Contents – Cambridge IGCSE Economics (0455)
- ✅ 1 The Basic Economic Problem
- ✅ 2 Allocation of Resources
- ✅ 3 Micro‑economic Decision‑Makers
- ✅ 4 Government & the Macro‑economy
- ⏳ 5 Economic Development
- ⏳ 6 International Trade & Globalisation
1 The Basic Economic Problem
1.1 Scarcity, Choice & Economic Goods
- Scarcity: Resources (land, labour, capital, entrepreneurship) are limited, while human wants are unlimited.
- Economic goods vs. free goods
- Economic goods – scarce; must be produced at a cost (e.g., smartphones, wheat).
- Free goods – abundant; available without cost (e.g., air, sunlight).
1.2 The Three Fundamental Questions
- What goods and services should be produced?
- How should they be produced?
- For whom should they be produced?
1.3 Factors of Production & Their Rewards
| Factor of Production | Typical Reward |
|---|
| Land (natural resources) | Rent |
| Labour | Wages |
| Capital (machinery, buildings) | Interest |
| Entrepreneurship | Profit |
1.4 Opportunity Cost
Definition: The value of the next‑best alternative that must be given up when a choice is made.
Conceptual formula:
Opportunity Cost = Benefit of the Next Best Alternative – Benefit of the Chosen Option
Key points
- Measured in terms of the most valuable forgone alternative (often in monetary terms, but can be expressed in units of another good).
- Arises because of scarcity – every decision involves a trade‑off.
- Fundamental to both micro‑ and macro‑economic analysis.
1.5 Production Possibilities Frontier (PPF)
- Shows the maximum possible output of two goods given fixed resources and technology.
- Points on the curve = efficient production; inside = under‑utilisation; outside = unattainable.
- Moving along the curve illustrates opportunity cost – the slope (marginal rate of transformation) tells how many units of one good must be sacrificed to produce an extra unit of the other.
- Shifts:
- Outward/rightward: Economic growth (more resources or better technology).
- Inward/leftward: Recession, natural disaster, war.
Diagram suggestion: Draw a PPF for “Cars” (horizontal axis) vs “Computers” (vertical axis). Label points A (on curve), B (inside), C (outside). Show the opportunity cost of moving from A to D (a point further right). Indicate the slope as the opportunity cost of one more car in terms of computers.
2 Allocation of Resources
2.1 Demand and Supply – Definitions & Diagrams
- Demand: Quantity of a good that consumers are willing and able to buy at each price, ceteris paribus. Downward‑sloping demand curve.
- Supply: Quantity that producers are willing and able to sell at each price, ceteris paribus. Upward‑sloping supply curve.
- Market equilibrium: Intersection of demand and supply (price = Pₑ, quantity = Qₑ).
2.2 Movements vs. Shifts
| Cause | Effect on Demand | Effect on Supply |
|---|
| Change in price of the good itself | Movement along the curve | Movement along the curve |
| Income (normal good) | Right‑ward shift (increase) | – |
| Income (inferior good) | Left‑ward shift (decrease) | – |
| Price of related good (substitute) | Right‑ward shift (increase) | – |
| Price of related good (complement) | Left‑ward shift (decrease) | – |
| Consumer tastes & expectations | Shift right or left depending on direction | – |
| Technology | – | Right‑ward shift (increase) |
| Input price | – | Left‑ward shift (decrease) |
| Number of firms | – | Right‑ward shift (increase) or left‑ward (decrease) if firms exit |
2.3 Price Determination & Price Changes
- At equilibrium, Pₑ = MC = MR for a price‑taking firm; the market price adjusts to equate quantity demanded and quantity supplied.
- Price increase: Movement up the supply curve and down the demand curve – quantity supplied rises, quantity demanded falls.
- Price decrease: Movement down the supply curve and up the demand curve – quantity supplied falls, quantity demanded rises.
2.4 Elasticity
2.4.1 Price Elasticity of Demand (PED)
Formula: PED = %ΔQd ÷ %ΔP
- Elastic demand: |PED| > 1 – quantity changes proportionally more than price.
- Unit‑elastic demand: |PED| = 1.
- Inelastic demand: |PED| < 1 – quantity changes proportionally less than price.
Determinants
- Availability of close substitutes.
- Proportion of income spent on the good.
- Nature of the good (necessity vs. luxury).
- Time horizon (short‑run vs. long‑run).
Significance
- Guides firms on how a price change will affect total revenue.
- Helps governments predict the impact of taxes or subsidies.
2.4.2 Price Elasticity of Supply (PES)
Formula: PES = %ΔQs ÷ %ΔP
- More elastic when firms can vary output quickly (e.g., services, commodities with spare capacity).
- Less elastic in the short‑run for goods requiring long production periods (e.g., aircraft).
2.5 Market Systems
| System | Key Characteristics | Typical Example |
|---|
| Free‑market (price) economy | Private ownership, profit motive, minimal government intervention | USA (most sectors) |
| Command (planned) economy | State ownership, central planning, limited consumer choice | North Korea |
| Mixed economy | Combination of market forces and government control | UK, India |
2.6 Market Failure & Government Intervention
2.6.1 Types of Market Failure
- Public goods – non‑rival and non‑exclusive (e.g., street lighting, national defence). Usually provided by government because the market would under‑provide.
