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CAIE As Level Economics Theory

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CAIE As Level Economics Theory

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ZNOTES.

ORG

UPDATED TO 2023-2025 SYLLABUS

CAIE AS LEVEL
ECONOMICS
SUMMARIZED NOTES ON THE THEORY SYLLABUS
Prepared for Nina for personal use only.
CAIE AS LEVEL ECONOMICS

3 Basic Economic Questions -> These 3 economic

1. Basic Economic Ideas & problems must be addressed in every economy
1. What Goods to Produce? -> And how much will
Resource Allocation be produced; it is the process of selection
2. How to Produce the Goods? -> The production
process involves 4 factors of production (FOPS);
1.1. Scarcity, Choice, and Opportunity this prompt considers how the FOPS will be
Cost utilised to produce what is required in an
economy
The Fundamental Economic Problem 3. Whom to Produce the Goods For -> It is
necessary to determine who (individuals) will
Scarcity -> There is a scarcity of resources to satisfy receive what (goods). The Answers to the 3
society's unlimited needs and wants. Questions Above -> Will determine how the
E.g. Skilled Labour -> Unemployment may occur, but resources will be allocated within the unlimited
highly skilled labour is always scarce in its potential needs and want to achieve certain objectives
demand. The Answers to the 3 Questions Above -> Will determine
Main Outcome of this Problem -> There is a need to how the resources will be allocated within the unlimited
consider the different possibilities for allocating the needs and want to achieve certain objectives
available resources.
1.2. Economic Methodology
Key Terms
Statement Basis
Economic Problem -> The situation of the relative
Positive Scientific / Factual Evidence
scarcity of resources in relation to the unlimited needs
Normative Value Judgement
and wants of people
Needs -> The demand for something essential, such as
Value Judgement -> Value that is a reflection of
food or shelter
particular values or beliefs; the opinion is based upon
Wants -> The demand for something less important than
belief rather than factual evidence (subjective)
the demand for a need, for example, a new car
Scarcity -> The condition where there are insufficient Ceteris Paribus
resources to satisfy all the needs and wants of people
Choice -> The need to make decisions about the possible Definition -> All other factors influencing 2 variables are
alternative uses of scarce resources assumed to remain constant; “all other things being
Assumption -> Given the existence of limited equal” (Latin)
resources and unlimited needs and wants Economic Laws -> Principles in Economics that can be
Economic Agents -> Individuals (consumers), Firms, and observed to operate regularly; these laws require certain
Governments variables to be unchanged to withhold
Consumption -> The process by which consumers Isolation -> Allows to identification of the link between
satisfy their needs/wants variables, without other factors affecting the relationship
Production -> The process of creating goods and Main Purpose of Ceteris Paribus -> Enables economic
services in an economy behaviours to be studied from a controlled approach
Factors of Production -> Land, Labour, Capital,
Enterprise Time Periods
Opportunity Cost Short Run -> Some FOPS will be fixed and some will be
variable
Definition -> The next best alternative that is given up as Long Run -> All FOPS may change
a result of making a choice Very Long Run -> All FOPS may change + Supply can
Purpose -> Indicates the benefits that could have been change as a result of Technical Progress
obtained by choosing the next best alternative Technical Progress -> Constant in the short and long
Application -> It can be used to evaluate both run, only variable in the very long run; improves the
consumption and production decisions firm's ability to supply
Resource Allocation

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CAIE AS LEVEL ECONOMICS
FOPS that can Factor of
Period Output Definition Reward
Change Production
This can only increase by Land Natural resources Rent
Only some FOPS may
Short Run using more of the Human Workforce; Physical Wages /
change Labour
variable factors and Mental human effort Salaries
This can be increased by Man-made resources; eg.
Long Run All FOPS may change using more of the Capital Interest
Machinery
variable factors Production management,
Supply can change (as a Enterprise Profit
Very Long risk-taking endeavours
All FOPS may change result of technical
Run
progress)
1.4. Different Economic Systems
1.3. Factors of Production 3 Basic Economic Questions for Resource
Economic Resources Allocation

Definition -> The inputs used to produce goods and Answered Differently -> Depending on the type of
services; they are divided into 4 factors of production Economic System
(FOPS)
Economic System
Land Definition -> The way in which a particular country
Definition -> The natural resources of an economy; all attempts to answer the basic economic problem
that lays on the surface of the earth Allocative Mechanism -> Method by which scarce
Examples -> Farmland, mineral deposits, forests, lakes economic resources are allocated between alternative
and rivers uses
3 Types of Economic Systems -> Each uses a different
Labour allocative mechanism to decide how scarce resources
should be used
Definition -> The human workforce of the economy, 1. Market Economy
includes the physical and mental effort involved 2. Planned Economy
production 3. Mixed Economy
Alias -> Intellectual capital or Human capital
Considers -> Skills, knowledge and abilities, AND the Market Economy
potential workforce (the ones willing and able to work,
yet currently unemployed) Definition -> Type of Economic System where resource
Size/Magnitude -> Depends on population size, working allocation is taken by the private sector, producers and
age, and education/training of the workforce consumers
Alias -> Market System, Free Market/Enterprise System
Capital Market -> Space that brings together buyers and sellers
to exchange products
Definition -> The human-made inventions that aid in A market can either be physical or digital
production NO Government Intervention -> Unrealistic; no country
Examples -> Tools, machinery, equipment, buildings (eg. applies to this in the real world
factories Price Mechanism -> The process in which changes in
Fixed Capital -> Machinery price (resulting from demand/supply changes) bring
Working Capital -> Eg. Stocks of raw materials about changes in resource allocation
Good Example -> USA, although they do have some Gov.
Enterprise Intervention (eg. Amtrak transportation)

Definition -> The role of the Entrepreneur in managing

all 3 other FOPS, in order to enable production
Entrepreneur -> His risk-taking endeavours make him
differentiate from other workers
Responsibility -> Organise all 3 other FOPS to promote
efficiency and increase output

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CAIE AS LEVEL ECONOMICS
Advantages Disadvantages Feature
Market Economy Planned Economy
1) The government can Assessed
Concentrate Elsewhere: Eg. 1) Lack of Public Good Decision Made by consumers Made by the
International Diplomacy (since Provision: Eg. Police or Making and producers State/Government
the price mechanism allocates Defense are not supplied at all Determined by the
resources) Price Mechanism;
Resource State; central planning
Market forces of
2) Merit Good Under- Allocation agencies, NOT by
2) Firm Innovation: Profit Demand and Supply
Consumption/Production: Eg. Market Forces
maximisation incentivises
Health and Education are Producers = Maximise
sellers to be more innovative Maximisation of overall
underproduced and under- Profits ; Consumers =
and cost-effective Aim of Focus Social Welfare, NOT
consumed Maximise their
Profit
3) Demerit Good Over- Utility/Satisfaction
3) Consumer Welfare: Firms
Consumption/Production: Ownership Private State (Public)
should be more cost-effective,;
Alcohol and Tobacco are Public Goods Absent Present
lower prices for consumers
overproduced and
should arise Profit Motive Present Absent
overconsumed
4) Negative Externalities: Eg. Adam Smith; “Invisible
Key
4) Maximisation of Noise and Visual pollution are Hand”, Price N/A
Economist
Consumer and Producer not taken into consideration in Mechanism
Surplus the midst of the production Free Market, Laissez Centrally Planned,
Alias
scheme Faire, etc. State-Owned, etc.
Good
USA North Korea
Examples
Planned Economy
Definition -> Type of Economic system where resource Mixed Economy
allocation is taken by the State/Gov. Agencies
Alias -> Command Economy Definition -> Type of Economic System where resource
Gov. Intervention -> Very High allocation is taken by both private and public sector
In Theory -> Would suggest NO private sector Purpose -> Combine the advantages of Market and
involvement Planned Economies
In Reality -> No countries apply to this absolutely Minimised Flaws -> Of both Market and Planned
Good Example -> North Korea, the closest resemblance Economies
Decision Making -> Both by Private and Public sector
Advantages Disadvantages Applicable Examples -> Most Economies in the world
1) Decisions Regard the 1) Bureaucracy: Inflexible and
Interests of the Whole Unresponsive System to Feature Being Assessed Mixed Economy
Society: Since the State has changes in demand; since the Divided between Private and
Ownership
control over almost all Government intervenes in so Public sector
resources many areas Self-Interest ; Profit (producers)
2) The state can Decide 2) Firm Inefficiency: Less Private Sector’s Aim & Utility/Satisfaction
Which Goods to Produce: also incentives for firms to innovate (consumers)
can decide to whom they will since profit is not as supported Broader community aims,
Public Sector’s Aim
be supplied as in a Market Economy public interest
3) Economic Inefficiency: Lack The conflict between Public Measures like taxation and
3) Price-Stability is Very of competition leads to v/s Private Sectors regulation burdens
Likely inefficiency and low levels of Differs depending on the
productivity Resource Allocation sector; market forces (private)
4) Short Option Diversity + or direct measures (public)
4) Lower Unemployment
Poorer Quality of
Rate is very Likely
Goods/Services Transitional Economy
Market v/s Planned Economy

Definition -> Economy that is in the process of changing Definition -> Joins the different combinations of
from a Planned Economy to a more Mixed Economy products that can be produced in an economy in a given
Market Forces -> Assume greater importance and period of time
responsibility in resource allocation PPC’s Assumption -> Assuming the existing resources
Good Examples -> Former Eastern Europe, People’s and level of technology available
Republic of China, etc. Alias -> Production Possibility Frontier/Boundary
(PPF/PPB)
Issues of Transition Purpose -> Shows the maximum possible output that
can be achieved; does this by illustrating the idea of
1. Inflation -> Prices become volatile, hence the choice and opportunity cost**
inflation rate could be higher than in the Planned
Economy.
2. Industrial Unrest -> Trade Unions may exploit their
stronger authority to get higher wages; which could
result in strikes, protests, etc.
3. International Trade Side Effects -> May lead to BOP
imbalances of export/imports, could result in current
account deficits.
4. Unemployment -> May arise from workers
struggling to adapt to structural employment
changes; since planned economies usually have a
higher rate of employment than transition
economies.
5. Fall in Output -> Some industries perish when **
market forces are introduced, leading to a fall in
output. Graph Analysis
6. Reduction in Welfare Services -> Standard of living
may deteriorate for some when market forces Increasing the Output of 1 Product = Reduces the
acquire responsibility for welfare provision. Output of the Other Product
Opportunity Cost of Increasing Output A -> Loss in
1.5. Production Possibility Curves Output B; hence shows the cost of what the next best
alternative would have been
Production Possibility Curve (PPC) Disclaimer -> Figure shows a movement along a PPC
from one point to another; figure does not show a shift
of the whole PPC
Point X -> Consumer Output = A ; Capital Output = B
Point Y -> Consumer Output = C ; Capital Output = D
Point 1 -> Inefficient use of resources = Unemployment ;
Inside the PPC = Not all resources are being used, hence
output is lower than potential output
Point 2 -> Efficient use of resources = Full Employment ;
Lays on the PPC line = Maximum output/capacity
withholds

Shape of the PPC

Reason for its Curve -> Returns are not constant Causes of a Shift of PPC to the Right
Constant Returns -> Would theoretically suggest that
the amount of production sacrificed by one product and 1. Investment in Technology -> Labour Productivity
gained by another are the same/constant (this is Rises = Increase in the Future Production
incorrect) Potential/Capacity
Law of Diminishing Returns -> As extra units of input Example -> Investing in Capital Equipment
are used in the production process, increase in output (machinery)
will be successively smaller as more inputs are added 2. Introduction of New Resources -> Enhances the
possibility of an economy to produce more
Constant & Increasing Opportunity Costs Example -> New mineral deposits
3. Increase in the Supply of Labour -> Increase in
PPC is NOT a Straight Line -> Because of the distinction population size affects labour; this increases the
between constant and increasing opportunity costs potential quantity of labour available for employment
Increasing Opportunity Costs -> Occurs when the extra Example -> Increase in Immigration or Increase in
production of one good involves incrementing sacrifices Birth Rate
of another 4. Improvements in Human Capital -> Skills of labour
Reason -> Different FOPS have different qualities can be improved through education and training =
Eg. If Country wants to raise the Production of a Increase in the rate of productivity
Good -> It has to use an increasing amount of 5. Improved Management of Resources -> Changes in
resources that are less suitable for its production the production system may lead to greater output
Increase of FOPS that are Less Suitable for Example -> Greater division of labour should
Production = Increase in the Marginal Cost of improve productivity
Production 6. Encouragement of Enterprise Culture ->
Government can support new firms, through
Causes & Consequences of Shifts in PPC financial support or providing appropriate
information/resources
**
Causes of a Shift of PPC to the Left
1. Migration out of Country (Emmigration)
2. Reducing Labour Supply
3. Reduction in Financing Educational Initiatives ->
Reduces the quality of the future labour force

1.6. Classification of Goods & Services

Free Goods
Definition -> Good which is not scarce, thus does not
need a mechanism to allocate it
**
Scarcity -> Does NOT apply
Disclaimer -> Figure shows a shift of the whole PPC Quantity -> Sufficient to satisfy the good’s demand
PPC Shifts to the Right -> PPC1 to PPC2 ; Economy can Demand -> Equal to its supply at zero price
produce more of both types of goods NO Cost of Consumption -> This distinguishes it from
Economic Growth -> Increase in the productive private/economic goods
potential or capacity of an economy, since more of Examples -> Sunshine, air, sea water, etc.
both goods can be produced
Point X -> Inefficient use of resources = Unemployment Private Goods
Point Y -> Efficient use of resources = Full Employment

Definition -> Good that is relatively scarce, thus needs to Private Goods -> Usually provided in markets, since
be allocated to a particular use through an allocative producers can profit on charging for their consumption
mechanism Public Goods -> Usually lack production since there is no
Scarcity -> Does apply profit incentive for producers
Alias -> Economic Good Due to Non-Rivalness and Non-Excludability
2 Essential Qualities -> Rival and Excludable Main Outcome -> Public goods must be provided by the
Rival -> If one individual consumes it, there is less State/Government
available for others (reduces quantity)
Excludable -> Price is charged for a good, thus will be Quasi-Public Goods
excluded from those unable or unwilling to pay its price
2 Types of Private Goods -> 1)Merit Goods and Definition -> Impossible to distinguish between if it’s a
2)Demerit Goods private or public good
Characteristics -> Blend between the 2 types of goods
Public Goods Examples -> Public transportation, roads, parks,
libraries, etc.
Definition -> Good which is both “non-rival” and “non- Reason -> They may be accessible, but rivalrous and
excludable” partially excludable
Opposite of Private Good -> Non-Rival and Non-
Excludable Type Opportunity
Free-
Examples -> Street lighting. Police and law, National of Cost & Rivalry Excludability Rejectability
Rider
Good Scarcity
Defense, etc.
Free
Non-Rival -> If one person consumes it, it does not Good
No No No Yes No
reduce its availability to others
Private
Non-Excludable -> It is not possible to exclude any Good
Yes Yes Yes No Yes
person from its use
Public
Impossible to Prevent -> The consumption of the Yes No No Yes No
Good
good by others
Non-Rejectable -> Some public goods can’t be rejected Merit Goods
(not all of them)
Definition -> Private good that would likely be
Free Rider Problem underproduced and underconsumed in a market
economy
Definition -> The fact that it’s impossible to exclude Reason -> People may not be aware of the potential
individuals who have not paid for a product benefits of the product; underestimated benefits
Free Rider -> Person who has no incentive to pay for the
Imperfect Information -> Both producers and
use of a public good because he can still consume it
consumer don’t have the full information needed to
without paying make rational decisions
Main Outcome -> Price cannot be charged for public Outcome -> Reduces the extent of efficiency
goods (usually) Characteristics -> Rival and Excludable
Examples -> Education, Public Libraries, Health Care,
Non-Rejectability
Museums, etc.
Definition -> Idea suggesting that certain public goods
can not be rejected
Merit Good Provision
Examples -> Police Force, National Defense, etc.
Does NOT Apply to all Public Goods -> Eg. Education,
since consumers can avoid making use of provided
education

