Cambridge International AS & A‑Level Economics – Complete Syllabus Notes
1. Foundations of Economics (AS Level)
1.1 Scarcity, Choice & Opportunity Cost
- Resources are limited → societies must decide how to allocate them.
- Opportunity cost = value of the next best alternative foregone.
- Economic rationality: maximise satisfaction (utility) given constraints.
1.2 Economic Methodology
- Positive statements – describe what is; normative statements – prescribe what ought to be.
- Assumptions, models and the ceteris paribus (all else equal) condition.
- Diagrams are used to illustrate relationships and to simplify complex reality.
1.3 Factors of Production & Economic Systems
- Land, labour, capital, enterprise.
- Market (capitalist), command (socialist) and mixed economies – different degrees of government intervention.
1.4 Production Possibility Curve (PPC)
- Shows the maximum output combinations of two goods that can be produced with existing resources and technology.
- Points on the curve = efficient; inside = inefficient; outside = unattainable.
- Shifts:
- Outward: economic growth (more resources or better technology).
- Inward: war, natural disaster, loss of resources.
1.5 Classification of Goods
- Private goods – rival & excludable (e.g., a sandwich).
- Public goods – non‑rival & non‑excludable (e.g., national defence).
- Club goods – non‑rival but excludable (e.g., cable TV).
- Common‑pool resources – rival but non‑excludable (e.g., fisheries).
- Merit goods – socially desirable but under‑consumed (e.g., education). Government may subsidise or provide directly.
- Demerit goods – socially undesirable but over‑consumed (e.g., cigarettes). Government may tax or restrict.
2. Micro‑economics (AS & A‑Level)
2.1 Demand and Supply (AS)
- Law of demand – inverse relationship between price and quantity demanded.
- Law of supply – direct relationship between price and quantity supplied.
- Market equilibrium: where Qd = Qs at price P*.
- Shifts vs. movements along the curves (e.g., income change → demand shift).
2.2 Elasticities (AS)
| Elasticity | Formula | Interpretation |
|---|
| Price elasticity of demand (PED) | %ΔQd / %ΔP | |PED|>1 = elastic; |PED|<1 = inelastic; =1 = unitary. |
| Price elasticity of supply (PES) | %ΔQs / %ΔP | High PES → producers can respond quickly to price changes. |
| Income elasticity of demand (YED) | %ΔQd / %ΔY | Positive = normal good; negative = inferior good. |
| Cross‑price elasticity (XED) | %ΔQd(A) / %ΔP(B) | Positive = substitutes; negative = complements. |
2.3 Interaction of Demand and Supply (AS)
- Simultaneous shifts: the direction of the new equilibrium depends on the relative magnitude of each shift.
- Example: an increase in consumer income (right‑shift of demand) together with a rise in input costs (left‑shift of supply) – price may rise while quantity change is ambiguous.
2.4 Consumer & Producer Surplus (AS)
Surplus measures welfare gains from market transactions.
- Consumer surplus (CS) = area between the demand curve and the market price, up to the quantity bought.
- Producer surplus (PS) = area between the supply curve and the market price, up to the quantity sold.
Worked example (staple food market):
Demand: P = 20 – 0.5Q; Supply: P = 5 + 0.2Q.
Equilibrium: 20 – 0.5Q = 5 + 0.2Q → Q* = 20, P* = 15.
CS = ½ × (20 – 15) × 20 = £50.
PS = ½ × (15 – 5) × 20 = £100.
2.5 Government Intervention to Correct Market Failure (AS)
| Instrument | Purpose | Typical Example |
|---|
| Tax | Internalise negative externalities | Cigarette excise duty |
| Subsidy | Encourage positive externalities | Renewable‑energy feed‑in tariff |
| Price ceiling | Protect consumers from excessively high prices | Rent control |
| Price floor | Support producers’ incomes | Minimum agricultural price |
| Buffer‑stock scheme | Stabilise market prices of commodities | Government grain reserves |
| Provision of information | Reduce information asymmetry | Nutrition labelling |
2.6 Market Structures (A‑Level)
| Structure | Key Characteristics | Price & Output Implications |
|---|
| Perfect competition | Many firms, homogeneous product, free entry/exit, perfect information | P = MC = MR; zero economic profit in LR |
| Monopolistic competition | Many firms, differentiated products, low barriers to entry | P > MC; LR profit eroded by entry |
| Oligopoly | Few large firms, inter‑dependence, possible collusion | Prices above MC; outcomes depend on strategic behaviour (e.g., kinked‑demand) |
| Monopoly | Single seller, high barriers, price‑setter | P > MC; allocative inefficiency (dead‑weight loss) |
2.7 Labour Market (A‑Level)
- Demand for labour derived from the marginal product of labour (MPL); firms hire up to the point where MPL = real wage.
