Drawing and interpretation of demand curve diagrams to show different PED

IGCSE Economics (0455) – Complete Revision Notes (2027‑2029 Syllabus)

Learning Objectives

• Explain the basic economic problem and the four factors of production.
• Analyse how markets allocate resources – demand, supply, equilibrium and the role of elasticity.
• Identify and evaluate the decisions of households, firms, workers and the government.
• Assess fiscal, monetary, supply‑side and trade policies and their impact on growth, unemployment and inflation.
• Discuss economic development, international trade, balance of payments and globalisation.
• Draw and interpret demand‑curve diagrams that illustrate the five possible values of price elasticity of demand (PED).

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1. The Basic Economic Problem

1.1 Scarcity & Choice

• Resources are limited → societies must decide what to produce, how to produce and for whom to produce.
• Opportunity cost = the next best alternative foregone.

1.2 Production Possibility Curve (PPC)

• Points on the curve = efficient use of resources.
• Movement along the curve = trade‑off between the two goods.
• Outward shift = economic growth (more resources or better technology).
• Inward shift = economic contraction.

1.3 Factors of Production

Factor	Definition	Example
Land	Natural resources	Minerals, farmland
Labour	Human effort (physical & mental)	Factory workers, teachers
Capital	Man‑made tools, equipment and infrastructure	Machines, factories, roads
Entrepreneurship	Risk‑taking, organisation and innovation	Start‑up founders, business managers

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2. Allocation of Resources – Markets

2.1 Demand

• Definition: Quantity of a good that consumers are willing and able to buy at each price, ceteris paribus.
• Law of demand – inverse relationship between price and quantity demanded.
• Determinants: income, tastes & preferences, prices of related goods (substitutes & complements), expectations, number of buyers.

2.2 Supply

• Definition: Quantity of a good that producers are willing and able to sell at each price, ceteris paribus.
• Law of supply – direct relationship between price and quantity supplied.
• Determinants: input prices, technology, expectations, number of sellers, taxes & subsidies.

2.3 Market Equilibrium

• Equilibrium: Q_d = Q_s.
• Surplus → downward pressure on price.
• Shortage → upward pressure on price.

2.4 Price Elasticity of Demand (PED)

2.4.1 Definition & Formula

PED measures the responsiveness of quantity demanded to a change in price.

\[ \text{PED}= \frac{\%\Delta Q_{d}}{\%\Delta P} \]

Because the law of demand gives a negative relationship, PED is usually expressed as a negative number or by its absolute value.

2.4.2 Interpreting the Absolute Value

Absolute PED	Elasticity Type	Interpretation	Typical Curve Shape
> 1	Elastic	Quantity changes proportionally more than price.	Flatter (more horizontal)
= 1	Unitary elastic	Proportional change.	Intermediate slope
0 < |PED| < 1	Inelastic	Quantity changes proportionally less than price.	Steeper (more vertical)
0	Perfectly inelastic	No change in quantity regardless of price.	Vertical line
∞ (undefined)	Perfectly elastic	Any price rise drives quantity demanded to zero.	Horizontal line

2.4.3 Sketching Different PED Curves

1. Draw axes – price (P) on the vertical, quantity (Q) on the horizontal.
2. Mark a starting point \((P_{1},Q_{1})\) on the curve.
3. Choose a small price change (e.g., 10 % decrease to \(P_{2}\)).
4. Calculate the new quantity using \[ Q_{2}=Q_{1}\Bigl[1+\text{PED}\times\frac{\Delta P}{P_{1}}\Bigr] \] (remember PED is negative, so a price fall raises Q).
5. Plot \((P_{2},Q_{2})\). Repeat with another price change to obtain a smooth curve.