Market Failure

Governments -> 2 Choices: Either 1) Subsidise or 2) **

Provide Free Consumption
Eg. Education -> Prevents consumption from being
limited to only those able to pay for it

Main Takeaways from Graph

Reason for Over-Provision and Over-Consumption ->
Main Takeaways from Graph
Lack of recognition about damages of demerit good
Reason for Under-Consumption & Under-Production -
Treatment -> Government intervenes to discourage
> Lack of recognition about benefits of merit good
consumption and production of demerit goods
Treatment -> Government intervenes to encourage
Measure -> Taxation
consumption and production of merit goods
Examples -> Education, Health care, etc. Type of
Rival Excludable Production Consumption
Good
Demerit Goods Merit
Yes Yes Underproduction Underconsumption
Good
Definition -> Private good which would be overproduced Demerit
and overconsumed in a market economy Yes Yes Overproduction Overconsumption
Good
Reason -> Individuals may not be aware of the potential
damage of its over-consumption (imperfect information) Information Failure
Characteristics -> Rival and Excludable
Examples -> Cigarettes, Alcohol, etc. Definition -> Situation where people do not have the full
information needed to make informed decisions about
Demerit Good Discouragement their behaviour
Alias -> Imperfect Information
Governments -> Discourage consumption through tools Key Element in Private Goods -> Influences market
such as taxation failure in both Merit and Demerit Goods
Taxation -> Makes demerit goods more expensive, 1. Merit Goods -> Under-Consumption and Under-
hence demand falls Provision; Unaware of potential benefits
Eg. Cigarette Demand -> Reduction would benefit 2. Demerit Goods -> Over-Consumption and Over-
the individuals concerned Provision; Unaware of potential damages
Price Elasticity of Demand -> Determines the effectivity
of taxation in discouraging demerit goods Treatment for Information Failure
Inelastic Demerit Goods -> Consumers may ignore
the price hike and maintain similar levels of Government Intervention -> Either encourage or
consumption due to addiction discourage consumption and production of good
Merit Goods -> Encourage
Demerit Goods -> Discourage
Gov’s Aim -> Treat the imperfection of the market
Misallocation of Resources -> Product is not consumed
and produced in the right quantities

2. The Price System & the

Microeconomy

Definition -> The total demand for a particular product

2.1. Demand & Supply Curves in the market
Purpose -> Shows the relationship between market
Effective Demand demand and the price of a product
Calculation -> Adding together the quantity demanded
Definition -> The quantity of a good or service an
of each individual at any given price**
individual is willing and able to purchase over a range of
prices over a period of time.
Desire for a Product -> Must be backed up with the
ability to pay for it
Important Note -> You must distinguish an individual’s
demand for a product from the desire or need for a
product
Eg. an Individual wants a Ferrari but can’t Afford
It -> Economics states that he does not have a
demand for it
Reason -> Individual may be willing but is not able to;
hence, Effective Demand is not met

Demand
Individual Demand -> Relationship between individual
demand and the price for a product
Law of Demand -> For most goods and services, the
quantity demanded is inversely proportional to its price.
Demand Curve -> Curve showing the relationship
between the quantity of products individuals are willing **
and able to buy over a range of prices over a period of
time. Supply
Assuming Ceteris Paribus -> All other factors
affecting demand are held constant
Illustrates the Law of Demand -> Relationship
between demand and price

E.g. Demand for Tomatoes by Individual “Tom”

Assuming Ceteris Paribus -> All other factors
affecting Tom’s demand for tomatoes remain
constant
Absence of the Supply Curve -> We cannot determine
the quantity demanded and the price

Market Demand

Definition -> The quantity of a good a producer is willing Definition -> The total supply for a particular product in
and able to offer for sale over a range of prices, over a the market
given period of time Purpose -> Shows the relationship between market
Determining the Equilibrium Price and Quantity -> supply and the price of a product
One must evaluate both demand and supply curves of a Calculation -> Adding together the quantity supplied of
product. each individual producer at each price**
Individual Supply -> Relationship between an individual
producer’s supply and the price for a product
Law of Supply -> For most goods and services, the
quantity supplied is directly proportional with its price.
If Price Rises -> Quantity Supplied Rises
If Price Falls -> Quantity Supplied Falls
Supply Curve -> Curve showing the relationship
between the quantity of a product producers are willing
and able to offer for sale over a range of prices, over a
period of time
Assuming Ceteris Paribus -> All other factors
affecting supply are held constant
Illustrates the Law of Supply -> Relationship between
supply and price

Law of Supply Explanation

Higher Prices -> Producers are willing to supply more
because it is likely more profitable **
Lack of Demand Curve -> We cannot determine the
quantity supplied and at what price Shift of the Curve v/s Movement Along Curve.
** Price -> Moves along the given curve (either supply or
demand curve)
Determinants of Demand/Supply -> Bring about
changes in the whole curve when these conditions
change
Movement Along Curve is NOT the Same as Shift in
Curve
Movement Along Curve -> Either contractions or
extensions of demand/supply
** Shift in Curve -> Movement of the whole curve due to
changes in the determinants
Market Supply
Determinants of Demand
Price is NOT the Only Factor -> Other factors affect an
individual’s demand for a good/service
Conditions of Demand -> Affect how much an individual
will demand at each price
Produce Shifts in Demand -> Either to right or left

1) Income

Normal Good -> Good whose demand rises as income Individuals -> Unlikely to consume products they do not
rises, and falls as income falls; most goods and services like
Inferior Good -> Good whose demand falls as income The More Attractive a Good Is -> The greater the
rises, and rises as income falls demand is likely to be
Reason -> Consumers usually opt for cheaper
alternatives when their income is reduced Advertising -> Can influence individual’s tastes and
Eg. McDonald’s -> The least “well-off” opt for fast preferences, hence influence the demand of a product
food over real meals due to them being cheaper
4) Speculation
Type of Income Income Income
Example Individuals -> May buy products hoping their price will
Good Relationship Rises Falls
Direct Demand Demand rise, thus can profit when reselling it
Normal Most goods
relationship rises falls Speculative Products -> Houses, Shares, Antiques, etc.
Inverse Demand Demand Fast food (eg. High Speculation of Rising Prices -> Demand is likely to
Inferior
relationship falls rises McDonald’s) rise

2) Price of Other Goods 5) Size, Age, Gender or Population

Goods are Usually Related to One Another -> Either as Population Size -> Generally directly proportional with
A)Substitutes or B)Complements demand for most goods and services
A) Substitutes -> Goods that are alternative to one Age and Gender Fluctuations -> Influences the
another ; they can replace each other behaviour of demand for goods and services that have a
Example -> Coffee v/s Tea specific demographic
If Price of Tea Rises -> Tea’s demand is reduced, Example -> Products targeted to the young or
since individuals opt for coffee ; Coffee’s demand elderly, or focused on either males or females
rises
If Price of Tea Falls, -> Opposite happens 6) Distribution of Income
B) Complements -> Goods that are consumed together
Example -> Gas Fuel and Car Income Equality -> Demand for normal goods should
If Price of Cars Rises -> Car’s demand will fall increase
Fuel’s Demand Falls Too -> Since fuel’d demand Income Inequality -> Demand for luxury goods (rich)
is likely inversely related to the price of cars and inferior goods (poor) should increase
Influence on Inferior and Luxury Goods -> Will
Good Price of A Price of A depend on the nature of the change in distribution
Good A & B Example
Relationship Rises Falls
Good A’s Good A’s Determinants of Supply
They can demand demand
replace each falls ; rises Coffee v/s Price is NOT the Only Factor -> Other factors affect an
Substitutes
other; Good B’s ;Good B’s Tea individual producer’s supply for a good/service
alternatives demand demand Conditions of Supply -> Affect how much an individual
rises falls \n
producer will supply at each price
Good A’s Good A’s
demand demand
Produce Shifts in Supply -> Either to right or left
They are
falls ; rises Car and
Complements consumed 1) Costs of Production
Good B’s ;Good B’s Gas Fuel
together \n
demand demand
falls rises Rise in Costs -> Supply curve should fall
Reason -> Producers can offer less for sale at each
3) Tastes & Preferences price
Examples -> Cost of chips for making phones, salaries of
office workers

2) Availability of Resources
More Availability -> Supply curve should rise
Eg. More Copper Deposits are Discovered -> Tech
industries can produce more electronic chips

3) Climate

Does NOT Affect All Goods -> Only affects industries If Any of the Conditions of Demand Change ->
that are concerned with the weather Demand curve will shift according to the nature of the
Example -> Agriculture condition affected
Bad Weather Conditions -> Supply curve should fall Shift in Demand Curve -> Individuals are either able to
Reason -> It reduces the ability to produce more purchase more or less of a product at each price
crops Shift to the Right -> Demand Grows ; individuals can
Other Industries Impacted -> Construction, tourism, buy more of a product at each price
etc. Shift to the Left -> Demand Shrinks ; individuals can
buy less of a product at each price
4) Technology
**
Improvements in Technology -> Supply curve should
rise
Reduction in Costs of Production -> Lets firms produce
more at each given price
Eg. New Machinery -> Might significantly increase
tech industries’ ability to produce electronic chips

5) Government Regulation
**
Government’s Purpose/Aim -> Health and safety, Demand Condition Rise in Demand // Fall in Demand //
consumer welfare, legislation, etc. Being Assessed Shift to the Right Shift to the Left
Main Goal -> Protect employees from being Normal Goods: Rise Normal Goods: Fall
exploited; equal pay and minimum wage 1) Income
in Income; Inferior in Income; Inferior
High Regulation -> Supply curve should fall Goods: Fall in Goods: Rise in
Reason -> Usually rises the costs of production or Income Income
reduces efficiency of FOPS Substitute’s price Substitute’s price
2) Relationship of
rises; Complement’s falls; Complement’s
Goods
price falls price rises
6) Taxes & Subsidies
More Advertising // Less Advertising //
3) Tastes &
Indirect Taxes -> Supply curve should fall Product becomes Product becomes
Preferences
more Attractive less Attractive
Reason -> Increases the costs of production for
High Speculation High Speculation
producers
4) Speculation that Good’s price that Good’s price
Subsidies -> Supply curve should rise will Rise will fall
Reason -> Reduces the costs of production for Increase in Good’s Fall in Good’s Target
producers; producers can supply more output at 5) Population
Target Population \n Population
lower prices More even Less even
6) Income distribution of distribution of
Determinants of Demand & Supply Distribution income (Income income (Income
Equality) Inequality)
Conditions of Demand Conditions of Supply
1) Income 1) Costs of Production Shifts in the Supply Curve
2) Price of Other Goods //
2) Resource Availability
Relationship of Goods
3) Tastes & Preferences //
3) Climate Weather
Advertising
4) Speculation 4) Technology
5) Size, Age, Gender or Population 5) Government Regulation
6) Income Distribution 6) Taxes & Subsidies

Shifts in the Demand Curve

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CAIE AS LEVEL ECONOMICS
**
If Any of the Conditions of Supply Change, the Supply
curve will shift according to the nature of the condition
affected
Shift in Supply Curve -> Producers can purchase more
or less of a product at each price.
Shift to the Right -> Supply Grows; individuals can
buy more of a product at each price.
Shift to the Left -> Supply Shrinks; individuals can
buy less of a product at each price \n

PED < 1 = Price Inelastic -> Demand is relatively

Supply Condition Rise in Supply // Fall in Supply // unresponsive to a change in price
Being Assessed Shift to the Right Shift to the Left
**
Lower Wages // Higher Wages //
1) Costs of
Cheaper Raw Expensive Raw
Production
Materials Materials
2) Resource Discovery of Ore
Trade Embargoes
Availability Deposits
Optimum Weather Bad Weather
3) Climate Weather
Conditions Conditions
Improvements in
4) Technology N/A
Technology
Minimum Excessive
5) Government
Government Government
Regulation
Regulation Regulation
6) Taxes & Less Taxes; More More Taxes; Less
Subsidies Subsidies Subsidies
**
2.2. Price Elasticity, Income Elasticity &
Cross Elasticity of Demand
Price of Elasticity of Demand
Definition -> Measures the responsiveness of a change
in demand to a change in price
Formula -> PED = (%Change in Quantity Demanded) /
(%Change in Price)
PED > 1 = Price Elastic -> The change in price leads to an
even bigger change in demand

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Type of PED PED Value Shape Factor Being
Elastic PED Inelastic PED
Perfectly Elastic PED = ∞ \n Horizontal Line Assessed
Elastic PED > 1 Less Steep Curve Luxury Goods; eg. Necessary Goods; eg.
1) Necessity
Unitary Elastic PED = 1 Hyperbola travelling food/electricity
Inelastic PED < 1 More Steep Curve 2) Substitute Several Substitutes; Fewer Substitutes; eg.
Availability eg. phones bread
Perfectly Inelastic PED = 0 Vertical Line
3) Addictiveness Less Addictive More Addictive
4) Proportion of Greater Proportion; Smaller Proportion;
Eg. Price of Bread Increases Income eg. car eg. magazine
Longer Durability;
Increase in Price -> 15% 5) Durability eg. washing
Shorter Durability; eg.
Decrease in Quantity Demanded -> -20% food
machine
PED -> -20% / 15% = -1.33 6) Peak and Off-
Ignore Whether Value is Positive or Negative -> Solely Off-Peak times Peak times
Peak
consider the magnitude
Magnitude = 1.33 -> 1.33 > 1, so PED is relatively price Point Price Elasticity of Demand
elastic
Definition -> Measures the price elasticity of demand at
Factors Influencing Price Elasticity of Demand a specific point on the demand curve instead of over a
range of it**
1. Necessity -> Determines whether a good’s demand
is more likely to respond to a change in price
Necessary Goods -> Relatively Inelastic Demand,
since even though prices rise consumers still
need to consume those goods
Luxury Goods -> Relatively Elastic Demand, since
they are not necessary
2. Substitutes -> The amount of substitutes a good has
can influence the elasticity
Several Substitutes -> Relatively Elastic Demand
Eg. Market for Bread -> Relatively Inelastic
Demand, since there are less substitutes for
bread
3. Addictiveness -> More addictive goods have **
Relatively Inelastic Demand, since consumers are As Price Rises -> Point PED becomes more elastic, as
addicted to them consumers become more sensitive to price changes
Eg. Cigarettes -> Consumers continue As Price Falls -> Point PED becomes more inelastic
demanding them, even if price increases
4. Proportion of Income Spent on the Good -> Income Elasticity of Demand
Influences consumers capability to afford the
product, hence its demand Definition -> Measures the responsiveness of a change
Smaller Proportion -> Relatively Inelastic in demand to a change in income
Demand Formula -> YED = (%Change in Quantity Demanded) /
Greater Proportion -> Relatively Elastic Demand (%Change in Income)
5. Durability of the Good -> A good’s duration YED < 0 = Inferior Good -> As income increases, demand
determines how much consumers are willing to wait decreases; consumers switch to better quality
to buy another one alternatives; inferior good demand is reduced
Longer Durability -> Relatively Elastic Demand YED > 1 = Luxury Good -> As income increases, an even
6. Peak and Off-Peak Demand -> During peak times, bigger increase in demand occurs; luxury good demand
demand for tickets is Relatively Inelastic increases

