Edexcel IAL Economics: Scarcity, models, production possibility frontiers and economic systems (YEC11) – Revision Notes

These notes condense section 1.3.1 Introductory concepts, items 1 to 6, of the Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification (YEC11), Issue 2, June 2018. It is Unit 1 content, which the specification labels IAS and which also counts towards the full IAL. The study guide has the full explanations and worked examples. Figures here are invented.

Links: Edexcel economics hub, printable checklist, practice set, Unit 1 revision notes and free 10-minute diagnostics.

Key definitions

Term	Definition
Social science	Studies human behaviour; cannot normally run controlled experiments on whole economies
Model	Simplified description of reality built on assumptions
Ceteris paribus	Other things held equal while one variable changes
Positive statement	Can be tested against evidence (true or false)
Normative statement	Value judgement about what ought to be
Scarcity	Unlimited wants, finite resources
Opportunity cost	The best alternative forgone
Free good	No opportunity cost in use; zero price clears the market
Economic good	Scarce, uses resources, has an opportunity cost
PPF	Curve of the largest output pairs of two goods, using every resource and current technology
Capital good	Used to produce other goods and services
Consumer good	Satisfies wants directly
Productivity	Output per worker (or per unit of input)

Formulas and calculations

Idea	Method
Opportunity cost of good X in Y	Y given up divided by X gained
Marginal opportunity cost along a PPF	Change in the other good divided by change in this good
Percentage change	(new − old)/old × 100
Productivity	Total output divided by number of workers
Unit labour cost	Wage bill divided by output
Real value of money after inflation of i for n years	Amount divided by (1 + i)ⁿ
Dividend yield	Dividend per share divided by share price

Small reminder (invented). A farmer has 100 hours. A tonne of potatoes takes 10 hours and a tonne of onions takes 4 hours. The most potatoes is 100/10 = 10 tonnes and the most onions is 100/4 = 25 tonnes. The opportunity cost of one tonne of potatoes is 2.5 tonnes of onions, and of one tonne of onions is 0.4 tonnes of potatoes. The frontier is a straight line because the ratio never changes.

Method: reading a PPF

1. Check the axes and the units.
2. Points on the frontier: all resources used efficiently.
3. Points inside: unemployed or misallocated resources, so output can rise at no opportunity cost.
4. Points outside: unobtainable with current resources and technology.
5. Move along the frontier: calculate the marginal opportunity cost as the amount given up divided by the amount gained.
6. Ask whether the question is about a movement (reallocation) or a shift (change in potential).

PPF distinctions

	Movement along	Shift outwards	Shift inwards
Meaning	Reallocation between two goods	Productive potential rises	Productive potential falls
Causes	Change in priorities or choices	More or better resources, new technology, investment, education, migration	Destruction of capital, war, natural disaster, resource depletion, emigration
Opportunity cost	Shown by the slope	Not applicable	Not applicable

• Bowed out: marginal opportunity cost rises because resources are not equally suited to both goods.
• Straight line: constant opportunity cost.
• Moving from inside the frontier to the frontier uses idle resources. It is not growth.
• Capital goods raise productivity and potential output, but making more now means fewer consumer goods now.
• The PPF cannot say which point is best. That depends on values.

Specialisation and the division of labour

Advantages	Disadvantages
Skill and dexterity grow	Repetition, boredom, higher turnover
Less time lost switching tasks	Loss of broader skills
More use of machinery	Dependence on every stage
Higher output per worker, lower unit cost	Risk of unemployment if demand shifts

Adam Smith (The Wealth of Nations, 1776) argued that dividing work into small tasks, using a pin factory as his illustration, raises output.

Small reminder (invented). A wage bill of 300 and output of 50 gives a unit labour cost of 6. If specialisation doubles output to 100, the cost per unit falls to 3, a 50% fall.

Money and financial markets

Function of money	Link to specialisation
Medium of exchange	Avoids the double coincidence of wants in barter
Measure of value	Prices make goods and wages comparable
Store of value	Earnings can be saved for later purchases
Deferred payment	Credit and wage contracts become possible

Inflation erodes the store of value. 5,000 units held for two years at 3% inflation have the purchasing power of 5,000/1.03² = 4,712.98.

