Drawing and interpretation of supply curve diagrams to show different PES

IGCSE Economics (0455) – Complete Revision Notes

Learning Objectives

• Understand the basic economic problem and the key concepts that underpin the syllabus.
• Analyse how markets allocate resources using demand, supply and elasticities, and interpret the effects of shifts, equilibrium, and price changes.
• Explain the decisions made by households, workers and firms, and calculate costs, revenues and profits.
• Identify the macro‑economic aims of governments and evaluate fiscal, monetary and supply‑side policies.
• Use development indicators to compare living standards and assess the causes of poverty and population change.
• Assess the benefits and drawbacks of international trade, specialisation and globalisation.

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Unit 1 – The Basic Economic Problem

1.1 Scarcity, Choice and the Three Economic Questions

• Scarcity: limited resources (land, labour, capital, entrepreneurship) versus unlimited wants.
• Economic goods: scarce goods that have a price (e.g., a smartphone).
• Free goods: abundant and available without limit at zero price (e.g., air).
• Because of scarcity, societies must answer three basic questions:
  1. What goods and services should be produced?
  2. How should they be produced?
  3. For whom should they be produced?
• Every choice involves an opportunity cost – the value of the next best alternative fore‑gone.

1.2 Factors of Production

Factor	Definition / Example
Land	Natural resources – farmland, minerals, locations.
Labour	Human effort – factory workers, teachers, doctors.
Capital	Man‑made inputs – machinery, buildings, software.
Entrepreneurship	Risk‑taking and organisation of the other three factors.

1.3 Opportunity Cost and the Production Possibility Curve (PPC)

• The PPC shows the maximum combinations of two goods that can be produced with available resources and technology.
• Points on the curve = efficient use of resources; points inside = under‑utilisation; points outside = unattainable.
• Movement along the curve illustrates opportunity cost – the slope (marginal rate of transformation) shows how many units of Good A must be given up to produce one more unit of Good B.

1.4 Economic Systems

System	Key Features	Advantages	Disadvantages
Market economy	Decisions made by households and firms; price mechanism allocates resources.	Efficient allocation; encourages innovation.	Can lead to inequality; may ignore externalities.
Command economy	Central authority decides what, how and for whom to produce.	Can mobilise resources quickly for large projects.	Often inefficient; lacks consumer choice.
Mixed economy	Combination of market forces and government intervention.	Balances efficiency with equity; can correct market failures.	Risk of excessive regulation; possible government failure.

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Unit 2 – Allocation of Resources (Markets)

2.1 Demand

• Law of demand: ceteris paribus, a higher price leads to a lower quantity demanded.
• Determinants of demand: price, income, tastes & preferences, prices of related goods, expectations, number of buyers.

Price Elasticity of Demand (PED)

Measures the responsiveness of quantity demanded to a change in price:

\[ E_d=\frac{\%\Delta Q_d}{\%\Delta P} \]

Calculation formula (mid‑point method):

\[ E_d=\frac{(Q_2-Q_1)}{(Q_2+Q_1)/2}\;\bigg/\;\frac{(P_2-P_1)}{(P_2+P_1)/2} \]

Worked example:

• Price rises from $5 to $6 (ΔP = $1).
  \[ \%\Delta P=\frac{1}{(5+6)/2}= \frac{1}{5.5}=18.2\% \]
• Quantity falls from 100 to 80 (ΔQ = –20).
  \[ \%\Delta Q=\frac{-20}{(100+80)/2}= \frac{-20}{90}= -22.2\% \]
• Elasticity: \[ E_d=\frac{-22.2\%}{18.2\%}= -1.22 \] (elastic demand).

2.2 Supply

• Law of supply: ceteris paribus, a higher price leads to a higher quantity supplied.
• Determinants of supply: price of the good, input prices, technology, expectations, number of sellers, taxes/subsidies.

