Cambridge International AS & A Level Economics: Model Essays (Preview)

Copyright Š 2020 by Sunway University Sdn Bhd Published by Sunway University Press An imprint of Sunway University Sdn Bhd No. 5, Jalan Universiti Sunway City 47500 Selangor Darul Ehsan Malaysia press.sunway.edu.my

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Cambridge Assessment International Education bears no responsibility for the example answers to questions taken from its past question papers which are contained in this publication.

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Past question papers contained in this publication are reproduced by permission of Cambridge Assessment International Education.

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All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, now known or hereafter invented, without permission in writing from the publisher.

ISBN 978-967-5492-03-7

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Perpustakaan Negara Malaysia

Cataloguing-in-Publication Data

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Wong, Wai Leong Cambridge International AS & A-Level ECONOMICS : Model Essays / Wong Wai Leong, Ngew Shook Ying, Nedumaran Munusamy.

ISBN 978-967-5492-03-7 1. Economics--Problems, exercises, etc.

I. Ngew, Shook Ying.

II. Nedumaran Munusamy.

III. Title.

330.76

Edited by Hani Hazman Designed by Rachel Goh Typeset by Helen Wong Printed by Nets Printwork Sdn Bhd, Selangor

Cover image: Alexandr Shevchenko/Shutterstock.com Image used under license from Shutterstock.com

Foreword While people have studied Economics for almost two centuries, it is only recently that the subject is perceived as a “highly mathematical, value-free, abstract subject�.

This book aims to help students organise and write coherent essays for the Cambridge International AS and A Level Economics (9708) examination. I am sure you will gain useful insights from the author Wong Wai Leong, who has had years of experience teaching the subject. This book will undoubtedly provide added knowledge and comprehensive coverage of the subject.

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It is hoped that the wisdom provided in this book will not only aid you in preparing for the Cambridge International AS and A Level examination, but that it will help spark a greater interest in the fascinating subject of Economics.

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Elizabeth Lee (Dr) Chief Executive Officer

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Contents

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Sunway Education Group

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Introduction How to use this book

ii iv

AS Level Chapter 1 Chapter 2 Chapter 3 Chapter 4 Chapter 5

Basic Economic Ideas The Price System Government Microeconomic Intervention Macroeconomic Concepts Government Macroeconomic Intervention

2 20 34 56 74

Basic Economic Ideas The Price System Government Microeconomic Intervention Macroeconomic Concepts Government Macroeconomic Intervention

90 106 152 164 190

A2 Level Chapter 1 Chapter 2 Chapter 3 Chapter 4 Chapter 5

Introduction While the prospect of writing an essay can be intimidating for some students, learning some crucial tips can help you go through the essay-writing process with ease.

Question interpretation Many students lose significant marks due to question misinterpretation. You must read the question clearly—and several times, if needed—to fully understand the question and avoid writing irrelevant content.

Command words

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There is a command word in every question. It is important for you to understand the difference between the words ‘State’, ‘Explain’, ‘Analyse’, ‘Evaluate’ and ‘Discuss’.1

The most popular command word in the examination paper is ‘Discuss’. When the word is used,

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you must provide a discussion that looks at an issue from both sides—the good and the bad.

Use of paragraphs

Avoid writing an essay without breaks in paragraphs. It is ideal for you to present each idea or argument in its own single paragraph. In other words—one idea, one paragraph. This makes the

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essay more systematic, and easier to read and understand.

Use of diagrams

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Diagrams are crucial in illustrating and clarifying ideas in an essay. There are three things to keep in mind when using diagrams in an essay:

Diagrams must be fully labelled (including the y and x axes, the zero value at the start of the

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(i)

axes, the line or curve names, and the arrows showing the direction of any line or curve shift) (ii) Make references to diagrams in the essay

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(iii) Be generous in using space when drawing diagrams

Elaboration of examples When explaining a point or argument, you need to provide examples to support the answer. It is best that you elaborate on the example instead of just listing it out.

Names of key economic figures You can impress your examiner by including the names of prominent economists associated with any economic idea you are discussing in your essay. Among the key economic figures are:

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Refer to the Glossary page in the 2019–2021 Syllabus of the Cambridge International AS & A Level Economics 9708 for a comprehensive list of command words.