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CAIE AS LEVEL ECONOMICS
YED Value Type of Good Interpretation Type of
Formula Sign (+ or -) Purpose
Demand decreases as Income Elasticity
YED < 0 Inferior Good increases ; consumers switch to Optimising prices
PED = (%ΔQd) / Must be
better quality alternatives PED for revenue and
(%ΔPrice) ignored
Demand increases as Income taxation
YED > 0 Normal Good increases ; consumers can buy Determining type
YED = (%ΔQd) / Must be
more of the good YED of Good (inferior,
(%ΔIncome) Considered
Demand increases in a bigger normal or luxury)
YED > 1 Luxury Good
proportion than income Determining
YED = (%Δ Good relationship
Must be
Cross Elasticity of Demand XED X’s Qd) / (%Δ between goods
Considered
Good Y’s Price) (complements or
substitutes)
Definition -> Measures the responsiveness of a change
in demand of one good, X, to a change in price of
another good, Y 2.3. Price Elasticity of Supply
Formula -> XED = (%change in X’s Quantity Demanded) /
(%change in Y’s Price) Price Elasticity of Supply
XED < 0 = Complements -> If Y becomes more
expensive, the quantity demanded of both goods falls
XED > 0 = Substitutes -> If Y becomes more expensive,
the quantity demanded of X rises; consumers switch to
the alternative
XED = 0 = No Relationship -> Goods have no kind of
relationship or influence on each other’s demand

XED Feature Interpretation Application

Degree of change
between demands
Greater Magnitude Stronger relationship
of both goods is
(farther from 0) between goods
much more
significant
Degree of change
Smaller
Weaker relationship between demands
Magnitude**(closer
between goods of both goods is
to 0)** \n
less significant
If Good Y becomes
more expensive;
Positive Sign (+) Substitutes
demand of Good X
rises
If Good Y becomes
more expensive,
Negative Sign (-) Complements
demand of both
goods falls
Variations in Good
No Relationship
Y’s price have no
XED = 0 (between both
effect in Good X’s
Goods)
demand

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Type of PES PES Value Shape
Perfectly Elastic PES = ∞ Horizontal Line 1. Time Scale -> Determines whether a good’s supply is
more likely to respond to a change in price
Elastic PES > 1 Less Steep Curve
Short Run -> Price Inelastic Supply, since
Inelastic PES < 1 More Steep Curve
producers cannot quickly increase supply
Perfectly Inelastic PES = 0 Vertical Line
Long Run -> Price Elastic Supply
2. Spare Capacity -> Availability of resources
Eg. the Price of Wheat Increases determines whether producers can supply more or
less of their product
Increase in Price -> 15%
Full Capacity -> Price Inelastic Supply, since there
Decrease in Quantity Demanded -> 20%
is no spare resources left to increase supply
PES -> 20% / 15% = 1.33
Spare Resources -> Price Elastic Supply, since
Ignore Whether the Value is Positive or Negative ->
there are lots of spare and unemployed resources
Solely consider the magnitude
3. Level of Stocks -> Amount of storage determines
Magnitude = 1.33 -> 1.33 > 1, so PES is relatively price
whether producers can allow themselves to increase
elastic
supply
Storable Goods -> Price Elastic Supply, since
Factors Influencing Price Elasticity of Supply firms can allow themselves to stock additional
supply
Perishable Goods -> Price Inelastic Supply,s since
firms cannot stock them for long
4. Flexibility of Factors of Production -> Determines
whether producers can reallocate their resources to
where extra supply is needed
Flexible FOPS -> Price Elastic Supply
Fixed FOPS -> Price Inelastic Supply
5. Market Barriers of Entry -> Determines the
accessibility that producers have to enter a brand
new market/industry
Higher Entry Barriers -> Price Inelastic Supply;
producers struggle to enter into the product’s
market
Lower Entry barriers -> Price Elastic Supply

Factor Being Assessed Elastic PES Inelastic PES

1) Time Scale Long Run Short Run
2) Spare Capacity Spare Resources Full Capacity
3) Level of Stocks Storable Goods Perishable Goods
4) Flexibility of Factors
Flexible FOPS Fixed FOPS
of Production
5) Market Barriers to Lower Entry Higher Entry
Entry Barriers Barriers

2.4. Interaction of Demand and Supply

Market Equilibrium

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CAIE AS LEVEL ECONOMICS
Market
Definition -> When supply meets demand; shown by P* Definition Example
Relationship
Qd in the graph below **Gas Fuel &
Price has No Tendency for Change -> Since producers When goods are
Car:**Increase in Car
1) Joint complements
are meeting consumers’ demand demand is likely to lead
Demand (goods that are
Market Disequilibrium -> Whenever supply is not equal to an increase in the
bought together)
to demand; 2 scenarios: 1)Surplus or 2)Shortage demand for gas fuel \n
Surplus -> Occurs when supply exceeds demand; **iPhone v/s
excess supply (blue line in graph) When goods are Samsung:**Increase in
2) Alternative substitutes (goods iPhone demand is likely
Shortage -> Occurs when demand exceeds supply;
Demand that are alternatives to lead to a fall in the
excess demand red line in graph) for each other) demand for Samsung
phones \n
**
When the demand **PC’s &
for a good produces Microchips:**Increase in
3) Derived a corresponding PCs’ demand is likely to
Demand demand for lead to an increase in the
another related demand for microchips
good \n
When increasing **Lamb Supply & Wool
the supply of one Supply:**Increase in
4) Joint Supply good influences the Lamb supply is likely to
supply of another lead to an increase in the
good supply of wool \n

The Price Mechanism // The Invisible Hand

Price has 3 Main Functions -> Rationing, Signalling, and
** Incentivising
A)Rationing -> Price increases by default when
Relationships Between Different Markets resources are scarce
Increase in Price -> Discourages demand,
consequently rations resources
Eg. Plane Ticket Rise as Seats are Sold -> Because
spaces are running out
Disincentive to Purchase the Tickets -> Results in
rationing the tickets
B)Signalling -> Price acts as a signal to consumers and
new firms entering the market
Price Variations -> Indicate where resources are
needed in the market
C)Incentivising -> Consumers can inform producers the
products they desire by making choices
High Prices -> Encourage firms to increase their
output, since they can make more profit
Low Demand -> Results in lower prices, which
disincentivize firms’ output production

2.5. Consumer and Producer Surplus

Consumer Surplus

Definition -> The difference between the price the Definition -> The difference between the price the
consumer is willing and able to pay and the price they producer is willing to charge and the price they actually
actually pay charge
Basis -> What the consumer perceives their private Basis -> The private benefit gained by the producer that
benefit will be from consuming the good covers their cost
Measurement -> Profit**
**

**
** Location in Graph -> Area below the market price and
Location in Graph -> Area above market price and above the supply curve
below the demand curve Increasing Producer Surplus -> Either a)Rise in Supply
Law of Diminishing Marginal Utility -> Consumer or b)Rise in Demand
Decreasing Producer Surplus -> Either a)Fall in Supply
surplus generally declines with each extra unit consumed
Extra Unit -> Generates less utility than the one or b)Fall in Demand
already consumed
Main Outcome -> Consumers are willing to pay less
Economic Welfare
for extra units
Inelastic Demand Curves -> Have larger consumer
surplus, since consumers are willing to pay much higher
prices to consume the good
Increasing Consumer Surplus -> Either a)Rise in
Demand or b)Rise in Supply
Decreasing Consumer Surplus -> Either b)Fall in
Demand or b)Fall in Supply

Producer Surplus

Definition -> The total benefit society receives from an Definition -> Price control set by the Government as the
economic transaction lowest legal price that can be set for a good or service
Calculation -> Area of producer and consumer surplus Alias -> Price Floor
added together Aim -> Discourage consumption/production of
Importance -> When considering the effects of goods/services
Government Intervention Minimum Wage -> Type of minimum price; could reduce
** employment but, encourages positive externalities
Positive Externalities -> Improved socioeconomic
welfare and incentivises work
**

3. Government Key Takeaways from Minimum Price Graph (above)

Microeconomic Intervention 1. 1)Quantity Supplied (Qs) > Quantity Demanded
(Qd)
3.1. Maximum & Minimum Prices Supply -> Rises from Q* to Qs
Demand -> Reduced from Q* to Qd
Minimum Prices 2. 2)Price Minimum is ABOVE Equilibrium -> Makes it
more profitable to sell the good; incentivises
production, and less affordable to consume
(discourages consumption)
More Quantity Supplied (Qs) -> Suppliers are
encouraged to supply more of their product
Less Quantity Demanded (Qd) -> Consumers
are discouraged from purchasing the product,
since it becomes less affordable
3. Main Outcome → Excess Supply (difference between
Q* and Qs)

Eg. of Minimum Price) Minimum Wage

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Advantages Disadvantages
1. Definition -> Minimum hourly wage an employer 1)Informal Labour -> Workers
must pay an employee 1)Discourage Demerit Good
who are employed unofficially
2. Aim/Purpose -> Reduce poverty; increasing living Consumption -> Reduces
in order to work for less than
negative externalities
standard of workers the minimum wage
3. Perverse Outcomes (Negative Side Effects) 2)Raise Living Standard of
2)Unemployment Rate Rises
Unemployment Increased -> More expensive to the Poorest
hire workers; firms must lay off part of their 3)Incentive for People to 3)Decrease in the Wealth of
workforce Work Consumers
Labour Costs Rise 4)Inflation
Reward for Working Rises -> More workers are
willing to supply their labour Maximum Prices
Hurts Unskilled Workers -> Since firms are
stricter in the abilities they demand of their Definition -> Price control set by the Government as the
employees at higher wage rates highest legal price that can be set for a good or service
4. Requisites to be Effective: Alias -> Price Ceiling
Minimum Wage must be ABOVE Equilibrium -> Aim -> Encourage consumption/production of
Or else employers will ignore minimum wages goods/services; avoid goods from getting too expensive
below the market wage (equilibrium level) **
Consider the Elasticity of Labour Demand
Inelastic Demand -> Will result in a smaller
excess of unemployed workers; firms don’t
respond in such extreme degree to rise in
labour costs
Elastic Demand -> Will result in a more
accentuated excess of unemployed workers;
firms respond adhoc to the rise in labour
costs

Minimum Price Impact on Producer & Consumer

Surplus
\n **

Key Takeaways from Maximum Price Graph Above

Minimum Price Advantages & Disadvantages

1. Quantity Demanded (Qd) > Quantity Supplied (Qs) **

Supply -> Falls from Q* to Qs
Demand -> Rises from Q* to Qd
2. Price Maximum is BELOW Equilibrium -> Makes it
less profitable to supply the good; discourages
production, and more affordable to consume
(encourages consumption)
Less Quantity Supplied (Qs) -> Suppliers are
discouraged from supplying their product, since it
becomes less profitable to sell
More Quantity Demanded (Qd) -> Consumers
are encouraged to purchasing the product, since
it becomes more affordable \n **
3. Main Outcome -> Supply Shortage // Excess Demand
(difference between Q* and Qs) Maximum Price Advantages & Disadvantages
Consumers Require Rationing of the Good ->
Since more consumers want the product than Advantages Disadvantages
what is currently available 1)Supply Shortage // Excess
Rationing Mechanisms -> Must be put in order Demand -> Results in the need
1)Essential Goods become
to fairly distribute the product’s output of a rationing mechanism to
More Affordable
fairly distribute the supply of
the desired product
Eg. of Maximum Price) Real Estate Rent Prices
2)Bribery & Corruption ->
2)Housing Market ->
Regarding those responsible
1. Aim/Purpose -> Maintain the rent affordable for Theoretically prevented from
for regulating the queue or
tenants (consumers) becoming too expensive
rationing process
2. Perverse Outcomes (Negative Side Effects) 3)Informal/Black Market ->
Landlords (Suppliers) -> Unwilling to supply their Supply scarcity is satisfied
real estate to the market, since prices aren’t as through illegal means outside
3)Transportation Market ->
profitable than before the maximum rent limit Fares are restricted from
of the legal market; informal
Tenants (Consumers) -> Struggle to find price becomes far more
reaching an exceeding price
available housing, since less landlords are willing expensive than both the
maximum and equilibrium
to rent
price
Black Market Arises -> Landlords accept bribes
4)Prevents Monopoly
from desperate tenants; results in extremely Exploitation -> Monopolies 4)Reduction in Firms’ Profits -
exclusive rent prices, since demand accentuates can’t exceed a set price level > Less profit revenue, hence
significantly) legally, so even though they less money to reinvest into the
3. Requisites to be Effective: could manipulate all alternative business; this may also lead to
Price Ceiling must be BELOW Equilibrium -> Or supply options, they would not restricted economic growth
else producers will ignore price ceilings be able to get away with it
5)Can Result in Welfare Gains
Maximum Price Impact on Producer & Consumer -> Due to lower prices making 5)May Lead to Government
goods more affordable; better Failure
Surplus standard of living (theoretically)
6)Increase in Firms’ Efficiency
-> Since they must figure out
how to cut their costs in order
to raise their profitability again

Buffer Stock Schemes

Markets with Supply Variations -> Experience price Eg. of Buffer Stock Scheme) Demand & Supply in
volatility (price equilibrium varies constantly) Agricultural Market
Reasons -> Eg. Agriculture Industry: difficult weather Supply in Any Year -> Perfectly Inelastic (PES=0,
conditions vertical supply curve)
Agricultural Markets -> Have their supply fixed in Years 1-3 -> S, S1, S2
the short run Government’s Aim -> Wants equilibrium to be at
Government Intervenes -> Aims to reduce price price P* and quantity Q*
volatility through the use of buffer stock schemes Year S1
Buffer Stock -> Amount of a commodity that is held to Equilibrium Quantity -> Q1
limit its price volatility Equilibrium Price -> P2
When Commodity has Production Surplus -> Government Buys Extra Output (Q1-Q*) -> This
Product is bought and stored in the buffer stock shifts the equilibrium price to P*
When Commodity has Production Shortage -> Year S2
Buffer stock supplies the amount needed to cover Equilibrium Quantity -> Q2
the shortage Equilibrium Price -> P1
Government Sells Buffer Stock to Cover Shortage
** (Q2-Q*) -> This shifts the equilibrium price to P*

Buffer Stock Scheme Advantages & Disadvantages

Advantages Disadvantages
1)May be Arbitrary to
1)Solves Price Volatility -> Determine the Equilibrium
Achieves to establish price Price -> Uncertainty about
stability in uncertain markets what the equilibrium price of a
commodity should be
2)Additional Costs of
Operating the Buffer Stock
2)Stable Incomes for
Scheme -> Either the
Farmers/Workforce of
Government or producers will
Unstable Markets -> Eg.
need to contribute; may
** agricultural market’s profits are
distract the Government from
stabilised
focusing in other
Key Takeaways from Buffer Stock Graph (above) responsibilities
3)Encourages Producers to
Engage in Long-Term
Business Plans & Deals -> 3)Difficulties to Store Excess
Gives way to economic growth, Supply -> Perishability of the
discovery of new industries, produce must be considered
international competitiveness,
etc.

