Definitions, drawing and interpretation of diagrams, advantages and disadvantages of maximum and minimum prices in product markets

Cambridge IGCSE Economics 0455 – Complete Syllabus Overview

Learning objectives

  • Understand and apply the six content units of the syllabus.

  • Define all key terms in the exact wording required by Cambridge.

  • Draw, label and interpret the mandatory supply‑and‑demand diagrams.

  • Analyse the advantages and disadvantages of each government‑intervention tool and link them to the relevant type of market failure.

  • Use appropriate examples to illustrate concepts.

Unit 1 – The Basic Economic Problem

1.1 Key concepts (one‑sentence definitions)

  • Scarcity: The condition that resources are limited while human wants are unlimited.

  • Factors of production: Land, labour, capital and entrepreneurship.

  • Opportunity cost: The value of the next best alternative fore‑gone when a choice is made.

  • Production Possibility Curve (PPC): A diagram showing the maximum combinations of two goods that an economy can produce using all resources efficiently.

  • Economic efficiency: Producing on the PPC where marginal cost equals marginal benefit.

  • Economic growth: An outward shift of the PPC indicating an increase in an economy’s productive capacity.

1.2 Diagram – PPC

  1. Draw a downward‑sloping curve labelled PP​C.

  2. Mark points A and B on the curve – illustrate opportunity cost by showing the loss of good X when moving from A to B.

  3. Shade the area inside the curve (feasible production) and label the area outside as “unattainable”.

  4. Show an outward shift to PP​C′ and label it “economic growth”.

Unit 2 – Allocation of Resources (Mixed Economic System)

2.1 Definition

Mixed economic system: An economy that combines private‑sector market allocation with government intervention to correct market failure and achieve social objectives.

2.2 Why governments intervene? – Market failure

  • Public goods: Non‑rival and non‑excludable (e.g. street lighting) – market under‑provides.

  • Externalities: Costs or benefits that affect third parties (pollution – negative; education – positive).

  • Merit & demerit goods: Goods whose consumption is socially desirable (merit) or undesirable (demerit) relative to the private optimum.

  • Monopoly power: Ability of a firm to set price above marginal cost.

  • Information failure: Consumers cannot assess quality (e.g. food safety).

2.3 Government‑intervention toolbox (required by the syllabus)

InterventionOne‑sentence definition (syllabus wording)Diagram required for examKey labels to includeAdvantages (≥ 2)Disadvantages (≥ 2)
Price ceiling (maximum price)Legal upper limit on the price of a good set below the equilibrium price.Supply‑and‑demand graph with a horizontal line below equilibrium.E, Pe, Qe, Pc, Qs, Qd, shortage rectangle, DWL triangle

  • Protects low‑income consumers (addresses equity failure).

  • Can curb inflation on essential goods.

  • Creates a shortage (Qd > Qs).

  • May lead to black markets, queues or reduced quality.

Price floor (minimum price)Legal lower limit on the price of a good set above the equilibrium price.Supply‑and‑demand graph with a horizontal line above equilibrium.E, Pe, Qe, Pf, Qs, Qd, surplus rectangle, DWL triangle

  • Guarantees a minimum income for producers (e.g., agricultural supports, minimum wage).

  • Encourages investment in socially important sectors.

  • Creates a surplus (Qs > Qd).

  • Higher prices reduce consumer surplus and may require government purchase or waste of output.

Tax (direct & indirect)Compulsory payment to the government on each unit sold (indirect) or on income/wealth (direct).Supply curve shifts upward by the amount of the tax (indirect tax) or demand curve shifts left (direct tax on consumers).E, Pe, Qe, Pc (price paid), Ps (price received), tax rectangle, DWL triangles

  • Internalises negative externalities (e.g., carbon tax).

  • Generates revenue for public spending.

  • Raises the price for consumers – reduces consumer surplus.

  • If set too high, can cause market distortion or black‑market activity.

Subsidy (grant)Payment from the government to producers or consumers that lowers the effective market price.Supply curve shifts downward (producer subsidy) or demand curve shifts upward (consumer subsidy).E, Pe, Qe, Pc, Ps, subsidy rectangle, DWL triangles

  • Encourages production/consumption of merit goods (e.g., education, renewable energy).

  • Increases consumer and producer surplus.

  • Costly for the government – may increase fiscal deficit.