Introduction

Notable Economic Ideas or Works

Adam Smith

Absolute advantage, canons of taxation, invisible hands, laissez faire, market equilibrium

David Ricardo

Comparative advantage, law of diminishing marginal returns

Friedrich Hayek

Neo-classical economics, The Road to Serfdom

George Akerlof

Imperfect information, The Market for Lemons

John Keynes

Animal spirits, circular flow, cross diagram, The General Theory of Employment, Interest and Money, the paradox of thrift

John Nash

Game theory

Joseph Schumpeter

Austrian school of economics, creative destruction, dynamic efficiency

Karl Marx

Centrally planned economic system

Milton Friedman

Chicago school of economics, neo-classical economics, the Monetarists

Richard Thaler

Behavioural economics, nudge theory, irrationality

Ronald Coase

Coase theorem

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Economist

Writing of an evaluation

An evaluation is an important component in essays that require students to exercise higher-order

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thinking skills. To evaluate means to critically consider or assess a point of discussion. In writing an evaluation, you can consider these points: The importance of a particular factor in making an economic impact

(ii)

The short-run versus the long-run impact of an economic decision

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(i)

(iii) The identification of ‘winners’ and ‘losers’—who benefits and who loses from a

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particular economic action? (iv) A review of economic model assumptions for any weaknesses

Writing of a conclusion Conclusions are very important in long essays, particularly those that require students to discuss or evaluate a certain problem. The mark allocation is often one third of the total marks. Sadly, many students leave out the conclusion completely or write it too briefly.

Time management Time management is one of the biggest challenges for students answering Paper 4 (and Paper 2, to a lesser extent). The best preparation to manage time well is to practise writing a lot of essays under time constraint. Allocate 45 minutes for each question, and once the allocated time is up, move on to the next question. This is to avoid spending more time on lower-marked questions than higher-marked ones.

Practice If you wish to be proficient at writing essays, all you need to do is practise. There is no short cut! iii

How to use this book This book is tailored for students undertaking the Cambridge International AS and A Level Economics (9708) examination. Best used as a complement to textbooks, this book is a revision guide covering the 2019-2021 syllabus and is filled with tips that will enhance your essaywriting skills.

Key features of the book:

1 Basic Economic Ideas

Charts These are placed at the start of every chapter for an overview of fundamental concepts of each topic area

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Economic idEaS and rESourcE allocation

COST-BENEFIT ANALYSIS

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ECONOMIC EFFICIENCY

SHORT RUN

Allocative efficiency

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Productive efficiency

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(a) Use examples to illustrate the difference between private goods and

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public goods, and explain why only private goods will be supplied in a free market economy.

[8]

DYNAMIC EFFICIENCY

Output level is at minimum average cost

PARETO EFFICIENCY

Hint!

for the second part of

imperfect information exists.

Question 2(a).

One cannot be made better off without another being made worse off

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Hint!

This is a tip found throughout the book on understanding essay questions and basic Economic concepts

90

Cambridge International AS & A Level Economics 9708 Paper 22 Q2 a & b June 2016

MODEL ESSAY

Economic EFFiciEncY

Efficient output level in the long run

the main discussion point

[12]

Externalities

ALLOCATIVE EFFICIENCY

always ensure a satisfactory outcome for consumers even when Discuss this view.

Dynamic efficiency

Output level is at price equals marginal cost

The free-rider problem is

(b) The factor enterprise and the free working of the price mechanism

LONG RUN

PRODUCTIVE EFFICIENCY

CHAPTER 1 Basic Economic Ideas

QUESTION 2

MARKET FAILURES

Past Year Questions Each model essay is a sample answer to carefully curated questions from actual examination papers

A2-Level Econs-Chap 1.indd 90

(a) Private goods are goods that are rival and excludable in nature, while

Define ‘private goods’, ‘public

public goods are goods that are non-rival and non-excludable. The inherent difference between the two goods can help explain why only private goods will be supplied in a free market economy, an economic

6/4/19 5:02 PM

introduction goods’ and ‘free market

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economy’ BodY

system where goods are produced and consumed with little to no

Explain the characteristics

government intervention.

of private goods and cite an example for each:

For private goods, the rival characteristic means the consumption of a

• Rival—limited number of seats

of this characteristic is the limited number of seats in a cinema hall. l When a person occupies a seat in a 200-seat cinema hall, the number of

• Excludable—non-paying passengers being refused from boarding a bus

available seats left for others will be 199.

