Cambridge Igcse Economics Keyterms Revision and Notes
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Chapter 11-Price Elasticity of Demand
The Definition & Calculation of PED
The law of demand states that when there is an increase in price, there will be a fall in
quantity demanded
Economists are interested by how much the quantity demanded will fall
Price elasticity of demand reveals how responsive the change in quantity demanded is
to a change in price
The responsiveness is different for different types of products
Calculation of PED
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Chapter 12-Price Elasticity of Supply
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Chapter 13-Market Economic System
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Chapter 14-Market Failure
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Causes of Market Failure:-
• When social costs exceed social benefits (especially where negative externalities (external costs)
are high).
• Over-provision of demerit goods like alcohol and tobacco: the external costs arising from demerit
goods are not reflected in the market and so they are overproduced.
• Under-provision of merit goods such as schools, hospitals and public transport, since the external
benefits of these goods are not reflected in the market, they are underproduced.
• Lack of public goods such as roads, bus terminals and street lights: since their consumption cannot
be measures and charged a price for, they are not produced by the private sector.
• Immobility of resources: when resources cannot move between their optimal uses and thus are not
used to the maximum. For example, when workers (labour) don’t have occupational or geographic
mobility.
• Information failure: when information between consumers, producers and the government are not
efficiently and correctly communicated. Example: a cosmetics firm advertises its products as healthy
when it is in fact not. The consumers who believe the firm and use its products might suffer skin
damage.
• Abuse of monopoly* powers: monopolistic businesses may use their powers to charge consumers a
high price and only produce products they wish to, since they know consumers have no choice but to
buy from them.
• Chapter 15-Mixed Economic System
In a mixed economic system, both the market and government intervention co-exist. Examples
include almost all countries in the world (India, UK, Brazil etc.). This is because it overrides all the
disadvantages of both the market and planned (govt. only) economies. It identifies the importance of
the price mechanism in operating an efficient resource allocation and also the role of the government
in correcting (any) market failures.
Features:
• both the public and the private sector exists
• planning and final decisions are made by the govt. while the market system can determine allocation of
resources owned by it, along with the public organizations.
Advantages:
• The govt. can provide public goods, necessities and merit goods. The private businesses can provide
profitable and most-demanded goods (luxury goods, superior goods). Thus, everyone is provided for.
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• The govt. will keep externalities, monopolies, harmful goods etc. in control.
• The govt. can provide jobs in the public sector (so there is better job security).
• The govt. can also provide financial help to collapsing private organizations, so jobs are kept secure.
Disadvantages:
• Taxes will be imposed, which will raise prices and also reduce work incentive.
• Laws and regulations can increase production costs and reduce production in the economy.
• Public sector organizations will still be inefficient and will produce low quality goods and services.
GOVERNMENT INTERVENTION TO PREVENT MARKET FAILURE:-
The specific ways in which the government, in a mixed economic system, can correct market
failures of the market:
• Legislation and regulation – the government can make laws that regulate market activity, for example,
prohibit smoking in public (which would cause a negative externality). One important kind of legislation
the govt. can undertake is price controls – setting a minimum price or maximum price on goods.
• Minimum price or price floor is set to control a decreasing tendency of price. The minimum wage laws
in many countries are an example of minimum price. The government sets the minimum wage above the
existing market equilibrium wage, to ensure that all workers get a basic minimum wage to sustain them.
But even as low-income workers now get better wages, the higher wage will cause the demand for
labour to contract, as shown in the diagram to the left. There will also be higher supply of labour
(workers who want work) because of higher wages. A reduced demand and increased supply will cause
excess supply of labour i.e., unemployment.
• Maximum price or price ceiling is set to control an increasing tendency of price. It is usually set on rent
(this is called rent control), to ensure that low-income tenants can afford to rent homes. But as a result of
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the lower rent, landlord will stop renting more homes, causing supply to contract, as shown in the
diagram to the left. At the same time, lower rent will increase the demand for homes. A reduced supply of
homes and higher demand for them will cause a shortage of supply in relation to demand.
