Cambridge IGCSE Economics: Micro and macro, markets and the price mechanism (0455)

This guide covers sections 2.1 and 2.2 of the Cambridge IGCSE Economics 0455 syllabus for examination in 2026 (version 2). Section 2.1 separates microeconomics from macroeconomics. Section 2.2 explains how a market system works, the three key allocation questions and how the price mechanism answers them. The syllabus is not tiered, so all of this applies to every candidate. All names and figures are invented, and each worked example is labelled as illustrative.

Links: the Cambridge IGCSE Economics hub, the printable checklist, the revision notes, the practice questions and the free diagnostics. Earlier groundwork is in the scarcity and factors of production guide.

What you must be able to do

Section	What the syllabus asks
2.1.1	Explain what microeconomics is and name its decision makers
2.1.2	Explain what macroeconomics is and name its decision makers
2.2.1	Explain how markets work, covering buyers, sellers, the allocation of scarce resources, equilibrium and disequilibrium
2.2.2	Show why scarcity forces three questions on every society: what, how and for whom
2.2.3	Explain the price mechanism’s answers to the three questions

The later sections on demand, supply, price determination and elasticity build on this one, so get the vocabulary firm here.

2.1 Microeconomics and macroeconomics

Microeconomics is about the choices made by single households, workers and firms, and how single markets work. Macroeconomics studies the economy as a whole, using totals and averages.

	Microeconomics	Macroeconomics
Scale	One household, worker, firm or market	The whole economy
Typical decision makers	Households (consumers), workers, firms	Government, central bank
Typical questions	Why did the price of rice change? Should a firm hire more workers?	Why is unemployment high across the country? Why is the general price level rising?
Typical measures	The price of one good, one firm’s costs and profit, one wage	Economic growth, unemployment rate, inflation, the balance of payments

The decision makers differ because their choices differ.

• Households (consumers) decide what to buy, how much to save and how much to borrow.
• Workers decide whether to work, in which job and for what pay.
• Firms decide what to produce, which methods to use and what price to charge.
• Government decides taxes, spending and laws. It acts at micro level when it taxes one product, and at macro level when it changes taxation to affect national output.
• The central bank decides policy on interest rates and money for the whole economy.

Worked example: classifying a statement (illustrative)

Country X has real output of 800 units in year 1 and 832 units in year 2.

growth = (832 - 800) / 800 x 100 = 32 / 800 x 100 = 4.0%

This is a macroeconomic measure because it covers all the output of the country. The unemployment rate works the same way. If 1,200 of the 15,000 people in the labour force are unemployed, the rate is 1,200 / 15,000 x 100 = 8.0%. By contrast, the price of mangoes at one market stall is a microeconomic fact.

Topics often link the two. A fall in the wages of one group of workers (micro) can change total spending across the economy (macro). Say which level each point belongs to.

2.2.1 The market system

A market is any set-up in which buyers and sellers meet to trade, whether in a shop, a street or online. It does not need a physical place.

• Buyers (consumers) want goods and services and are willing and able to pay for them. Their willingness to pay is shown by demand.
• Sellers (producers) supply goods and services in order to earn revenue and profit. Their willingness to sell is shown by supply.

Resources are scarce, so every unit of land, labour and capital used for one product cannot be used for another. In a market system, the interaction of buyers and sellers decides where the scarce resources go. Resources move towards products that buyers are willing to pay for and sellers can supply at a profit.

Market equilibrium

Market equilibrium exists at the price where the quantity demanded equals the quantity supplied. At that price there is no pressure for the price to change. This price is the equilibrium price and the quantity traded is the equilibrium quantity.

Worked example: finding equilibrium (illustrative)

Weekly market in Town M, mangoes, price per kg in invented currency units, quantities in kg per day.

Price	Quantity demanded	Quantity supplied	Demand minus supply	Market state
2	90	20	+70	Excess demand (shortage)
3	75	40	+35	Excess demand (shortage)
4	60	60	0	Equilibrium
5	45	80	-35	Excess supply (surplus)
6	30	100	-70	Excess supply (surplus)

The equilibrium price is 4 and the equilibrium quantity is 60 kg. Revenue at equilibrium is 4 x 60 = 240 units.

In a diagram, price is on the vertical axis and quantity on the horizontal axis. Demand is a downward-sloping line and supply an upward-sloping line. They cross at price 4 and quantity 60 kg, the equilibrium point. Label both axes, both curves and the equilibrium in an exam.

Market disequilibrium

Market disequilibrium exists when quantity demanded and quantity supplied are unequal at the current price.

• Excess demand (shortage): the price is under the equilibrium level, so buyers want more than sellers offer. At a price of 2, buyers want 90 kg and sellers offer only 20 kg, a shortage of 70 kg.
• Excess supply (surplus): the price is over the equilibrium level, so sellers offer more than buyers want. At a price of 6, sellers offer 100 kg and buyers want 30 kg, a surplus of 70 kg.

When the market is out of equilibrium, the quantity actually traded is the smaller of the two quantities, because nobody can be forced to buy or sell. At a price of 2, only 20 kg is traded and revenue is 2 x 20 = 40 units. At a price of 6, only 30 kg is traded and revenue is 6 x 30 = 180 units. Both are below the 240 units earned at equilibrium.