2.4.4 Diagrammatic Illustrations (draw the indicated curve in the space provided)

Perfectly Elastic Demand

Highly Elastic Demand

Unitary Elastic Demand

Inelastic Demand

Perfectly Inelastic Demand

2.4.5 Using PED in Decision‑Making (Evaluation Framework)

• Pricing strategy:
  1. If demand is elastic, a price cut increases total revenue (TR); a price rise reduces TR.
  2. If demand is inelastic, a price rise increases TR; a price cut reduces TR.
• Tax incidence: The side of the market that is less elastic bears a larger share of the tax burden.
• Revenue forecasting: Combine PED with the expected percentage price change to estimate the percentage change in quantity and thus TR.

2.5 Price Elasticity of Supply (PES)

Formula: \(\displaystyle \text{PES}= \frac{\%\Delta Q_{s}}{\%\Delta P}\)

Absolute PES	Elasticity Type	Interpretation	Typical Curve Shape
> 1	Elastic	Quantity supplied changes more than price.	Flatter supply curve
= 1	Unitary	Proportional change.	Intermediate slope
0 < |PES| < 1	Inelastic	Quantity supplied changes less than price.	Steeper supply curve
0	Perfectly inelastic	Quantity supplied fixed (e.g., land).	Vertical line
∞ (undefined)	Perfectly elastic	Any price change leads to infinite change in quantity supplied.	Horizontal line

• Determinants: time period, spare capacity, availability of inputs, flexibility of production techniques.
• Short‑run supply is usually inelastic; long‑run supply tends to be more elastic.

2.6 Market Failure & Government Intervention

2.6.1 Types of Market Failure

• Public goods – non‑rival & non‑excludable (e.g., street lighting). Government provision is required.
• Externalities – spill‑over effects.
  • Positive (e.g., vaccination) → subsidies or provision.
  • Negative (e.g., pollution) → taxes, regulation or tradable permits.
• Merit & demerit goods – under‑ or over‑consumed relative to society’s optimum.
• Monopoly – single seller, price‑setter → dead‑weight loss.

2.6.2 Government Intervention Diagrams (draw in the spaces)

Price ceiling (e.g., rent control)

Price floor (e.g., minimum wage)

Tax on a good

Subsidy

2.6.3 Evaluation Framework for Any Policy

1. Intended macro‑objective: (e.g., reduce unemployment, control inflation, raise revenue).
2. Potential side‑effects: (e.g., dead‑weight loss, black‑market activity, distributional impacts).
3. Uncertainty & timing: short‑run vs. long‑run effects, administrative costs.
4. Equity considerations: who gains and who loses?

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3. Micro‑Economic Decision‑Makers

3.1 Households

• Goal: maximise utility subject to income and prices.
• Key diagram: indifference curve + budget line.

  

• Relevant concepts: marginal utility, substitution effect, income effect, diminishing marginal utility.

3.2 Firms

• Goal: profit maximisation (TR = MR, TC = MC).
• Short‑run cost curves:

  

• Long‑run adjustments – entry/exit → zero economic profit (P = ATC).
• Revenue‑cost analysis using PED:
  • If |PED| > 1 → price ↓ → TR ↑.
  • If |PED| < 1 → price ↑ → TR ↑.

3.3 Workers (Labour Market)

• Supply of labour – upward sloping (higher wages attract more workers).
• Demand for labour – derived from the marginal product of labour (MPL).
• Equilibrium wage & employment.

  

• Unemployment types (required by the syllabus):

  Type	Cause	Typical Policy Response
  Frictional	Job search & matching	Job‑centre services, training
  Structural	Skill mismatch, geographic immobility	Retraining, relocation incentives
  Cyclical	Insufficient aggregate demand	Fiscal/monetary stimulus
  Seasonal	Season‑dependent industries	Seasonal hiring programmes

3.4 Government (Micro‑intervention)

• Taxes – shift supply upward; incidence depends on relative PED & PES.
• Subsidies – shift supply downward; encourage production/consumption.
• Price controls – ceilings create shortages; floors create surpluses.
• Evaluation framework (see 2.6.3) applies to each instrument.