Price Elasticity of Supply (PES)

Measures the responsiveness of quantity supplied to a change in price:

\[ E_s=\frac{\%\Delta Q_s}{\%\Delta P} \]

Calculation (mid‑point method):

\[ E_s=\frac{(Q_2-Q_1)}{(Q_2+Q_1)/2}\;\bigg/\;\frac{(P_2-P_1)}{(P_2+P_1)/2} \]

Worked example:

• Price rises from $10 to $12 (ΔP = $2).
  \[ \%\Delta P=\frac{2}{(10+12)/2}= \frac{2}{11}=18.2\% \]
• Quantity supplied rises from 100 to 130 (ΔQ = 30).
  \[ \%\Delta Q=\frac{30}{(100+130)/2}= \frac{30}{115}=26.1\% \]
• Elasticity: \[ E_s=\frac{26.1\%}{18.2\%}=1.43 \] (elastic supply).

2.3 Market Equilibrium and Price Changes

• Equilibrium where Q_d = Q_s at price Pₑ and quantity Qₑ.
• Shift in demand: rightward shift → higher equilibrium price and quantity; leftward shift → lower price and quantity.
• Shift in supply: rightward shift → lower price, higher quantity; leftward shift → higher price, lower quantity.
• Surplus (Qs > Qd) creates downward pressure on price; shortage (Qd > Qs) creates upward pressure.

2.4 Price Controls

• Price floor: minimum legal price set above the equilibrium price (e.g., minimum wage). Leads to a surplus.
• Price ceiling: maximum legal price set below the equilibrium price (e.g., rent control). Leads to a shortage.

2.5 Tax and Subsidy Effects

• Per‑unit tax on producers: shifts supply curve leftward (S → S₁). The vertical distance between the two curves equals the tax amount.
• Per‑unit subsidy to producers: shifts supply curve rightward (S → S₂). The vertical distance equals the subsidy.
• Both cause a new equilibrium with different consumer price, producer price and government revenue/​expenditure.

2.6 Determinants and Types of Price Elasticity of Supply

Determinants of PES

Determinant	Effect on Elasticity
Time period for production	Longer periods → more elastic (firms can adjust inputs).
Availability of inputs	Abundant, easily stored inputs → more elastic.
Mobility of factors of production	Highly mobile factors → more elastic.
Complexity of production process	Simple, flexible processes → more elastic.
Spare production capacity	Excess capacity → more elastic.

Five Supply‑Curve Types

1. Perfectly Inelastic Supply (Eₛ = 0)
   • Quantity supplied does not change when price changes.
   • Diagram: vertical line at a fixed quantity.
2. Inelastic Supply (0 < |Eₛ| < 1)
   • Quantity supplied changes, but less proportionally than price.
   • Diagram: steep upward‑sloping curve.
3. Unitary Elastic Supply (|Eₛ| = 1)
   • Percentage change in quantity equals percentage change in price.
   • Diagram: moderately sloped curve where equal % moves on axes line up.
4. Elastic Supply (|Eₛ| > 1)
   • Quantity supplied changes more than proportionally to price.
   • Diagram: relatively flat upward‑sloping curve.
5. Perfectly Elastic Supply (|Eₛ| = ∞)
   • Producers are willing to supply any quantity at a particular price; a tiny price rise leads to an infinite increase in quantity.
   • Diagram: horizontal line at the market price.

Step‑by‑Step Guide to Drawing the Five Curves

1. Draw axes: price (P) on the vertical axis, quantity supplied (Qₛ) on the horizontal axis.
2. Mark a reference point, e.g., P = $10 and Qₛ = 100 units.
3. Sketch each curve through that point:
   • Perfectly inelastic – vertical line through Q = 100.
   • Inelastic – steep line passing through (10, 100).
   • Unitary elastic – line with a moderate slope such that a 10 % rise in price (to $11) gives a 10 % rise in quantity (to 110).
   • Elastic – flat line through the reference point.
   • Perfectly elastic – horizontal line at P = $10.
4. Show a price increase (e.g., $10 → $12) and illustrate the different quantity responses along each curve.