3.2. Taxation
Example of Average v/s Marginal Tax

Money Earned -> $100,000 Definition -> Taxes which are levied on expenditure of
Money Paid in Income Tax -> $25,000 goods and services
Net Income -> $75,000 Collected from Sellers -> This increases the production
Average Rate of Taxation -> 25% costs of producers, thus resulting in less supply
Marginal Tax Rate -> The rate of tax that you pay on Market Price of Good Rises -> Hence Quantity
your next dollar earned Demanded is lower (contracts)
May be Different from Average Rate of Taxation - Consumer Incidence -> The amount of tax passed from
> Since it depends on the next tax bracket the the producer to the consumer
individual is on Producer Incidence -> Portion of the tax which the
Tax Rate Formula -> [(Total Tax Paid) / (Total Income)] * producer pays
100 Examples -> VAT (UK), Sales Tax (USA)
Tax Rate Eg. -> [(21, 036.75)/(100,000)] * 100 = 21.04% Excise Duty -> Specific Tax on a particular good
2 Main Types -> A)Specific/Per-Unit Tax and B)Ad
Valorem/Value Added Tax
A) Specific/Per-Unit Tax -> Fixed amount of tax charger
to the seller per each unit of good/service sold
The Most Common Type of Indirect tax
Largest Source of Tax Revenue for Governments
B) Ad Valorem/Value Added Tax -> Tax based upon the
total value of a transaction, levied as a % of a good’s
value

Proportional, Progressive & Regressive Taxes

** Marginal Tax
Type Definition Examples
Marginal Tax Rate in Image Above -> 28% Rate
Fixed rate for all
Flat =
Direct Taxes Proportional Average Rate
taxpayers, Corporation Tax;
regardless of Firms, LLcs, etc.
of Tax
Definition -> Taxes that are levied on income, wealth income
and profit Taxes those
Rises with
Payee (Recipient of Tax Payments) -> Direct taxes are Progressive with higher Income Tax
income
paid directly to the Government incomes more
Responsibility -> Bears on the Consumer/Firm through Lower incomes
Falls with
Regressive pay more in Sales Tax
income, inheritance, etc. income
taxes (indirectly)
Examples -> Income Tax, Capital Gains Tax, Corporation
Tax

Indirect Taxes

Impact on Inelastic Product

Quantity Demanded -> Minimally reduced from Q*
\n Impact v/s Incidence of a Tax to Q1
Price -> Rises sharply from P* to Pconsumer
Impact -> The individual/company on which the tax is Ineffective to Reduce Demerit Good Demand ->
levied on Since addicted consumers purchase anyways
Incidence of a Tax -> Eventual distribution of the Great source of revenue for Government
burden of a tax
A2)Incidence of a Specific Tax
A1)Impact of a Specific tax
Elastic Demand

Inelastic Product

Impact on Elastic Product

Quantity Demanded -> Reduced from Q* to Q1
Price -> Rises from P* to Pconsumer
Inelastic Demand

Elastic Product

Main Takeaway -> The more inelastic a product is, the

greater the burden lies on the consumer. **

Scenarios for Complete Consumer Burden B1) Impact of an Ad Valorem Tax

NO Producer Burden -> Either because consumers Main Difference from Specific Tax -> Tax value rises as
absorb all the burden or producers refuse to adjust to the price rises
consumers’ demands Elastic Demand
Perfectly Inelastic Demand -> PED = ∞ ; consumers
absorb all the burden since they do not respond to **
changes in price; vertical demand curve

Impact on Elastic Product

** Quantity Demanded -> Reduced from Q* to Q1
Price -> Rises from P* to Pconsumer
Perfectly Elastic Supply -> PES = ∞ ; consumers absorb Inelastic Demand
all the burden since producers refuse to adjust to
consumers’ demands; vertical supply curve

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CAIE AS LEVEL ECONOMICS
**
Value of the Tax -> Difference between Pconsumer and
PSupplier
Tax Revenue -> Q1 * Value of Tax // Q1 * (Pconsumer-
Psupplier)
Producer Burden
Area -> Above Psupplier, below market/equilibrium
price, left of Q1
Inelastic Market -> Producer burden is smaller;
more money spent on product
Elastic Market -> Producer burden is greater; less
revenue due to less sales
Consumer Burden
Area -> Below Pconsumer, above market/equilibrium
** price, left of Q1
Inelastic Market -> Consumer burden is greater; more
Impact on Inelastic Product money spent by consumers
Quantity Demanded -> Minimally reduced from Q* Elastic Market -> Consumer burden is smaller;
to Q1 consumers don’t tolerate a rise in price, less demand,
Price -> Rises sharply from P* to Pconsumer less sales
Deadweight Loss (DWL) -> Inefficient allocation of
B2) Incidence of an Ad Valorem Tax resources, market failure; no party enjoys the benefit
Inelastic Market -> DWL is much smaller; revenue is
** collected anyway since consumers still buy the
product
Elastic Market -> DWL is much greater; revenue is
much smaller since consumer demand contracts

3.3. Subsidies
Subsidies
Definition -> Benefit given by the government to
producers to reduce their production costs.
Aim -> Encourage further production
Financing/Budget for Subsidies -> Tax Revenue
Opportunity Cost -> Government revenue could have
** been used elsewhere; potential government failure:
there may be inefficient spending.
Taxation Graph Calculations & Formulas
Impact of a Subsidy

Shift Supply Curve to the Right // Supply Expands -> Consumers -> Do not fully benefit from the full value of
Producers can supply more of their product at each the subsidy
given price. Producers -> Absorb some of the benefit of the subsidy
Market/Equilibrium Price -> Lowered from P* to for their own gain
Pconsumer (see below) Inelastic Demand
Value of Subsidy Per-Unit -> Difference between P* and
Pconsumer **
Total Government Spending on Subsidy -> Per-Unit
Subsidy * Output
Elastic Demand

Main Takeaway from Inelastic Demand -> Leads to

greater consumer benefit
Elastic Demand
**
**
Impact on Elastic Product:
Price -> Slightly reduced from P* to Pconsumer
Quantity Supplied -> Large increase from Q* to Q1

Incidence of a Subsidy
**

Main Takeaway from Elastic Demand -> Leads to

Greater Producer Benefit.

3.4. Income & Wealth Inequality

** Income v/s Wealth
Income -> Flow of money; variable
Wealth -> Stock of money or assets; constant

Income

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CAIE AS LEVEL ECONOMICS
Country Gini Coefficient
Definition -> Money received, especially on a regular 1)Azerbaijan 0.166
basis
2)Ukraine 0.250
Wages & Salaries -> Paid to people as a reward for the
3)Slovenia 0.254
work they have carried out
4)Iceland 0.256
Benefits -> Ways in which income can be received;
5)Czech Republic 0.259
pensions or tax credit
Profits -> Income that flows into businesses 6)Moldova 0.263
Dividends -> Income distributed to shareholders of 7)Slovakia 0.265
businesses 8)Kyrgyzstan 0.268
Rental Income -> Flow of income to people who own 9)Kazakhstan 0.269
and rent/lease out their property 10)Belarus 0.270
Interest -> Paid to people who hold money in interest-
paying accounts with financial institutions Economic Reasons for Income and Wealth
Inequality
Wealth
1. Employment -> Hard to find well-paid employment
Savings -> Held in multiple types of accounts with Increase in Unemployment -> Fewer people
financial institutions receiving wages, more receiving state benefits
Shares -> Ownership of shares issued by limited Fewer Full-Time Positions -> Part-time jobs rise,
companies income inequality increases since wages are
Property -> Ownership of property lower in part-time positions
Bonds -> Money held in bonds 2. Government Policy:
Pension Schemes -> Wealth held in occupational Wage Freezes -> The wage increase rate rises
pension schemes and life assurance schemes slower than inflation; seeks to reduce further
inflation
The Gini Coefficient Fall in Standard of Living -> Mostly seen in
public sector workers
Definition -> A statistical measure of the degree of 3. Taxation -> The Government may raise tax levels to
inequality of income in an economy increase public revenue, makes taxes even more
The Lower the Figure -> The more equal the regressive for lower sectors of the economy
distribution of income 4. Distribution of Wealth:
The Bigger the Figure -> The more unequal the People Who Already Hold Wealth -> Can invest,
distribution of income which creates even more wealth for them
Purpose -> Measuring income & wealth inequality 5. The existing Concentration of Wealth -> Makes
inequality a vicious cycle
2020’s Highest Gini Coefficients // Most Inequality
Policies to Redistribute Income and Wealth
Country Gini Coefficient
1)South Africa 0.630
2)Namibia 0.610
3)Botswana 0.605
4)Zambia 0.571
5)Central African Republic 0.562
6)Lesotho 0.542
7)Mozambique 0.540
8)Swaziland 0.515
9)Brazil 0.513
10)Colombia 0.508

2020’s Lowest Gini Coefficients // Least Inequality

Effect of Transfer Payments on the Market Governments -> Attempt to ensure there is no
information failure; must raise awareness of the
Transfer Payments -> Can be given in various forms of advantages of merit goods and the disadvantages of
income support to those who struggle economically. demerit goods.
Unemployment Benefit -> Money paid out to Imperfect Information -> May lead to market failure
unemployed workers Consumers & Producers -> Require perfect information
Side Effect -> May discourage workers from finding to make informed economic decisions
employment (benefits are argued to be too high) Example -> Second-hand car dealers must show the
Perverse Outcome -> Inefficient allocation of entire history of a car
resources; labour is NOT fully employed Downsides & Challenges -> It’s expensive to regulate
information provision properly
3.5. Direct Provision of Goods &
3.6. Nationalisation & Privatisation
Services
Nationalisation
State Provision of Public Goods
Advantages Disadvantages
Public & Merit Goods -> May not be provided or
Lack of Competition -> The
underprovided by the private sector. May Lower Costs -> By
Government lacks incentives to
Examples -> Education, Defense, State Provision of assuming control of an
cut costs, hinders innovation
Wealth, etc. industry
and development
Government Intervention -> Attempts to ensure Industries Run for the Lower Quality
there is an optimal level of provision of public & merit Benefit of Society -> Instead Goods/Services -> Due to lack
goods of seeking profit of competition
E.g. Street Lighting, Police and National Defence -> Private Monopoly Prevented
Provided by the State, since otherwise they would not be -> Since the Government can Reduced Pool of Options for
provided at all. assume control of an entire Consumers
industry
Redistribute Income & Wealth -> Money used to pay
for provision comes from taxation.
Reduces Inequality -> Tax revenue pays for Privatisation
goods/services the poor are not able to afford
Tradeoff -> Increased spending = less spending Definition -> Transfer of ownership, property or
elsewhere business from the Government to the Private Sector
Method -> The Government sells the ownership of the
Effects to Notice previously state-owned asset; private firms pay the State
for ownership
Reduced Role of the Private Sector -> The State has no Example -> British Airways shares were open to the
competition and is not motivated by profit. market
May Lead to Less Efficiency -> Since there is a lack
Advantages Disadvantages
of incentive to reduce production costs
1)Benefit of Society not
Solution -> The Government can pay private firms to 1)Reduction in Costs -> Due to
Ensured -> It may not be
provide goods/services the constant pressure of
addressed due to profit-
Delegate Provision to Firms -> Instead of supplying competition within the industry
seeking behaviour
them themselves 2)Higher Quality
May Result in Lower Costs -> Firms may compete to be Goods/Services -> Due to 2)Monopolies May Arise
hired by the Government competition
3)Fewer Income Streams for
Provision of Information 3)National Budget May Rise - Government Budget -> The
> Through the sale of state- State can no longer rely on an
owned industries ex-industry as a source of
revenue

Definition -> GNI taking into account the depreciation of

4. The Macroeconomy fixed capital assets due to wear and tear
Calculation -> GNI - Depreciation
Basis -> Focused in the sum of all income of the country
4.1. National Income Statistics
Market Prices
National Income
Measure -> Value in terms of actual market prices in
Definition 1 -> Total value of a country’s final output of which goods are sold in 1 year
goods/services in a year Includes -> Taxes
Definition 2 -> Total value of a country’s production of Excludes -> Subsidies
goods/services
Important Note -> Goods must not be counted twice Basic Prices
Considerations -> Must consider net property income
from abroad and depreciation Definition -> Amount producer receives from consumer
per unit of goods purchased
Net Property Income from Abroad Includes -> Subsidies
Excludes -> Taxes
Definition -> Inflow of interests Transport Costs -> Are excluded if they are invoiced
Calculation -> (Profits + Dividends from Abroad) - separately
Outflow of Money
GDP & GNP
Depreciation
Different Price Calculations -> They can be shown as
Definition -> Measures the fall in value of the capital either market prices or basic prices
stock of a country A)Market Price -> Includes Taxes, Excludes Subsidies
Loss in Value of Country’s Assets -> Housing, B)Basic Price -> Includes Subsidies, Excludes Taxes
Vehicles, Machinery, etc. Eg. GDP at Basic Prices -> GDP at Market Price - Taxes +
Purpose -> Sets the difference between gross and net Subsidies
measurements
Alias -> Capital Consumption
Eg. 1 Net Domestic Product (NDP) -> GDP - 4.2. Circular Flow of Income
Depreciation
Eg. 2 Net National Income -> GNI - Depreciation Circular Flow of Income
Definition -> Shows how money circulates in an
Measuring National Income
economy
Different Approaches -> Basis can be on the following: Between -> Households, Firms and Government
Expenditure, Income, Output Data Money -> Is provided to the FOPS for their services
“Per Capita” -> Means “Per individual in the Economy” FOPS -> Owners of the FOPS spend money on
Eg. GDP Per Capita -> GDP/population goods/services which are provided
Flow of Money Resembles a Circle
1)Gross Domestic Product (GDP) Injections & Leakages -> Affect the circulation of money

