Economics (Preview)

ECONOMICS

Wong Wai Leong

with Insights on Hot Exam Topics and Tips

ECONOMICS

Wong Wai Leong

Copyright © 2024 by Sunway University Sdn Bhd

Published by Scola Books

An imprint of Sunway University Sdn Bhd

No. 5, Jalan Universiti Sunway City

47500 Selangor Darul Ehsan Malaysia

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Cambridge Assessment International Education bears no responsibility for the example answers to questions taken from its past question papers which are contained in this publication.

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Answers to questions in the book can be found on the Sunway University Press website.

Acknowledgements

A good chef cannot produce an appetising dish with rotten ingredients, but the best ingredients can do little without a skillful chef. Food preparation alone is challenging— there are spices to include, ingredients to mix and sauces to create. Then, there is cooking to do and food presentation to perfect. All of this magic rests in the hands of the chef.

Likewise, the publication of a good book is not possible without the great team at Sunway University Press (SUP). The bona fide Michelin-star chefs of SUP are Carol Wong, Hani Hazman, Chong Wah Tien and Rachel Goh. These individuals toiled and sweat for the book, meticulously going over each word and sentence, carefully designing the layout, and repeatedly sending drafts to me for revisions (five in total!). Excuse the cliché, but this book would not have been possible without their untiring effort and contribution. For that, I am infinitely grateful and thank each and every one of you from the bottom of my heart.

I would also like to express my gratitude to my family for their support and encouragement—my wife Soo Mooi, and my beautiful daughters Zi Qing and Zi Yin. Thank you very much.

Wong Wai Leong Sunway College, Malaysia

Charts

These appear at the start of each chapter and show an overview of fundamental economic concepts

How to use this book

This book is designed to support students undertaking Cambridge International AS and A Level Economics (9708). It contains examination-focused features to enhance students’ understanding of the subject and equip them with the knowledge and skills needed to excel in the examination.

Key features of the book:

This is an alert on common during examination

Keyword

This provides clear definitions of essential economic terms

Hot Topics for Examination

This highlights frequently tested examination topics

Review Questions

These are questions that reinforce learning

Past-Year Questions

These are actual past examination questions that can be used for practice

Hint!

This is a tip that identifies crucial points to note when tackling examination questions

The Economist’s Mind

This delves beyond the syllabus, offering applications of economic principles to real-world scenarios and current events, and their implications

AS Level

Basic Economic Ideas and 1 Resource Allocation

RESOURCE

CLASSIFICATION

Basic Economic Ideas and 1 Resource Allocation

HOT TOPICS FOR EXAMINATION

• Factors of production. Understand the role played by entrepreneurs in managing factors of production and driving an economy. This topic is relevant when discussing a government’s role in regulating, supporting and complementing the private sector to generate economic growth.

• Economic systems. Concentrate on the resource allocation aspect of the three economic systems—market, planned and mixed economies. Be prepared to compare the systems, focusing on their strengths and weaknesses, efficiency, competitiveness, and ability to generate growth.

• Production possibility curve (PPC). You must be able to convincingly discuss the core concepts of scarcity, choice and opportunity cost using the PPC model.

• Shape and shift of the PPC. Examiners often set questions on why the shape of the PPC is concave to the origin, and the differences between the causes of a PPC shift and a movement along the PPC. You must be prepared to answer these questions accordingly.

• Classifications of goods. It is important to be able to distinguish between different types of goods. This topic forms the foundation for Chapter 3 on Government Microeconomic Intervention.

1.1 Scarcity,

choice and opportunity cost

Economics is a human science that studies the relationship between limited resources and unlimited wants. Scarcity, choice and opportunity cost arise when unlimited wants cannot be fully satisfied. In Gandhi’s words, there is enough for everyone’s needs, but not everyone’s greed.

Scarcity

Scarcity is a central problem in Economics and is inevitable, be it on an individual, organisational or national level.

On an individual level, we can use time as an example of scarcity. There is never enough time for football matches, parties, or even examination revision. On an organisational level, limited funds are available for marketing, operational and capital expenditures. Management will then have to decide what to spend on, selecting some and forgoing others. On a national level, a government cannot satisfy the people’s unlimited wants due to limited land, labour, capital and entrepreneurs.

Scarcity may give the impression that people want unlimited things, but that is not entirely true. Ask yourself: do you want unlimited pairs of sneakers? Each extra pair will bring less and less satisfaction and you will want to stop at some point, even if the extra pair of sneakers is free. However, you may have other wants apart from sneakers. After all, our desires are insatiable.