- Merit goods – socially desirable but under‑consumed (e.g., education, vaccinations). Government may subsidise.
- Demerit goods – socially undesirable but over‑consumed (e.g., cigarettes, alcohol). Government may tax or restrict.
- Externalities
- Negative – pollution, noise. Government response: tax, regulation, tradable permits.
- Positive – herd immunity, research spill‑overs. Government response: subsidy, grant.
- Monopoly power – single seller can set price above marginal cost → allocative inefficiency.
- Privatisation – transfer of state‑owned enterprise to private sector to improve efficiency.
- Nationalisation – transfer of private enterprise to state ownership, often to protect strategic industries.
- Quotas – limits on the quantity of a good that can be produced or imported, used to protect domestic producers.
2.6.2 Government Tools
| Tool | Purpose | Typical Example |
|---|
| Tax | Reduce consumption of demerit goods / raise revenue | Excise duty on alcohol |
| Subsidy | Encourage consumption/production of merit goods | Renewable‑energy grant |
| Price ceiling | Make essential goods affordable | Rent control |
| Price floor | Protect producers | Minimum wage |
| Regulation | Correct externalities or safety issues | Emission standards |
| Privatisation | Increase efficiency & competition | Sale of British Telecom |
| Nationalisation | Secure strategic control | Nationalisation of railways |
| Quota | Limit imports/production to protect domestic industry | Import quota on textiles |
3 Micro‑economic Decision‑Makers
3.1 Money & Banking
- Functions of money: medium of exchange, unit of account, store of value, standard of deferred payment.
- Banking role: Accept deposits, provide loans, create money through the multiplier effect (deposit × money multiplier = total money supply).
- Interest rates influence consumer borrowing, business investment and overall aggregate demand.
3.2 Households
- Sources of income: wages, profit, rent, interest, transfers.
- Key decisions: how much to consume, save or borrow.
- Factors affecting consumption: income level, interest rates, consumer confidence, price expectations, taxes.
3.3 Labour Market (Workers)
- Wage determination: Interaction of labour demand (derived from the marginal product of labour) and labour supply.
- Influencing factors: skill levels, education, immigration, minimum‑wage legislation, union activity, geographic mobility.
- Mobility:
- Geographic – willingness to move for better pay.
- Occupational – ability to retrain for different jobs.
3.4 Firms – Production, Costs & Revenue
3.4.1 Production
- Short‑run: At least one factor of production is fixed.
- Long‑run: All factors variable; firms can adjust plant size.
- Law of diminishing marginal returns: Adding more of a variable factor, holding others constant, eventually yields smaller increases in output.
3.4.2 Cost Concepts (Short‑run)
| Cost | Formula | Graphical Shape |
|---|
| Total Cost (TC) | TC = TFC + TVC | U‑shaped |
| Total Fixed Cost (TFC) | Cost when output = 0 | Horizontal line |
| Total Variable Cost (TVC) | Cost that varies with output | Rising curve |
| Average Fixed Cost (AFC) | AFC = TFC ÷ Q | Declines as Q rises |
| Average Variable Cost (AVC) | AVC = TVC ÷ Q | U‑shaped |
| Average Total Cost (ATC) | ATC = TC ÷ Q = AFC + AVC | U‑shaped; minimum = efficient scale |
| Marginal Cost (MC) | MC = ΔTC ÷ ΔQ | U‑shaped; intersects ATC at its minimum |
3.4.3 Revenue & Profit
- Total Revenue (TR): TR = Price × Quantity.
- Profit: Profit = TR – TC. Positive = profit, zero = break‑even, negative = loss.
- Profit‑maximising rule: Produce where MR = MC. For a price‑taking firm, MR = P, so P = MC.
3.4.4 Economies & Diseconomies of Scale (Long‑run)
- Economies of scale: ATC falls as output rises (e.g., bulk buying, specialised labour, better utilisation of plant).
- Diseconomies of scale: ATC rises after a certain size due to management difficulties, coordination problems, or morale issues.
- Long‑run ATC curve is typically U‑shaped, showing the range of efficient scale.
3.5 Market Structures
| Structure | Key Features | Efficiency | Typical Example |
|---|
| Perfect competition | Many sellers, homogeneous product, free entry/exit, price‑taker | Allocative & productive efficiency (P = MC, lowest ATC) | Market for wheat |
| Monopoly | Single seller, unique product, high barriers, price‑setter | Usually allocative inefficiency (P > MC) | Water supply in a town |
| Monopolistic competition | Many sellers, differentiated products, some entry barriers | Less efficient than perfect competition | Clothing retailers |
| Oligopoly | Few large firms, inter‑dependent decisions, possible collusion | Potential for market power & inefficiency | Airline industry |
4 Government & the Macro‑economy
4.1 Macro‑economic Aims
- Economic growth (increase in real GDP).
- Low unemployment.
- Price stability (low inflation).
