3.1 The operation of markets and market failure
This section of the specification is primarily about microeconomics. Students will be required to acquire knowledge and understanding of a selection of microeconomic models and to apply these to current problems and issues. Microeconomic models such as demand and supply, the operation of the price mechanism and causes of market failure are central to this part of the specification. Students should be provided with opportunities to use these models to explore current economic behaviour. When applying and evaluating all the microeconomic models in the specification, such as supply and demand theory and production possibility curves, students should be critically aware of the assumptions upon which these models are based and their limitations when they are used to make sense of real world phenomena. Students should be able to apply their knowledge and skills to a wide variety of situations and to different markets and examples of market failure, including environmental market failures. They should appreciate that economic decisions relating to individual markets may be affected by developments in the macroeconomy.
Economic methodology and the economic problem
Economic methodology
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Students should understand how thinking as an economist may differ from other forms of scientific enquiry. |
The nature and purpose of economic activity
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Economic resources
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Scarcity, choice and the allocation of resources
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Production possibility diagrams
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Students should be able to use production possibility diagrams to illustrate these features. |
Price determination in a competitive market
The determinants of the demand for goods and services
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Students should understand the factors that influence the spending decisions of consumers, including: price, income, wealth, the price of substitutes and complementary goods, and individual preferences. They should also appreciate that such decisions are influenced by social and emotional factors. |
Price, income and cross elasticities of demand
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Students should be able to interpret numerical values of these elasticities of demand. |
The determinants of the supply of goods and services
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Price elasticity of supply
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Students should be able to interpret numerical values of price elasticity of supply. |
The determination of equilibrium market prices
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Students should be able to use demand and supply diagrams to help them to analyse causes of changes in equilibrium market prices. They should be able to apply their knowledge of the basic model of demand and supply to a variety of real-world markets. |
The interrelationship between markets
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Students should, for example, be able to explore the impact of changes in demand, supply and price in one market upon other related markets. |
Production, costs and revenue
Production and productivity
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Specialisation, division of labour and exchange
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Costs of production
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Students should be able to calculate average and total costs from given data. Students should appreciate that the short-run average cost curve is likely to be U-shaped but a formal link with the law of diminishing returns is not expected. They should understand that the shape of the long-run average cost curve is determined by economies and diseconomies of scale. |
Economies and diseconomies of scale
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Students should be able to categorise and give examples of both internal and external economies of scale. |
Average revenue, total revenue and profit
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Students should be able to calculate average, total revenue and profit from given data. |
Competitive and concentrated markets
Market structures
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Students are not required to draw or use the traditional ‘theory of the firm’ diagrams. |
The objectives of firms
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Students should be aware that firms may have a variety of objectives but a detailed knowledge of these objectives is not required. However, students should appreciate that the objectives of a firm will affect its behaviour. |
Competitive markets
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An understanding of the formal model of perfect competition and the associated diagrams is not required. |
Monopoly and monopoly power
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Students should appreciate that there are few examples of pure monopoly but many firms have monopoly power. A formal diagrammatic analysis of monopoly is not required but students should be able to use a demand curve to illustrate that if a monopolist raises the market price above the competitive level, output will fall. They should also be able to use a long-run average cost curve to illustrate the benefits from economies of scale that may result from monopoly. Students should appreciate the various factors which affect the behaviour and performance of firms in a variety of real-world markets. |
The competitive market process
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Students should recognise that many large firms compete vigorously with each other but monopoly power may lead to consumers being exploited. |
The market mechanism, market failure and government intervention in markets
How markets and prices allocate resources
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Students should understand how economic incentives influence what, how and for whom goods and services are produced. |
The meaning of market failure
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Students should be able to provide examples to inform their discussion of each of these causes of market failure. |
Public goods, private goods and quasi-public goods
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Positive and negative externalities in consumption and production
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Students should be able to illustrate the misallocation of resources resulting from externalities in both production and consumption, using demand and supply diagrams. Students are not required to use Marginal Social Cost/Marginal Social Benefit (MSC/MSB) diagrams. |
Merit and demerit goods
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Students should be able to illustrate the misallocation of resources resulting from the consumption of merit and demerit goods using demand and supply diagrams. Students are not required to use MSC/MSB diagrams. It should be understood that not all products that result in positive or negative externalities in consumption are either merit or demerit goods. |
Market imperfections
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An inequitable distribution of income and wealth
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At AS, students are not expected to have an in-depth knowledge of the causes of inequality but they should be aware that progressive taxes and government spending are used to reduce inequality. |
Government intervention in markets
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Students should be able to apply economic models to assess the role of markets and the government in a variety of situations. Students should appreciate the consequences of government intervention in markets for consumers, producers and other economic agents. Students should be able to evaluate the case for and against government intervention in particular markets and to assess the relative merits of different methods of intervention. |
Government failure
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Students should appreciate that the possibility of government failure means that, even when there is market failure, government intervention will not necessarily improve economic welfare. Students should understand that consumers and producers may not have access to the same information and that this may contribute to markets operating inefficiently. |