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4. Government & the Macro‑Economy

4.1 Fiscal Policy

• Components: Government spending (G) and taxation (T) affect aggregate demand (AD).
• Expansionary: increase G or cut T → AD shifts right.
• Contractionary: decrease G or raise T → AD shifts left.
• Diagram: AD/AS model.

  

• Evaluation points:
  1. Effect on growth vs. inflation (crowding‑out, demand‑pull inflation).
  2. Time lag – implementation and multiplier effect.

4.2 Monetary Policy

• Controlled by the central bank (e.g., Bank of England).
• Tools: interest rates, open‑market operations, reserve requirements.
• Expansionary: lower interest rates → investment ↑ → AD rightward.
• Contractionary: raise rates → investment ↓ → AD leftward.
• Diagram: IS–LM model.

  

• Evaluation:
  1. Transmission mechanism – impact on borrowing, exchange rate and expectations.
  2. Potential conflict with price stability.

4.3 Supply‑Side (Structural) Policies

• Goal: increase long‑run productive capacity without creating inflation.
• Typical measures: education & training, research & development, deregulation, tax incentives, infrastructure investment.
• Diagram: LRAS shift rightward in AD/AS model.
• Evaluation:
  1. Time lag – benefits appear in the long run.
  2. Distributional effects – who gains the new jobs?

4.4 Inflation

Cause	Mechanism	Typical Policy Response
Demand‑pull	AD exceeds LRAS → upward pressure on P.	Contractionary fiscal/monetary policy.
Cost‑push	Higher input costs (wages, oil) shift SRAS left.	Supply‑side measures, wage‑price controls (short‑run only).
Built‑in (wage‑price spiral)	Expectations of inflation → higher wages → higher prices.	Credibility of monetary policy, income policies.

Consumer Price Index (CPI) is the standard measure of inflation in the syllabus.

4.5 Unemployment (summary table)

Type	Definition	Key Indicator
Frictional	Short‑term job search	Job vacancy rates
Structural	Mismatch of skills/locations	Long‑term unemployment rate
Cyclical	Result of insufficient AD	Difference between actual and NAIRU
Seasonal	Predictable seasonal fluctuations	Seasonally‑adjusted unemployment

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5. Economic Development

5.1 What is Development?

• Broadly defined as sustained rise in living standards – higher real income, better health, longer life expectancy, improved education.
• Key indicators: GDP per capita, Human Development Index (HDI), Poverty rate, Gini coefficient.

5.2 Poverty

Aspect	Definition/Explanation
Absolute poverty	Living below a fixed minimum standard (e.g., $1.90 a day).
Relative poverty	Living significantly below the average standard of a society.
Multidimensional poverty	Deficits in health, education and living standards (UNDP’s MPI).

5.3 Population Dynamics

Measure	Formula / Explanation
Birth rate	Number of births per 1,000 population per year.
Death rate	Number of deaths per 1,000 population per year.
Net migration rate	Immigrants – emigrants per 1,000 population.
Population growth rate	\(\displaystyle \frac{(B - D) + (I - E)}{Population} \times 100\)

5.4 Determinants of Development

• Physical capital formation (investment, infrastructure).
• Human capital – education, health, nutrition.
• Technology & innovation.
• Institutions – property rights, rule of law, political stability.
• External factors – foreign aid, FDI, trade openness.

5.5 Barriers to Development

• Low savings and investment rates.
• Poor infrastructure (transport, electricity).
• Disease and poor health outcomes.
• Corruption and weak institutions.
• Geographic disadvantages (landlocked, climate).

5.6 Development Strategies (Cambridge Syllabus Headings)

Strategy	Focus	Typical Measures
Import‑substitution industrialisation (ISI)	Develop domestic manufacturing	Tariffs, import quotas, subsidies for local firms.
Export‑led growth	Specialise in tradable goods	Free trade agreements, devaluation, export incentives.
Foreign Direct Investment (FDI) attraction	Bring in capital, technology & management	Tax holidays, relaxed regulations, special economic zones.
Human‑capital development	Improve education & health	Universal primary education, vaccination programmes, micro‑finance.