Role of financial markets	Example
Facilitate saving	Deposits and bonds
Make funds available	Loans, mortgages, share issues
Facilitate exchange	Payment systems, credit
Forward markets	Fix a future price of a commodity or currency
Market for equities	Buy and sell company shares

Economic systems

	Free market	Command	Mixed
Allocation	Price mechanism	Central planning	Both
Advantages	Efficiency incentives, choice, flexibility	Equity, public provision, strategic direction	Combines markets with correction of failures
Disadvantages	Inequality, missing public goods, externalities, monopoly	Information problems, weak incentives, shortages and surpluses	Government failure, trade-offs about size of the state

Role of the state in a mixed economy: public and merit goods, regulation, tax and benefits, competition policy, macroeconomic management and sometimes ownership.

Models and ceteris paribus

• Economics is a social science. Economies cannot be put in a laboratory, people react to being studied, and many experiments would be unethical or too costly.
• A model keeps the key relationships and drops detail. Typical assumptions: rational decisions, two goods, fixed technology, no other changes.
• Ceteris paribus lets you isolate one cause. Its weakness is that in real markets other things do change, so predictions can fail.
• Evaluation: ask whether the dropped detail matters for the question. A model is useful if its assumptions are close enough to the case being studied.

Positive or normative

Look for “should”, “fair”, “too high” and “better”. These signal value judgements. Statements with measurable claims are positive even if false. Value judgements shape which objectives a government chooses and which trade-offs it accepts.

Chains of reasoning

Investment in capital goods and growth. Resources move from consumer to capital goods (movement along the PPF) → fewer consumer goods now → the capital stock rises → output per worker rises → the PPF shifts outwards → more of both goods are possible later. Evaluate: depends on the quality of investment, the size of the sacrifice, whether savings are available, and whether the extra output is shared fairly.

Forward markets. A business agrees today to sell 10 tonnes of a crop in three months at 200 a tonne (invented). If the spot price then is 170, it gains (200 − 170) × 10 = 300 compared with selling at spot. If the spot price is higher, it earns less than it could have. The benefit is certainty, which helps planning and investment.

Choosing a system. Identify the problem (for example, public goods are missing in a free market). Explain why the system fails (no one pays, free riders). Show how the state can respond. Then evaluate: the response may bring costs such as taxes, poor information or reduced incentives.

Quick self-test

1. Define ceteris paribus.
2. Is “the minimum wage should be raised” positive or normative?
3. Using the farmer above, what is the opportunity cost of one tonne of onions?
4. A frontier passes through (capital, consumer) = (0, 60), (10, 54), (20, 40) and (30, 0). Find the marginal opportunity cost of moving from 10 to 20 capital goods, and from 20 to 30.
5. A point lies outside a PPF. What does this mean?
6. Give two causes of an outward shift of a PPF.
7. 250 workers produce 12,500 units. After new machines, they produce 16,250. Find the percentage rise in productivity.
8. Why is a toll-free road not a free good?
9. State the four functions of money.
10. Give one advantage and one disadvantage of a command economy.

Answers

1. Other things being equal: all variables except the one being studied are held constant.
2. Normative (“should” is a value judgement).
3. 0.4 tonnes of potatoes.
4. From 10 to 20: (54 − 40)/10 = 1.4 consumer goods per capital good. From 20 to 30: (40 − 0)/10 = 4.
5. It is unobtainable with current resources and technology.
6. Any two of: investment in capital, better education, new technology, more labour (migration), discovery of resources.
7. Before: 12,500/250 = 50. After: 16,250/250 = 65. Rise: 15/50 = 30%.
8. It costs resources to build and maintain, so it has an opportunity cost, even though users pay no toll.
9. Medium of exchange, measure of value, store of value, method of deferred payment.
10. Advantage: resources can be directed to social goals and equality. Disadvantage: planners lack full information, so shortages and surpluses arise.

Where marks are usually lost

• Defining opportunity cost as the cost in money, or as all the alternatives rather than the next best.
• Calling a statement positive because it contains a number, when it also contains “should”.
• Saying a point inside the PPF shows growth.
• Describing shifts when the question asks about movements along the curve.
• Dividing the wrong way round when calculating marginal opportunity cost.
• Naming the functions of money without linking them to the question.
• Listing advantages of a system with no disadvantages, or vice versa.
• Describing a model as useless because it is simplified, rather than judging whether the assumption matters.

Official syllabus

Source: Pearson Education Limited, Edexcel International Advanced Subsidiary/Advanced Level in Economics (specification, Issue 2, June 2018; first teaching September 2018), section 1.3.1 Introductory concepts, items 1 to 6.