AS Microeconomics (AQA)
“The operation of markets and market failure”
“Economic Methodology”
Economic methodology refers to the techniques and approaches economists
use to understand and analyse economic phenomena. As a social science,
economics uses both theoretical models and empirical data to study how people
make decisions regarding the use of scarce resources.
Economists use a version of the scientific method, involving observation,
hypothesis formation, testing, and conclusion.
However, economics differs from natural sciences (like physics or
biology) because it deals with human behaviour, which can be
unpredictable and influenced by many factors.
Economists create simplified models to understand complex real-world
situations. These models make assumptions like ceteris paribus (all other
things being equal) to focus on specific factors.
For example, a demand and supply model assumes that only the price
and quantity change, while other variables (like consumer preferences)
remain constant.
Positive Statements: These are objective and fact-based. They describe
the world as it is and can be tested and verified. For instance, a positive
statement like "The unemployment rate is 5%" can be measured and
, checked using data. Positive economics focuses on explaining how
economic phenomena work without making value judgments.
Normative Statements: These are subjective and based on opinions or
value judgments. They describe how the world should be rather than how
it is. For example, "The government should increase the minimum wage"
reflects a belief about what ought to happen and cannot be proven true
or false. Normative economics is concerned with making
recommendations for policy based on ethical or social goals.
Rational Decision Making: Economists assume that individuals and firms
act rationally, meaning they make decisions that maximise their
satisfaction (utility) or profit. This assumption is central to many
economic models.
o Consumers: Aim to maximise their utility by purchasing goods and
services that provide the most satisfaction at the least cost.
o Firms: Aim to maximise profit by producing at the lowest cost
while selling at the highest possible price.
However, in reality, people and firms may not always behave rationally
due to factors like emotions, lack of information, or cognitive biases.
Factors of Production
Land: Refers to all natural resources available for production, such as
minerals, forests, and water. It includes anything that comes from the
Earth.
Labour: Represents the human effort—both physical and mental—used in
the production of goods and services. The quality and quantity of labour
can differ based on education, skills, and experience.
Capital: Includes man-made resources such as machines, factories, tools,
and buildings. These are used in the production process to make other
goods.
Enterprise: Refers to entrepreneurs who organize the other factors of
production (land, labour, capital) to produce goods and services.
Entrepreneurs also take risks to innovate and bring new products to
market.
Each of these factors of production earns a return in the economy. Land
earns rent, labour earns wages, capital earns interest, and enterprise
earns profit.
Scarcity: This means that resources (such as land, labour, and capital)
are limited and finite. However, human wants and needs are endless.
Because of scarcity, we cannot produce enough goods and services to
satisfy everyone’s wants.
, The Economic Problem: Due to scarcity, societies and individuals must
make choices about how to allocate resources. The three questions that
arise from the economic problem are:
What to produce? Should resources go towards making consumer goods
like food and clothing, or should they be used for producing investment
goods like factories and machines?
How to produce? Should goods be produced using more workers or more
machinery? Should production be more environmentally friendly but
costlier, or cheaper but with more environmental impact?
For whom to produce? Once goods and services are produced, society
must decide who gets them. Should they be distributed based on income,
need, or merit?
Opportunity Cost: This is a fundamental concept in economics and refers
to the cost of forgoing the next best alternative when making a decision.
In simpler terms, it’s the value of what you give up when you choose one
option over another.
For example, if a government decides to allocate more funds to
healthcare, the opportunity cost could be the education projects it can no
longer fund. For individuals, choosing to spend money on a vacation may
come at the opportunity cost of saving for future expenses or
investments.
Trade-offs: Because of opportunity cost, every economic decision
involves trade-offs. These are the compromises made when deciding
between competing uses of resources.
Production Possibility Frontier (PPF)
PPF: The Production Possibility Frontier is a curve that illustrates the
maximum output combinations of two goods or services that can be
produced with available resources and technology. It shows the trade-
offs and opportunity costs involved in production.
Points on the Curve: Points along the curve represent efficient
production, meaning that all resources are being fully and efficiently
used. Any point inside the curve indicates underutilisation of resources
(inefficiency), while any point outside the curve is unattainable with the
current resources.
Shifts in the PPF: If the curve shifts outward, it means that the economy
can produce more of both goods, usually due to improvements in
technology or an increase in resources (economic growth). Conversely,
an inward shift may occur due to a loss of resources or technology
(economic decline), such as in the case of natural disasters or war.
, Each point on the PPF below demonstrates a different concept. Points A, B,
C, E, and F represent efficient use of resources since they lie on the curve,
indicating that the factors of production are being fully utilised. Although all
these points are on the curve, they signify different things. Their positions
reflect unique combinations of the two goods on the axes. For instance, point A
shows that if all resources are used to produce 18 trucks, no hamburgers can be
made, and this is still productively efficient since it's on the curve. However,
while productively efficient, it might not be allocatively efficient if consumers
prefer a combination like point E, where more hamburgers are produced. Point
H indicates a level of production that is currently unattainable because there
aren't enough resources available. Lastly, point D reflects an underutilisation of
resources, meaning this combination is not productively efficient.
“Price determination in a competitive market”
In a competitive market, prices of goods and services are determined by the
interaction of demand and supply. Both buyers and sellers play a role in setting
the equilibrium price, where the quantity demanded equals, the quantity
supplied. This process of price determination is central to how markets operate
and how resources are allocated efficiently.
The Law of Demand
Demand refers to the quantity of a good or service that consumers are
willing and able to purchase at different prices over a period of time.