Needs and wants

Needs are the necessities required for survival. At the minimum level, we have physiological needs such as food, shelter and clothing. In more developed economies, there is a need for goods and services like transportation, personal communication devices, and internet connection.

Wants are what we desire over and above our needs, and are unlimited and insatiable. For example, we may want to drive a Tesla car, live in a bungalow, wear luxury clothing, and consume a variety of delicacies. Once we are used

Scarcity is the most fundamental concept in Economics. Examiners frequently set questions that require its application.

to consuming a good, we will seek other, newer things to satisfy a higher level of perceived happiness. Philosophers call this tendency to satisfy one fleeting pleasure after another the ‘hedonic treadmill’.

Scarcity therefore exists because of unlimited wants, and this problem cannot be solved by having more resources.

Choice

Scarcity leads to choices. Since we cannot have all that we want, we will have to choose what we want. From an individual viewpoint, we will have to choose between spending two hours watching a movie or studying Economics. For an organisation, it is either spending more on advertising or on research to improve sales. Choice is unavoidable when there is scarcity.

Opportunity cost is the value of the next best alternative forgone. This is a result of choice. When a choice is made, we forgo other options.

One example is a piece of land with three alternative uses—a shopping complex, an amusement park or a football field. The expected annual return for each is US$20m, US$10m and US$5m, respectively. If the decision is to build a shopping complex, then the opportunity cost is US$10m (the return on the amusement park forgone). Between the amusement park and the

sunk cost. For example, you are considering selling your three-year-old car which you bought at US$70,000. The highest price you can get for the same three-year-old car today is US$50,000. Meanwhile, the exact model is selling at US$65,000 today. After much deliberation, you decide to keep your old car.

What, then, is the opportunity cost of keeping your old car? It will be US$50,000, which is the benefit you would have gotten if you had sold it. It is not US$70,000, which is the price you paid for the car. This is because US$70,000 is a sunk cost, money that you cannot recover whether you sell or keep the car. The US$65,000 of the new but exact car model is irrelevant.

Basic economic questions of resource allocation

There are three basic economic questions of resource allocation—what is to be produced, how and how much is it to be produced, and for whom is it to be produced?

The first question pertains to the decision on the goods and services an economy wants to produce. Due to scarcity, an economy cannot produce all the goods and services the people want.

The second question examines the production method and the quantity required for each good and service. Some methods are more labour intensive (or require more labour), while others are more capital intensive (or require more machinery). Depending on the resources and the level of technology available in an economy, the solution would be to choose the most efficient method of production that incurs the least opportunity cost.

The third question looks at the market or people who will use the goods and services produced. Are the goods and services produced for the old or the young, those living in urban or rural areas, or those with high or low income?

REVIEW QUESTIONS

1. What is Economics?

2. Why are economists interested in scarcity?

3. Explain, with examples, the concept of scarcity on an individual, organisational and national level.

4. Do unlimited wants mean people want an unlimited amount of goods?

5. Distinguish between opportunity cost, sunk cost and financial cost.

6. Why do we consider the benefits of the ‘best alternative’ and not the benefits of all the options available when measuring the opportunity cost?

Answers to these questions can be found on the Sunway University Press website.

HINT!

The three basic economic questions arise from the concept of scarcity. Scarcity is also key in explaining how the three economic systems work in allocating resources.

HINT!

Economic methodology is a topic that has been given additional emphasis in the new syllabus. A basic understanding of the methodology is a must!

1.2 Economic methodology

Economics as a social science

Is Economics a science? Unlike Mathematics or Physics, human behaviour does not adhere to the fundamental laws of nature, nor can it be explained using exact calculations. Instead, economists construct models to study and understand the world better through hypotheses and logic. Economic models enable us to understand how the rational ‘economic man’ behaves and makes decisions. These models, however, have many limitations and

The methodology in Economics is similar to that of pure sciences. We start with a hypothesis, then develop models to test the hypothesis, and finally observe the outcome. However, there is an important difference: economists do not conduct laboratory experiments. Instead, they study human

KEYWORD

A value judgement is an evaluative statement of how good or bad we think something is

Economic statements can be divided into two—positive and normative statements. Positive statements are factual and verifiable. Peter is tall and . We can ascertain both claims in this statement.

Normative statements are opinion statements based on value judgement Peter should not be wasting his time playing mobile games on his phone. Implicit in this statement is the opinion that playing games is unhealthy. However, this is not a fact and some may not subscribe to this thinking. Thus, the statement is normative.

