IGCSE Economics – Full Topic Notes (Cambridge 0455)
1. The Basic Economic Problem
- Scarcity: resources are limited but human wants are unlimited.
- Choice & Opportunity Cost: because of scarcity we must decide how to use resources. The cost of any choice is the value of the next best alternative fore‑gone.
- Factors of Production:
- Land (natural resources)
- Labour (human effort)
- Capital (machinery, buildings, tools)
- Enterprise (organisation, risk‑taking)
- Production Possibility Curve (PPC):
- Shows the maximum combinations of two goods that an economy can produce with full employment of resources.
- Points on the curve = efficient use of resources.
- Points inside the curve = under‑utilisation (inefficiency).
- Points outside the curve = unattainable with current resources.
- Shift outwards = economic growth (more resources or better technology); shift inwards = recession or loss of resources.
Diagram suggestion
Draw a PPC with Goods A and B on the axes. Label a point on the curve (efficient), a point inside (inefficient) and a point outside (unattainable). Show a right‑ward shift to illustrate growth.
2. Allocation of Resources (Micro‑economics)
2.1 Demand and Supply
- Law of Demand: as price falls, quantity demanded rises (ceteris paribus).
- Law of Supply: as price rises, quantity supplied rises (ceteris paribus).
- Market equilibrium: where the demand and supply curves intersect – the price at which quantity demanded = quantity supplied.
- Disequilibrium: surplus (price above equilibrium) or shortage (price below equilibrium) leads to price adjustments.
2.2 Price Elasticity
| Elasticity | Formula | Interpretation |
|---|
| Price Elasticity of Demand (PED) | Δ% Qd / Δ% P | ‑> |PED| > 1 = elastic; =1 = unit elastic; <1 = inelastic. |
| Price Elasticity of Supply (PES) | Δ% Qs / Δ% P | Similar interpretation to PED. |
- Determinants of PED: availability of substitutes, proportion of income spent, necessity vs luxury, time‑frame.
- Determinants of PES: flexibility of production, time to adjust, spare capacity.
2.3 Market Failure & Government Intervention
- Public goods – non‑rival and non‑excludable (e.g., national defence). Market under‑provides → government provision.
- Merit goods – socially desirable but may be under‑consumed (e.g., education). Government subsidises or provides.
- Demerit goods – socially undesirable (e.g., tobacco). Government taxes or restricts.
- Externalities – costs or benefits that affect third parties. Solutions: taxes (negative), subsidies (positive), regulation.
- Price controls – ceilings (max price) can cause shortages; floors (min price) can cause surpluses.
3. Micro‑economic Decision‑makers
| Agent | Key Decisions | Typical Objective |
|---|
| Households | What to buy? How much to work? | Maximise utility (satisfaction) |
| Firms | What to produce? How many workers? What price to charge? | Maximise profit |
| Workers | Which job to take? How many hours? | Maximise real income / leisure balance |
| Bank (Money & Banking) | Set interest rates, provide loans, manage money supply. | Maintain financial stability, support economic growth. |
Market structures (brief)
- Perfect competition: many sellers, homogeneous product, free entry, price‑taker.
- Monopoly: single seller, unique product, barriers to entry, price‑setter.
4. Government and the Macro‑economy
4.1 Fiscal Policy – Budget Balance
- Government revenue: taxes (direct & indirect) + non‑tax receipts (fees, rents, dividends).
- Government expenditure: current spending (wages, welfare, interest) + capital spending (infrastructure, equipment).
- Budget Balance = Revenue – Expenditure
- Positive result = budget surplus.
- Negative result = budget deficit.