Definition -> Total value added in production of goods 1)Closed Economy

and services in a country in 1 year
Method 1 -> Value of final goods and services produced NO Foreign Trade -> Economy has no exports or
Method 2 -> Value added in the production process imports
Important Note -> Double counting must be prevented Components -> Consumption (C), Investment (I), and
Basis -> Focused on the Output Data of the Economy Government Expenditure (G)

2)Gross National Income (GNI) 2)Open Economy

Definition -> Total incomes received by a country’s Foreign Trade -> Economy has exports and imports
residents in 1 year Components -> Consumption (C), Investment (I),
Basis -> Focused in the sum of all income of the country Government Expenditure (G), and Net Exports (X)

3)Net National Income (NNI) Components of Different Economies

1. Simple Closed Economy -> Y = C + S Definition -> Money from outside the circular flow of
2. Closed Free Market Economy -> Y = C + I income
3. Closed Mixed Economy -> Y = C + I + G Main Outcome -> GDP’s value is increased
4. Open Economy -> Y = C + I + G + (X - M) Calculation -> Injections = Investment + Government
Expenditure + Exports
Circular Flow of Income in a Closed Free Market
Economy Equilibrium
Households -> Supply their labour and in return receive Definition -> Economy is neither growing nor shrinking
income J = W -> Leakages = Injections
Firms -> Make a profit on the income spent by Important Note -> Equilibrium is not the same as Full
consumers in their goods/services Employment Equilibrium
Price Level is NOT Increasing -> When resources
are fully employed
J = W Says Nothing About Employment or Inflation

Important Note 2 -> Economy can be in Equilibrium while

dealing with Unemployment or Prices Increasing

Disequilibrium
Open Economy Diagram -> Must show money from
exports entering, and money from imports leaving Definition -> Economy is either growing (J > W) or
shrinking (J < W) in size
Introduction of Government Greater Injections -> Economy is increasing in size; J >
W
Diagram -> Part of each flow would go into/come from Greater Leakages -> Economy is shrinking in size; J < W
the Government
Supply of Labour -> Would go to both Government and
Firms
Consumption -> Would go to both Government and
Firms
Goods & Services -> Some would go to households

Leakages
Definition -> Reduce the circular flow of income
Leakage -> Income is not passed onto the circular flow
of income 4.3. Aggregate Demand & Aggregate
Main Outcome -> GDP’s value is reduced Demand Analysis
Calculation -> Leakage = Savings + Taxes + Imports
Savings -> Part of household’s current income which Aggregate Demand (AD)
is not consumed
Taxes & Imports -> Money flows out to other Definition 1 -> Total amount of goods and services
economies demanded in an economy
Important Note -> Each type of leakage is opposite to Definition 2 -> Total expenditure on goods and services
one of the injections in an economy
At a given price level and period of time
Injections
Components of AD

AD = C + I + G + (X-M) Exports -> Sale of goods and services to foreign

C -> Consumption; households & consumers countries or people living abroad
I -> Investment; by firms and companies Injection -> Exports are injections since they bring
G -> Government Expenditure; consumption by the money into the country
Government Imports -> Purchase of goods and services from abroad
(X-M) -> Net Exports; the difference between total Leakage -> Imports are leakages/withdrawals since they
exports and imports take money away from the country

1)Consumption Determinants of AD
Definition -> Part of income that is spent on goods and 1. Interest Rates -> Affects Consumption
services (Households/Consumers) and Investment (Firms)
By individuals or households If Rates Fall -> Firms are more likely to invest,
Examples -> Buying a bike or going to a restaurant investment increases; Consumers can borrow
Factors of Consumption -> Influence the degree of money for a lower cost, consumption increases
consumption made by households Overall Effect -> AD Rises/Shifts to the Right
Disposable Income 2. Income & Wealth -> Affects Consumption
Saving If Consumer’s Incomes Rise -> They are likely to
Consumer Confidence spend more, consumption increases
House Prices / Wealth Overall Effect -> AD Rises/Shifts to the Right
Income Tax / VAT 3. Inflation Expectations -> Affects Consumption
Interest Rates If Inflation is Expected to Increase -> People
Cost of Living are likely to spend now, consumption increases
Overall Effect -> AD Rises/Shifts to the Right
2)Investment 4. Currency Exchange Rate -> Affects Net Exports
If Native Currency’s Value Rises -> Imports
Definition -> Spending on an asset or capital good for Increase since they become cheaper, net
future use exports fall
Usually by firms Overall Effect -> AD Falls/Shifts to the Left
This spending should generate income in the future
Examples -> Firm building a new factory or installing a Nature of the AD Curve
new computer system
Factors of Investment -> Influence the degree of Downwards Slope -> Rising price levels
investment made by firms If Inflation Rises -> Real Output Falls
Confidence A)Foreign Trade Effect -> As price level drops, exports
Animal Spirits become more attractive to foreign buyers; domestic
Interest Rates goods become more attractive
Availability of Finance B)Wealth/Real Balances Effect -> As price level drop,
Government Regulations the value of wealth rises
Economic Growth **Eg. 5000andP riceLevelF alls− > ∗∗5000 can
now purchase more goods and services
3)Government Expenditure C)Interest Rate Effect
Lower Price Levels -> Encourage savings, results in
Definition -> All Government Consumption, Investments lower interest rates
and Transfer Payments Higher Price Levels -> More money needed to
Examples -> Pay for Government employees, education purchase, borrowing rises = interest rate rises
and health services
Consequences of Rising Price Levels
4)Net Exports

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CAIE AS LEVEL ECONOMICS
Change in Real Output
1. Nominal Interest Rates Rise -> This leads to a fall in Effect in Price Representation
AD &
demand for goods/services, due to a fall in AD Curve Level in Graph Above
Component Employment
consumption AD curve
2. Purchasing Power is Reduced -> Leads to a fall in shifts
consumption and investment outwards;
3. Domestic Goods become more Expensive -> Leads equilibrium P1 →
Increase Y1 → Y2 AD1 → AD2
to a fall in exports and rise in imports; fall in net level of P2
output and
exports price both
rise
AD curve
P2 →
shifts Decrease Y2 → Y1 AD2 → AD1
P1
inwards

Aggregate Supply (AS)

Definition 1 -> Total production of goods and services in
an economy
Definition 2 -> Total value of goods and services
produced in an economy

Productivity
**
Definition -> Quantity of goods/services produced per
Shifts in the AD Curve unit of input per unit of time

Requisite -> Any change in any one of AD’s Determinants of AS

components (C, I, G, (X-M))
1. Production Costs -> If wages rise, costs rise; AS is
** likely to be reduced
2. Tech Innovations -> Increase in productivity of
labour and capital, AS increases
3. Production Taxes -> If taxation increases, costs of
production rises, AS decreases
4. Subsidies -> If subsidies increase, costs of production
decrease, AS increases
5. Quality of Labour & Capital -> Improvement in
Education, Training, etc. results in a increase in
productivity, AS Increases

1)Short-Run AS Curve (SRAS)

Definition -> Quantity of Real GDP (Output) supplied in
** an economy at different price levels
Upwards Sloping -> As general price level increases,
more will be supplied
Even Though Costs Rise -> A rise in prices will be more
than enough to cover those costs
Example -> Firms need to pay workers overtime to
produce more

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CAIE AS LEVEL ECONOMICS
**
Representation in Graph Above -> AS1 -> AS2
Fall in Output & Employment -> Y1 -> Y2
Rise in Price Level -> P1 -> P2 (Inflation)

Rise in SRAS
Representation in Graph Above -> AS2 -> AS1
Rise in Output & Employment -> Y2 -> Y1
Lower Degree of Price Increase -> P2 -> P1 (Disinflation)

2)Long-Run AS Curve (LRAS)

**
Rise in SRAS Fall in SRAS When AS Reaches Full Capacity -> All resources are
1)Decrease in Production Costs 1)Increase in Production Costs fully employed
2)Cut in Indirect Taxes 2)Increase in Indirect Taxes Long-Run -> No ability to increase output
3)Increase in Subsidies 3)Cut in Subsidies Any Increase in Demand -> Solely results in a rise in
4)Positive Supply Shocks → Eg.
prices
4)Negative Supply Shocks → Shifts to the Right -> May occur due to some of the
discovery of new raw materials,
Eg. war, explosions, natural following phenomenons: Improved Education, Increase
technological breakthroughs,
disasters, etc. in Capital Equipment, Improved Productivity
etc.
5)Improvements in Productivity A)Increase in Output
B)Fall in Unemployment
** C)Fall in Price Level
Important Note -> AS curve only shifts if productive
capacity of the economy is increased
Important Note -> The LRAS curve can be displayed in
various different ways: eg. Keynesian; due to the
different parameters economists consider essential in
the long run
**

Important Note
Price Level on Y-Axis -> Shows the Rate of Inflation
Fall in Price Level -> Fall in Inflation Rate
This is Disinflation -> NOT a fall in the actual prices;
Disinflation is not the same as Deflation
**
Fall in SRAS

Lower Degree of Price Increase -> P1 -> P2 (Disinflation)

Interaction of AS & AS in the Short Run

Equilibrium in the AD/AS Model -> Occurs when AD
** and AS intersect
Rise in LRAS Fall in LRAS Does not represent size/degree of Output or Price
1)Increase in Size of Workforce
1)Decrease in Size of Levels
Workforce (Brain Drain / Can Occur in Unstable Employment & Price Levels
(Immigration, Lower Labour
Emigration from Domestic All it Says -> That there is no increase/decrease in
Minimum Age)
Country) the Economy
2)Increase in Capital Stock 2)Destruction of Capital Assets Main Takeaways from Graph Below:
3)Negative Supply Shocks -> Eg. Shift in AD -> Output and Price Level change in same
3)Higher Quality Education war, explosions, natural
direction as the AD curve
disasters, etc.
Shift in AS -> Output changes in same direction as
4)Increase in Productivity
the AS curve; Price Level changes in opposite
Main Outcome -> More can be direction as the AS curve
produced with the same inputs
Movement along AD Curve = Shift in AS Curve
** \n Movement along AS Curve = Shift in AD Curve
**

**
**
Important Note
Shifting LRAS to the Right == Growth in PPC
Outwards

Fall in SRAS
Representation in Graph Above -> LRAS1 -> LRAS3
Fall in Output & Employment -> Y1 -> Y3
Rise in Price Level -> P1 -> P3 (Inflation)

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CAIE AS LEVEL ECONOMICS
Shift in Output &
Eg. Factor Price Level Nominal GDP -> Total value of goods/services at current
Curve Employment
Decrease in prices
A)Rise in Falls from Increases from Y1 Real GDP -> Nominal GDP adjusted to changes in
Production Costs ->
SRAS P1 -> P2 \n -> Y2
More Output inflation
B)Fall in Increase in Resource Rises from Decreases from Y1 Alias -> “GDP at Constant Prices”
SRAS Prices -> Less output P1 -> P3 -> Y3 \n Positive Inflation -> Nominal GDP is greater than Real
Greater Access to GDP
C)Rise in Credit -> Rises from Increases from Y1 Negative Inflation -> Real GDP is greater than Nominal
AD Consumption P1 -> P3 -> Y2 GDP
Increases \n GDP Deflator -> Transforms from Nominal to Real GDP
Government Purpose -> Measures price changes from a base year
D)Fall in Falls from Decreases from Y1
Expenditure
AD P1 -> P2 -> Y3 Constant Prices -> Will be indicated; eg. “2018 = 100” or
Decreases
“at 2018 prices”

4.4. Economic Growth Causes of Economic Growth

Meaning of Economic Growth Either Shifting the AD or AS Curves -> OUTWARDS

Definition -> Increase in production potential or real 1)Shifters of AD to the Right

level of output of an Economy
Real v/s Potential Growth -> Possible to distinguish Government Expenditure -> Higher G
between both of them Investment in Infrastructure -> Eg. Roads, Rail and
Real Economic Growth -> Only occurs when growth is Power Supplies
greater than increase in inflation Improved Transport -> Allows goods and people to
Calculation -> Either in terms of GDP or GNP flow more freely
Most Popular Measure -> Real GDP Main Outcome -> Productivity increases
Tax Cuts -> Higher C + I
Measurement of Economic Growth More Disposable Income -> Allows individuals to
spend more, firms can invest more
Different Methods -> Either in GDP or GNP Depreciation of Currency -> Higher (X-M), due to
Economic Growth -> Percentage rate of increase in Real exports becoming more attractive & imports more
GDP, assuming the effects of inflation expensive
Comparison -> Economic Growth is used for Lower Interest Rates -> Higher C + I, due to the cost of
comparison; eg. Either the same economy over time or borrowing money being lower
between different countries Higher Real Wages -> Higher C
GDP Per Capita -> Most popular measure for Financial Stability -> Individuals feel confident
comparison, although it’s a simplistic method (does not enough to spend more on goods and services
reflect the realities of the entire population)
Different Population Sizes → Must be taken into 2)Shifters of AS to the Right
account when comparing countries/periods of time
with GDP Per Capita.