  • If poorly targeted, can lead to over‑production and waste.

Quota (licence quota)Legal limit on the quantity of a good that can be produced or imported.Vertical line at the quota quantity; price determined by intersection with demand.E, Pe, Qe, Qq, Pq, rent area, DWL triangle

  • Protects domestic industries from foreign competition.

  • Can conserve scarce resources (e.g., fishing quotas).

  • Creates economic rents for licence holders – risk of corruption.

  • Higher prices for consumers and a dead‑weight loss.

RegulationRules that set standards (e.g., safety, environmental) rather than price.Usually shown as a shift in supply (cost of compliance) or demand (information provision).E, Pe, Qe, new S or D, DWL triangle

  • Improves health, safety and environmental outcomes.

  • Protects consumers from harmful products.

  • Compliance costs raise production costs and prices.

  • Over‑regulation can stifle innovation and efficiency.

PrivatisationTransfer of ownership of a public enterprise to private hands.No specific diagram required.–

  • Increases efficiency through competition and profit motive.

  • Reduces the fiscal burden on the state.

  • Risk of monopoly power if not properly regulated.

  • Potential job losses or higher user fees.

NationalisationTransfer of a private enterprise into public ownership.No specific diagram required.–

  • Ensures essential services remain affordable and universally available.

  • Allows the state to direct production toward social goals.

  • May reduce efficiency and innovation.

  • Places a financial burden on the government.

Direct provisionGovernment supplies a good or service directly to consumers.No specific diagram required.–

  • Guarantees access to merit goods (e.g., public health, education).

  • Can achieve economies of scale.

  • High cost to the exchequer – may require higher taxes.

  • Risk of bureaucratic inefficiency.

2.4 Diagram checklist for the exam (price controls, tax, subsidy, quota)

DiagramMust labelWhat each label represents
Price ceilingE, Pe, Qe, Pc, Qs, Qd, shortage rectangle, DWL triangleE = equilibrium; Pe = equilibrium price; Qe = equilibrium quantity; Pc = ceiling price; Qs = quantity supplied; Qd = quantity demanded; shortage = Qd‑Qs; DWL = lost net benefit.
Price floorE, Pe, Qe, Pf, Qs, Qd, surplus rectangle, DWL trianglePf = floor price; surplus = Qs‑Qd; other symbols as above.
Tax (indirect)E, Pe, Qe, Pc (price paid), Ps (price received), tax rectangle, DWL trianglesTax rectangle = government revenue; DWL = loss of surplus due to reduced quantity.
Subsidy (producer)E, Pe, Qe, Pc, Ps, subsidy rectangle, DWL trianglesSubsidy rectangle = cost to government; DWL = inefficiency if subsidy does not correct a market failure.
QuotaE, Pe, Qe, Qq, Pq, rent area, DWL triangleQq = quota quantity; Pq = price with quota; rent = extra producer surplus captured by licence holders.

2.5 Linking advantages/disadvantages to market failures

  • Price ceilings – address equity failures but create shortages (a form of allocative inefficiency).

  • Price floors – correct low producer incomes (merit of supporting agriculture) but generate surpluses (resource waste).

  • Tax – internalises negative externalities (pollution) but may cause dead‑weight loss if set above the marginal external cost.

  • Subsidy – internalises positive externalities (education) but can be fiscally unsustainable.

  • Quota – protects domestic industry (market‑failure of infant‑industry) yet creates rents and higher consumer prices.

  • Regulation – solves information or safety failures but raises production costs.

Unit 3 – Micro‑Decision‑Makers

3.1 Households

  • Utility: Satisfaction obtained from consuming a good or service.

  • Budget constraint: P₁Q₁ + P₂Q₂ ≤ Income.

  • Marginal utility (MU) and the law of diminishing marginal utility.

  • Consumer equilibrium: MU₁/P₁ = MU₂/P₂ = … (maximises total utility).

3.2 Firms

  • Profit: Total revenue – Total cost.

  • Cost concepts: Fixed cost (FC), Variable cost (VC), Total cost (TC = FC + VC), Average cost (AC = TC/Q), Marginal cost (MC = ΔTC/ΔQ).

  • Short‑run vs long‑run: In the short run at least one factor is fixed; in the long run all factors are variable.

  • Profit‑maximising rule: Produce where MC = MR (marginal revenue). In perfect competition MR = P.

