O Level Economics: The Allocation of Resources — Revision Notes

Condensed for the final weeks. For the full explanation, use the The Allocation of Resources study guide.

Micro vs macro

Microeconomics — decisions of individual households and firms (2.1). Macroeconomics — the economy as a whole (national income, inflation, unemployment).

The market system

The price mechanism allocates resources by answering what, how and for whom to produce, without central planning — prices act as the signal that moves resources toward what buyers are willing to pay for (2.2).

Demand

Demand — the quantity of a good buyers are willing and able to buy at a given price (2.3.1).

Law of demand: as price rises, quantity demanded falls — an inverse relationship, shown by a downward-sloping curve.

Term	Cause	Effect on the curve
Extension / contraction	Change in the good’s own price	Movement along the curve
Shift (increase/decrease)	Change in a condition of demand	The whole curve moves

Conditions of demand (2.3.4): income, tastes/fashion, price of substitutes, price of complements, population, advertising.

Supply

Supply — the quantity producers are willing and able to sell at a given price (2.4.1).

Law of supply: as price rises, quantity supplied rises — a direct relationship, upward-sloping curve.

Same extension/contraction (price change, movement along) vs shift (non-price change, whole curve moves) distinction as demand applies to supply.

Conditions of supply (2.4.4): cost of production, technology, number of firms, government taxes/subsidies, weather (for agricultural goods).

Price determination

Equilibrium (2.5.1) — where the demand and supply curves intersect; quantity demanded = quantity supplied, and there is no tendency for price to change.

Disequilibrium (2.5.2):

• Price above equilibrium → excess supply (surplus) → sellers undercut each other → price falls back to equilibrium.
• Price below equilibrium → excess demand (shortage) → buyers bid the price up → price rises back to equilibrium.

Price changes

A shift in demand or supply changes both the equilibrium price and the equilibrium quantity. Always identify which curve shifts, in which direction, and state the new price/quantity outcome (2.6).

Price elasticity of demand (PED)

PED = % change in quantity demanded / % change in price

PED value	Meaning	Example goods
PED > 1	Elastic — demand changes more than proportionally	Luxuries, goods with close substitutes
PED < 1	Inelastic — demand changes less than proportionally	Necessities, addictive goods
PED = 1	Unit elastic	—

Determinants (2.7.3): availability of substitutes, whether the good is a necessity or luxury, proportion of income spent, time period.

PED and revenue (2.7.4): if demand is elastic, a price cut raises revenue; if inelastic, a price rise raises revenue. This link is a favourite exam angle.

Price elasticity of supply (PES)

PES = % change in quantity supplied / % change in price

Determinants (2.8.3): spare capacity, ease of storing stock, time period, ease of switching resources between uses.

Economic systems

System	Definition	Advantage	Disadvantage
Market (2.9)	Resources allocated by prices, with minimal government involvement	Efficient, responsive to consumer demand	Can neglect public goods and worsen inequality
Mixed (2.11)	Combines market forces with government intervention	Corrects market failure while retaining price signals	Government intervention has its own costs and can distort incentives

Market failure

Market failure (2.10.1) — where the price mechanism fails to allocate resources efficiently.

Causes (2.10.2), exactly as the syllabus phrases them — public goods (non-excludable, non-rival — the market under-provides them), merit and demerit goods (under- or over-consumed relative to the social optimum), external costs and external benefits (affecting third parties), abuse of monopoly power, and factor immobility. Examples are required with respect to these areas only.

Government responses (2.11.2): taxes and subsidies, regulation, direct provision of public goods, price controls.

Exam traps

• Confusing a movement along a curve (caused by the good’s own price) with a shift of the curve (caused by a condition of demand/supply).
• Drawing an unlabelled or incorrectly sloped diagram — axes, curve labels and the equilibrium point are all markable.
• Saying a point inside a PPC or a surplus/shortage is “unattainable” rather than the correct term.
• Forgetting that PED determines the direction revenue moves when price changes — this is a distinct syllabus point (2.7.4), not automatic.
• Treating capital as money rather than machinery/tools/factories (a factor-of-production error that resurfaces here).
• Listing market failure causes without linking them to a specific government response.

Self-test

1. Distinguish a movement along the demand curve from a shift of the demand curve.
2. What happens to price and quantity when a market is in disequilibrium with excess supply?
3. Give the formula for price elasticity of demand.
4. If demand for a good is price inelastic, what happens to total revenue when price rises?
5. Name two causes of market failure and one government response to each.

Answers: 1. A movement along the curve is caused only by a change in the good’s own price (an extension or contraction); a shift is caused by a change in a condition of demand, such as income or tastes, and moves the whole curve. 2. Excess supply means sellers have unsold stock, so they cut prices; price falls and quantity moves back toward equilibrium. 3. PED = % change in quantity demanded ÷ % change in price. 4. Total revenue rises, because the fall in quantity demanded is proportionally smaller than the rise in price. 5. Externalities — corrected by a tax (on a negative externality) or a subsidy (on a positive externality); public goods — corrected by direct government provision, since the market under-provides non-excludable, non-rival goods.