Typical Real‑World Examples

Supply Type	Example
Perfectly inelastic	Land in a fixed location.
Inelastic	Specialist medical equipment with long lead‑times.
Unitary elastic	Many agricultural products in the short run.
Elastic	Clothing manufacturers with excess factory capacity.
Perfectly elastic	Theoretical perfectly competitive commodity market.

2.7 Market Failure and Government Intervention

• Market failure: when the free market does not allocate resources efficiently (e.g., externalities, public goods, information asymmetry, monopoly power).
• Government tools:
  • Price controls – floors and ceilings.
  • Taxes – shift supply leftward; can correct negative externalities.
  • Subsidies – shift supply rightward; encourage positive externalities.
  • Regulation – standards, licensing, quotas.
  • Provision of public goods – direct government provision.

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Unit 3 – Microeconomic Decision‑Makers

3.1 Households – Consumer Behaviour

• Utility maximisation: consumers allocate income to maximise total satisfaction.
• Budget constraint: P₁Q₁ + P₂Q₂ = I (where I = income).
• Optimal choice when MU₁/P₁ = MU₂/P₂ = … = MUₙ/Pₙ.
• Link to PED: the steeper the demand curve, the more inelastic the demand.

3.2 Workers – Labour Market

• Supply of labour: determined by wage rates, working conditions, alternative employment, population and mobility of labour.
• Demand for labour: derived from the marginal product of labour (MPL) and the price of the output: Wage = MPL × P.
• Division of labour: specialisation increases productivity but may reduce flexibility.
• Mobility of labour: geographic and occupational mobility affect supply elasticity.

3.3 Firms – Production, Costs and Revenues

3.3.1 Production Functions

• Short‑run: at least one factor (usually capital) is fixed.
• Long‑run: all factors are variable; firms can change plant size.

3.3.2 Cost Concepts (Short‑run)

Cost	Definition
Total Fixed Cost (TFC)	Costs that do not vary with output (e.g., rent).
Total Variable Cost (TVC)	Costs that vary with output (e.g., hourly wages).
Total Cost (TC)	TC = TFC + TVC.
Average Fixed Cost (AFC)	AFC = TFC / Q.
Average Variable Cost (AVC)	AVC = TVC / Q.
Average Total Cost (ATC)	ATC = TC / Q = AFC + AVC.
Marginal Cost (MC)	Change in total cost from producing one additional unit.

3.3.3 Revenue and Profit

• Total Revenue (TR): TR = P × Q.
• Profit: Profit = TR – TC.
• Short‑run profit maximisation occurs where MR = MC (for a price‑taking firm, MR = P).

3.3.4 Economies and Diseconomies of Scale

• Economies of scale: average costs fall as output rises (e.g., bulk buying, specialised staff).
• Diseconomies of scale: average costs rise as output rises (e.g., managerial inefficiency, coordination problems).
• Long‑run average cost (LRAC) curve is typically U‑shaped, illustrating both concepts.

3.4 Types of Markets

Market Type	Key Characteristics	Diagram
Perfect competition	Many sellers, homogeneous product, no barriers to entry, price taker.	Horizontal demand faced by individual firm; market demand downward sloping.
Monopoly	Single seller, unique product, high barriers to entry, price maker.	Downward‑sloping demand curve is also the average revenue curve.

3.5 Mergers & Market Power

• Horizontal merger: combines firms at the same stage of production (e.g., two car manufacturers). Can increase market share and raise prices.
• Vertical merger: combines firms at different stages (e.g., a bakery buying a flour mill). Can reduce costs but may raise antitrust concerns.
• Both can lead to economies of scale but may also reduce competition.

3.6 Money and Banking

• Functions of money: medium of exchange, unit of account, store of value, standard of deferred payment.
• Types of money: commodity money, fiat money, electronic money.
• Role of banks: accept deposits, provide loans, create money through the multiplier effect, facilitate payments.
• Interest rates: price of borrowing; set by central bank (monetary policy) and influence investment and consumption.