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

This study guide is aligned to the Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification (YEC11), Issue 2, June 2018. It covers section 1.3.1 Introductory concepts, items 1 to 6, which sit in Unit 1: Markets in action. The specification labels Units 1 and 2 as International AS (IAS) and Units 3 and 4 as the extra International A2 (IA2) content. This topic is in Unit 1, so it is IAS content and also part of the full IAL.

All figures, countries and firms below are invented. Do not quote them as real data.

Related pages: the Edexcel economics hub, the printable checklist, the revision notes, the practice set, the wider Unit 1 guide and our free 10-minute diagnostics.

Scope of this guide

Item	What you must be able to do
1 Nature of economics	Social science, models and assumptions, ceteris paribus
2 Positive and normative	Statements versus value judgements, and their role in policy
3 Scarcity	Wants and resources, renewable or not, opportunity cost, free and economic goods
4 PPFs	Potential, efficiency, opportunity cost, growth and decline, movements and shifts, capital and consumer goods
5 Specialisation and money	Division of labour, Adam Smith, functions of money, financial markets
6 Economic systems	Free market, mixed and command economies, and the state

1 The nature of economics

Economics is a social science. It studies how people, firms and governments make choices. Unlike a chemist, you cannot normally run a controlled experiment on a whole economy or freeze the world and rerun it. People also change behaviour when studied, and policy experiments affect real lives.

So economists build models. A model is a simplified description of reality that isolates the key relationships. Every model rests on assumptions, such as “consumers are rational” or “there are only two goods”. Assumptions make a model usable but limit how far its conclusions apply.

Ceteris paribus means “all other things being equal”. To see the effect of one variable, you hold the others constant. Real markets never stand still, so it is a thinking tool, not a description.

Worked example (illustrative). A small bakery in Town X cuts the price of a roll by 10% (from 2.00 to 1.80). Weekly sales rise 12% (from 500 to 560). That week a rival bakery was shut for repairs, so the 12% cannot be put down to the price cut alone. The ceteris paribus statement is: “a fall in price raises quantity demanded, other things equal”. To test it, compare weeks when the rival was open.

2 Positive and normative economics

A positive statement can be tested against evidence. It may be true or false. A normative statement, or value judgement, says what ought to be and depends on opinion.

Statement (illustrative)	Type	Why
Unemployment in Country A rose from 6% to 8% last year	Positive	Checked against data (it may be false, but it is still positive)
Income inequality in Country A is too high	Normative	“Too high” needs a view of fairness
The government should cut income tax to reduce unemployment	Normative	“Should” signals a value judgement

Role of value judgements. Evidence alone never settles policy. Choosing between higher growth and lower pollution, or between lower taxes and better public services, needs a view on whose interests count and how much. Governments, voters and economists all use value judgements to set objectives and weigh trade-offs. Good writing shows which conclusions follow from the evidence and which depend on the judgement.

3 Scarcity

Unlimited wants and finite resources. Human wants are, in practice, unlimited. Resources (land, labour, capital and enterprise) are finite at any moment. Scarcity is this gap. It exists in every economy, so every society must choose what to produce, how and for whom.

Renewable and non-renewable resources.

	Renewable	Non-renewable
Meaning	Can regenerate or be replenished	Fixed stock that is used up
Examples	Fish stocks, forests, solar energy	Coal, oil, metal ores
Scarcity issue	Depleted if use exceeds regeneration	Each unit used now is unavailable later

Opportunity cost is what you forgo: the best alternative you did not choose. Scarcity forces choice, and choice creates opportunity cost.

Worked example (illustrative). In one oven-hour, a small bakery can make either 40 loaves or 60 pastries. The opportunity cost of one loaf is 60/40 = 1.5 pastries. The opportunity cost of one pastry is 40/60 = 2/3 of a loaf.

Free goods and economic goods. A free good has no opportunity cost in using it. There is enough to satisfy all wants at zero price, such as sunlight or air on a remote hillside. An economic good is scarce, uses resources and has an opportunity cost, so it normally carries a price. Do not confuse “free to the user” with “free good”. A public park with no entry fee is paid for through taxes. Its land and labour could have been used elsewhere, so it is an economic good.

4 Production possibility frontiers

A production possibility frontier (PPF) is a curve showing the largest pairs of outputs of two goods that an economy can reach, using every resource and its current technology. Here is Country A’s frontier (illustrative), in thousands of units.

Point	Capital goods	Consumer goods	Extra consumer goods lost per 10 more capital goods
A	0	100	–
B	10	96	4
C	20	84	12
D	30	60	24
E	40	0	60

What the diagram shows.

• Maximum potential. Points on the frontier (A to E) use all resources fully and efficiently. The frontier is the economy’s productive potential.
• Efficiency. A point on the frontier is productively efficient: more of one good needs less of the other. Point F (20, 70) is inside it. Resources are unemployed or misallocated. Moving from F to C raises consumer goods from 70 to 84 (+20%) with no loss of capital goods.
• Unobtainable. A point outside the frontier, such as (30, 84), cannot be produced with current resources and technology.
• Opportunity cost. From C to D, 10 more capital goods cost 24 consumer goods, a marginal opportunity cost of 24/10 = 2.4 consumer goods per capital good. From D to E it is 60/10 = 6.
• Shape. The frontier is bowed outward because the marginal opportunity cost rises. Resources are not equally good at making both goods, so the most suitable ones are moved first. A straight-line frontier means constant opportunity cost. The bakery above has one: 1.5 pastries per loaf throughout.