BodY Explain the characteristics

The excludable characteristic of private goods means the seller can

of public goods and cite an

exclude a person from consuming a good if the person does not pay for

example for each:

it. For example, a public bus driver can refuse passengers who are unable

• Non-rival—television broadcast

or unwilling to pay from boarding the bus. While public amenities

• Non-excludable—streetlight

are available to the general public, some are excludable since they can only be enjoyed after payment. Public buses, telephones and toilets are

common ErrorS

therefore private goods, and not public goods in the economic sense.

mistake of listing public

of a good by a person does not reduce the amount available for others. rival aspect of a public good. When a person watches a television programme, the broadcast signal received does not reduce or interfere

Common Errors This is an alert on common errors committed by students when writing essays

Students often make the

For public goods, the non-rival characteristic means the consumption Television broadcast is an example of a good that possesses the non-

Essay Outlines Structured into ‘Introduction’, ‘Body’ and ‘Conclusion’, the outlines are a guide for you to plan and organise your essays

in a cinema hall

good by a person reduces the amount available for others. An example

buses, telephones and

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toilets as examples of public goods in their answer. Take note that these are not public goods.

with the reception of other viewers.

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A1-Level Econs-Chap 1.indd 11

6/7/19 6:18 PM

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AS Level

1 Basic Economic Ideas Factors of production

Classification of goods and services

Money

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ECONOMIC IDEAS AND RESOURCE ALLOCATION

Production possibility curve

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Scarcity, choice and opportunity cost

Positive and normative statements

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Resource allocation mechanisms

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HUMAN DESIRE

WANTS

LAND

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NEEDS Basic necessities for survival

RESOURCES

ENTERPRISE

LABOUR

CAPITAL

LIMITED

UNLIMITED

SCARCITY

CHOICE

2

OPPORTUNITY COST

CHAPTER 1 Basic Economic Ideas

WHAT should we produce?

FOR WHOM should we produce?

THREE BASIC ECONOMIC QUESTIONS

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HOW should we produce?

FACTORS OF PRODUCTION

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ENTREPRENEURS

ROLES

PERSONALITY

• Mining • Timber • Agriculture

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• Proactive • Achievementoriented • Confident • Flexible • Creative • Innovative

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• Introduce new products or technology • Transform competition • Take risks in uncertain conditions • Recognise opportunities and exploit them

LAND

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• Workforce

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SINGAPORE

Land • Strategic location

LABOUR

CAPITAL • Machine • Commercial vehicle • Infrastructure ENTERPRISE • Organise production • Take risks

CHINA The only active factor of production

Labour • Ambitious • Hardworking

WHY ARE SOME COUNTRIES RICH? MALAYSIA Land • Fertile and suitable for plantation of palm and rubber • Rich in minerals and oil

GERMANY Labour • Highly disciplined • Skilled workers in the automobile industry

UNITED STATES Enterprise • Pioneering spirit • Confident • Risk-takers

3

CHAPTER 1

Basic Economic Ideas

Medium of exchange Standard for deferred payment

Durable

Divisible Portable

MONEY

FUNCTIONS

CHARACTERISTICS

Difficult to be forged

Store of value Unit of account

Time deposits

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Cash

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Accepted by all

More liquid

Limited in supply

Land and buildings

Bills

Less liquid

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TYPES OF MONEY Certificates of deposits

Bonds

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Sight deposits

DIGITAL MONEY

MEANING A payment instrument where monetary value is stored electronically on a device

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EXAMPLES • e-pay • e-wallet

CHARACTERISTICS • Convenient as there is no need to carry any cash • Similar to cash but unlike credit cards

CHAPTER 1 Basic Economic Ideas

CLASSIFICATION OF GOODS AND SERVICES

ECONOMIC GOODS

Unlimited in supply

Limited in supply

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FREE GOODS

PUBLIC GOODS

PRIVATE GOODS

• Non-rival • Non-excludable - Free-rider problem

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• Rival • Excludable

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TYPES OF ECONOMIC GROWTH

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ECONOMIC RECOVERY

Capital goods

ECONOMIC GROWTH

Capital goods

PPC

Increase in productive capacity

B

PPC2

A PPC1 0

Consumption goods

0

Consumption goods

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CHAPTER 1

Basic Economic Ideas

PRODUCTION POSSIBILITY CURVE (PPC) Capital goods A (Unattainable)

