A Level Economics: Basic Economic Ideas and Resource Allocation — Revision Notes

Condensed for the final weeks. For the full explanation, use the Basic Economic Ideas and Resource Allocation study guide.

The fundamental problem

Scarcity — resources are finite while wants are infinite. Everything else in economics follows from this.

Three questions every economy must answer: what to produce, how to produce it, and for whom.

Opportunity cost — the value of the next best alternative forgone. Not “what you lose” in general, and not the sum of all alternatives. The word next is what earns the mark.

Factors of production: land (natural resources, earns rent), labour (human effort, wages), capital (man-made aids to production, interest), enterprise (risk-taking and organisation, profit).

Production possibility curves

A PPC shows the maximum combinations of two goods with all resources fully and efficiently employed.

Position	Meaning
On the curve	Productively efficient, full employment
Inside the curve	Unemployment or inefficiency
Outside the curve	Currently unattainable

The curve’s shape depends on the assumption made about opportunity cost:

• Increasing opportunity cost (resources are not perfectly substitutable between the two goods) gives a curve that is concave to the origin — as more of one good is made, increasingly unsuitable resources must be switched, sacrificing more of the other good each time.

• Constant opportunity cost (resources are perfectly substitutable between the two goods) gives a straight-line curve.

• Movement along the curve = a reallocation of existing resources, incurring opportunity cost.

• Outward shift = economic growth: more resources, better technology, improved education or productivity.

Choosing capital goods over consumer goods today shifts the PPC further out in future — the classic present-versus-future trade-off.

Positive and normative

Positive statements are factual and can be tested against evidence. Normative statements contain a value judgement and involve words like should, ought, fair, too much.

“Unemployment rose to 8%” is positive. “The government should reduce unemployment” is normative. A statement can be positive and still be wrong — testability, not truth, is the criterion.

Economic systems

System	Allocation	Strength	Weakness
Market	Price mechanism	Efficiency, choice, innovation	Inequality; public goods not provided; merit goods under-consumed and demerit goods over-consumed
Planned	Government	Equity, provision of merit and public goods	Inefficiency, no incentive, poor information
Mixed	Both	Balances the two	Requires effective regulation

Almost every real economy is mixed; the exam question is usually about the degree of intervention, not a binary choice.

Classification of goods and services (1.6)

AS Topic 1 (1.6) classifies free, private and public goods by scarcity, excludability and rivalry, and defines merit and demerit goods by the imperfect information that leads to their under- or over-consumption.

Type	Explanation
Free goods	Not scarce — no opportunity cost in using them (e.g. air)
Private goods (economic goods)	Scarce, excludable and rival — the type the free market allocates without difficulty
Public goods	Non-excludable and non-rival — the free-rider problem means the market provides none
Merit goods	Under-consumed as a result of imperfect information in the market — consumers underestimate the private benefit
Demerit goods	Over-consumed as a result of imperfect information in the market — consumers underestimate the private harm

Public goods must be defined by both properties. Non-excludable means non-payers cannot be prevented from consuming; non-rival means one person’s consumption does not reduce the amount available to others. Street lighting and national defence are the standard examples. Because of free riding, no private firm can profitably supply them — this is the strongest argument for government provision (Topic 3.1).

Market failure, externalities, market structures and government failure are A Level content (Topics 7 and 8) and are not examined at AS — don’t import them into a Topic 1 answer.

Worked example: reading opportunity cost from a PPC

An economy can produce a maximum of 100 units of food or 50 units of machinery, or any combination on the straight-line PPC between them. It moves from producing 60 food and 20 machinery to producing 40 food and 30 machinery.

Change in food:       60 -> 40  (a fall of 20 units)
Change in machinery:  20 -> 30  (a rise of 10 units)

Opportunity cost of the extra 10 machinery
   = the 20 units of food given up

Because this PPC is a straight line (constant opportunity cost), the ratio of food given up to machinery gained should be consistent along the whole curve — here, 2 units of food per 1 unit of machinery — which is a useful check on whether a stated pair of points genuinely lies on the same straight-line PPC.

Exam traps

• Defining opportunity cost without “next best”.
• Explaining the concave PPC as “the law of diminishing returns” instead of imperfect resource substitutability.
• Treating the PPC as always concave — it is only concave under increasing opportunity cost; constant opportunity cost gives a straight line.
• Giving only one property of a public good.
• Confusing merit goods with public goods — merit goods can be, and are, sold privately.
• Defining merit and demerit goods by externalities instead of imperfect information — externalities are A Level content.
• Judging a positive statement by whether it is true rather than whether it is testable.
• Presenting intervention as automatically improving on the market.

Self-test

1. Define opportunity cost precisely.
2. Under what condition is a PPC concave to the origin, and what shape does it take otherwise?
3. Give both defining properties of a public good and explain the free-rider problem.
4. What distinguishes a positive from a normative statement?

Answers: 1. The value of the next best alternative forgone. 2. It is concave to the origin under increasing opportunity cost, where resources are not perfectly substitutable between uses, so as output of one good rises, increasingly unsuitable resources must be transferred and the opportunity cost rises; under constant opportunity cost, where resources are perfectly substitutable, it is a straight line. 3. Non-excludable and non-rival; because non-payers cannot be excluded, consumers have an incentive to free-ride, so no private firm can cover its costs and the market provides none. 4. A positive statement is factual and testable against evidence; a normative statement contains a value judgement and cannot be tested.