4.2 Budget Surplus & Deficit – Comparison
| Aspect | Budget Surplus | Budget Deficit |
|---|
| Revenue – Expenditure | Positive (e.g., +£50 m) | Negative (e.g., –£30 m) |
| Typical fiscal stance | Contractionary or neutral | Expansionary or neutral |
| Immediate effect on borrowing | Reduces need for borrowing → lower public debt | Increases need for borrowing → higher public debt |
| Automatic stabilisers | Less active (tax receipts rise, benefits fall) | More active (tax receipts fall, benefits rise) – helps cushion recessions |
4.3 Worked Example – Calculating the Balance
| Example – Fiscal Year 2025/26 |
|---|
| Total Tax Revenue | £800 bn |
| Non‑tax Revenue (fees, dividends) | £120 bn |
| Total Revenue | £920 bn |
| Current Expenditure (welfare, health, interest) | £950 bn |
| Capital Expenditure (infrastructure) | £100 bn |
| Total Expenditure | £1 050 bn |
| Budget Balance | £920 bn – £1 050 bn = –£130 bn |
| Result | £130 bn deficit |
4.4 Why Governments Raise Revenue (Taxation)
- Revenue‑raising – fund public services and interest on debt.
- Redistribution – progressive taxes reduce income inequality.
- Re‑allocation – move resources to socially desirable activities (e.g., subsidised education).
- Regulation – discourage harmful behaviour (excise duties on tobacco, alcohol).
- Stabilisation (Automatic stabilisers) – income tax and National Insurance contributions fall when earnings drop, leaving households with more disposable income and cushioning a recession.
4.5 Why Governments Spend
- Health – hospitals, public health programmes.
- Education – schools, universities, vocational training.
- Welfare & Social Security – unemployment benefits, pensions.
- Infrastructure & Capital Projects – roads, rail, broadband, renewable energy.
- Defence & Public Safety – armed forces, police, emergency services.
- Interest on Public Debt – servicing existing borrowing.
4.6 Fiscal‑policy Instruments
- Taxes
- Increase → reduces disposable income → lowers aggregate demand (contractionary).
- Decrease → raises disposable income → raises aggregate demand (expansionary).
- Government Spending
- Increase → direct boost to aggregate demand (especially via capital projects).
- Decrease → reduces aggregate demand.
4.7 Impact of Fiscal Policy on the Three Macro‑economic Aims
| Policy Action | Typical Impact on Growth, Employment & Price Stability | Possible Side‑effects |
|---|
| Increase taxes | ↓ Aggregate demand → slower growth, lower inflation, possible rise in unemployment. | May be politically unpopular; can reduce incentives to work or invest. |
| Decrease taxes | ↑ Aggregate demand → higher growth and employment; risk of demand‑pull inflation. | Wider deficit → higher borrowing and debt interest payments. |
| Increase government spending | ↑ Aggregate demand → higher output & employment; can stabilise a downturn. | Higher deficit/debt; possible crowding‑out of private investment if financed by borrowing. |
| Decrease government spending | ↓ Aggregate demand → lower inflation, slower growth. | Reduced public services; higher unemployment; may deepen a recession. |
4.8 Evaluation of a Budget Surplus
Advantages
- Reduces the need to borrow → lower national debt and interest costs.
- Creates a fiscal cushion that can be used for future stimulus or to absorb shocks (automatic stabiliser or discretionary spending).
- Signals a stable macro‑environment, potentially attracting foreign investment.
Disadvantages
- If achieved by cutting essential services, it can harm social welfare, health, education and long‑term productivity.
- Excessive surpluses may indicate under‑investment in infrastructure, research and development, limiting future growth.
- High surpluses often require tax increases, which can be politically unpopular and may reduce household consumption.
4.9 Real‑world Example (UK Public Finances 2023/24 – pre‑vote)
| UK Treasury – 2023/24 (pre‑vote) |
|---|
| Total Revenue (taxes + non‑tax) | £1 050 bn |
| Total Expenditure (current + capital) | £1 120 bn |
| Budget balance | –£70 bn (deficit) |
Source: HM Treasury, Public Sector Finances 2023/24 (published March 2024).
4.10 Brief Note on Monetary Policy (to complete the macro‑economy unit)
- Goal: control inflation, support stable growth and employment.
- Instruments:
- Bank Rate (interest rate) – higher rates reduce borrowing and aggregate demand; lower rates stimulate.
- Open market operations – buying/selling government securities to influence money supply.
- Reserve requirements – changing the proportion of deposits banks must hold.
