AQA A Level Economics: Individuals, Firms, Markets and Market Failure — Revision Notes

Condensed for the final weeks. For the full explanation, use the Individuals, Firms, Markets and Market Failure study guide.

Foundations

Scarcity → choice → opportunity cost (the next best alternative forgone). PPCs show efficiency, unemployment, and growth.

Positive statements are testable; normative contain value judgements. Ceteris paribus is the assumption that makes economic models tractable.

Demand, supply and elasticity

Movement along ≠ shift. Own-price change gives a movement; anything else gives a shift.

PED = %ΔQd / %ΔP        PES = %ΔQs / %ΔP
YED = %ΔQd / %Δincome   XED = %ΔQd(A) / %ΔP(B)

Value	Meaning
PED inelastic	Price rise raises revenue
PED elastic	Price rise lowers revenue
YED negative	Inferior good
XED positive	Substitutes

The more inelastic side of the market bears more of an indirect tax. This single result explains why tobacco duty raises so much revenue and changes so little behaviour.

Costs, revenue and profit

AC = TC/Q       MC = ΔTC/ΔQ       AR = TR/Q = price      MR = ΔTR/ΔQ
profit maximised where MC = MR

Short run: at least one factor fixed, so the law of diminishing returns applies — adding a variable factor to a fixed one eventually raises marginal cost.

Long run: all factors variable, so the average cost curve’s shape is set by economies and diseconomies of scale.

Marginal cost cuts average cost at its minimum. That is not a coincidence: while MC is below AC it pulls the average down; once MC rises above AC it pulls the average up. Explaining why rather than just stating it is a distinguishing answer.

Normal profit is the minimum return needed to keep the entrepreneur in the industry, and is counted as a cost. Supernormal profit is anything above it.

Market structures

Structure	Firms	Barriers	Long-run profit	Efficiency
Perfect competition	Many	None	Normal only	Allocatively and productively efficient
Monopolistic competition	Many	Low	Normal	Neither, but close
Oligopoly	Few, interdependent	High	Supernormal possible	Neither
Monopoly	One	Very high	Supernormal	Neither, but may be dynamically efficient

Barriers to entry are the explanation, not an incidental feature: in perfect competition supernormal profit attracts entry, which competes it away; in monopoly barriers prevent that adjustment, so it persists.

• Allocative efficiency: P = MC.
• Productive efficiency: producing at minimum AC.
• Dynamic efficiency: innovation over time — which supernormal profit can fund, and is the strongest defence of monopoly.

Oligopoly is defined by interdependence. Each firm’s best action depends on rivals’ responses, giving price rigidity (the kinked demand curve), non-price competition, and an incentive to collude — which is why cartels are treated so seriously.

Price discrimination requires market power, the ability to separate markets, and different PEDs in each. It raises producer surplus and can allow output that would otherwise be unprofitable, but transfers surplus from consumers.

The labour market

Demand for labour is derived from demand for the product. Wage determination by supply and demand; elasticity depends on skill, training time and substitutability.

Monopsony — a single buyer of labour — restricts employment and pays below the competitive wage. This is why a minimum wage can raise both wages and employment in a monopsonistic labour market, which is the counter-intuitive result worth having ready, since the simple competitive model predicts only unemployment.

Market failure

Negative and positive externalities (in production and consumption), public goods, information gaps (asymmetric information, adverse selection, moral hazard), factor immobility, monopoly power.

Externality diagrams must be labelled — MPC, MSC, MPB, MSB, market outcome, social optimum, and the shaded welfare loss triangle. An unlabelled diagram is much weaker evidence of diagram technique, even when the explanation is correct.

Intervention: taxes, subsidies, regulation, tradable permits, state provision, price controls.

Government failure — worse outcomes than the market, through information gaps, administrative cost, unintended consequences and regulatory capture. A strong evaluation usually raises it.

Exam traps

• Treating a price change as a shift.
• Explaining monopoly profit without barriers to entry.
• Stating that MC cuts AC at its minimum without explaining why.
• Unlabelled externality diagrams.
• Assuming a minimum wage always causes unemployment — not in a monopsony.
• Omitting government failure from an evaluation.
• Concluding without a criterion.

Self-test

1. Who bears more of an indirect tax, and why?
2. Why does marginal cost cut average cost at its minimum?
3. Why does supernormal profit persist under monopoly but not perfect competition?
4. Define allocative, productive and dynamic efficiency.
5. Why might a minimum wage raise employment in a monopsonistic labour market?

Answers: 1. The more inelastic side, because it can least easily adjust quantity in response to the price change. 2. While MC is below AC it drags the average down; once MC exceeds AC it pulls the average up, so the two must cross at AC’s minimum. 3. Barriers to entry prevent new firms entering to compete the profit away; in perfect competition there are none, so entry continues until only normal profit remains. 4. Allocative: P = MC. Productive: output at minimum average cost. Dynamic: innovation and efficiency improvements over time. 5. A monopsonist restricts employment below the competitive level to hold wages down; a minimum wage removes its ability to do so, allowing both wage and employment to rise.