B Opportunity cost

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C

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PPC

0

PPC CONCEPTS

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Consumption goods

OPPORTUNITY COST SCARCITY • Point A is unattainable because resources are limited

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• Movement from point B to point C indicates an increase in consumption goods at the expense of capital goods • Amount foregone is the opportunity cost

CHOICE • Point B and point C indicate two different combinations of goods • Only one combination of goods is possible

CHAPTER 1 Basic Economic Ideas

RESOURCE ALLOCATION MECHANISMS

MIXED ECONOMY

CENTRALLY PLANNED ECONOMY

Allocation of resources through market forces

Uses both market economy and centrally planned economic mechanisms

Allocation of resources through central planning

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MARKET ECONOMY

DISADVANTAGES

ADVANTAGES

DISADVANTAGES

• Efficient allocation of resources - ‘Invisible hands’ of market forces • Producers are motivated due to possession of private property rights

• Public goods are not provided • Merit goods are under-provided • Demerit goods are over-provided • Human alienation due to disparity in wealth

• More equitable distribution of wealth and income • Prevents overproduction of undesirable goods • Reduces unnecessary competition

• Producers lack motivation due to public property rights • Poor quality of goods • No competition and innovation

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ADVANTAGES

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• Producers and consumers are free to choose what they want to do

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1 Basic Economic Ideas Basic Economic Ideas

QUESTION 1

COMMON ERRORS

(a) Explain what is meant by the term ‘money’ and outline its characteristics

Students often confuse

in a modern economy.

characteristics of money with functions of money.

[8]

(b) Discuss whether money is able to perform all its functions effectively in

For Question 1(a), pay

an economy that is experiencing a high rate of inflation.

attention to money characteristics only.

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CHAPTER 1

[12]

Cambridge International AS & A Level Economics 9708 Paper 22 Q3 a & b November 2015

Functions of money should be discussed in the answer for Question 1(b).

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MODEL ESSAY

(a) Money is anything that can be used as a means of payment to facilitate

Define ‘money’ and identify the

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types of money used in the past

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trade. In the past, people used items with intrinsic value as money INTRODUCTION

such as seashells, live stocks and salt. These items, however, were inconvenient to carry around in large amounts. They were therefore

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later substituted by fiat or token money, whose value is placed by a

BODY

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government or the law.

Describe the types of money used in a modern economy:

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• Notes and coins • Bank deposits • Cheques

• Digital money

• Financial assets

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In a modern economy, money consists of notes and coins, bank deposits and cheques. Notes and coins are physical money issued by a country’s central bank, while bank deposits are money placed in commercial bank accounts for safekeeping that are transferable by cheque. Today, notes and coins and cheques are being rapidly replaced by digital money.

Digital money exists in electronic form and is transferred to transacting parties by way of debit cards, e-wallets and Internet banking without any tangible currency.

Other forms of money include financial assets such as bonds, treasury bills and stocks. Also known as ‘near monies’, these assets are less liquid than other types of money but can be easily converted to cash.

Although credit cards are a prevalent form of payment today, they are not money and are only a money substitute. Credit cards enable a person to obtain instant loan and credit from the bank, the balance of which is payable at the end of the month. Credits cards are therefore a liability and do not function as a store of value.

8

CHAPTER 1 Basic Economic Ideas

Money has to have certain characteristics to serve its role in facilitating trade—it has to be durable, limited in supply, difficult to be forged, divisible, portable and accepted by all.

BODY Identify and explain the

Durability of money is important to ensure that money does not

characteristics of money:

deteriorate after repeated handling. The amount of money circulated

• Durable

must also be restricted, as money will lose its value if it is in unlimited l

• Limited in supply

supply. If counterfeit money floods the economy, for example, people

• Difficult to be forged • Divisible

will no longer trust and accept money as a form of payment.

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• Portable • Accepted by all

Another important characteristic is divisibility. This is because daily business transactions take place in various denominations. Money also

has to be portable and accepted by all as legal tender, usually through

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government sanction.

To conclude, the evolution of money from everyday items to digital CONCLUSION

of centuries. As the use of digital money becomes more prevalent today, l key money characteristics may similarly change over time to attune to a

the characteristics of money in

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money is a result of changing human needs and economies over a period

Make a concluding remark on the future

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more cashless economy in the future.