- Supply influenced by wage rates, demographics, immigration, and expectations.
- Equilibrium wage and employment determine the natural rate of unemployment (structural + frictional).
- Unemployment types:
- Frictional – short‑term job search.
- Structural – skill‑industry mismatch.
- Cyclical – due to insufficient aggregate demand.
- Seasonal – linked to calendar periods (e.g., agriculture).
- Technological – caused by automation.
- Government policies:
- Minimum wage – raises floor wage, may cause surplus labour.
- Training & apprenticeship programmes – shift labour supply curve rightward for skilled workers.
- Unemployment benefits – automatic stabiliser, but may reduce job‑search incentive.
3. Macroeconomics – Core Objectives & Policy Mix (AS & A‑Level)
3.1 The Four Core Macroeconomic Objectives
- Economic Growth – sustained increase in real GDP per capita.
- Full Employment – unemployment at the natural rate (structural + frictional).
- Price Stability – low and stable inflation (often 2‑3% target).
- External Balance – sustainable current‑account position and stable exchange rate.
3.2 Main Policy Instruments
| Policy Type | Tools | Primary Objectives Targeted |
|---|
| Fiscal Policy |
Government spending (G), taxation (T), public‑sector borrowing |
Growth, employment, demand‑side price stability |
| Monetary Policy |
Interest rates, open‑market operations, reserve requirements, quantitative easing |
Inflation, growth (via investment), exchange‑rate stability |
| Supply‑Side (Structural) Policy |
Education & training, R&D subsidies, deregulation, tax reforms, competition policy, infrastructure investment |
Long‑run growth, productivity, external balance, equity |
3.3 The Policy‑Mix Approach
Governments usually combine instruments to balance the four objectives. The table below summarises typical trade‑offs and the main government‑failure risks.
| Policy Mix |
Growth |
Unemployment |
Inflation |
External Balance |
Typical Government‑Failure Risks |
| Expansionary fiscal + accommodative monetary |
↑ (AD rightward) |
↓ (more jobs) |
↑ (demand‑pull pressure) |
↓ (current‑account deficit widens) |
Time lags, crowding‑out, political pressure |
| Contractionary fiscal + tight monetary |
↓ (AD leftward) |
↑ (higher cyclical unemployment) |
↓ (inflation falls) |
↑ (current‑account improves) |
Information failure, over‑reaction |
| Supply‑side reforms + neutral monetary |
↑ (potential LR) |
↓ (structural unemployment falls) |
↔ (short‑run neutral) |
↑ (competitiveness improves) |
Implementation lag, regulatory capture |
3.4 The Multiplier Process (A‑Level)
The fiscal multiplier shows how an initial change in autonomous expenditure leads to a larger change in equilibrium output.
Simple closed‑economy multiplier:
\[
k = \frac{1}{1 - MPC}
\]
Open‑economy multiplier (including taxes and imports):
\[
k = \frac{1}{1 - MPC(1-t) + MPI}
\]
- MPC – marginal propensity to consume.
- t – average tax rate.
- MPI – marginal propensity to import.
A high MPI reduces the multiplier, illustrating why fiscal stimulus may be less effective in a highly open economy.
3.5 Types of Unemployment (A‑Level)
- Frictional – short‑term job search.
- Structural – mismatch of skills/locations.
- Cyclical – insufficient aggregate demand.
- Seasonal – linked to calendar periods.
- Technological – caused by automation.
3.6 Causes of Inflation (A‑Level)
- Demand‑pull inflation – AD shifts right faster than LRAS.
- Cost‑push inflation – upward shift in SRAS due to higher input costs (wages, oil).
- Built‑in inflation – expectations of future price rises (wage‑price spiral).
The short‑run Phillips curve illustrates the inverse relationship between unemployment and inflation; in the long run the curve is vertical at the natural rate of unemployment.
3.7 International Economics (AS Level)
- Trade benefits – comparative advantage, gains from specialization, terms of trade.
- Protectionist measures:
- Tariffs – raise domestic price, protect domestic producers.
- Quotas – limit quantity imported, raise price.
- Subsidies to domestic producers – lower their cost.
- Non‑tariff barriers – standards, licensing.
- Balance of Payments (BoP) – simple table:
| Account | Typical Items |
|---|
| Current Account | Exports – imports of goods & services, net income, net transfers |
| Capital & Financial Account | Foreign direct investment, portfolio investment, loans, reserves |
| Official Reserves | Changes in central‑bank holdings of foreign currency |
- Exchange‑rate regimes:
- Fixed (pegged) – central bank intervenes to maintain a target rate.
- Floating – market forces determine the rate; central bank may smooth excessive volatility.
- Managed float – occasional intervention to avoid disorderly movements.
- Effect of depreciation on the current account (Marshall‑Lerner condition):
- Depreciation makes exports cheaper and imports more expensive.