- Interaction with fiscal policy: coordinated policies can reinforce each other (e.g., expansionary fiscal + low interest rates) or offset (tight fiscal + tight monetary).
4.11 Supply‑side Policies (short‑run & long‑run)
- Education & training – improves labour productivity.
- Research & Development subsidies – encourages innovation.
- Tax incentives for investment – lower corporation tax, accelerated capital allowances.
- Deregulation – reduces red‑tape, encourages competition.
- These policies aim to shift the long‑run aggregate supply (LRAS) curve to the right, boosting potential output without creating inflation.
5. Economic Development
- Living standards – measured by real GDP per head, GNI per head, and the Human Development Index (HDI).
- Poverty:
- Absolute poverty – living on less than a set threshold (e.g., $1.90 a day).
- Relative poverty – earning less than a certain proportion of median income (e.g., 60%).
- Population indicators:
- Birth rate, death rate, natural increase.
- Migration (net inflow/outflow).
- Dependency ratio – proportion of non‑working (young + old) to working‑age population.
- Development gaps – differences between developed and developing economies in income, health, education and technology.
- Policies to promote development:
- Foreign aid and loans (World Bank, IMF).
- Trade‑related assistance (preferential market access).
- Investment in health, education and infrastructure.
- Good governance, stable macro‑policy and property rights.
Diagram suggestion
Bar chart comparing real GDP per head of a developed country (e.g., UK) with a developing country (e.g., Kenya). Highlight the gap and label the HDI scores.
6. International Trade & Globalisation
6.1 Comparative Advantage & Specialisation
- Country should produce and export goods in which it has a lower opportunity cost, and import goods where it has a higher opportunity cost.
- Specialisation leads to higher global output and lower prices for consumers.
6.2 Benefits and Costs of Free Trade
- Benefits:
- Access to a larger variety of goods at lower prices.
- Increased efficiency through specialisation.
- Export‑led growth and higher national income.
- Costs:
- Domestic industries may shrink or disappear (structural unemployment).
- Dependence on foreign markets and supply‑chain vulnerabilities.
- Potential terms‑of‑trade losses for small economies.
6.3 Trade Restrictions – Tools Used by Governments
| Restriction | How it Works | Typical Objective |
|---|
| Tariff (import duty) | Tax on imported goods | Protect domestic producers; raise revenue. |
| Quota | Limit on quantity that can be imported | Protect domestic industry, manage balance of payments. |
| Subsidy to exporters | Financial support to domestic firms that export | Increase export competitiveness. |
| Import licence | Government permission required to import certain goods | Control volume, protect health or security. |
6.4 Balance of Payments (BOP) – Current Account
- Current account components:
- Trade in goods (exports – imports).
- Trade in services (tourism, banking, insurance).
- Primary income (interest, dividends, wages).
- Secondary income (remittances, foreign aid).
- A surplus means the country is a net lender to the rest of the world; a deficit means net borrowing.
6.5 Foreign‑exchange (FX) Rates
- Spot rate – current price of one currency in terms of another.
- Appreciation – domestic currency becomes more valuable (imports cheaper, exports more expensive).
- Depreciation – domestic currency loses value (exports cheaper, imports more expensive).
- Factors influencing FX rates: interest‑rate differentials, inflation differentials, expectations of future rates, political stability, and current‑account balances.
Diagram suggestion
Draw a simple supply‑and‑demand diagram for a foreign currency. Show a rightward shift in demand (e.g., higher foreign investment) leading to appreciation, and a leftward shift (e.g., reduced export demand) leading to depreciation.
Study Tips
- Use the syllabus numbering (e.g., 4.2 – Fiscal policy) when revising so you can match exam questions directly.
- Practice data‑response questions: calculate budget balances, elasticity percentages, or current‑account figures from tables.
- For evaluation, always weigh at least two advantages and two disadvantages, and consider short‑run vs long‑run effects.
- Link concepts across sections – e.g., how a budget deficit can act as an automatic stabiliser, or how comparative advantage relates to a country’s terms of trade.