3.3 Market types

Market typeKey characteristicsDiagram required
Perfect competitionMany buyers & sellers, homogeneous product, free entry & exit, price‑taker.Supply‑and‑demand diagram with horizontal MR = P line.
MonopolySingle seller, price‑setter, barriers to entry.Demand curve = MR curve (twice as steep); MC intersecting MR determines output and price.
Monopolistic competitionMany sellers, differentiated products, some price‑setting power.Downward‑sloping demand; MC intersecting MR; short‑run profit possible, long‑run zero economic profit.
OligopolyFew large firms, inter‑dependent pricing, possible collusion.Typically shown with kinked‑demand curve or game‑theory matrix (optional).

3.4 Price elasticity of demand (PED) & supply (PES)

  • PED formula: %ΔQd / %ΔP.

  • Interpretation: Elastic (|PED| > 1), Inelastic (|PED| < 1), Unit‑elastic (|PED| = 1).

  • Determinants: availability of substitutes, proportion of income spent, definition of the market, time horizon.

  • Implications for government policy: taxes on inelastic goods raise revenue with little quantity change (e.g., tobacco); price ceilings on highly elastic goods cause large shortages.

Unit 4 – Government & the Macro‑Economy

4.1 Fiscal policy

  • Expansionary fiscal policy: Increase government spending and/or cut taxes to boost aggregate demand (AD).

  • Contractionary fiscal policy: Decrease spending and/or raise taxes to reduce AD.

  • Key diagram: AD‑AS model showing a rightward (expansion) or leftward (contraction) shift of AD.

  • Labels: AD, AS, equilibrium output (Y), price level (P), recessionary gap, inflationary gap.

4.2 Monetary policy (central bank)

  • Expansionary monetary policy: Lower interest rates or increase money supply to shift AD right.

  • Contractionary monetary policy: Raise interest rates or reduce money supply to shift AD left.

  • Tools: Open market operations, reserve requirements, discount rate.

  • Diagram identical to fiscal‑policy AD‑AS; label the interest‑rate channel if required.

4.3 Supply‑side policies

  • Improve productivity and shift the long‑run aggregate supply (LRAS) right.

  • Examples: Investment in education & training, deregulation, tax incentives for R&D, privatisation of inefficient state enterprises.

  • Diagram: LRAS shift right; short‑run AS may also shift.

4.4 Macro‑economic objectives & trade‑offs

ObjectiveTypical indicatorPossible conflict with other objectives
Economic growthReal GDP growth rateMay increase inflation or environmental degradation.
Low unemploymentUnemployment rateVery low unemployment can fuel wage‑price spirals (inflation).
Price stabilityInflation rate (CPI)Tight monetary policy to curb inflation can raise unemployment.
Balance of payments equilibriumCurrent‑account balanceExport‑stimulating policies may conflict with environmental goals.
Equitable distribution of incomeGini coefficientRedistributive taxes can reduce incentives to work or invest.

Unit 5 – Economic Development

5.1 Measuring development

  • GDP per capita: Average income – useful but ignores distribution.

  • Human Development Index (HDI): Composite of life expectancy, education and per‑capita income.

  • Multidimensional Poverty Index (MPI): Measures acute deprivation in health, education and living standards.

5.2 Causes of under‑development

  • Low levels of human capital (poor education & health).

  • Insufficient physical capital (infrastructure, machinery).

  • Unfavourable geography (landlocked, disease‑prone).

  • Political instability, corruption and weak institutions.

  • External debt burden and adverse terms of trade.

5.3 Strategies for development

StrategyKey actionsPotential advantagePotential disadvantage
Foreign direct investment (FDI)Attract multinational firms, create special economic zones.Brings capital, technology and jobs.Profit repatriation, possible crowding‑out of local firms.
Export‑led growthDevelop comparative advantage, improve trade infrastructure.Earns foreign exchange, creates economies of scale.Vulnerability to external demand shocks.
Import substitutionProtect infant industries with tariffs or quotas.Reduces dependence on imports, builds domestic capability.May lead to inefficiency and higher consumer prices.
Human‑capital developmentInvest in education, health, nutrition.Increases labour productivity and earnings.Requires substantial public spending and time to realise benefits.
Good governance & institutionsStrengthen rule of law, reduce corruption, improve property rights.Encourages investment and efficient resource use.Reforms can be politically difficult and slow.