(b) Inflation is a persistent rise in the level of prices for goods and services

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as measured by the Consumer Price Index. Inflation affects the value of money, whereby a rise in price level is met with a fall in the purchasing l power of each dollar. In other words, one can get less goods with the

INTRODUCTION Define ‘inflation’

same dollar.

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HINT!

A high rate of inflation can challenge the effectiveness of monetary

You should support

functions as a medium of exchange, store of value, unit of account and

each explanation of monetary function with

standard for deferred payment.

an evaluation on how the function is affected by high inflation.

Money as a medium of exchange means it is the accepted means of payment between sellers and buyers. During a high rate of inflation,

BODY

sellers may no longer accept money as payment since the currency is

Identify and analyse the

unstable. Sellers may instead prefer stronger currencies such as the United States dollar or payments in kind akin to the barter system.

Such a scenario may occur in extreme cases of inflation, known as ‘hyperinflation’, similar to the one experienced by Zimbabwe in 2008.

In a hyperinflation, money will fail as a medium of exchange.

functions of money as a:

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• Medium of exchange • Store of value • Unit of account • Standard for deferred payment

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CHAPTER 1

Basic Economic Ideas

The second function of money is as a store of value. This function means money can retain wealth over a period of time. During a high rate of inflation, money is unable to effectively serve this role since the value of money will decrease. People are more likely to invest in assets and properties instead of holding on to devaluing cash. A high rate of inflation will thus adversely affect those with lower household incomes and money savings.

The third function of money is as a unit of account. This function means

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money is used as a standard measure to which economic items such as goods, services and assets are valued. During a high rate of inflation, money cannot effectively perform this function either. This is because prices will rapidly change, making it difficult to ascertain the value of

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goods and services.

A high rate of inflation will also lessen the value of debts, affecting the fourth function of money as a standard for deferred payment. Lenders

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will be at a disadvantage since the value of money received at the end of a loan term will be worth less than when it was borrowed.

Consider circumstances where money can still perform its inflation CONCLUSION

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functions during a high rate of

While the functions of money can generally be affected in an economy

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BODY

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Summarise discussion on functions of money and

experiencing a high rate of inflation, there are circumstances where money can still perform its functions effectively. For example, if vendors do not lose confidence in the currency despite high rates of inflation, money will still be accepted and function as a medium of exchange.

Furthermore, if high rates of inflation are anticipated, lenders can afford some time to factor in the necessary adjustments to price. This

circumstances where money

circumstance therefore enables money to continue performing some of

can still effectively exercise its

its functions.

functions during a high rate of inflation

To conclude, a high rate of inflation can have an adverse impact on the effectiveness of monetary functions as a medium of exchange, store of

COMMON ERRORS Students often generalise the effects of high rates

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crucial function of money as a store of value, for instance, is immediately compromised when inflation rate soars. Nevertheless, the extent to

of inflation on monetary

which the functions are affected depends on several circumstances,

functions. Avoid

including whether there is a loss of confidence in the currency or

committing this error by pointing out that the extent of the effects can depend on many factors.

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value, unit of account and standard for deferred payment. The most

whether the high rate of inflation is anticipated.

CHAPTER 1 Basic Economic Ideas

QUESTION 2 (a) Use examples to illustrate the difference between private goods and

HINT!

public goods, and explain why only private goods will be supplied in a free market economy.

[8]

The free-rider problem is

(b) The factor enterprise and the free working of the price mechanism

the main discussion point

always ensure a satisfactory outcome for consumers even when

for the second part of

imperfect information exists.

Question 2(a).

[12]

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Discuss this view.

Cambridge International AS & A Level Economics 9708 Paper 22 Q2 a & b June 2016

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MODEL ESSAY

(a) Private goods are goods that are rival and excludable in nature, while

INTRODUCTION Define ‘private goods’, ‘public

public goods are goods that are non-rival and non-excludable. The

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inherent difference between the two goods can help explain why only private goods will be supplied in a free market economy, an economic

goods’ and ‘free market

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BODY

system where goods are produced and consumed with little to no

Explain the characteristics

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government intervention.

economy’

of private goods and cite an example for each:

For private goods, the rival characteristic means the consumption of a

• Rival—limited number of seats in a cinema hall

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good by a person reduces the amount available for others. An example of this characteristic is the limited number of seats in a cinema hall. l When a person occupies a seat in a 200-seat cinema hall, the number of

• Excludable—non-paying passengers being refused from boarding a bus

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available seats left for others will be 199.

