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Unit 1 — Markets in Action
Pearson Edexcel International Advanced Level Economics 9EC0
IAS Unit 1 · 1h 30m · 40% of IAS
Sections A + B + C
Microeconomics
1Introductory Concepts
The scope of economics, the role of models, ceteris paribus, and the distinction between positive and normative statements.
1.1 What is Economics?
Economics is the study of how scarce resources are allocated among competing unlimited wants.
Scarcity: unlimited human wants against limited finite resources. This forces choices — every decision involves a trade-off. The link between scarcity and choice leads to opportunity cost — the next-best alternative forgone.
Factors of Production
| Factor | Definition | Payment |
|---|---|---|
| Land | Natural renewable/non-renewable raw resources | Rent |
| Labour | Human physical/mental work input | Wages |
| Capital | Fixed (machinery) + Working (materials) | Interest |
| Enterprise | Risk-taking organisers combining factors | Profit |
Free goods: zero opportunity cost, abundant (air, sunlight).
Economic goods: scarce, require resources, have opportunity cost.
Economic goods: scarce, require resources, have opportunity cost.
Production Possibility Frontier (PPF)
PPF: curve showing maximum output combinations of two goods with full efficient resource use. Outward shift = more resources/tech growth. Inward shift = resource loss.
Production Possibility Frontier — points A, B, C on PPF₁; X inefficient inside; Y on shifted PPF₂
Specialisation & Division of Labour
Specialisation: individuals/firms/nations focus on narrow production tasks. Division of labour: splitting production into separate repetitive tasks.
Economic Systems
| System | Decision-maker |
|---|---|
| Free market | Individuals / firms via price mechanism |
| Command (planned) | Government sets output, prices, distribution |
| Mixed economy | Both — most real-world economies |
1.2 Positive vs Normative
| Positive | Normative |
|---|---|
| Objective, testable, backed by data | Subjective, value-based judgement |
| “Inflation is 3%” | “Inflation is too high” |
If a statement contains “should,” “ought to,” “too much,” or “fair” — it is normative.
Consumer Behaviour
- Rational decision making: consumers maximise total utility
- Law of diminishing marginal utility: extra unit consumed yields less extra satisfaction
- Consumer surplus: difference between max willingness to pay & actual market price
2Consumer Behaviour & Demand
The law of demand, determinants, elasticity, and consumer surplus.
2.1 The Law of Demand
Law of Demand: ceteris paribus, as price rises, quantity demanded falls (and vice versa). The demand curve slopes downward.
Movement along vs Shift
| Movement along | Shift of curve |
|---|---|
| Change in price | Change in non-price factors |
| Change in quantity demanded | Change in demand |
Non-price Determinants of Demand
- Income — normal good (up income, up demand); inferior good (up income, down demand)
- Prices of related goods — substitutes (XED > 0); complements (XED < 0)
- Tastes and fashion
- Expectations of future price changes
- Population
2.2 Price Elasticity of Demand (PED)
PED FormulaPED = %ΔQd / %ΔP
| PED Value | Meaning |
|---|---|
| |PED| > 1 | Elastic |
| |PED| = 1 | Unit elastic |
| |PED| < 1 | Inelastic |
| PED = 0 | Perfectly inelastic (vertical) |
| PED = ∞ | Perfectly elastic (horizontal) |
PED and Total Revenue
- Elastic (|PED| > 1): price up, total revenue down
- Inelastic (|PED| < 1): price up, total revenue up
Determinants of PED
- Substitutes — more available = more elastic
- Necessity vs luxury — necessities tend inelastic
- Proportion of income — larger share = more elastic
- Time period — longer = more elastic
2.3 Income Elasticity (YED)
YED FormulaYED = %ΔQd / %ΔIncome
- YED > 0 → normal good (necessity: 0 < YED < 1; luxury: YED > 1)
- YED < 0 → inferior good
2.4 Cross-Price Elasticity (XED)
XED FormulaXED = %ΔQd of A / %ΔPrice of B
- XED > 0 → substitutes
- XED < 0 → complements
- XED = 0 → unrelated
3Supply
The law of supply, determinants, and price elasticity of supply.
3.1 The Law of Supply
Law of Supply: ceteris paribus, as price rises, quantity supplied rises. The supply curve slopes upward.
Non-price Determinants of Supply
- Input costs — wages, raw materials, energy
- Technology — better tech reduces costs
- Number of firms
- Government — subsidies (right), taxes (left)
- Expectations
3.2 Price Elasticity of Supply (PES)
PES FormulaPES = %ΔQs / %ΔP
Determinants of PES
- Time period — very short (inelastic) vs long run (elastic)
- Spare capacity — can increase output quickly
- Availability of stock
- Complexity of production
4Price Determination
Equilibrium, surplus, shortage, and the effects of shifts.
4.1 Market Equilibrium
Equilibrium: where Qd = Qs. The “market-clearing” price.
- Surplus (excess supply): price above equilibrium, downward pressure
- Shortage (excess demand): price below equilibrium, upward pressure
Supply & Demand equilibrium — surplus above Pe, shortage below Pe
Three Price Mechanism Functions
- Signalling — price changes signal scarcity/abundance
- Incentivising — price changes reward/penalise producers
- Rationing — high prices ration scarce goods
5Market Failure
When markets fail to allocate resources efficiently.
5.1 Types of Market Failure
Partial market failure: market operates but misallocates resources.
Complete market failure: market fails to exist entirely.
Complete market failure: market fails to exist entirely.
5.2 Externalities
Externality: a cost or benefit affecting a third party not involved in the transaction.
| Type | Relationship | Example |
|---|---|---|
| Negative production | Social cost > Private cost | Factory pollution |
| Positive production | Social benefit > Private benefit | Beekeeper helps orchards |
| Negative consumption | Social cost > Private cost | Smoking, loud music |
| Positive consumption | Social benefit > Private benefit | Vaccination, education |
Key RelationshipsMSC = MPC + MEC MSB = MPB + MEB
Negative production externality — MSC > MPC at market output; welfare loss triangle between social optimum and market equilibrium
Merit and Demerit Goods
- Merit goods — under-consumed because individuals underestimate private benefits (education, healthcare)
- Demerit goods — over-consumed because individuals underestimate private costs (drugs, junk food)
5.3 Public Goods
Public good: non-excludable and non-rivalrous. The free-rider problem means markets will not supply them (national defence, street lighting).
5.4 Information Gaps
- Asymmetric information — one party holds more information
- Moral hazard — party takes greater risks after being insulated
- Principal-agent problem — agents act in own interest instead of principal’s
6Government Intervention
Taxes, subsidies, price controls, and regulation.
6.1 Indirect Tax
A tax on spending (e.g., VAT). Shifts supply left. The burden is shared between consumers and producers depending on elasticity.
If demand is inelastic, consumers bear most of the tax burden.
Indirect tax — supply shifts left, tax burden shared between consumers (upper portion) and producers (lower portion)
6.2 Subsidies
A payment from government to producers. Shifts supply right, lowering price for consumers.
6.3 Price Controls
| Control | Effect |
|---|---|
| Price ceiling (max price) | Set below equilibrium — shortages, black markets |
| Price floor (min price) | Set above equilibrium — surplus, stockpiling costs |
Price controls — max price below equilibrium creates shortage; min price above creates surplus
6.4 Other Tools
- Regulation — legal controls on production/consumer activity
- Tradeable pollution permits — cap-and-trade for emissions
- State provision — government supplies public services directly
6.5 Government Failure
Government failure: intervention creates greater resource misallocation. Drivers: information gaps, conflicting policy targets, unintended side effects, high admin costs, rent-seeking.