Another example is a policy decision on whether a tax on alcohol should be introduced. A positive economist may say, “If you impose a heavy tax on alcohol, consumption will fall by half”. The positive economist says nothing about the desirability of such a tax, only the effect of such an action. On the other hand, a normative economist may say, “Alcohol consumption is bad. You should tax alcohol to reduce consumption”. The normative economist subscribes to a goal and then makes a policy to achieve it.

In summary, a positive economist will say, “If you want A, then you must do B”. A normative economist, on the other hand, will say, “You should have A as your goal, and you need B to achieve the goal”.

Ceteris paribus

Before economists construct an economic model, they have to make assumptions. Assumptions simplify the model and enable observations of our complex and unpredictable world. One of the most common assumptions is ceteris paribus, which means “other things being equal”.

Say, we add ceteris paribus state that the demand curve is constructed to show the relationship between various prices and the corresponding quantity demanded. Economists are aware that there are many other factors besides price that can influence demand. If all factors are considered, we will never be able to show the relationship between price and quantity. Thus, we assume that other factors that may influence demand are constant—

Time periods

Economists divide time periods into three categories—the short run, the long run, and the very long run. The short run is a period where at least one factor input is fixed, and both fixed and variable inputs are present. The long run is a period where all factor inputs are variable, and there is no fixed input. In the very long run, the state of technology changes.

The words ‘run’ and ‘term’ have very different connotations in Economics. For example, a specific length of time is used to differentiate ‘short term’ from ‘long term’. ‘Short run’ and ‘long run’, however, are only determined by whether fixed inputs are required in a production.

KEYWORD

Factor input is the resource used to produce goods and services

REVIEW QUESTIONS

1. How is the study of Economics different from the study of pure science?

2. If economists cannot conduct their experiments in a laboratory, can the study of Economics still be considered a science?

3. Why do economists include the assumption of ceteris paribus in economic models?

4. Why are assumptions important in the study of Economics?

5. Which of the two is more useful—positive economics or normative economics?

Differentiate the concept of ‘long run’ in Economics and ‘long

Can we say for certain the length of time of what economists

There are four major factors of production—land, labour, capital and entrepreneurs. These are technical terms with specific meanings in

• Land refers to resources we can extract from the natural environment, both renewable and non-renewable. Renewable resources include agricultural output and commodities like palm oil, rubber, fish and timber. Non-renewable resources meanwhile are minerals like oil, rare earth, tin, copper and iron. The use of land is compensated with rent.

• Labour is the size of the workforce in an economy. More precisely, labour refers to the quantity and quality of the workforce. Large workforce nations, like India and China, can supply an adequate number of workers

Answers to these questions can be found on the Sunway University Press website.

to industries and spur economic growth. Skilled labour is essential for economies that strive to become high-income economies. Labour is compensated with wages.

• Capital refers to goods used to make other goods. It consists of machinery, production plants, commercial vehicles, tools and various infrastructures in a country. Capital must be in a physical form, so investment products like shares and bonds are not considered capital. Money spent on renovation, furniture, and fittings for a restaurant, for example, is an investment because it increases the capital stock. Developed nations like Japan, Germany and France have a large capital stock because they accumulated substantial plants and machinery during the industrialisation period in the early 1900’s. Capital is rewarded by interest.

• Entrepreneurs take risks and organise production. This factor is important to the growth and development of a country because they are the only factor that is ‘active’. Entrepreneurs actively and creatively combine the other factors of production—labour, capital and land— to bring goods and services to consumers. If their products cannot sell, entrepreneurs take the losses and shut down production. Entrepreneurs are not confined to business owners alone. Managers who shoulder the responsibility of organising production also fit the description. Entrepreneurs are rewarded with profit.

Physical capital and human capital

A distinction can be made between physical capital and human capital. Physical capital refers to machinery, manufacturing plants and various communication, transportation, and utility infrastructures in a country. Physical capital is crucial in raising competitive levels. Physical capital can be increased through investment.

Human capital refers to both the quantity and quality of the labour force. Human capital can be formed through training, work experience and education. Developed economies, or high-income countries, require skilled workers in tertiary sectors like finance, banking, insurance, logistics and legal industries. Human capital that is both skilled and qualified is essential to these economies.

HINT!

Entrepreneurship is a hot topic in the recent examination trend. The role of entrepreneurs is key to economic recovery in many economies today.

