Cambridge AS and A Level Economics (9708) Syllabus

Give the formula for price elasticity of demand (PED).

PED = percentage change in quantity demanded ÷ percentage change in price.

How do you interpret the values of PED?

|PED| > 1 = elastic; |PED| < 1 = inelastic; |PED| = 1 = unit elastic; PED = 0 = perfectly inelastic; PED = ∞ = perfectly elastic. (PED is normally negative.)

List three determinants of PED.

Availability and closeness of substitutes, proportion of income spent on the good, whether it is a necessity or luxury, and time period considered.

Give the formula for income elasticity of demand (YED).

YED = percentage change in quantity demanded ÷ percentage change in income.

How does the sign of YED classify goods?

Positive YED = normal good (>1 luxury, between 0 and 1 necessity); negative YED = inferior good (demand falls as income rises).

Give the formula for cross elasticity of demand (XED).

XED = percentage change in quantity demanded of good A ÷ percentage change in price of good B.

How does the sign of XED classify the relationship between two goods?

Positive XED = substitutes; negative XED = complements; zero XED = unrelated goods. The larger the value, the stronger the relationship.

What is the relationship between PED and a firm's total revenue when price falls?

If demand is price elastic, a price fall raises total revenue; if inelastic, a price fall lowers total revenue; if unit elastic, total revenue is unchanged.

Give the formula for price elasticity of supply (PES).

PES = percentage change in quantity supplied ÷ percentage change in price.

List two determinants of PES.

Time period (longer = more elastic), availability of spare capacity/stocks, ease of switching production, and mobility of factors of production.

What is market equilibrium?

Market equilibrium occurs where quantity demanded equals quantity supplied, determining the equilibrium price and quantity; there is no tendency for price to change.

What happens in a market when price is above equilibrium?

There is excess supply (a surplus); this puts downward pressure on price until equilibrium is restored.

What happens in a market when price is below equilibrium?

There is excess demand (a shortage); this puts upward pressure on price until equilibrium is restored.

What are the three functions of the price mechanism?

Signalling (prices convey information about scarcity/value), incentive (prices motivate producers and consumers to act), and rationing/allocation (prices distribute scarce resources).

What is consumer surplus?

Consumer surplus is the difference between the maximum price consumers are willing to pay and the price they actually pay — the area below the demand curve and above the market price.

What is producer surplus?

Producer surplus is the difference between the price producers receive and the minimum price they were willing to accept — the area above the supply curve and below the market price.

How does a fall in price (due to increased supply) affect consumer surplus?

A lower price increases consumer surplus, as consumers pay less than they were willing to and more consumers enter the market.

What is a maximum price (price ceiling) and where must it be set to have an effect?

A maximum price is a legal limit above which price may not rise; to be effective it must be set below the free-market equilibrium price.

What is the main consequence of an effective maximum price?

It creates excess demand (a shortage), which may lead to queues, rationing, or black (illegal) markets.

What is a minimum price (price floor) and where must it be set to have an effect?

A minimum price is a legal limit below which price may not fall; to be effective it must be set above the free-market equilibrium price.

What is the main consequence of an effective minimum price?

It creates excess supply (a surplus); the government may need to buy up the surplus or it goes unsold (e.g. agricultural surpluses).

What is an indirect tax, and name its two types?

An indirect tax is a tax on expenditure (spending), levied on goods/services. Types: specific (a fixed amount per unit) and ad valorem (a percentage of the price).

How does an indirect tax shift the supply curve?

It shifts the supply curve upward/leftward — by a constant amount for a specific tax, and by a widening (proportional) amount for an ad valorem tax.

How does PED determine the incidence (burden) of an indirect tax?

The more inelastic the demand, the greater the share of the tax burden falling on consumers; the more elastic the demand, the greater the share falling on producers.

What is a subsidy and how does it affect the supply curve?

A subsidy is a payment by government to producers to lower costs/encourage output; it shifts the supply curve downward/rightward, lowering price and raising quantity.

What is market failure?

Market failure occurs when the free market fails to allocate resources efficiently, leading to a misallocation (over- or under-production) of goods and services.

What are the four properties distinguishing public goods, and define them?

Public goods are non-rivalrous (one person's use doesn't reduce others') and non-excludable (you can't prevent non-payers using them), e.g. street lighting; this leads to the free-rider problem.

What is a negative externality and its effect on production?

A negative externality is a cost imposed on third parties (e.g. pollution); social cost exceeds private cost, causing the good to be over-produced/over-consumed relative to the social optimum.

What is aggregate demand (AD) and its components?

AD is total planned spending on an economy's output at a given price level. AD = C + I + G + (X − M): Consumption, Investment, Government spending, plus net exports (Exports minus Imports).

What is aggregate supply (AS), and what determines macroeconomic equilibrium?

AS is the total output firms are willing to supply at a given price level. Macroeconomic equilibrium occurs where AD = AS, determining the equilibrium price level and real national output.