Real v/s Nominal GDP

Main Outcome of Prompts Below -> Greater Labour Resources -> Should be both used and conserved for
Productivity future use
Increased Investment Demand for Resources -> Should be greater than
Spending on Capital Goods -> Eg. Equipment and the potential supply
Machinery Lack of Preservation Measures -> Resources would
Likely to Increase Output & Quality -> Leads to eventually perish and no longer exist
greater sales Governments → Manage growth while simultaneously
Improved Technology preserving resources
More can be Produced -> With the same quantity of
capital 4.5. Unemployment
Improved Education & Training -> Affects quality and
quantity of goods and services Meaning of Unemployment
Main Outcome -> More literate and skilled
workforce Definition -> People of working age who actively seek
Increase in Workforce work, at current wage rate that are unable to do so
Main Factors -> Immigration or lower Minimum Important Note -> Considers individuals who are
Labour Age Laws willing and able to work, does not consider inactive
Discovery/Development of Natural Resources -> individuals
Stimulates growth in countries Inactive Individuals -> Pensioners, full-time
Examples -> Oil for Saudi Arabia, Copper for Zambia students, children-keepers (housewifes)
Consequences of Economic Growth Measurement of Unemployment
Analysis Parameters -> Human lives, Culture, Unemployment Rate -> Percentage of the working
Environment population who are unemployed
Calculation -> (Unemployed) / (Working Pop) * 100
Benefits Costs
Various Different Methods -> Depend by country
1)Environmental Damage ->
1)Rise in Standard Living ->
Pollution worsens,
Reduction of poverty, more
terraforming detriments the Labour Force Survey v/s Claimant Count
consumer goods
landscape, global warming, etc.
2)Opportunity Cost -> Country
Labour Survey -> Survey of a sample of households,
at maximum efficiency leads to unemployed are those seeking jobs without having one
2)Improved Health and Purpose -> Used for international comparisons
the need to decide between
Education -> Literacy rates
capital or consumer goods; Weaknesses -> Sampling errors, make the
rise, Infant & Death Rates fall
opportunity costs and tradeoffs calculation not fully accurate
become more eminent Claimant Count -> Unemployed are those claiming
3)Increase in Tax Revenue -> unemployment benefits; those not eligible or registered
More budget for infrastructure are not included
3)Unequal Benefits -> Change
and benefits for the poor;
in mechanisms, people will Sampling -> Proportion of population is used as
Important Note -> Higher
need to readapt to such abrupt representative of the whole
budget is the result of higher
changes
incomes and profits, not from
higher Taxation Unemployment Measurement Issues
4)Increase in Business & 4)Lower Quality of Life ->
Consumer Confidence -> A Overcrowding in populated
Positive view of the Economy areas, inferior air quality, etc.;
leads to investing; consumers Opportunity Cost -> More
are more willing to spend income, but poorer life quality

Suitable Economic Growth

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CAIE AS LEVEL ECONOMICS
Issue Explanation Type of Unemployment Explanation
Individuals that would work if Unemployment that arises
their current situation due to the trade cycle,
1)Inactive Workers
changed; eg. Parents with occurring during the downside
young children of the economy (Recession);
1)Cyclical // Demand
Individuals that are willing and Classic Keynesian
Deficient // General
2)Discouraged Workers able to work, but gave up due Unemployment -> Suggests
to not having found a job that Unemployment originates
Considered as employed, but from a lack of AD in the
3)Part-time Workers Economy as a whole
in reality are semi-employed
Individuals that register as Unemployment that can not
4)Unreported Legal be removed; considers
unemployed to collect State
Employment individuals who are
benefits 2)Frictional
transitioning for one job to
Individuals that register as another, that have not yet
5)Unreported Illegal unemployed, since they are started their new job
Employment involved in illegal practices like
drugs or prostitution Occurs in Specific Industries -
> Demand for workers
3)Seasonal depends on the time of the
Causes of Unemployment year; Examples -> Agriculture,
Construction, Tourism, etc.
1. Classical View -> Argues that unemployment occurs Unemployment that is the
due to the trade or business cycle result of a permanent fall in
Business Cycle -> The market is capable of fixing demand for products of an
it industry; might occur because
Monetarists -> Niche within classical view; argue an industry is running out of
that external interference produces 4)Structural resources or is losing its
comparative advantage;
disequilibrium (AS != AD) Main Association -> Labour-
Example of Interferences -> Minimum wage intensive firms moving to low-
laws, sindicates, corporate tax, cost countries, due to rising
unemployment benefits, etc. labour costs
2. Keynesian View -> Argues that unemployment Type of Structural
occurs due to the cyclical nature of unemployment Unemployment; workforce is
5)Technological
and lack of AD for goods/services laid off because technology
Proposed Solution -> Government Intervention replaces labour
to increase demand
Consequences of Unemployment
1. Opportunity Cost -> Resources are wasted (not used
efficiently); loss in the potential output of the
economy
2. NAIRU -> Specific level of Unemployment in an
Economy; does not increase inflation
3. Hysteresis Effect -> Tendency for Unemployment to
lead to longer-term Unemployment

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CAIE AS LEVEL ECONOMICS
** Economic Consequences Social Consequences
1)Labour Resources Wasted -
1)Health -> Loss of income
> Output is below potential,
makes it harder to provide
investments in education &
medical care, mental health
training is not capitalized
issues, and suicides
(used)
2)Education -> Children give
up their education so as to
2)Fall in Standard of Living ->
save money and get
Less income = less
introduced into the
consumption
workforce earlier so as bring
income
3)Lower AD -> Less
3)Family -> Pressure and
consumption due to
** stress may cause divorces and
employment uncertainty,
family breakups due to
which leads to firms laying off
homelessness, higher crime
workers, a vicious cycle, and a
rates, etc.
deflationary gap
4)Rise in NAIRU ->
Unemployed workers believe
their skills are outdated, lose
N/A
confidence in their skills, and
become afraid to work, a
hysteresis effect
5)More Expenditure on
Benefits -> Costs of taxpayers
rise in order to fund bigger N/A
revenue expenditure; national
budget deficit
6)Regional Problems -> Often
concentrated in specific areas;
younger individuals move
away to more attractive
regional locations, which N/A
depresses the region even
more; Main Outcomes ->
Older population, lack of
innovation & labour, etc.
7)Income Inequality Widens ->
Since more laid-off workers N/A
go into relative poverty

4.6. Price Stability

Inflation

Definition -> Fall in the value of money, as general price Definition -> Measure of the weighted average prices of
level rises a basket of goods & services purchased by households
Alias -> Low Stable Inflation Base Year -> Year chosen as the point of reference for a
Good for the Economy -> Eg. Federal Bank (US) aims price comparison between other years
for 2.0% inflation rate Weightings -> Values given to items in an index, to show
Rate > 0 -> Rate at which general level of prices rises their relative importance
over time, in annual rate Items have Different Weighting Values -> Eg.
Cost of Living Increases -> Since it becomes more Change in food price has more effect on household
expensive to consume the same goods & services expenditure than a change in a cinema ticket
Calculation -> (Index for Year 2) / (Index for Year 1) * 100
Hyperinflation Household Expenditure -> Total expenditure by
consumers that reside in a country (home or abroad)
Definition -> Period of rapid and out of control increases Minus // Excludes -> Expenditure by visitors on goods &
in the general price level services
In Practice -> Inflation rises at a rapid rate
Great Example -> Germany in the 1920s Development of the CPI
Deflation Stage Explanation
The base year is given a value
Definition -> General price level falls, the value of money 1)Base Year is Determined
of 100 basis points
rises Items must be the ones
Rate is Smaller than 0 -> Inflation is negative 2)Items for the Basket of
bought by an average family;
Goods are Selected
Purchasing Power Rises-> Consumers can afford more eg. bread, electricity, etc.
goods & services for the same amount of money 3)Each Item is Given a
Weighting shows the relative
Consumption May Fall -> Consumers may wait for even importance of the item within
Weighting
lower prices, assuming that deflation will accentuate the average family budget
further For each item in the basket,
Firms Sense Products Aren’t Selling -> 4)New Price Levels are general price levels are
Sourced Across Country determined by registering
Unemployment rises, deflationary gap prices across the nation
Each item’s price is
Disinflation multiplied by its weighting;
5)Weighted Price Relative is this determines the
Definition -> Slowing rate of inflation, general price level Calculated importance of the calculation
rises at a slower rate within the broader
Purchasing Power -> Starts falling at a slower rate development of the CPI
Associated With -> Periods of low inflation, eg. Many 6)Sum of Weighted Price The output of this calculation
countries in 2018-2020 Relatives is Divided by the gives the change in the Price
Sum of Weights (Items) Index
Consumer Price Index (CPI)
Difficulties in the CPI Measurement

1. Base Year -> Must not have unusual flucuations in Definition -> Occurs when total AD exceeds total AS
price, since it may mislead the calculations Usually Occurs -> Near Full Employment Level
2. Basket May not be Representative -> Different Scarcity -> Resources become unable to supply
groups have different basket of goods they consider sufficient goods to meet the rising AD
“essential” Price Level is Forced Upwards -> This brings AS and AD
3. Outdated Basket Representation -> Goods & back into equilibrium
services may not represent expenditure patterns in
actuality 2)Cost-Push Inflation
Eg. Cellphones -> Nowadays cellphones have
replaced multiple other goods that were Definition -> Occurs when the cost of supplying goods &
considered essential, such as mail services, services is increased, which rises the cost of final prices
telephones and even computers Different Causes -> The following 3 causes end up
4. Change in Quality/Type of Good -> Eg. Phones have raising the costs of production
much more features than 10 years ago 1. Rise in Raw Materials’ Cost -> Eg. Oil, as it
5. Importance of Goods & Services May Change -> becomes scarcer, its price rises significantly
Weights will need to be readjusted accordingly 2. Powerful Trade Unions -> Worker Associations
6. Different Measures -> RPI & CPI may exploit firms by pushing up wages in excess
of actual productivity gains; raises production
Nominal v/s Real Data costs
3. Monopolies -> May raise prices indefinitely since
Nominal Data -> Figues are expressed in current prices there is a lack of competition
Aliases -> Money Data, Money Values Producers may Justify Hike in Prices -> By
Eg. Money Wages -> Show the money people get, saying they had to rise wages demanded by
not what that amount can actually buy trade unions
Real Data -> Figures are adjusted for the change in the Wage-Price Spiral -> Rising wages = rising
value of money (inflation) prices = higher wage demands; vicious cycle
Eg. Real Wages -> Show what that money can
actually buy Monetarists
Example -> If inflation rose 5% and wages rose 6%,
real wages just rose 1% Alternative View Upon Inflation -> They argue the only
cause of inflation is the excess in money supply,
Calculation -> Real Data = Wage Rise % - Inflation Rise % assuming the velocity of money
Quantum Theory of Money -> Gives a strong basis for
Causes of Inflation monetarism
Main Argument -> They defend that both Demand-Pull
2 Main Causes of Inflation -> A)Demand-Pull Inflation & & Cost-Push Inflation are solely a result of excess money
B)Cost-Push Inflation supply
A)Demand-Pull Inflation -> Increase in the total AD If Money Supply Hike is Greater than Real Output ->
pulls up the general price level Excess money is “soaked up” by a raise in the general
B)Cost-Push Inflation -> Rise in production costs pushes price level (inflation)
up the general price level
Key Tip -> If question asks to discuss something is the Consequences of Inflation
only cause, you must mention other causes to reach a
conclusion History of Inflation -> It is completely normal for
inflation to occur
1)Demand-Pull Inflation When it Becomes an Issue -> When inflation reaches
very high levels

5. Government Must be Sustainable -> Does

not exhaust natural resources

Macroeconomic Intervention or cause too much pollution;

Increase in Living Standards;
1)Economic Growth High Growth Rates -> May be
very good for developing
5.1. Government Policy Objectives countries; No Excessive
Structural/Environmental
Economic Policy Difficulties
Lack of Rapid
Definition -> Attempt made by the Government to Inflation/Deflation; Does NOT
Mean 0% -> Governments
generate increases in economic welfare
target steady levels of low-
After the Great Depression -> Recognition that the moderate inflation; High Rates
Government & Monetary Authorities are responsible to 2)Price Stability
Must be Prevented -> Since it
advocate for economic welfare results in the following:
Methods -> Controlling Inflation, Unemployment and reluctant investors, menu costs,
Economic Growth concerns those on fixed
2 Main Types of Policies -> 1)Demand-Side Policies & incomes
2)Supply-Side Policies Target -> 0% Cyclical
Employment; Natural Rate of
Demand-side Policies 3)Full Employment -> Those Unemployment -> Some
willing and able to have a job seasonal, frictional and
can get one structural unemployment are
Definition -> Economic policies that influence the level acceptable & inevitable in the
of Aggregate Demand economy
2 Main Types -> Fiscal Policy & Monetary Policy In the Long-Run -> Value of
Exports = Value of Imports**; In
Supply-side Policies 4)Equilibrium in the Balance Any Given Year ->** Country
of Payments may run a deficit/surplus; not
Definition -> Economic policies that influence the level an issue unless it persists in
of Aggregate Supply the long run
Fair Distribution -> Subjective,
Macroeconomic Objectives 5)Income & Wealth
not a matter of simply deciding
on a fixed number; If Small
Inequality -> Addresses the
Group has Very Large
distribution of income/wealth
Proportion -> Could lead to
of a nation
social unrest and dissatisfaction
with the Government

5.2. Fiscal Policy

Government Budget

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CAIE AS LEVEL ECONOMICS
Reason Explanation
Definition -> Annual financial statement showing the 1)Raise Revenue for Taxation is used along other
estimates of expected revenue and spending during a Government Spending methods simultaneously
fiscal year Taxation is one of various
Budget Deficit -> Government Spending is greater than 2)Manage Aggregate methods to meet the
Tax Revenue Demand Government’s economic
Cyclical Deficit -> Due to slowdown/recession in the objectives
Economy Income tax’s aim is to take
3)Alter Distribution of
Structural Deficit -> Consistently spending more money from the better off and
Income & Wealth
than tax revenue; fiscally irresponsible Government give it to the poorer
Budget Surplus -> Government Spending is smaller Taxation is one way in which
4)Manage Market Failure or
than Tax Revenue market failures can be
Environmental Issues
reduced/minimised
National Debt
Main Types of Taxes
Definition -> Amount of money Government owes both
domestically and abroad, which has accumulated over Type of
Definition Examples
the years Tax
In Other Words -> The accumulation of a nation’s Tax levied directly on
Income Tax, Corporation
Direct Tax incomes & wealth,
budget deficit over time Tax, Inheritance Tax, etc
individuals or firms
Government ends up Needing to Raise Extra Finance
Levied when goods & Value Added Tax (VAT),
-> Printing more money, or by borrowing even more Indirect
services are bought, Goods & Services Tax
money Tax
taxes on expenditure (GST)
Printing Money -> Reduces its actual value in the
greater scheme/term, leading to inflation Excise Duty // Specific Tax -> Amount charged, Ad
Further Borrowing -> Either short or long term, and Valorem Tax = % Rate of the Basket
domestic or foreign sources
Main Takeaway -> Either method increases the 1)Progressive Tax
National Debt
Main Issue -> When large proportion is owed abroad, or Definition -> Proportion of income paid in tax increases
it looks as if it can’t be paid as income increases
Domestic Debt -> Paid back to those with government Marginal Rate of Tax Increases
bills through tax revenue Great Eg. -> Income Tax; richer people spend a greater
National Debt is NOT the Same -> National debt is proportion of their income in income taxes
internal, while BOP is external
2)Regressive Tax
Automatic Stabilisers
Definition -> Proportion of income paid in tax falls as
Definition -> Mechanisms built into Government’s income increases
Budgets in order to stimulate AD when economy Marginal Rate of Tax Decreases
requires a boost Great Eg. -> IVA, VAT, GST; poorer people spend a
When AD’s Situation Improves -> These stabilisers greater proportion of their income in consumption taxes
automatically turn off
Recession -> Ease financial stress by decreasing tax bills, 3)Proportional Tax
or giving away State benefits
Without changes in the tax code or legislation Definition -> Same proportion of income is paid in tax,
Limit the Impact of Changes in the Economic Cycle -> independent of the level of income
Recession, Expansion Marginal Rate of Tax = Average Rate of Tax
Average Rate of Tax -> Average percentage of total
Reasons for Taxation income that is paid in taxes
Great Eg. -> Corporation Tax

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CAIE AS LEVEL ECONOMICS
** Reason Explanation
Public goods (eg. Defence),
1)Supply Goods & Services
Merit goods (eg. hospitals), and
that Private Sector Would
Transfer Payments (eg.
Fail to Do
Benefits)
2)Achieve Supply-Side
Spending on Education =
Improvements in
Labour Productivity
Macroeconomy
3)Reduce Negative
Eg. Pollution
Externalities Effects
**
4)Subsidise Industries in
Eg. Agriculture
Need of Financial Support
Rates of Tax 5)Redistribute Income Thus achieve more equity
A)Average Rate of Tax 6)Inject Extra Spending into Help increase Aggregate
Macroeconomy Demand and Economic Activity
Alias -> “Effective Rate of Tax” ; “Average Propensity
to Pay Tax”
Calculation -> ART = (Total Tax Due) / (Total Taxable Types of Fiscal Policies
Income)
Definition -> Use of Government Revenue and
B)Marginal Rate of Tax
expenditure to control the economy, including
Alias -> “Proportion of Increase in Income which is
Government borrowing
Taken in Tax”
Purpose -> Influence the level of AD within the economy
Calculation -> MRT = (Change in Tax Due) / (Total
Taxable Income) Fall in Tax -> AD rises since consumers can spend more
+ firms have more disposable (net) revenue to invest into
MRT is Greater Than ART as Income Increases -> In
business
progressive tax systems
Government Expenditure -> Defence, Social Services,
Government Spending Infrastructure and Education
Financed through Taxes
A)Capital Expenditure Important Note -> Fiscal Policies may be used as a
Definition -> Spending by the Government on goods means of Supply-Side measures
& services intended to create future benefits Discretionary Policy -> Actions taken in response of
Alias -> Government Investment; Gross Capital economic events
Formation Extreme Measures -> In order to offset the complex
Infrastructure -> Roads, buildings, etc. economic scenario
Health & Education -> New hospitals, Schools or
Sewage Systems
Research/Innovation -> Defence, Space or
Vaccinations
B)Current Expenditure
Definition -> Government Consumption spending on
goods & services for current use to directly satisfy the
needs of members of the community
Examples -> Wages of Public Sector’s Workforce, Road
Maintenance, etc.