The chain of adjustment

Surplus at a price of 5 (45 demanded, 80 supplied):

1. Unsold stock builds up and sellers face wasted produce.
2. Sellers cut the price to sell the stock.
3. As the price falls, buyers buy more (demand extends from 45 towards 60).
4. As the price falls, sellers produce less (supply contracts from 80 towards 60).
5. The surplus shrinks until the price reaches 4, where 60 is demanded and supplied.

Shortage at a price of 3 (75 demanded, 40 supplied) runs in the opposite direction. Buyers compete for limited stock and sellers see they can charge more. The price rises, buyers buy less and sellers supply more until the price reaches 4.

2.2.2 The three key allocation questions

The economic problem is that wants are unlimited and resources are scarce. Because of this, every society must choose how to use its resources. This creates three questions.

Question	Meaning	Example (illustrative)
What to produce?	The goods and services to make, and how much of each	More rice or more maize on a given farm; more homes or more shops in a town
How to produce?	Which resources and methods: labour-intensive or capital-intensive	Harvesting by hand or using a machine
For whom to produce?	Who receives the output	Those with the income to pay, or those the government decides to serve

Each answer has an opportunity cost, because using resources on one answer means giving up another.

Worked example: choosing how to produce (illustrative)

A rice farm can harvest 500 kg a day in two ways. The daily wage per worker is w.

• Method A (by hand): 8 workers plus 30 units for tools. Cost = 8w + 30.
• Method B (machine): 3 workers plus 200 units for the machine. Cost = 3w + 200.

At w = 40: A = 8 x 40 + 30 = 350 and B = 3 x 40 + 200 = 320. Method B is cheaper. Cost per kg: A = 350 / 500 = 0.70, B = 320 / 500 = 0.64.

At w = 25: A = 8 x 25 + 30 = 230 and B = 3 x 25 + 200 = 275. Method A is cheaper.

The two methods cost the same where 8w + 30 = 3w + 200, so 5w = 170 and w = 34. Above a wage of 34 the machine is cheaper, below it hand harvesting is cheaper. The “how” answer depends on the relative prices of labour and capital.

2.2.3 How the price mechanism answers the three questions

The price mechanism is the way that changes in prices, resulting from the interaction of demand and supply, coordinate the decisions of buyers and sellers and allocate resources. It does three jobs.

• Signalling: a high price tells producers that buyers want more of a product. A low price tells them that buyers want less.
• Incentive: a rising price raises the profit from supplying a product, which encourages producers to supply more. A rising price also encourages consumers to buy less. A falling price does the reverse.
• Rationing: when a good is scarce, the price rises until only those who are willing and able to pay can buy it.

Applying the three jobs

Question	How the price mechanism answers it
What to produce	Firms produce the goods that buyers pay high prices for, because these offer the most profit. Goods with falling prices and losses are cut back. Resources move from one use to another.
How to produce	Firms choose the cheapest method given the prices of labour, land and capital, since lower cost means higher profit. If wages rise, firms tend to switch towards capital.
For whom to produce	Output goes to those who can afford the price. Consumers with high incomes can buy more, so the distribution of income largely decides who receives the output.

Worked example: for whom (illustrative)

Mangoes sell at a price of 4 per kg. A buyer wants 5 kg a week, which costs 5 x 4 = 20 units. Household H has a weekly income of 600 and Household L has 150.

Household H: 20 / 600 x 100 = 3.3% of income
Household L: 20 / 150 x 100 = 13.3% of income

Both households want the mangoes. The price rations them. For L the same purchase takes four times the share of income, so L is more likely to buy less or go without. Willingness to pay depends on need and also on ability to pay.

Evaluating the price mechanism

For exam answers that ask you to discuss or evaluate, weigh both sides.

Strengths:

• Decisions are made by millions of buyers and sellers, so resources respond quickly to changes in what people want.
• It gives firms an incentive to keep costs low and to supply what is wanted.
• No central planner needs to collect all the information.

Limitations:

• Output goes to those with money, not necessarily those with the greatest need.
• Products with no profitable price, or with effects on people other than the buyer and seller, may be under-provided or over-provided.
• Adjustment is not instant, so shortages and surpluses can persist.

A balanced answer says which limitation matters most in the context given and why. Later sections on market failure and the mixed economic system develop this.

Common errors

• Writing that microeconomics is “small” and macroeconomics is “big” without naming what is studied.
• Giving the government as a micro decision maker only. It acts at both levels, so say which decision you mean.
• Saying equilibrium means “nobody wants more”. The point is that quantity demanded equals quantity supplied at that price.
• Mixing up shortage and surplus. A price below equilibrium gives a shortage.
• Treating the revenue at a disequilibrium price as price times the larger quantity. Use the smaller quantity.
• Writing that the price mechanism answers “for whom” by need. It answers by ability and willingness to pay.
• Describing the three questions as separate topics. They are linked: a change in what is produced changes how and for whom.

Official syllabus

The Cambridge IGCSE Economics 0455 syllabus for examination in 2026, version 2, published by Cambridge University Press & Assessment (Cambridge International Education), sections 2.1 and 2.2.