HINT!

THE ECONOMIST’S MIND

Are rich mineral deposits a curse or a blessing?

In Malaysia, oil was discovered off the coast of Terengganu in the 1970’s. The oil and gas company Petronas was formed to manage joint ventures with foreign oil companies. The royalty earned became a major source of income for the nation and strengthened its fiscal position considerably.

In the Democratic Republic of the Congo, rival factions constantly engage with one another to control coltan mines, leading to slavery, violent conflicts and massive losses of lives. Coltan is used in mobile devices, military weapons and almost any electronic device. Regarded as more valuable than gold, coltan has been a

The fate of Congo is common in many countries with rich natural resources. Economists consider natural resources as ‘intensifiers’— they can bring rapid economic development to countries with sound, competent and independent institutions. However, natural resources can be a curse and bring death and suffering to the people if the country does not have strong economic and

Specialisation and division of labour

Specialisation is the division of tasks where each worker is only responsible for a narrow range of tasks. The concept of specialisation was popularised by economist Adam Smith in his 1776 book The Wealth of Nations. Using the setting of a pin factory, Smith observed that each worker could produce up to 20 pins a day without specialisation. However, if the tasks were divided into many distinct tasks—like drawing the wire, cutting it, and so on—the productivity of workers would soar. With division of labour, the factory could produce up to 48,000 pins daily.

Division of labour can happen at an organisational or national level where production is focused on one or two goods.

Specialisation is tied to the international trade topic. Past examinations show that questions on these two topics are frequently framed together.

The benefits of specialisation include the following:

• Increased efficiency. When a worker performs the same task repeatedly, he will become better with repeated practice. His efficiency will then increase.

• Time efficiency. Specialisation removes the need to change tools, thus increasing efficiency in production. In an assembly line setting, for instance, workers stay in one place along a conveyor belt doing just one task. This also saves time.

• Cost effectiveness. Large efficient machinery and specialised tools can reduce production costs substantially. However, obtaining such machinery and tools is only worthwhile if they are frequently used.

• Suitability. Workers can be assigned jobs that are suitable to their abilities and personality. Productivity, morale and motivation are improved when a worker’s aptitude, personality and values fit the job.

There are, however, some drawbacks to specialisation. At the top of the list is boredom. Repeating a narrow range of tasks repeatedly for hours can be mind-numbing.

The second drawback is the degree of dependence on others. If one worker in a team is absent and others cannot cover the work of that absent worker, production stops entirely.

The third drawback is the increased risk of over-specialisation for a worker. With his skills and knowledge confined to a very narrow range of specialisations, career mobility will be severely limited.

THE ECONOMIST’S MIND

Does a large population guarantee economic growth?

India is set to be the fastest-growing economy in the world in the next two decades, replacing China. The main reason for India’s economic growth is its current large and working-age population. However, population size per se does not guarantee rapid economic growth. If a large population is too top-heavy (high ageing population) or bottom-heavy (high young population), it becomes a drag on economic growth. It is the combination of two demographic factors—a large population and a large working-age segment—that makes economic growth unstoppable.

HINT!

The robustness and innovation of entrepreneurs are the main drivers of economic growth.

Examination questions on the role of entrepreneurs are often framed within the context of private sectors in a market economy.

Role of entrepreneurs in contemporary economies

Entrepreneurs have two main roles—organising production and taking risks. Entrepreneurs are crucial to the functioning of a market and the growth of an economy. They need to read or interpret the market correctly, understand what consumers want, identify new products or methods of production, and bring the goods to the market.

The following are among the chief contributions of entrepreneurs:

• Create jobs. When entrepreneurs start a business venture, they need to hire workers, machinery, raw materials and other inputs. New business ventures will thus lead to the creation of jobs in an economy.

Entrepreneurs constantly introduce new and exciting products, innovations and services to consumers to make

Competition increases economic efficiency, thus reducing prices and expanding consumer choices. Competition therefore creates an overall beneficial effect on an economy.

Entrepreneurs borrow money from banks to invest in capital and start an enterprise.

Entrepreneurs create wealth by making profitable ventures and growing their businesses. When the business sector thrives, national income will rise as well.

The role of entrepreneurs, or the private sector, is undeniably essential to the growth of any economy. Governments therefore make efforts to facilitate, encourage and support entrepreneurs in an economy by providing conducive business environments and improving ease of doing business.

Functions of governments to facilitate entrepreneurship

HINT!