Reasons for Government Spending

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CAIE AS LEVEL ECONOMICS
Expansionary // Contractionary //
Feature Being
Assessed
Reflationary Fiscal
Policy
Deflationary Fiscal
Policy
5.3. Monetary Policy
Use of fiscal policy to Use of fiscal policy to
enable the economy reduce the size of the Monetary Policy
Definition
to grow, increase the economy, decrease in
level of AD the level of AD Definition -> Central Bank’s use of interest rates, money
Cut in Taxes, Rise in Taxes, supply and exchange rates to control the economy
Increase in Decrease in Type of Demand-Side Policy
Government Government Instruments // Methods
Methods
Spending; Main Spending; Main 1. Controlling Interest Rates
Outcome -> C rises, I Outcome -> C falls, I 2. Targeting the Money Supply
rises, G rises falls, G falls 3. Maintaining the Exchange Rate
Unemployment Falls Rises Central Bank
Rises, since Price Fall, since Price Level Definition -> Public institution that manages the
Inflation
Level increases decreases currency of a country (or countries), controls the
Balance of money supply and monetary policy
Possible Deficit N/A
Payments
Purpose -> Price Stability; some are required to enhance
Results in Surplus, as full employment
Results in Deficit
National Budget Government Revenue
Generally
is increased
1)Interest Rates
AD/AS Analysis of the Impact of Fiscal Policy Definition -> Cost of borrowing money, and reward on
lending/saving money
Interest Rate Policy -> Use of interest rates to influence
AD, through consumers and businesses
Other Banks -> Set their rates according the Central
Bank’s base rate
Purpose -> Ensure targeted inflation rate and
liquidity in the economy

Type of Spending
Interest Cost of
Interest Rate Savings v/s
Rates Borrowing
Policy Saving
Lower
Lower,
Rates;
hence Discouraged, Spending
Main
people can since reward greater
Expansionary Outcome:
borrow for saving is than
C rises, I
more lower Saving
rises, AD
money
rises
Higher
Rates; Higher, Spending
Encouraged,
Main hence is
since reward
Contractionary Outcome: people smaller
for saving is
C falls, I borrow than
higher
falls, AD less money Saving
falls

2)Money Supply

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CAIE AS LEVEL ECONOMICS
Type of Monetary Effect on AD
Definition -> Total amount of money circulating in an Net Exports
Policy Exchange Rates Curve
economy at a given time Fall, exports
Considers: Coins, Notes, Deposits, Current Accounts, Appreciation of become less
Contractionary Falls
etc. Currency competitive
Controlling Supply -> Very complex, hence this method abroad
has been mostly replaced by managing interest rates; yet Rise, exports
Depreciation of
it’s still relevant and applicable Expansionary become cheaper Rises
Currency
Quantitative Easing -> Central Bank prints money to abroad
buy paper assets in order to increase money supply
AD/AS Analytics of the Impact of Fiscal Policy
Effect on
Money Interest Consumption & AD
Money
to Lend Rates Investment Curve
Supply
Falls, since
Increased More
the value of
Money money to Both rise Rises
lending is
Supply lend
lesser
Rises, since
Decreased Less
the value of
Money money to Both fall Falls
lending is
Supply lend
greater

Credit Regulations
Definition -> Use of qualitative control measures by the
Central Bank to regulate the consumer credit on certain
products
Certain Products -> Mainly the ones affected by
inflation or deflation
Inflation -> Central Bank aims to make borrowing and
spending harder
Main Outcome -> Price Level Falls = Stability
Deflation -> Central Bank aims to make borrowing and
spending easier
Main Outcome -> Price Level Rises = Stability

3)Exchange Rates
Definition -> Cost of domestic currency in relation to
other currencies
Higher Interest Rates -> Domestic currency
appreciates in value
AD Falls -> Net Exports fall, since exports become
more expensive abroad and imports become
cheaper
Attracts Foreign Depositors -> Increases the demand
for the domestic currency (hot money flows)

Purpose -> Improving productivity and productive

5.4. Supply-Side Policy capacity of the economy
Microeconomic Measures -> That influence the
Supply-Side Policy Macroeconomy
Productivity -> Quantity of goods & services produced
Definition -> Policy that helps to improve a country’s
per unit of input
productive potential of the economy Increasing Productivity -> Real output can rise
Purpose -> Shift the Long-Run Aggregate Supply Curve without an increase in the price level
(LRAS) to the right Productive Capacity Increase -> Potential output of the
Method -> Increasing the quantity or quality of the FOPS economy has increased
**
Shifting LRAS Outwards = PPC Outwards -> Supply-
side policies’ effect can be shown in either PPCs or
LRAS graphs
**

** **
Effects on Macroeconomy
1. Economic Growth -> Real GDP rises Tools of Supply-Side Policy
2. Unemployment -> Falls
3. Price Level -> Falls 1. Labour Market Measures
Important Note -> There is a notable time-lag in the 2. Product-Market Measures
effect of Supply-Side policies on LRAS
1)Labour Market Measures
Objectives of Supply-Side Policy
Definition -> Policies that involve increasing
Government intervention in the development of the
FOPS
Alias -> Interventionist Supply-Side Policy
A)Pressuring Trade Unions -> Enhance working of the
labour market
B)Education & Training -> Improves worker’s human
capital, productivity improves
C)Tax and Benefits -> Lower tax rates encourage people
to work, so does lowering unemployment benefits
Lower Corporate Tax -> Encourages firms to try and
be more efficient, since they can keep more of their
profits

2)Product-Market Measures

Definition -> Policies that involve decreasing Determinants of the Outcome of Supply-Side Policy
Government intervention or involvement in markets 1. Shape of the AS Curve
Alias -> Market-led Supply-Side Policy 2. Whether other Policies are Considered
A)Privatisation & Deregulation -> Introduce 3. If AD is also Changing
competition into market, thus improving efficiency and **
productivity
B)Investment in Technology -> Productivity and
Efficiency would improve
Financing -> Done through grants or through the tax
system
Main Outcome -> Encourages a more
entrepreneurial culture
C)Reduction in Red Tape -> Allows businesses to
establish themselves, or to make changes

Shifting the PPC Outwards

Main Factors
Immigration **
Deregulation Eg. Better Education
Labour Market Participation AS Curve Rises -> AS -> AS1
Innovation Equilibrium National Income -> Rises
Investment Real GDP Rises -> Y -> Y1
Productivity Gains Unemployment Falls -> Y -> Y1
Education Price Level Falls -> P -> P1
**
Interaction Between Changes in AS & AS

AD/AS Analysis of the Impact of Supply-Side

Policy

** A)Absolute Advantage -> Ability to produce more of a

product than another country, with the same amount of
resources
B)Comparative Advantage -> Ability to produce a
product at a lower opportunity cost than another
country (in comparison)
International Trade -> Makes it possible for all
countries to benefit from other countries’ comparative
advantages
Even when one of the countries is more efficient at
producing all products

Benefits of Specialization // Free Trade

**
Original Equilibrium -> PY, AD = AS Example Scenario) Japan v/s Sweden
If AD Rises to AD1 -> NNI, Real GDP and Employment all Main Assumption -> Assume that only one person is
rise to Y1; Price Level rises to P1 available, and shares its time equally between cars and
AS Rises to AS 1 Simultaneously -> This further toys
reinforces the rise in output Cars Toys
Price Level -> Returns back to P (original stability)
Sweden 2 8
Evaluating Supply-Side Policy Japan 8 2

Interventionist Policies -> May increase aggregate Analysis

demand, due to an increase in Government Expenditure
Other Policies -> May have harmful effects on Terms of Trade -> 1:4 (Sweden) and 4:1 (Japan)
consumers, workers and the environment Sweden -> AA in toys
Environmental Deregulation -> Leads to negative Japan -> AA in cars
externalities to society To Increase Total Output -> Both countries should
Supply-Side Policies -> Usually effective at shifting LRAS specialise in their AA good
Main Downside -> They may take years in order to
show their results After Specialization
Cars Toys
6. International Economic Sweden 0 16
Japan 16 0
Issues
Both Countries can Trade -> As long as they stay within
their terms of trade (1:4, 4:1)
6.1. Terms of Trade Possible Exchange Rate -> 1:1
Sweden -> Gives up 6 toys
Absolute v/s Comparative Advantage Japan -> Gives up 6 cars

After Free Trade

Cars Toys
Sweden 6 10
Japan 10 6

Overall Benefit
Sweden -> Gained 2 toys, 4 cars
Japan -> Gained 4 toys, 2 cars
Main Outcome of Specialisation + Free Trade -> Both
countries have more from each good than previously

Terms of Trade

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CAIE AS LEVEL ECONOMICS
Cause Explanation
Definition -> Ratio of a country’s export prices to import Expansion of world trade in
prices goods & services + capital flow,
Exports -> Sale of goods & services abroad 1)Globalisation
leading to international
Imports -> Purchase of goods & services from abroad interdependence
Calculation -> Terms of Trade = (Index of Export Prices) / Increased demand for raw
(Index of Import Prices) * 100 materials may push up prices,
Rise in Index = Improvement in the Terms of 2)Economic Development improving the terms of trade of
Trade -> More imports can be purchased with the primarily exporting countries
(eg. Canada or South Africa)
given amount of exports
Fall in Index = Deterioration in the Terms of Trade If Inelasticity of Exports is
greater than Imports’ -> Terms
-> Less imports can be purchased with the given 3)Price Elasticity of Demand of trade will improve, since
amount of exports export prices can be increased
further than import prices
Free Trade Benefits Import Demand Increases ->
Terms of trade worsen; Supply
1)Lower Overall Price of Import Substitutes
2)Greater Choice of Goods for Consumers 4)Economic Development Increases -> Terms of trade
3)Firms benefit from Economies of Scale improve; More Goods for
Exports -> Terms of trade
4)Increased Exports
improve
5)Specialisation -> Countries gain an increase in economic
Depreciation or Devaluation -
welfare > Terms of trade worsen; export
5)Exchange Rate prices have fallen, import prices
Causes of Changes in Terms of Trade have risen (relative to the
domestic currency)
Eg. Tariffs -> When these
measures are taken, import
6)Protectionist Measures prices are likely to fall, overall
improvement in the terms of
trade
More Goods are Demanded ->
Therefore import demand rises,
7)Population Growth
overall worsening in the terms
of trade
Monopoly in a Good’s
Production -> It can raise the
8)Competition good’s national price, overall
improvement in the terms of
trade
**Competition Rises ->**Either
lowers the prices of country’s
exports, or improves other
country’s export availability \n
9)Globalisation
**Exporting Countries -
>**Terms of Trade Worsen \n
Importing Countries -> Terms
of Trade Improve

Impact of Changes in Terms of Trade

Main Factor -> Depends on the PED of imports and Definition -> Tax/Duty on a particular product as it is
exports being imported
Either Specific or Ad Valorem
Effect Explanation Purpose -> Shift good’s supply curve to the left
If Terms of Trade Improve, but Main Outcome -> Import’s Competitiveness falls,
both PEDs are Elastic -> Overall Price rises, Quantity Demanded Falls
worsening of trade balance +
Extent of Fall in Qd -> Depends on the Import’s PED
possible unemployment, since
total export income falls and Domestic Industry -> Sees its competitiveness
1)Trade Balance total import spending rises** \n increased, hence its own production sales rise
**If Terms of Trade Improve, but Main Drawback -> Consumer welfare is reduced
both PEDs are Inelastic -> Overall **
improvement of trade balance,
since total export income rises
and total import spending falls
Usually Dependent on Raw
Material Exports ->Fall in their
export prices significantly
deteriorate their terms of
trade; ** \n Standard of Living
Falls -> Earn less from same
2)Developing Countries
volume of exports, cannot
afford to import as much \n
**Important Note -> The **
opposite holds true; improvement
in terms of trade is likely to 2)Import Quota
improve its standards of living
If Terms of Trade Improve -> Definition -> Legal limit on the quantity of the good that
Export prices increase more than can be imported to a country
import prices; fall in
competitiveness and export Eg. USA -> Quota on sugar imports
demand; damages the BOP** \n Licences -> Are given to firms allowing them to import
3)Price Competitiveness up to a set limit
Export PED -> Determines how
much export demand falls \n **If Consumer Welfare Loss -> Greater loss than tariffs,
Terms of Trade Worsen -> Rise in since no tax revenue is generated
competitiveness and export **
demand; benefits the BOP

6.2. Protectionism
Protectionism
Definition -> Action designed to reduce international
trade
Main Reason -> Countries fear that without trade
barriers, domestic industries may not be able to
compete with foreign imports **
Opposite -> Free Trade
3)Export Subsidy
1)Tariff