Movements and shifts. A movement along the frontier is a reallocation of resources between the two goods. It is caused by a change in choices or priorities. A shift of the frontier changes productive potential.

Outward shift (growth)	Inward shift (decline)
More or better resources: investment in capital, education, migration, discovery of resources	Destruction of capital or land: war, flood, earthquake
New technology	Population loss or emigration of skilled workers
Better infrastructure	Depletion of resources

Moving from F to C is not growth. It is better use of existing resources.

Capital goods and consumer goods. Capital goods (machines, factories, tools) are used to make other goods. Consumer goods satisfy wants directly. Some goods are both, such as a van.

Why capital goods matter. They raise productivity, which is output per worker, and so raise potential output.

Worked example (illustrative). Country A chooses point D (30, 60). Country B chooses point B (10, 96). Country A gives up 36 consumer goods (96 − 60 = 36, or 37.5%) now. Suppose that after some years Country A’s frontier moves out by 20%, so its consumer-goods maximum rises from 100 to 120, while Country B’s moves out by 5%, to 105. Country A has sacrificed current consumption for a higher future potential. The evaluation points:

• The gain is uncertain and depends on the quality of the investment.
• The sacrifice falls on today’s households, and investment needs savings.
• The PPF cannot say which point is best. That depends on preferences, a normative question.

Limits of the model. It uses two goods, assumes fixed resources and technology, and ignores distribution.

5 Specialisation, money and financial markets

Specialisation means a worker, firm or region concentrates on a narrow range of tasks. The division of labour breaks a job into stages and gives each stage to a different person.

Adam Smith argued, in The Wealth of Nations (1776), that dividing a job into small tasks raises output because workers gain skill and dexterity, save time moving between tasks and make use of machinery. His illustration was a pin factory.

Worked example (illustrative). Six bakery workers each do every task and make 24 loaves a day, so total output is 6 × 24 = 144. After tasks are split, each makes 32, so total output is 192. That is a 33.3% rise. With a wage bill of 6 × 96 = 576 a day, cost per loaf falls from 576/144 = 4.00 to 576/192 = 3.00, a 25% fall.

Disadvantages.

• Repetitive work reduces motivation and raises staff turnover.
• Workers lose wider skills, and narrow training risks unemployment if demand shifts.
• The line depends on every stage. One absence or machine failure can stop output.

Functions of money.

• Medium of exchange. It removes the double coincidence of wants in barter. With 10 goods and no money, there are 10 × 9/2 = 45 exchange rates. With money, there are 10 prices.
• Measure of value. It lets you compare prices and costs.
• Store of value. It keeps purchasing power over time. Inflation erodes this: 1,000 units held through three years of 5% inflation buys what 1,000/1.05³ = 863.84 bought at the start.
• Method of deferred payment. It allows loans, credit and wage contracts.

Together these make specialisation workable: workers sell output for money and buy what they need.

Role of financial markets. They:

• Facilitate saving. Savers deposit funds and earn a return.
• Make funds available to businesses and individuals, by loans, bonds and shares. This finances capital goods.
• Facilitate exchange of goods and services through payment systems and credit.
• Provide forward markets in commodities and currencies. A bakery agrees today to buy 30 tonnes of flour in three months at 420 a tonne. If the spot price turns out to be 465, it saves (465 − 420) × 30 = 1,350. If it is 390, it pays 900 more than spot, but it had certainty.
• Provide a market for equities. An investor buys 200 shares at 15 (3,000). A dividend of 0.60 a share pays 120, a 4% yield. If the price rises to 18, the capital gain is 600, or 20%.

6 Free market, mixed and command economies

	Free market	Command	Mixed
Who decides	Consumers and firms through prices	The state through planning	Both
Ownership	Private	State	Private and public
Incentive	Profit	Targets, orders	Profit plus public objectives

Free market: advantages. Prices signal scarcity and coordinate decisions without a planner. Profit rewards efficiency and innovation. Consumers have choice. Disadvantages. It may underprovide public and merit goods, ignore external costs, allow monopoly power and produce unequal incomes.

Command economy: advantages. The state can direct resources to social goals, aim at equality and provide basic goods for all. Disadvantages. Planners lack full information, so shortages and surpluses arise. Incentives are weak, choice is limited, innovation is slow and bureaucracy grows.

Role of the state in a mixed economy. The state provides public goods and many merit goods, corrects externalities by regulation and taxes, promotes competition, redistributes income through taxes and benefits, manages overall demand and sometimes owns firms.

In Country B (illustrative), the state spends 180 of a national income of 500, or 36%. Real economies sit on a spectrum and are rarely purely one system.

Common errors

• Treating a move from inside the frontier to the frontier as growth.
• Giving opportunity cost in money, or listing every alternative instead of the next best.
• Describing a free-to-use service as a free good.
• Calling one system better with no conditions.

For technique, see the exam preparation page.

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.