5.7 Evaluating Development Policies (2‑point framework)

1. Effectiveness in raising living standards: measurable outcomes (GDP per capita growth, HDI improvement).
2. Potential side‑effects or trade‑offs: inequality, environmental damage, debt sustainability, cultural impacts.

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6. International Trade & Globalisation

6.1 Comparative Advantage & Gains from Trade

• Country specialises where it has the lower opportunity cost.
• Both countries can consume beyond their own PPCs after trade.
• Diagram: Two‑country PPC with specialization and the terms‑of‑trade line.

  

6.2 Trade Barriers

• Tariffs – tax on imports; raises domestic price, reduces import quantity.
• Quotas – physical limit on quantity; creates scarcity and higher price.
• Subsidies – payments to domestic producers; can lead to over‑production and WTO disputes.
• Non‑tariff barriers (NTBs) – standards, licences, embargoes.

6.3 Balance of Payments (BoP)

Account	Components (examples)
Current account	Exports of goods & services, imports of goods & services, net primary income (interest, dividends), net secondary income (remittances, aid).
Capital & financial account	Foreign direct investment, portfolio investment, loans, reserves.
Statistical discrepancy	Accounting errors; ensures the BoP balances.

• Surplus = inflow of foreign currency; deficit = outflow.
• Policy responses: exchange‑rate adjustment, devaluation, import controls, fiscal tightening.

6.4 Exchange‑Rate Regimes

Regime	Characteristics	Typical Policy Tools
Floating (flexible)	Market determines rate; can appreciate or depreciate.	Monetary policy, foreign‑exchange intervention.
Fixed (pegged)	Government sets a target rate against another currency or basket.	Foreign‑exchange reserves, capital controls.
Managed float	Predominantly market‑driven but with occasional intervention.	Selective buying/selling of reserves.

• Appreciation makes imports cheaper, exports more expensive; depreciation has the opposite effect.
• Evaluation: stability vs. loss of monetary‑policy autonomy.

6.5 Globalisation

• Increasing interdependence through trade, investment, technology transfer, migration and information flows.
• Positive effects: economies of scale, diffusion of innovation, lower consumer prices.
• Negative effects: cultural homogenisation, environmental pressures, widening income inequality.
• Policy debate – “globalisation vs. protectionism”.

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7. Using PED in Decision‑Making (Recap)

• Pricing: Firms with elastic demand should avoid price rises; a price cut can raise total revenue. Inelastic demand allows price increases without large loss of sales.
• Tax incidence: The side of the market that is less elastic bears a larger share of the tax burden.
• Revenue prediction: Combine the PED value with the expected percentage price change to estimate the change in quantity and total revenue.
• Policy evaluation: Use the 2‑point framework (objective vs. side‑effects) for any decision that alters price or quantity.

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8. Quick Revision Checklist

• Define and calculate PED and PES; know the formulae for percentage changes.
• Identify the five PED categories and sketch their characteristic demand curves.
• Draw the required micro‑economic diagrams (PPC, demand‑supply equilibrium, PED/PES curves, indifference curve‑budget line, ATC/MC, labour market, monopoly DWL, AD/AS, IS‑LM, BoP balance sheet, exchange‑rate regime).
• Explain market equilibrium and the effects of shifts in demand and supply.
• Recall the four micro‑decision‑makers and the key diagram for each.
• Describe fiscal, monetary, supply‑side and trade policies, and evaluate their likely advantages and disadvantages.
• Know the definitions of poverty, population growth measures, unemployment types, inflation causes, and the components of the balance of payments.
• Use the two‑point evaluation framework for any policy or diagram you discuss.