4.1 Individuals, firms, 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, perfect competition, monopoly, the operation of the price mechanism and the causes of market failure are central to this part of the specification. Students will need to demonstrate a realistic understanding of the decisions made by firms and how their behaviour can be affected by the structure and characteristics of the industry in which they operate. Other key models relate to the operation of labour markets, wage determination and causes of inequalities in the distribution of income and wealth.
Students will be expected to understand that traditional economic theory generally assumes that economic agents act rationally but they should also be introduced to models that recognise that consumer and firms’ behaviour is often governed by more complex influences.
During their course of study, students should be provided with opportunities to use economic models to explore current economic behaviour. They 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 and labour market failures. They should appreciate and be able to assess the impact that developments in the European Union and in the global economy have upon microeconomic behaviour and performance.
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. |
Individual economic decision making
Consumer behaviour
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Students should appreciate that the hypothesis of diminishing marginal utility supports a downward sloping demand curve but they are not expected to understand the principle of equi-marginal utility or to use this principle to explain why there is likely to be an inverse relationship between price and quantity demanded. |
Imperfect information
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Students should recognise that imperfect information makes it difficult for economic agents to make rational decisions and is a potential source of market failure. |
Aspects of behavioural economic theory
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Students should appreciate that behavioural economists question the assumption of traditional economic theory that individuals are rational decision makers who endeavour to maximise their utility. They should understand some of the reasons why an individual’s economic decisions may be biased. |
Behavioural economics and economic policy
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Students should appreciate that insights provided by behavioural economists can help governments and other agencies influence economic decision making. |
Price determination in a competitive market
The determinants of the demand for goods and services
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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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Students should also know that, under perfect competition, the supply curve is the marginal cost curve. |
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. They should be aware of the assumptions of the model of supply and demand. |
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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The law of diminishing returns and returns to scale
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Students should appreciate that both the law of diminishing returns and returns to scale explain relationships between inputs and output. They should also understand that these relationships have implications for costs of production. |
Costs of production
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Students should be able to calculate different costs from given data. They should also be able to draw and interpret cost curves. |
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. Students should understand the significance of the minimum efficient scale for the structure of an industry and barriers to entry. |
Marginal, average and total revenue
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Students should be able to calculate marginal, average and total revenue from given data. They should also be able to draw and interpret revenue curves. |
Profit
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Technological change
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Students should understand how the process of creative destruction is linked to technological change. |
Perfect competition, imperfectly competitive markets and monopoly
Market structures
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The objectives of firms
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Students should recognise that firms have a range of possible objectives including survival, growth, quality, maximising their sales revenue and increasing their market share. Students should be able to discuss how the divorce of ownership from control may affect the objectives of firms, their conduct and performance. |
Perfect competition
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Students should be aware that perfect competition, in both product and labour markets, provides a yardstick for judging the extent to which real world markets perform efficiently or inefficiently, and the extent to which a misallocation of resources occurs. Students should also be able to assess critically the proposition that perfectly competitive markets lead to an efficient allocation of resources. |
Monopolistic competition
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Oligopoly
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Students should be aware of the various factors which affect the behaviour and performance of firms in a variety of real world markets. The factors include different barriers to entry and the degree of concentration and product differentiation. The kinked demand curve model should be used as an illustration of the interdependence between firms and not taught as if it is the only model of oligopoly. Students should recognise that collusion may allow oligopolists to act as a monopolist and maximise their joint profits. |
Monopoly and monopoly power
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Students should appreciate that firms operating in monopolistically competitive and oligopolistic markets are price makers and have varying degrees of monopoly power. |
Price discrimination
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Students should be aware of real-world examples of price discrimination and be able to assess its impact on producers and consumers. A diagrammatic analysis of price discrimination is expected. |
The dynamics of competition and competitive market processes
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Students should understand that if firms have monopoly power and are making large profits, over time there will be an incentive for new firms to enter the market and to innovate to overcome the existing barriers to entry. Students should understand that this process of creative destruction is a fundamental feature of the way in which competition operates in a market economy. |
Contestable and non-contestable markets
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Market structure, static efficiency, dynamic efficiency and resource allocation
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Students should be able to apply efficiency concepts when comparing the performance of firms in markets with different structures. They should understand how conduct and performance indicators can be used to compare market structures. |
Consumer and producer surplus
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Diagrammatic analysis is expected. |
The labour market
The demand for labour, marginal productivity theory
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Influences upon the supply of labour to different markets
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Students will not be required to understand the determinants of an individual’s supply of labour or the backward-bending supply curve. |
The determination of relative wage rates and levels of employment in perfectly competitive labour markets
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Students should appreciate that all real-world markets are imperfectly competitive to a greater or lesser extent. |
The determination of relative wage rates and levels of employment in imperfectly competitive labour markets
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The use of relevant diagrams is expected. |
The Influence of trade unions in determining wages and levels of employment
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The use of relevant diagrams is expected. |
The National Minimum Wage
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Discrimination in the labour market
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Real-world examples should be used to illustrate wage discrimination. Students should be able to assess the advantages and disadvantages of wage discrimination for workers, employers and the economy as a whole. |
The distribution of income and wealth: poverty and inequality
The distribution of income and wealth
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Some knowledge of the distribution of household income and wealth in the United Kingdom is expected. Students should understand that the degree of inequality can be measured but that whether or not a given distribution of income is equitable (fair and just) involves a value judgement. Students will be expected to interpret measures of inequality such as the Gini coefficient but they will not be expected to calculate the Gini coefficient. Students should understand that excessive inequality is both a cause and consequence of market failure. They should also appreciate that value judgements will influence people’s views of what constitutes an equitable distribution of income and wealth and that these views will influence policy prescriptions. |
The problem of poverty
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Government policies to alleviate poverty and to influence the distribution of income and wealth
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Students should be able to evaluate the various approaches to redistributing income and wealth and alleviating poverty, recognising the moral and political perspectives. |
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. Students should be able to assess the view that the price mechanism is an impersonal method of allocating resources. They should also be able to assess the view that introducing the price mechanism and markets into some fields of human activity may be undesirable and is likely to affect the nature of the activity, eg introducing a market for blood changes the nature of the transaction and the incentives involved. |
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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Students should appreciate the relevance of the ‘tragedy of the commons’ for environmental market failures. |
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 diagrams showing marginal private and social cost and benefit curves. |
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 diagrams showing marginal private and social cost and benefit curves. 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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Competition policy
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Examples of real-world applications of such policies should provide contexts in which students can evaluate the use of economic models to explore economic behaviour and further develop their appreciation of the behaviour of firms. Detailed knowledge of UK and EU competition law is not required. |
Public ownership, privatisation, regulation and deregulation of markets
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Students should be able to assess the application of such policies in the United Kingdom and be able to evaluate their effects on economic performance. |
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 be able to explain, analyse and evaluate the strengths and weaknesses of the market economy and the role of government within it. 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. |