BODY Explain the characteristics

The excludable characteristic of private goods means the seller can

of public goods and cite an

exclude a person from consuming a good if the person does not pay for

example for each:

it. For example, a public bus driver can refuse passengers who are unable

• Non-rival—television broadcast

or unwilling to pay from boarding the bus. While public amenities

• Non-excludable—streetlight

are available to the general public, some are excludable since they can only be enjoyed after payment. Public buses, telephones and toilets are

COMMON ERRORS

therefore private goods, and not public goods in the economic sense.

Students often make the

For public goods, the non-rival characteristic means the consumption

mistake of listing public

of a good by a person does not reduce the amount available for others.

Television broadcast is an example of a good that possesses the nonrival aspect of a public good. When a person watches a television programme, the broadcast signal received does not reduce or interfere

buses, telephones and

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toilets as examples of public goods in their answer. Take note that these are not public goods.

with the reception of other viewers.

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CHAPTER 1

Basic Economic Ideas

Public goods are also non-excludable, which means the benefits derived from consuming a good cannot be limited to only those who have paid for it. An example of a good that possesses this characteristic is a streetlight. Once a streetlight is installed on a public street, everybody using the street at night can benefit from the light. This means a person cannot be excluded from enjoying the good despite not bearing any financial cost for its provision.

In a free market economy, only private goods will be supplied due to the

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free-rider problem that is inherent in public goods.

The free-rider problem occurs when consumers can enjoy a good that they do not pay for. It is a problem that is inherent in public goods since

BODY Introduce the concept of the

public goods are non-rival and non-excludable in nature. No one will be

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free-rider problem

willing to pay for public goods since everybody will wait for somebody else to pay in order for them to use the goods for free.

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The free-rider problem therefore results in public goods not having a market at all, an instance of economic inefficiency known as a ‘missing

BODY

market’. While there is demand for public goods, the market for them

and not public goods, are supplied in a free market economy

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does not exist because firms do not have any incentive to supply goods

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Explain why only private goods,

that they will not profit from. As a result, only private goods—which

CONCLUSION

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have to be bought and sold for consumption—are supplied in a free

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Summarise discussion on the

difference between private and

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market economy.

In conclusion, private goods are goods that are rival and excludable, while public goods are goods that are non-rival and non-excludable.

public goods, and the free-rider

Only private goods are supplied in the free market economy due to the

problem

free-rider problem that is inherent in public goods. (b) Factor enterprise is one of the four factors of production and refers to a risk-taking endeavour by entrepreneurs. It is the role of the factor

INTRODUCTION Define ‘factor enterprise’ and ‘free working of the price mechanism’

enterprise to manage the other three passive factors of production— l

land, labour and capital. The free working of the price mechanism means the free forces of demand and supply determine the price of goods and services in the market. The response of price to changes in demand and supply will then determine how resources are allocated.

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CHAPTER 1 Basic Economic Ideas

The factor enterprise and the free working of the price mechanism ensure a satisfactory outcome for consumers by allocating resources based on consumer demand. This is because the factor enterprise is driven by profit and will quickly respond to changes in the price mechanism to maximise its gains.

A satisfactory outcome for consumers through the workings of the factor enterprise and price mechanism is evident during periods of shortages

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and surpluses.

When there is a shortage of goods, price will rise because the quantity demanded is greater than the quantity supplied. The increase in price is

BODY

towards production to meet consumer demand. When there is a surplus

Describe the satisfactory

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a signal to the factor enterprise that more resources should be allocated

of goods, or when consumers do not want the goods anymore, the factor enterprise will be left with many unsold stocks. This is because the

outcomes that the factor

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enterprise and price mechanism can ensure during: • Shortages

unsold stocks, the factor enterprise will reduce price and stop producing

• Surpluses

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quantity supplied is greater than the quantity demanded. To dispose of the goods altogether. The following diagram shows the gaps between

Price

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the demand and supply curves, indicating a shortage and a surplus.

S

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Surplus

p2

p1

P

e

p3

Shortage 0

q1

D Quantity

The elimination of shortages and surpluses through the price mechanism will lead to an efficient allocation of resources. As conceptualised by economist Adam Smith, the ‘invisible hands’ of the market forces will bring the demand and supply of goods to an equilibrium at the right price and quantity. As a result, a satisfactory outcome for consumers is ensured.

