shape of the PPC: constant and increasing opportunity costs

Cambridge AS & A‑Level Economics – Complete Syllabus Notes (2026‑2028)

1 Foundations of Economics

1.1 Scarcity, Choice & Opportunity Cost

• Scarcity: Resources are limited while human wants are unlimited – the fundamental economic problem.
• Choice: Deciding how to allocate scarce resources among alternative uses.
• Opportunity Cost (OC): The value of the best‑foregone alternative when a choice is made.
  Numeric illustration: If a factory can produce either 100 units of wheat or 200 units of cloth, choosing 30 units of wheat means giving up the cloth that could have been produced with those resources – the OC of the 30 units of wheat is the amount of cloth sacrificed.
• Trade‑off curve: the Production Possibility Curve (see §1.5).

1.2 Economic Methodology

• Positive statements: Describe “what is”; they are testable and objective.
• Normative statements: Prescribe “what ought to be”; they involve value judgements.
• Ceteris paribus: All other relevant factors are held constant when analysing a relationship.
• Models & diagrams: Simplified representations of reality (e.g., PPC, AD/AS, circular flow) used to illustrate economic concepts.

1.3 Factors of Production & the Entrepreneur

Factor	Definition	Examples
Land (natural resources)	All gifts of nature used in production	Minerals, forests, climate
Labour	Human effort – physical and mental	Factory workers, teachers, doctors
Capital (physical)	Man‑made goods that assist production	Machinery, factories, computers
Capital (human)	Skills, knowledge, health of the workforce	University education, vocational training
Entrepreneurship	Risk‑taking, innovation and coordination of the other factors	Start‑up founders, small‑business owners

1.4 Economic Systems

• Market (capitalist) economy: Resources allocated by the price mechanism; private ownership of factors.
• Planned (command) economy: Central authority decides what, how and for whom.
• Mixed economy: Combination of market forces and government intervention to correct market failure or achieve equity.

1.5 Production Possibility Curve (PPC)

Assumptions

• Only two goods are considered (for simplicity).
• Resources are fixed in quantity and quality during the period analysed.
• Technology is constant.
• All resources are fully employed and efficiently used.
• Resources are mobile between the two sectors.

Opportunity Cost on the PPC

Moving from one point on the curve to another requires giving up a certain amount of the other good. The slope of the PPC at any point is the Marginal Rate of Transformation (MRT) – the amount of good Y that must be sacrificed to produce one more unit of good X.

Shape of the PPC

1. Constant Opportunity Cost

• Resources are perfectly substitutable between the two goods.
• MRT is constant – the curve is a straight line.
• Equation: Y = a – bX where b is the constant MRT.

2. Increasing Opportunity Cost

• Resources differ in suitability; as production of one good expands, less‑suitable resources are employed.
• MRT rises as output of the good increases – the curve bows outward (concave to the origin).
• Typical quadratic form: Y = a – bX + cX² with c > 0.

Numerical Illustration

1. Maximum output: 100 units of wheat (W) or 200 units of cloth (C).
2. Constant OC example: MRT = 2 C per W.
   Producing 10 W reduces cloth output by 20 C → point (10 W, 180 C).
3. Increasing OC example: The first 10 W cost 1.5 C each, the next 10 W cost 2 C each, the final 10 W cost 2.5 C each.
   Points: (10 W, 185 C), (20 W, 165 C), (30 W, 140 C). Connecting these points yields a bowed‑out curve.

Implications of the Curve’s Shape

• A bowed‑out PPC shows that reallocating resources becomes progressively more costly – a strong argument for specialization and trade.
• Policy shifts toward a good that uses less‑efficient resources incur higher opportunity costs.
• Economic growth is represented by an outward shift of the entire PPC (more resources or better technology).

1.6 Classification of Goods

Type	Characteristics	Examples
Private goods	Rival & excludable	Food, clothing, smartphones
Public goods	Non‑rival & non‑excludable	National defence, street lighting
Common‑pool (common) goods	Rival but non‑excludable	Fish stocks, groundwater
Merit goods	Undervalued by consumers, socially desirable	Vaccinations, education
Demerit goods	Over‑consumed, socially undesirable	Cigarettes, illegal drugs

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2 Micro‑economic Foundations

2.1 Demand

• Law of demand: Ceteris paribus, price and quantity demanded move in opposite directions.
• Determinants of demand: price of the good, consumer income, tastes & preferences, expectations, prices of related goods, number of buyers.
• Movement vs. shift: A change in the good’s own price causes a movement along the curve; any other determinant causes the whole curve to shift.