• Direct provision of merit and public goods – since there is little incentive for the price mechanism to
supply these goods, governments usually provide them. For example, free education, free healthcare,
public parks. One way the govt. can do this is by nationalising certain products it considers essential to
be provided by a governing authority, rather than the market. For example, in India, the government
operates the only railway network because only it can provide cheap services to its millions of poor,
daily passengers.
• Taxation on products – imposing a tax on products (indirect taxes) with negative externalities can
discourage its production and consumption. For example, a tax on tobacco will make it expensive to
produce and consume. In the diagram below, a tax has been imposed on a product, causing its supply to
shift from S to S1. The price rises from P to P1 because of the additional tax amount, and the quantity
traded in the market falls from Q to Q1.
• Subsidies – a subsidy is a grant (financial aid) on products that have a positive externality. Subsidising,
for example, cooking gas for the poor, will increase the living standard of the population. In the diagram
below, a subsidy has been imposed on a good, causing its supply to shift from S to S1. It results in a fall in
price from P to P1 and subsequently, an increase in the quantity traded in the market from Q to Q1.
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*Note: movements along a demand or supply curve of a good only happen as a result of a direct change in
price of the good; changes caused by any other factor, tax and subsidy included, is represented by a shift in
the curves.
• Tradable permits – firms will have to buy permits from the government to do something, for example,
pollute at a certain level, and these can be traded among firms. Since permits require money, firms will
be encouraged to pollute less.
• Extension of property rights – one of the main reasons for pollution in public spaces is that it is public
– it does not harm a specific private individual – the resource is the government’s who cannot charge
compensations easily. So the government can extend property rights (right to own property) of public
places to private individuals. This will effectively privatise resources, create a market for these spaces
and then individuals can be fined for polluting
• International cooperation among governments – governments work together on issues that affect the
future of the environment.
As you can see, market failure can be corrected by governments in a variety of ways and the
presence of a government is quite indispensable in any modern economy. Planned (government-
only) economies are too inefficient and free market (no government) economies result in market
failures. So a mixed economic system tries to balance both sides. That being said, there are
certain drawbacks to government intervention in an economy.
• Political incentives: this occurs when there is a clash between political and economics (because a
government is a political entity with political incentives). For example, even though mining companies
cause a lot of environmental damage, the government may encourage and promote their activities to
garner political and financial support from them.
• Lack of incentives: in the free market, individuals have a profit incentive to innovate and cut costs, but
in the public sector, such an incentive is absent since the government will pay them salaries regardless
of their performance. So, even as the government provides certain public and merit goods directly to the
people at low costs, they tend to be very inefficient.
• Time lags, information failure: these are some of the government failure arising because of a lack of
incentive. Government offices and employees don’t have an incentive to provide timely services or give
accurate information and this leads to very inefficient systems.
• Welfare effects of policies: government policies such as taxation and welfare payments distort the
market. This means that such policies will influence demand and supply in the economy and cause
markets to move away from the efficient points produced by a market system. For example, high
corporate taxes will deter companies from expanding their operations and making more profits or deter
new enterprises from entering the market. Unemployment benefits given out by the government may
cause people to stay unemployed and receive free benefits instead of working.
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Chapter 22- Firm’s Costs,revenue and Objectives
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Chapter 23-Market Structure
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Chapter 24-The Role of Government:-
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Chapter 29-Economic Growth
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Chapter 30-Employment and Unemployment
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Chapter 31-Inflation andf Deflation
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Causes of Deflation
• Fall in the money supply
• Decline in confidence
• Lower production costs
• Technological advances
• Increase in unemployment
• Increase in the real value of debt
Policies to Control Inflation & Deflation
• Contractionary fiscal and monetary policy for inflation
• Expansionary fiscal and monetary policy for deflation
• Supply-side policy can increase aggregate supply and thus control both inflation and deflation
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Section 5-Economic Development
Chapter 32-Living Standards
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