The role of governments in managing an economy is often highlighted in past examination questions. Pay attention to the critical role governments play in creating a conducive environment for entrepreneurs to flourish.

Governments can hinder entrepreneurial activities through excessive regulations (red tape) and high taxes. Political instability can also be a factor in scaring away existing and would-be entrepreneurs.

It is imperative that governments create a conducive environment in which entrepreneurs can thrive. The following are some crucial functions of governments in stimulating entrepreneurial growth:

• Invest in infrastructural development. The existence of efficient transportation, telecommunication and utility systems is a necessary

condition for private investment. Highways, bridges, electricity grids, Internet connectivity and public transportation systems are important factors in making the cost of doing business competitive in an economy. Infrastructural investments are usually too large for the private sector to undertake. We will delve more into this in Chapter 5.

• Provide quality public education. Quality public education provides the necessary supply of skilled labour, professionals and learned entrepreneurs to an economy. Steve Jobs, for example, could never have created the revolutionary iPhone without a great army of technicians, programmers and inventors. It is public education, funded by taxpayers, that builds this army.

• Maintain macroeconomic stability and maintenance of fiscal stability are some of the chief objectives a government should undertake. A responsible government must manage these macroeconomic aspects competently to ensure the long-term wellbeing of the citizens.

• Regulate business enterprise competition in all industries and prevent large firms from exercising predatory behaviour well-being of consumers against irresponsible and unethical businesses, protection of the environment, and prevention of labour exploitation.

In a market economy, the private and public sectors must work together, complementing each other to achieve economic growth, protect the natural environment, and improve the overall welfare of the nation.

THE ECONOMIST’S MIND

How important is geography to economic growth?

Many people attribute the economic success of Singapore to the hardworking and skilled workforce, and the able political leadership in the nation’s formative years. One grossly overlooked factor is geography, or ‘land’.

Singapore is strategically located in the middle of the most significant global east-west maritime trade route, with the Strait of Malacca being one of the busiest straits in the world since the 16th century. Singapore capitalised on this favourable location and focused on developing a modern and efficient port, engaging in the lucrative entrepôt or transhipment business. The biggest

KEYWORD

Predatory behaviour refers to unfair, non-competitive actions by large firms to harm smaller ones

contributor to Singapore’s success as a world-class port, however, is its neighbouring island Sumatera. The huge Barisan Mountains on Sumatera, covering over 17,000km from north to south, serve as a natural protection and shield the island country from the

The United States (US) also benefits largely from its geography or land resources. Situated between two great oceans, the Pacific and the Atlantic, the US is one of the most well-protected countries among the great powers. In the entire history of the country, there were only two foreign attacks on US soil—Pearl Harbour in 1941 and the World Trade Center in 2001. Thus, throughout the 20th century when two world wars economically destroyed Europe, the US industrial sectors and plants were left intact and in a much stronger position to lead after World War II.

Malaysia Indonesia

Indonesia

Singapore

South China Sea

Indian Ocean Java Sea

Atlantic Ocean

Straits of Malacca

Malaysia

Brunei

REVIEW QUESTIONS

1. Describe, using examples from the country you are currently in, the four factors of production.

2. Which factor of production do you think contributes the most to the economic growth of the following countries? Substantiate your answers.

• Malaysia.

• China.

• United States.

• South Korea.

• Singapore.

3. Can a government Explain your answer.

4. Entrepreneurs are critical in organising production in an economy. However, countries. How an economy?

Answers to these questions can be found on the Sunway University Press website.

1.4 Resource allocation in different economic systems

Economic systems are the means by which a country allocates resources to produce goods and services. There are three types of economic systems:

• Market economy.

• Command economy

• Mixed economy.

Each economic system uses a different allocative mechanism to resolve the three basic economic questions of what, how and for whom to produce.

KEYWORD

Command economy is also known as planned economy

Students often get asked about the market economy in examination questions. Remember to base your answer on the allocative mechanism—use the three basic economic questions to explain this.

Market economy

Market economy uses the price mechanism to allocate resources. This means prices of goods and services function as a signal to producers and consumers. For example, when a shortage occurs, prices will go up. This is a signal to producers to increase output and for consumers to ration. When there is a glut or surplus, prices will fall. This is a signal to producers to cut production, and for consumers to buy more due to lower prices.