- Current‑account improves if |εX| + |εM| > 1, where ε are the price elasticities of export and import demand.
4. Government Failure in Macro‑Policy
4.1 Definition
Government failure occurs when policy actions intended to improve economic outcomes either fail to achieve their objectives or create new problems. The causes include imperfect information, time lags, political pressures, unintended side‑effects, and coordination problems.
4.2 Main Sources of Government Failure
- Information Failure
- Difficulty measuring the output gap, natural rate of unemployment, or potential growth.
- Reliance on outdated or inaccurate data → inappropriate policy magnitude.
- Time Lags
- Recognition lag: time to detect a macro‑economic problem.
- Decision lag: time to formulate and approve a response.
- Implementation lag: time for the policy to affect the economy.
- Combined lags can cause overshooting (inflation) or undershooting (persistent unemployment).
- Political Constraints
- Electoral cycles encourage short‑term stimulus before elections (political business cycles).
- Interest‑group lobbying may distort tax or spending decisions.
- Fiscal rules can be ignored for political gain.
- Unintended Consequences
- Crowding‑out: expansionary fiscal policy financed by borrowing raises interest rates, reducing private investment.
- Credit crunch: tight monetary policy can sharply contract bank lending, harming growth.
- Distributional effects: supply‑side reforms (e.g., tax cuts for high earners) may increase inequality.
- Coordination Failure
- Lack of alignment between fiscal and monetary authorities leads to mixed signals (e.g., simultaneous expansionary fiscal and contractionary monetary policy).
- International spill‑overs – a country’s exchange‑rate or fiscal stance can affect its trading partners, undermining global stability.
- Implementation & Regulatory Capture
- Complex reforms (e.g., labour‑market deregulation) may be delayed by bureaucracy.
- Regulators may act in the interests of the industries they oversee, reducing policy effectiveness.
4.3 Illustrative Diagrams (suggested for exam answers)
- Short‑run Phillips curve with arrows showing how recognition, decision and implementation lags shift the curve.
- AD/AS diagram: fiscal expansion moves AD right; subsequent crowding‑out shown as a leftward shift of LRAS.
- Multiplier diagram: initial increase in G → series of induced consumption increases → final ΔY.
- Supply‑side policy diagram: LRAS shifts rightward after reforms (e.g., deregulation, investment in R&D).
4.4 Real‑World Examples
- 2008 Global Financial Crisis – US fiscal stimulus – The American Recovery & Reinvestment Act (ARRA) injected $831 bn. The impact arrived after a recognition and implementation lag, providing a boost when the economy was already stabilising, illustrating timing issues.
- Eurozone Sovereign‑Debt Crisis – Austerity measures – Tight fiscal consolidation in Greece, Spain and Italy reduced deficits but deepened recession, raised unemployment and created deflationary pressures, showing how a policy aimed at fiscal soundness can worsen other objectives.
- Japan’s “Lost Decade” – Monetary policy limits – Prolonged near‑zero interest rates failed to revive growth because structural problems (ageing population, weak domestic demand) persisted, highlighting the need for supply‑side reforms alongside monetary easing.
- UK 2022 Energy Price Cap – Government intervention to protect households caused a supply‑side distortion for energy firms, leading to reduced investment in generation capacity and later supply shortages.
5. Mitigating Government Failure – Policy Recommendations
- Better Data & Real‑Time Monitoring – Use big‑data analytics, satellite imagery, high‑frequency indicators (e.g., weekly retail sales) to reduce information gaps.
- Rules‑Based Frameworks – Adopt transparent rules (e.g., Taylor rule for interest rates, fiscal rules on deficit/GDP) to limit discretionary errors.
- Automatic Stabilisers – Progressive tax systems and unemployment benefits act without political delay, smoothing cyclical fluctuations.
- Enhanced Coordination – Formal joint committees between treasury, central bank and trade ministries; shared targets for inflation, growth and external balance.
- Ex‑ante Impact Assessments – Cost‑benefit analysis of major supply‑side reforms before implementation.
- Independent Institutions – Strengthen central‑bank independence and regulator autonomy to reduce political interference.
- Clear Communication Strategy – Forward guidance on monetary policy and fiscal plans to manage expectations and reduce uncertainty.
6. Summary & Conclusion
Cambridge Economics requires students to understand both the theoretical potential of macro‑policy and the practical limitations caused by government failure. Fiscal, monetary and supply‑side policies can, in principle, move an economy toward the four core objectives—growth, full employment, price stability and external balance—but real‑world constraints such as imperfect information, time lags, political pressures, unintended side‑effects and coordination problems often reduce effectiveness.
Recognising these pitfalls, employing rules‑based and data‑driven approaches, and designing policies that incorporate automatic stabilisers, robust inter‑agency coordination, and independent institutions are essential for achieving sustainable macro‑economic stability.