13

CHAPTER 1

Basic Economic Ideas

The existence of imperfect information, however, can undermine a satisfactory outcome and lead to a misallocation of resources. Imperfect

BODY Introduce the concept of imperfect

information is a situation where parties to a transaction do not have the

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information

same amount of information about a particular good. For example, the seller may know more about the benefits of a good than the buyer, or vice versa.

An unsatisfactory outcome for consumers due to imperfect information is evident in the under-consumption of merit goods,

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over-consumption of demerit goods, as well as the incidence of moral hazard and adverse selection.

Merit goods are socially desirable goods which benefits, or positive

COMMON ERRORS

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externalities, are underestimated by consumers. Some examples of merit goods include education, healthcare, insurance and retirement

Students often confuse merit

savings. If buyers do not have full knowledge of the benefits of these

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goods with public goods. It

particular goods, they will not be willing to spend money for their

that merit goods are a type

optimal consumption. As a result, merits goods will be under-produced

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is important to remember of private goods that are

and under-consumed.

defined by their underproduction and under-

Demerit goods meanwhile refer to socially undesirable goods which

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consumption.

costs to well-being, or negative externalities, are underestimated by

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consumers. Some examples of demerit goods include tobacco, alcohol

BODY

Describe the unsatisfactory

outcomes caused by imperfect information: goods

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• Under-consumption of merit

• Over-consumption of demerit goods

and illegal drugs. When there is imperfect information, buyers will not be fully aware of the harm that these goods can cause to society.

Consumers will therefore continue consuming demerit goods. As a result, demerit goods will be produced and consumed beyond their optimal level.

• Moral hazard

Moral hazard occurs when a party increases its exposure to risks after

• Adverse selection

entering into a business transaction. For example, a car owner may have less incentive to take any precaution against car theft after getting a complete car insurance covering any loss. Without perfect information, the insurer would not know whether the insured would engage in riskier behaviour that should have warranted a higher premium.

Adverse selection occurs when one party has an information advantage over the other before entering into a business transaction. For example, in the health insurance market, an insurance applicant may withhold information about being a high-risk person from the insurer to obtain a lower premium than what would have been charged to high-risk people.

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CHAPTER 1 Basic Economic Ideas

In conclusion, the factor enterprise and the free working of the price mechanism cannot always ensure a satisfactory outcome for consumers

CONCLUSION

due to the existence of imperfect information. Government intervention

Briefly consider how a

in the form of regulatory controls, tax imposition or direct provision l

satisfactory outcome can be

may therefore be necessary to correct a misallocation of resources and

ensured despite the existence of imperfect information

overcome issues related to merit and demerit goods, moral hazard and adverse selection.

HINT!

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QUESTION 3

(a) Show the difference between a movement along, and a shift in, a

Production possibility

production possibility curve. Explain what might cause each to occur.

curve (PPC) is a popular

[8]

examination question. Be

(b) Discuss the way in which resources are allocated in planned economies

sure you understand and

IE

Use diagrams to support your answer.

master the basic concepts

and free market economies. Consider which type of economic system is likely to have the more beneficial outcome.

of PPC, and remember to

[12]

include key assumptions underlying PPC.

MODEL ESSAY

E

V

Cambridge International AS & A Level Economics 9708 Paper 22 Q3 a & b November 2017

R

(a) Production possibility curve (PPC) is a curve that shows the maximum potential output that an economy can produce with existing resources.

INTRODUCTION Define ‘production possibility curve’ (PPC)

P

This economic model is constructed based on a few assumptions—the l economy is a closed economy, only two types of goods are produced, factors of production are not equally productive, resources are limited, and the state of technology is constant.

A movement along a PPC means the economy reallocates its resources

BODY

by producing less of one good in order to produce more of the other. The

Explain the causes for:

trade-off between goods illustrates the concept of scarcity, whereby one good will have to be ‘sacrificed’ in order to produce more of the other.

Since limited resources cannot satisfy unlimited wants, consumers cannot have more of both goods at the same time. A movement along the PPC is shown in the following diagram, moving from point A to point B.

• A movement along a PPC —scarcity

l

• An outward shift of a PPC —economic growth • An inward shift of a PPC —reduction in economic resources

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