Edexcel IGCSE Economics: The Market System — Revision Notes

Condensed for the final weeks. For the full explanation, use the The Market System study guide.

The economic problem

Scarcity — unlimited wants, limited resources. Every choice therefore carries an opportunity cost: the next best alternative forgone.

Factors of production and rewards: land–rent, labour–wages, capital–interest, enterprise–profit. Capital means machinery and equipment, not money.

Production possibility curves: on the curve means efficient and fully employed; inside means unemployment or inefficiency; outside is unattainable. An outward shift represents economic growth from more or better resources, improved technology, or better education.

Demand and supply

Movement along is caused by a change in the good’s own price; a shift by anything else.

Conditions of demand: income, price of substitutes and complements, tastes, population, advertising, expectations. Conditions of supply: costs, technology, taxes, subsidies, number of firms, weather.

For an inferior good, demand falls as income rises.

Equilibrium: above it, excess supply pushes price down; below it, excess demand pushes price up.

The four-step answer to “explain the effect of X on this market”: which curve shifts, which direction, the new equilibrium, and the effect on both price and quantity. Answering about price alone forfeits half the marks.

Elasticity

PED = %change in Qd / %change in P
PES = %change in Qs / %change in P
YED = %change in Qd / %change in income

PED	Raising price will
Inelastic (<1)	Increase total revenue
Elastic (>1)	Decrease total revenue

Determinants of PED: availability of substitutes (the most important by far), necessity versus luxury, proportion of income spent, whether it is addictive, and the time period.

Applying the determinants: petrol is inelastic — few close substitutes, and most journeys are necessary. A particular crisp brand is elastic — many close substitutes, so buyers switch readily. Salt is inelastic — a necessity taking a tiny share of income, with no real substitute. Foreign holidays are elastic — a luxury taking a large share of income, and easily postponed or replaced with a domestic trip.

PES is higher when there is spare capacity, available stock, and time to adjust — which is why supply is more elastic in the long run.

The practical application: taxes on cigarettes and fuel raise large revenue precisely because demand is inelastic, so consumption barely falls. The same fact means such taxes are weak at changing behaviour.

Worked example — YED. A 5% rise in income causes an 8% rise in quantity demanded: YED = 8 ÷ 5 = +1.6, a positive value greater than 1, so the good is a luxury (or income-elastic normal good) — demand rises proportionally faster than income. A negative YED indicates an inferior good: as income rises, demand actually falls, because consumers switch to better alternatives they can now afford — value supermarket own-brand products are a typical example.

Costs, revenue and competition

total cost = fixed + variable        profit = total revenue - total cost

Fixed costs do not vary with output (rent, insurance); variable costs do (materials, hourly wages).

Economies of scale reduce average cost as a firm expands — purchasing, technical, financial, marketing, managerial. Total costs still rise; it is cost per unit that falls. Diseconomies raise average cost when a firm grows too large to communicate and coordinate effectively.

Competitive markets deliver lower prices, more choice, better quality and more innovation. Monopoly brings higher prices and less choice, but may achieve economies of scale and fund research — so evaluate both sides rather than condemning it.

Market failure

Failure	Result
Negative externality	Third parties bear costs — over-production
Positive externality	Third parties gain benefits — under-production
Public goods	Non-excludable and non-rival — the market provides none
Merit goods	Under-consumed; benefits underestimated
Demerit goods	Over-consumed; harms underestimated
Monopoly power	Restricted output, prices above the competitive level

A public good requires both properties. Street lighting and defence qualify; healthcare and education are merit goods, since they can be and are sold privately.

Government intervention: indirect taxes, subsidies, regulation, state provision, price controls, information campaigns.

• Maximum price below equilibrium → shortage, queues, black markets.
• Minimum price above equilibrium → surplus.

Both are ineffective if set on the wrong side of equilibrium.

Government failure — intervention leaving the outcome worse than the market, through poor information, administrative cost, or unintended consequences such as smuggling. Raising it is what lifts an evaluation into the top band.

Exam traps

• Treating a price change as a shift.
• Calling money a factor of production.
• Answering only about price when quantity is also required.
• Giving one property of a public good.
• Confusing merit goods with public goods.
• Saying economies of scale cut total costs.
• Setting a price control on the wrong side of equilibrium.

Self-test

1. Define opportunity cost.
2. Give the four steps for answering “explain the effect of X on this market”.
3. If PED = 0.4, what happens to revenue when price rises, and why?
4. Give both properties of a public good.
5. What is government failure, and why does mentioning it matter?

Answers: 1. The next best alternative forgone when a choice is made. 2. Identify which curve shifts, state the direction, describe the new equilibrium, and give the effect on both price and quantity. 3. Revenue rises — demand is inelastic, so quantity falls proportionally less than price rises. 4. Non-excludable and non-rival. 5. When government intervention produces a worse outcome than the free market; raising it shows the balanced evaluation that top-band answers require.