- Equitable distribution of income.
- External balance (stable balance of payments).
4.2 Fiscal Policy
- Components: Government spending (G) and taxation (T) affect aggregate demand (AD = C + I + G + (X‑M)).
- Expansionary fiscal policy: Increase G or cut T → AD shifts right → higher output & price level.
- Contractionary fiscal policy: Decrease G or raise T → AD shifts left.
- Budget balance: Deficit = G – T (when G > T); Surplus = T – G.
4.3 Monetary Policy
- Conducted by the central bank (e.g., Bank of England, Federal Reserve).
- Key tools:
- Interest rate (base rate).
- Open market operations (buying/selling government securities).
- Reserve requirements.
- Quantitative easing (large‑scale asset purchases).
- Lower interest rates → cheaper borrowing → increase consumption & investment → AD shifts right.
- Higher rates → opposite effect.
4.4 Supply‑Side Policies
- Goal: increase productive capacity and shift the long‑run aggregate supply (LRAS) curve right.
- Examples: improving education & training, deregulation, tax incentives for investment, infrastructure development, promoting research & development.
4.5 Inflation, Unemployment & Economic Growth
| Indicator | Definition | Typical Measurement |
|---|
| Inflation | Rate at which the general price level rises. | Consumer Price Index (CPI) % change. |
| Unemployment | Percentage of the labour force that is willing & able to work but has no job. | Unemployment rate = (Unemployed ÷ Labour force) × 100 %. |
| Economic Growth | Increase in real GDP over time. | Annual % change in real GDP. |
4.6 Evaluation – Policy Trade‑offs
- Fiscal expansion can boost growth but may increase inflation and public debt.
- Monetary tightening can curb inflation but may raise unemployment.
- Supply‑side measures improve long‑run growth but often have long lag times and may be costly.
- Policy choice depends on the current macro‑economic situation and the relative importance placed on each aim.
5 Economic Development
5.1 What Is Development?
- Improvement in the standard of living and quality of life of a nation’s people.
- Measured by indicators such as:
- Real GDP per capita.
- Human Development Index (HDI) – combines life expectancy, education and income.
- GNI per capita (adjusted for purchasing power).
5.2 Causes of Development
- Investment in physical capital (machinery, infrastructure).
- Human capital formation – education, health, skills.
- Technological progress and innovation.
- Good institutions – stable government, rule of law, low corruption.
- Access to international markets and foreign direct investment (FDI).
5.3 Barriers to Development
- Low levels of education and health.
- Political instability, corruption, weak institutions.
- Insufficient infrastructure (roads, electricity, water).
- Dependence on a narrow range of exports (commodity dependence).
- High levels of external debt.
5.4 Role of Aid & Investment
- Official Development Assistance (ODA): Grants & concessional loans aimed at building infrastructure, health, education.
- Foreign Direct Investment (FDI): Brings capital, technology and managerial expertise.
- Both can stimulate growth if well‑targeted, but may create dependency if not managed properly.
5.5 Sustainable Development
- Meeting present needs without compromising the ability of future generations to meet theirs.
- Balancing economic growth, social inclusion and environmental protection.
- Policies: renewable energy, sustainable agriculture, pollution control, education on environmental stewardship.
6 International Trade & Globalisation
6.1 Benefits of Trade
- Specialisation according to comparative advantage → higher overall output.
- Access to a larger variety of goods and services.
- Economies of scale for exporters.
- Technology transfer and diffusion.
6.2 Costs & Risks of Trade
- Domestic industries may lose market share (import competition).
- Exposure to external shocks (commodity price swings, exchange‑rate volatility).
- Potential for trade‑related environmental degradation.
6.3 Trade Protection Instruments
| Instrument | Purpose | Typical Example |
|---|
| Tariff | Raise the price of imports to protect domestic producers | Import duty on steel |
| Quota | Limit the quantity of a good that can be imported | Textile import quota |
| Subsidy to exporters | Make domestic goods cheaper abroad | Agricultural export subsidies |
| Anti‑dumping duties | Counteract foreign firms selling below cost | Duty on cheap electronics |
6.4 Balance of Payments (BOP)
- Current account: Trade in goods & services, income, transfers.
- Capital & financial account: Investment flows, loans, FDI.
- A surplus means inflows exceed outflows; a deficit the opposite.
6.5 Exchange Rates
- Floating exchange rate: Determined by market forces of supply and demand.
- Fixed (pegged) exchange rate: Government or central bank maintains a set rate, often using reserves.
- Changes affect export competitiveness and import prices.
6.6 International Organisations
- World Trade Organisation (WTO): Sets rules for global trade, resolves disputes.
- International Monetary Fund (IMF): Provides short‑term financial assistance, monitors exchange‑rate policies.
- World Bank: Offers long‑term development loans and technical advice.
6.7 Evaluation of Globalisation
- Promotes economic growth and poverty reduction in many developing countries.
- Can widen income inequalities within and between nations.
- Environmental concerns arise from increased production and transport.
- Policy choices (e.g., trade agreements, regulation) determine whether the benefits outweigh the costs.