Unit 6 – International Trade & Globalisation

6.1 Benefits of trade (comparative advantage)

  • Specialisation leads to higher total output.

  • Consumers gain access to a greater variety of goods at lower prices.

  • Technology transfer and economies of scale.

6.2 Trade restrictions

RestrictionHow it worksDiagram impact (AD‑AS or supply‑and‑demand)Key advantageKey disadvantage
TariffTax on imported goods; raises domestic price.Supply curve for imports shifts left; domestic price rises, quantity falls; dead‑weight loss shown.Protects domestic producers; generates revenue.Higher prices for consumers; creates inefficiency.
QuotaPhysical limit on import quantity.Vertical quota line; price rises to the level where domestic supply meets quota‑restricted demand.Protects strategic industries; can be used for resource conservation.Creates rents for import licences; leads to higher consumer prices.
Import licenceGovernment‑issued permission to import a set amount.Functionally identical to a quota in the diagram.Allows selective protection of certain sectors.Administrative costs and potential for corruption.
Export subsidyGovernment payment to domestic exporters, lowering their effective cost.Supply curve for exported good shifts right; world price falls; domestic producers gain extra surplus.Boosts export earnings and market share.Expensive for the government; can provoke retaliation.

6.3 Balance of payments (BOP)

  • Current account: Trade in goods & services, income, transfers.

  • Capital account: Financial flows – foreign direct investment, portfolio investment, loans.

  • Surplus = Exports + Net capital inflow > Imports; Deficit = opposite.

  • Persistent deficits may lead to currency depreciation or need for borrowing.

6.4 Exchange rates

  • Floating rate: Determined by market forces of supply and demand for currencies.

  • Fixed (pegged) rate: Government or central bank maintains a set exchange rate, intervening in the foreign‑exchange market.

  • Diagram: Demand and supply for a currency showing equilibrium exchange rate; illustrate the effect of an appreciation (demand shift right) or depreciation (supply shift right).

Quick reference tables

Key definitions (one‑sentence)

TermDefinition
Market failureWhen the free market does not allocate resources efficiently or equitably, resulting in a loss of total welfare.
ExternalityCost or benefit incurred by a third party not reflected in the market price.
Merit goodA good that is under‑consumed in a free market because its social benefits exceed private benefits.
Demerit goodA good that is over‑consumed in a free market because its private benefits exceed social benefits.
Dead‑weight loss (DWL)The loss of total surplus that occurs when market equilibrium is not achieved.

Diagram‑label checklist (exam)

DiagramLabels required
Price ceilingE, Pe, Qe, Pc, Qs, Qd, shortage rectangle, DWL triangle
Price floorE, Pe, Qe, Pf, Qs, Qd, surplus rectangle, DWL triangle
Tax (indirect)E, Pe, Qe, Pc, Ps, tax rectangle, DWL triangles
Subsidy (producer)E, Pe, Qe, Pc, Ps, subsidy rectangle, DWL triangles
QuotaE, Pe, Qe, Qq, Pq, rent area, DWL triangle
AD‑AS (fiscal/monetary)AD, AS, LRAS, Y (output), P (price level), recessionary gap, inflationary gap
Exchange‑rate marketSupply of currency, Demand for currency, Equilibrium exchange rate, appreciation/depreciation shift

Exam‑style tip sheet

  1. Start every diagram with the basic S‑D set‑up and label the equilibrium (E, Pe, Qe).

  2. For price controls, clearly show the horizontal line, the resulting Qs/Qd, the surplus/shortage rectangle and the DWL triangle.

  3. When discussing an intervention, first state the market‑failure it aims to correct, then list at least two advantages and two disadvantages, linking each to welfare effects (consumer/producer surplus, DWL, equity).

  4. Use the correct syllabus terminology – e.g., “maximum price” instead of “price ceiling”, “minimum price” instead of “price floor”.

  5. Remember that “subsidy” and “grant” are synonymous in the syllabus; always mention the government cost.

  6. Distinguish between direct taxes (on income, profits) and indirect taxes (on goods & services); only indirect taxes are drawn on the supply‑and‑demand diagram.

  7. When answering a question on a specific country, briefly state the relevant policy (e.g., UK minimum wage, US carbon tax) to earn extra marks.