, it can sell its spare permit to other firms hence
giving them an incentive to earn profit.
c) Laws and Regulations imposed include large fines on any company that contravenes the law. (Strict laws prohibiting
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smoking in public areas.
d) Nudge theory suggest that consumer behavior can be influence by small suggestions or positive reinforcement.
Warnings and advertisement educate the general public about the adverse effects of the good and make them
understand the drawbacks of consuming the good.
E.g. Media campaign can focuses on benefit of recycling. Fall in demand will lead to lower consumption hence
production will fall and allocative efficiency can be achieved.
3. Merit goods / Positive externalities
- Merit goods are under consumed and under produced without government intervention, which causes a problem in
society as these goods have positive externalities associated with them.
- Information failure that arises because consumer is unaware of how good a product is for them is due to not having the
right information or simply lacking any relevant information at all.
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