Definition -> Money given to an exporter, so that the Definition -> Industry expected to have a comparative
price of a good can be reduced, thus more competitive advantage, yet small and unable to compete with foreign
internationally established industries at the moment
Increases Sales -> Output and Employment Increase Protectionism -> Enables infant industry to establish its
Drawback -> May increase inefficient allocation of comparative advantage and compete in its own right
resources Short Run -> Higher Prices
Government -> Could have used the money to focus Long Run -> Lower Prices in the Future
on goods with potential comparative advantage Issues -> Accurately identifying infant/sunrise industries
Main Effect -> Long-term economic growth may be is uncertain and subjective, and deciding when they are
reduced able to compete without protection gives rise to
discussion
4)Embargoes Diversification -> High dependence in production of
single good (1ry material) leads to instability
Definition -> Complete ban on products from a Protectionism Allows Development of New
particular country Industries -> This reduces monoproduct
Political Reasons -> Embargoes are usually the result of dependence (especially of developing countries)
disputes between nations or during times of war Developing Countries -> Embrace this argument to
Placed on Dangerous/Harmful Products -> Eg. Drugs justify their trade barriers
Longest Standing Embargo -> USA on foreign trade with Sunrise Industry -> New industries rapidly growing that
Cuba are believed to have potential to be a market leader in
the future
5)Excessive Administrative Burdens // Red Tape Important Note -> The same arguments from Infant
Industries apply to Sunrise Industries
Definition -> Excessive “red tape” imposed on importers,
in order to make importing more difficult 2)Unfair Competition
Purpose -> Limit the quantity of imports of particular
products into a country Countries May Have Vast Supplies of Low Cost
Types of Red Tape -> Establishing Health/Production Labour -> Eg. China and India can sell at prices with
Standards, Detailed Documentation, Scarce Set Entry industrial countries can not compete with
Points, Multiple Procedures and Tedious Documentation Compelling Argument for Protectionism -> If
Processes exploitation of labour can be proved
Main Outcome -> Benefits domestic producers but Not Justifiable -> Comparative Advantage theory
consumer welfare is reduced (due to sharper scarcity of explains how countries benefit when opportunity costs
imported available options) differ
Industrial Nation’s Should NOT Attempt to
Arguments for v/s Against Protectionism Compete -> Rather, they should specialise in
products they do have CA on
1)Infant Industry Retaliation -> Country employs restrictions on trade in
2)Unfair Competition order to retaliate against other country’s protectionist
3)Unemployment measures
4)Sunset Industries Not Justifiable -> As retaliation usually leads to a
5)Dumping significant fall in world trade and welfare globally

1)Infant Industry 3)Unemployment

Protecting Home Industries -> Increases Definition -> Record of transactions in terms of trade in
competitiveness of national industries, preserving the goods, services and primary & secondary income
employment in the country Trade in Goods -> Export and import of goods
Argument Used Alongside Infant/Sunrise Industry Alias -> Visible Trade
Arguments Trade in Services -> Export and import of services
Major Flaw -> One must realise why home industries Alias -> Invisible Trade
couldn’t compete in the 1st place Primary Income -> Income from interest, profits,
Higher Costs than Overseas = Lack of Comparative dividends from foreign investment + payments from
Advantage -> This means nation should instead people living overseas
compete in markets where they do have CA Secondary Income -> Transfer of money that is not an
Other Methods for Solving Unemployment -> investment, without receiving anything in return, Eg.
Monetary, Fiscal and Supply-Side Policies Donations, overseas aid, military grants, etc.
Surplus -> Payments received greater than payments
4)Sunset Industries made by the country
Deficit -> Payments received smaller than payments
Definition -> Industries that have lost their comparative made by country
advantage; usually industries that established Balance of Trade -> Visible + Invisible Balance
themselves long ago and that demonstrate a decline in
productivity and fruition Calculating the Balance of the Current Account
FOPS are Immobile -> This supposedly justifies that
sunset industries can not shift to expanding industries Balance of the CA -> Difference between money flowing
(thus why protectionism could theoretically be justified) in and money flowing out
Temporary Protection -> Justified, to enable FOPS to Components -> Trade in goods & services and 1ry
migrate + prevent structural unemployment and 2ry income
Long-Term Protection -> Not justified, since it sharpens Imbalance in the CA -> Either a deficit (negative figure)
inefficiency + reduces consumer welfare or a surplus (positive figure)
Example -> Trade in Goods = 373,149 credits + 504,029
5)Dumping debits = -130,880 deficit imbalance of trade in goods
Balance of Trade in Goods & Services -> Trade in
Definition -> Sale of good in foreign market at a price Goods Balance + Trade in Services balance
below its marginal cost of production
Sold Below the Marginal Price -> Sold at a price that UK Current Account Balance of Payments
domestic producers can not compete at marginally
Persistent Dumping -> May continue indefinitely since Credits Debits Balance
exporting firm could be a monopoly Trade in Goods 373,149 504,029 -130,880
Difficult to Justify Protectionism -> Exporting country Trade in Services 317,674 217,296 100,378
has CA in good’s production Balance of Trade 690,823 721,325 -30,502
Importing Country -> Receives lower prices + Primary Income 207,497 244,810 -37,313
welfare gains Secondary Income 18,040 45,535 -27,495
Predatory Dumping -> Intention of destroying foreign Total Current Account 916,360 1,011,670 -95,310
competition, involving predatory pricing
Importing Country -> Experiences temporary
Financial Account
benefits, but is later affected; domestic industry is
destroyed + loss of competition, overseas monopoly Definition -> Record of the movement of money in the
may form form of investments by residents of a country and
Protectionism -> Only rationally justified in cases of inward flow of investment
predatory dumping Net Portfolio Investment -> Shares/stocks,
Government/Corporate bonds and derivatives
6.3. Balance of Payments Net Foreign Investment -> E.g. Huawei opens research
facility in the UK
Current Account Reserve Assets -> Holdings of foreign currencies

Capital Account Consequences of Imbalances in the Current

Account
Definition -> Capital transfers, including transfer of
ownership of fixed assets or non-financial assets Effects on Domestic Economy Effects on External Economy
Examples -> Cash grants, patents, copyrights Need to Tighten Fiscal &
Governments Under
Monetary Policies → Reduce
Balancing Item Pressure → To
domestic demand + introduce
introduce/increase
supply-side policies, improve
protectionist measures
Definition -> Difference between the current account productive capability.
and the capital and financial accounts Devaluation of the Exchange
Purpose -> Address errors and illustrate statistics Rate → Higher import prices
and lower export prices;
Less Access to Imported
Causes of Imbalances in the Current Account Important Note →
Goods → As protectionist
Effectiveness depends on
policies are imposed
Marshall-Lerner and J-Curve,
Deficit Surplus may lead to further loss of
Excellent Reputation in confidence
Limited Domestic Production
Production -> Export demand Fall in Foreign Investment →
-> Country relies on imports
increases Sine confidence declines, less
Higher Standards of Living -> economic growth + higher
Demand for a broader range of unemployment
goods, imports rise
Unfavourable Terms of Trade
-> Country believes they must 6.4. Exchange Rates
export more and more to
maintain export revenue, Exchange Rates
developing countries
particularly Definition: Price of one currency expressed in terms of
Lack of Competitiveness -> another currency or against a basket of other currencies
Overvalued currency and/or 3 Types of Exchange Rate Systems: Floating, Fixed, and
greater rate of inflation,
exports fall, imports rise
Managed-Float
Appreciation: When a floating exchange rate increases
Economic Growth -> Requires
import of capital goods =
in value compared to another currency
persistent deficit, consumers Depreciation: When a floating exchange rate decreases
become better off, thus why in value compared to another currency
they demand more imports
Inflation Faster than Floating Exchange Rate
Competitors -> Exports
become less competitive than Definition: a country’s currency's value is determined
imports, results in trade deficit; solely by supply and demand market forces.
may lead to a depreciation to
offset this
Lack of Confidence in an
Economy -> Due to factors
such as persistent deficits or
large rises in Government
deficit, investors may fear
political change or lack of a
stable Government
Trading Partners with
Negative Economic Growth ->
Buy less of its exports; the
opposite happens when there
is rapid growth

Causes of Changes in a Floating Exchange Rate

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CAIE AS LEVEL ECONOMICS
Cause Explanation Actual
Effect Net AD Price
**Countries with Deficit - Output Unemployme
Considered Exports Curve Level
>**End up supplying more of (GDP)
their currency, leads to Fall:
depreciation; ** \n Imports
Balance of Payments Falls,
**Eventually -> Foreign rise since
Disequilibrium since Falls, Falls,
money will start to leave to cheaper,
Appreciation Net P1 -> Y1 -> Rises, Y1 -> Y
offset its loss in value, again Exports
Exports P2 Y2
increasing the supply of fall since
decrease
currency more
**Country with Rate Higher expensive
than Others ->**Loss in Rise;
confidence of its currency; ** Imports
High Inflation Rises,
\n **People Sell the Currency fall since
since Rises, Rises,
-> Its supply increases on the more
Depreciation Net P2 -> Y2 -> Falls, Y2 -> Y
market, leading to depreciation expensive,
Exports P1 Y1
**International Money - Exports
increase
>**Seeks the highest return;** rise since
\n **If Country Raises its cheaper
Interest Rate ->**Attracts
Interest Rates inflows of money from foreign Appreciation Impact on the Economy \n
investors; \n **Appreciation -
> Since foreign investors will
need to buy the currency to
deposit in domestic institutions
Speculation -> When one or
more people gamble on a
Aim to Make a Profit: By
currency rising (by buying) or
buying it back at a lower price
falling (by selling), a floating
or selling it at a higher price
exchange rate increases in
value

Impact of Changes in a Floating Exchange Rate

Price Elasticity of Demand for Exports & Imports:
Determine the impact of exchange rates and Marshall
Lerner’s condition Depreciation Impact on the Economy \n

Trade Weighted Exchange Rate

Definition -> Weighted average of exchange rates of the Main Issue -> Produces difficulties for trading partners
domestic currency against foreign currency Especially if it’s a Member of Monetary Union ->
Weight for Each Country -> Set by its proportion in They are unable to depreciate their exchange rate to
trade with the domestic country offset the trade surplus
Eg. Eurozone -> Faced this issue with Germany being in
E.g. Country X Trades with USA and Japan surplus, while Greece was in debt (both at the same
period of time)
90% of Trade -> USA
10% of Trade -> Japan Effect of Policies on the Current Account
Base Trade-Weighted Exchange Rate -> 100
Country X’s Currency -> Rises 10% against USD$ Type of Policy Effects
Country X’s Currency -> Also rises 50% against Yen Expansionary -> Current Account
Value of X’s Trade-Weighted Exchange Rate Index -> Improves: since net exports rise
1)Fiscal Policy
114 Contractionary -> Current Account
USD -> (100*0.9) * 1.1 = 99 Worsens: since net exports fall
Japan -> (100*0.1) * 1.5 = 15 Higher Interest Rates -> “Hot
Money” may appreciate the
Trade-Weighted Exchange Rate -> 99 + 15 = 114 currency; Current Account
2)Monetary Policy
Improves ; Lower Interest Rates ->
Fixed Exchange Rates Imports rise; Current Account
Worsens
Definition -> Government fixes the value of its currency Promotion of Research &
Development -> Intends to create
to another currency, a basket of currencies, or a better/new products to gain
commodity, e.g. Gold. competitive advantage; Current
Revaluation -> Government intervenes to increase the Account Improves \n
value of its currency 3)Supply-Side Policy Improvement in Education &
Devaluation -> Government intervenes to decrease the Training -> Improves skills of
value of its currency workforce, quality of graduates
improves; takes time, no
guarantee that skills will benefit
6.5. Policies to Correct Imbalances in the Current Account
the Current Account of the Balance of Tariffs, Quotas, Etc. -> Domestic
goods replace imports; Current
Payments Account Improves ; Excessive
4)Protectionist Policy Administrative Burdens // Red
Government Policy Objective Tape -> Imports more difficult due
to multiple barriers of entry; leads to
Retaliation
Stability of the Current Account

Ideal Situation
CA in Equilibrium -> Inflows of Money = Outflows of
Money
In Reality -> Governments attempt to keep a steady
level of imbalance

Persistent Deficit
Main Issue -> Country could face severe economic
problems
Exchange Rate -> Depreciates with time, purchasing
power of domestic currency worsens abroad
Inability to Pay International Debts -> May lead to
extreme bankruptcy in some circumstances

Persistent Surplus

© ZNotes Education Ltd. & ZNotes Foundation 2024. All rights reserved.
This version was created by Nina on Wed Nov 27 2024 for strictly personal use only.
These notes have been created by Michelle Yusuf for the 2023-2025 syllabus.
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CAIE As Level Economics Theory

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ZNOTES.

UPDATED TO 2023-2025 SYLLABUS

3 Basic Economic Questions -> These 3 economic

Definition -> The role of the Entrepreneur in managing

Shape of the PPC

1.6. Classification of Goods & Services

Governments -> 2 Choices: Either 1) Subsidise or 2) **

Main Takeaways from Graph

2. The Price System & the

Definition -> The total demand for a particular product

E.g. Demand for Tomatoes by Individual “Tom”

Law of Supply Explanation

2) Price of Other Goods 5) Size, Age, Gender or Population

Shifts in the Demand Curve

PED < 1 = Price Inelastic -> Demand is relatively

XED Feature Interpretation Application

Factor Being Assessed Elastic PES Inelastic PES

2.4. Interaction of Demand and Supply

The Price Mechanism // The Invisible Hand

2.5. Consumer and Producer Surplus

3. Government Key Takeaways from Minimum Price Graph (above)

Eg. of Minimum Price) Minimum Wage

Minimum Price Impact on Producer & Consumer

Key Takeaways from Maximum Price Graph Above

Minimum Price Advantages & Disadvantages

1. Quantity Demanded (Qd) > Quantity Supplied (Qs) **

Buffer Stock Schemes

Buffer Stock Scheme Advantages & Disadvantages

Proportional, Progressive & Regressive Taxes

Impact on Inelastic Product

Impact on Elastic Product

Main Takeaway -> The more inelastic a product is, the

Scenarios for Complete Consumer Burden B1) Impact of an Ad Valorem Tax

Impact on Elastic Product

Main Takeaway from Inelastic Demand -> Leads to

Main Takeaway from Elastic Demand -> Leads to

3.4. Income & Wealth Inequality

2020’s Lowest Gini Coefficients // Least Inequality

Definition -> GNI taking into account the depreciation of

Definition -> Total value added in production of goods 1)Closed Economy

2)Gross National Income (GNI) 2)Open Economy

3)Net National Income (NNI) Components of Different Economies

Important Note 2 -> Economy can be in Equilibrium while

AD = C + I + G + (X-M) Exports -> Sale of goods and services to foreign

Aggregate Supply (AS)

Requisite -> Any change in any one of AD’s Determinants of AS

1)Short-Run AS Curve (SRAS)

2)Long-Run AS Curve (LRAS)

Lower Degree of Price Increase -> P1 -> P2 (Disinflation)

Interaction of AS & AS in the Short Run

4.4. Economic Growth Causes of Economic Growth

Definition -> Increase in production potential or real 1)Shifters of AD to the Right

Real v/s Nominal GDP

Suitable Economic Growth

4.6. Price Stability

5. Government Must be Sustainable -> Does

Macroeconomic Intervention or cause too much pollution;

5.2. Fiscal Policy

Reasons for Government Spending

Purpose -> Improving productivity and productive

Shifting the PPC Outwards

AD/AS Analysis of the Impact of Supply-Side

** A)Absolute Advantage -> Ability to produce more of a

Benefits of Specialization // Free Trade

Interventionist Policies -> May increase aggregate Analysis

After Free Trade

Impact of Changes in Terms of Trade

1)Infant Industry 3)Unemployment

Capital Account Consequences of Imbalances in the Current

Causes of Changes in a Floating Exchange Rate

Impact of Changes in a Floating Exchange Rate

Trade Weighted Exchange Rate

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