2.2 Supply

• Law of supply: Ceteris paribus, price and quantity supplied move in the same direction.
• Determinants of supply: price of the good, input costs, technology, expectations, number of sellers, taxes & subsidies.
• Movement vs. shift: As with demand, a price change causes movement; other factors shift the curve.

2.3 Market Equilibrium & the Price Mechanism

• Equilibrium occurs where QD = QS. The corresponding price is the market‑clearing price.
• Surplus: Quantity supplied exceeds quantity demanded → downward pressure on price.
• Shortage: Quantity demanded exceeds quantity supplied → upward pressure on price.

2.4 Consumer & Producer Surplus

• Consumer surplus (CS): Difference between what consumers are willing to pay and what they actually pay.
• Producer surplus (PS): Difference between what producers receive and the minimum they would accept.
• Welfare gain from trade = CS + PS.
• Changes in surplus depend on the price elasticity of demand and supply.

2.5 Elasticities (with worked examples)

Elasticity	Formula	Interpretation
Price Elasticity of Demand (PED)	\displaystyle \frac{\% \Delta Q_d}{\% \Delta P}\approx\frac{(Q_2-Q_1)/Q_1}{(P_2-P_1)/P_1}	|PED| > 1 = elastic; |PED| < 1 = inelastic; |PED| = 1 = unit‑elastic.
Price Elasticity of Supply (PES)	\displaystyle \frac{\% \Delta Q_s}{\% \Delta P}	Higher PES when firms can adjust output quickly (e.g., services).
Income Elasticity of Demand (YED)	\displaystyle \frac{\% \Delta Q_d}{\% \Delta Y}	YED > 0 = normal good; YED < 0 = inferior good.
Cross‑price Elasticity of Demand (XED)	\displaystyle \frac{\% \Delta Q_{dX}}{\% \Delta P_Y}	Positive = substitutes; Negative = complements.

Numerical example (PED): Price of coffee rises from £2.00 to £2.20 and quantity demanded falls from 500 cups to 460 cups.

\[ \text{PED}= \frac{(460-500)/500}{(2.20-2.00)/2.00}= \frac{-0.08}{0.10}= -0.8 \]

Demand is price‑inelastic; total revenue therefore rises.

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3 Government Intervention & Inequality

3.1 Reasons for Intervention

• Market failure: public goods, externalities, information asymmetry, monopoly power.
• Equity concerns: redistribution of income and wealth.
• Macroeconomic stability: controlling inflation, unemployment and balance‑of‑payments problems.

3.2 Policy Tools

Tool	Purpose	Illustrative Example
Taxes (excise, income)	Reduce consumption of demerit goods / raise revenue	Sugar‑sweetened beverage tax
Subsidies	Encourage production/consumption of merit goods	Renewable‑energy feed‑in tariff
Price controls	Protect consumers (ceilings) or producers (floors)	Rent control; minimum wage
Regulation & standards	Correct externalities, ensure safety	Emission standards for cars
Information provision	Address information failure	Nutrition labeling on food packages

3.3 Inequality & Redistribution

• Measurement: Gini coefficient, Lorenz curve, poverty lines.
• Policies: Progressive income tax, welfare benefits, minimum wage, public provision of education & health.

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4 Macroeconomic Fundamentals

4.1 Economic Objectives

• Economic growth (increase in real GDP)
• Low unemployment
• Price stability (low inflation)
• External balance (current‑account equilibrium)
• Equitable distribution of income

4.2 National Income Accounting

• GDP (expenditure approach): \(Y = C + I + G + (X-M)\)
• GDP (income approach): Sum of wages, rent, interest and profits.
• GNI: GDP + net primary income from abroad.
• NNI: GNI – depreciation.
• Real vs. nominal: Use the GDP deflator or CPI to adjust for price changes.

4.3 Circular‑Flow Diagram

4.4 Aggregate Demand (AD) & Aggregate Supply (AS)

• AD: Total spending on domestically produced goods and services at each price level (C + I + G + X‑M).
• SRAS: Positively sloped because wages and some input prices are sticky in the short run.
• LRAS: Vertical at the economy’s full‑employment output – reflects the long‑run capacity.

