A Level Economics: Markets in Action — Revision Notes

Condensed for the final weeks. For the full explanation, use the Markets in Action study guide.

Demand, supply and equilibrium

Movement along the curve is caused by a change in the good’s own price; a shift is caused by anything else.

Conditions of demand: income, price of substitutes and complements, tastes, population, expectations, advertising. Conditions of supply: costs, technology, taxes, subsidies, number of firms, weather.

Consumer surplus — the difference between what consumers are willing to pay and what they actually pay. Producer surplus — the difference between the price received and the minimum acceptable price.

Both shrink when a market moves away from equilibrium, which is how welfare loss from intervention or market failure is measured on a diagram.

Elasticity

PED = %change in Qd / %change in P        PES = %change in Qs / %change in P
YED = %change in Qd / %change in income   XED = %change in Qd of A / %change in P of B

Value	Interpretation
PED inelastic (<1)	Raising price raises total revenue
PED elastic (>1)	Raising price lowers total revenue
YED negative	Inferior good
XED positive	Substitutes
XED negative	Complements

Tax incidence follows elasticity, and this is the single most useful application: the more inelastic side of the market bears more of the tax. Where demand is inelastic and supply elastic, consumers pay most of it.

Market failure

Failure	Mechanism
Negative externality in production	MSC > MPC — over-produced
Negative externality in consumption	MSB < MPB — over-consumed
Positive externality in consumption	MSB > MPB — under-consumed
Public goods	Non-excludable, non-rival — free riding means zero private provision
Information gaps	Asymmetric information — the better-informed party exploits the other
Immobility of factors	Geographical and occupational immobility sustain unemployment
Monopoly power	Output restricted, price above marginal cost

Externality diagrams are where the marks are. Label the private and social curves, mark the market outcome and the socially optimum outcome, and shade the welfare loss triangle between them. An unlabelled diagram earns nothing.

Asymmetric information produces two distinct problems worth naming: adverse selection (the wrong people select in — the used-car and insurance cases) and moral hazard (behaviour changes once insured).

Government intervention

Policy	Strength	Weakness
Indirect tax	Internalises the externality; raises revenue	Optimal rate hard to set; inelastic demand means little behaviour change; regressive
Subsidy	Corrects positive externalities	Opportunity cost; may encourage inefficiency
Regulation	Direct, enforceable	Monitoring costs; can create black markets
Tradable permits	Market finds the cheapest abatement	The cap must be set correctly
Minimum/maximum price	Protects producers or consumers	Creates surpluses or shortages
State provision	Guarantees public and merit goods	Risk of inefficiency without a profit motive

Government failure — intervention producing a worse outcome than the market: information gaps, administrative costs, unintended consequences (black markets, smuggling), and regulatory capture. Every top-band evaluation of intervention raises it.

The tax paradox is worth stating explicitly: a tax on a demerit good with inelastic demand raises large, stable revenue and barely reduces consumption. Those are not contradictory findings — they are the same fact viewed from two ends, and combining the tax with education (which shifts demand left and makes it more elastic over time) is the standard evaluated recommendation.

Behavioural economics

Traditional theory assumes rational utility-maximising agents with full information. Behavioural economics documents systematic departures:

• Bounded rationality — limited information, time and computational capacity.
• Rules of thumb (heuristics) — mental shortcuts that are usually adequate but predictably biased.
• Anchoring — over-reliance on the first figure encountered.
• Availability bias — overweighting easily recalled events.
• Social norms — behaviour shaped by what others do.
• Loss aversion — losses feel roughly twice as significant as equivalent gains.

Nudges — changing choice architecture without removing options. Default choices are the most powerful: automatic enrolment in pension or organ-donation schemes raises participation dramatically, because inertia now works for the desired outcome rather than against it.

Evaluation of nudges: cheap and preserves freedom of choice, but effects can be small, may fade, raise questions about who chooses the default, and cannot address structural problems such as poverty.

Exam traps

• Treating a price change as a shift.
• Drawing an externality diagram without labelling MPC, MSC or the welfare loss.
• Omitting government failure from an evaluation of intervention.
• Confusing adverse selection with moral hazard.
• Claiming a tax on an inelastic demerit good will substantially reduce consumption.
• Concluding without a criterion — “it depends on the size of the externality” is a conclusion; “there are pros and cons” is not.

Self-test

1. Who bears more of an indirect tax, and what determines it?
2. Give both defining properties of a public good.
3. Distinguish adverse selection from moral hazard.
4. Why can a tax on a demerit good raise large revenue yet change little behaviour?
5. Why are default choices the most effective form of nudge?

Answers: 1. The more inelastic side of the market; if demand is inelastic relative to supply, consumers bear most of it. 2. Non-excludable and non-rival. 3. Adverse selection occurs before the transaction — the worse risks are the ones who select in; moral hazard occurs after — behaviour becomes riskier once covered. 4. Demand is inelastic, so quantity barely falls while the tax is collected on nearly the same volume; the two results are the same fact seen from opposite ends. 5. Because inertia means most people accept the default, so setting it to the desired outcome makes doing nothing the beneficial choice — while still preserving the option to opt out.