4.5 Government Macro‑economic Policies (AS‑Level)

Fiscal Policy

• Expansionary: Increase government spending or cut taxes → AD shifts right.
• Contractionary: Decrease spending or raise taxes → AD shifts left.
• Diagram: AD shift with resulting changes in output and price level.

Monetary Policy (conducted by the central bank)

• Expansionary: Lower interest rates or increase money supply → AD shifts right.
• Contractionary: Raise interest rates or reduce money supply → AD shifts left.
• Key tools: open‑market operations, reserve ratio, discount rate.

Supply‑Side Policies

• Improve LRAS by increasing productivity (e.g., investment in education, R&D, deregulation, tax incentives).
• Short‑run effect: may shift SRAS right if input costs fall.

Policy Mix & Effectiveness

• Combination of fiscal and monetary measures can reinforce or offset each other.
• Timing (lags) and the state of the economy (inflationary gap vs. recessionary gap) determine which mix is appropriate.

4.6 International Economic Issues (AS‑Level)

Reasons for Trade & Comparative Advantage

• Specialisation allows each country to produce the goods for which it has the lowest opportunity cost.
• Gains from trade are illustrated with a PPF diagram showing post‑trade consumption points outside the domestic PPC.

Protectionist Measures

• Tariffs – tax on imports; raise domestic price, protect domestic producers.
• Quotas – quantitative limits on imports; create scarcity and raise price.
• Subsidies to domestic producers – lower their marginal cost.

Balance of Payments (BoP)

• Current account = trade balance + net primary income + net secondary income.
• Capital account records capital transfers and acquisition/disposal of non‑produced, non‑financial assets.
• Financial account records net inflows/outflows of investment.

Exchange‑Rate Regimes

• Fixed (pegged) exchange rate: Central bank intervenes to maintain a set rate.
• Floating exchange rate: Determined by market forces of supply and demand for foreign currency.
• Impact on exports/imports and on the current account.

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5 A‑Level Extension (Preview of Topics 7‑11)

5.1 Micro‑economic Theory (Topic 7)

• Perfect competition – price takers, long‑run equilibrium, zero economic profit.
• Monopoly – price maker, profit maximisation (MR = MC), dead‑weight loss.
• Monopolistic competition – product differentiation, excess capacity.
• Oligopoly – kinked‑demand curve, collusion, game theory (prisoner’s dilemma).
• Externalities – positive & negative, corrective taxes/subsidies, Pigouvian solutions.
• Public‑good provision – free‑rider problem, government provision or club goods.

5.2 Labour Markets & Income Distribution (Topic 8)

• Derived demand for labour; marginal productivity theory.
• Wage differentials – skill, geography, gender.
• Trade‑union impact – bargaining power, wage‑price spiral.
• Government policies – minimum wage, employment subsidies.

5.3 Macroeconomic Policy Inter‑relationships (Topic 9)

• Interaction of fiscal and monetary policy – coordination vs. conflict.
• Supply‑side reforms and their long‑run impact on LRAS.
• Short‑run Phillips curve – inverse relation between inflation and unemployment.
• Expectations‑augmented Phillips curve – role of adaptive & rational expectations.

5.4 Development Economics (Topic 10)

• Measures of development – HDI, GNI per capita, poverty rates.
• Constraints: low productivity, poor institutions, inadequate infrastructure.
• Policy options: trade liberalisation, technology transfer, micro‑finance, foreign aid.

5.5 Globalisation & International Macroeconomics (Topic 11)

• Benefits of openness – larger markets, economies of scale.
• Risks – sudden stops, currency crises, contagion.
• International policy coordination – IMF, World Bank, G20.
• Eurozone challenges – fiscal rules, monetary union without fiscal union.

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6 Study & Examination Tips

• Always link diagrams to the underlying theory – label axes, curves, equilibrium points and indicate shifts clearly.
• Use the “key‑concept” boxes to check that you have applied the required terminology (e.g., opportunity cost, marginal rate of transformation, externalities).
• When answering essay questions, structure your response: Define → Explain → Illustrate with a diagram/example → Evaluate.
• Practice past‑paper data response questions for the PPC, AD/AS and trade sections – focus on interpreting tables and calculating growth rates or balance‑of‑payments components.
• Time‑management: allocate roughly 20 % of the exam to planning and diagram drawing; the rest to concise, well‑structured prose.