Figure 1.1 is a demand and supply diagram of a good. At price p2, the quantity supplied is greater than the quantity demanded. As a result, a surplus arises. Producers will want to get rid of unsold stocks by cutting prices. This will bring the market price down towards the equilibrium price, p1

, the quantity supplied is lesser than the quantity demanded. This results in a shortage of the good. During a shortage, consumers will be willing to pay more for the good and higher prices will encourage producers to increase their production. As a result, the price will

When left to the market, the price of each good will eventually move towards the equilibrium price, where the quantity demanded is equal to the quantity supplied. This is achieved without government intervention in the market.

There are a couple of things to note here. First, we assume that all economic agents in an economy—that is, the producers and consumers—are rational and make their decisions based on self-interest. The economic agents are therefore profit or satisfaction maximisers.

Figure 1.1 Surplus and shortage of demand and supply Quantity

HINT!

Second, the interaction of demand and supply will eventually produce a market-clearing price, where the quantity demanded equals the quantity supplied. This is called an ‘equilibrium’. In a market economy, an equilibrium is reached without government intervention. Adam Smith, father of modern Economics, called the market forces the invisible hand

The three basic economic questions of what, how, and for whom to produce are answered through the workings in the market, based on many individual and uncoordinated decisions. The market economy is also called the ‘laissez faire’, which means ‘to leave it alone’.

Command economy

In a command economy, a government—also called the public sector—plays a central role in allocating resources. The three basic economic questions of what, how and for whom to produce are addressed by a planning committee. The committee plans the production of all goods and services for the entire nation.

The planning committee’s primary goals are to produce enough necessities, maximise the welfare of the people, and optimise the efficient use of resources. It also needs to identify the resources available and allocate them accordingly. These decisions will then be communicated to each firm in an economy, and the planning committee further directs workers to work in these firms.

In a command economy, there is no free enterprise and every economic activity is directed and organised by the state.

Mixed economy

The mixed economy system incorporates both the invisible hand mechanism and the central planning system in allocating resources. There are two sectors in this economic system—the private and the public. The private sector allocates resources using the price mechanism, while the public sector or the government plans the use of resources.

In the world today, all economies are mixed economies. The size of the public and private sectors varies between mixed economies. Hong Kong, often used as the ‘poster boy’ for the laissez faire economy, has a very small

HINT!

The basic assumptions in a market economy are outlined here. These points are very useful in explaining the market economy in an examination essay.

HINT!

When answering examination questions that compare a mixed economy with other economic systems, you must be able to explain the relative merits and roles of the private sector and the public sector.

HINT!

This section provides the key points for evaluative comments when answering essay questions.

public sector and a very low corporate tax. At the other end of the spectrum is North Korea with a very small private sector. It is interesting to note that the United States (US), a vocal supporter of the market economy system, has a government spending that exceeds 35% of the country’s gross domestic product. This can be compared with China at 34% in 2019, a country known for its central planning or state-directed economy.

Which is better: Market or command economy?

Each economic system has its strengths and weaknesses. We can consider them in the following aspects:

A market economy is more efficient in allocating resources hand. The price mechanism will eliminate shortages or surpluses in the market, requiring no government intervention. Feedback to producers to adjust production is almost

A command economy lacks efficiency due to the sheer complexity of planning for the entire nation. Imagine answering the first question— what is it to be produced?—for a million people in a year! Furthermore, consumer tastes and preferences are not static. Feedback from an economy during a shortage or surplus can be very slow, leading to many empty shops, long queues, and wastage of unwanted goods.

KEYWORDS

Private property rights refer to ownership and control over resources by individuals or private entities

Public property rights refer to ownership and control over resources by a government or public entities

The key motivation in a market economy is private property . As workers and entrepreneurs can keep what they earn, they are probably more motivated to work hard, innovate, and push new ideas into the market. This trait makes an economy more robust, dynamic and competitive, resulting in greater economic growth in the long run.

public property rights. Citizens are expected to be driven by the noble idea of contributing to the nation. Karl Marx, father of Communism, once said, “From each according to their ability, to each according to their needs”. This means work is assigned based on one’s ability and competence but rewards are based on needs, not performance. In reality, not many are motivated by the ideals of communism. This makes workers sluggish and an economy less robust, with anaemic growth at best.

• Competition. The element of competition is strong in a market economy. Profits attract and incentivise firms to enter the market and compete. Competition increases quality, service, and innovation of goods and services. It brings prices down and benefits consumers in general.

A command economy generates no competition. There is only one make of each good and consumers are not given a choice. Thus, the quality of goods and services is inferior to those in a market economy. Substandard quality makes goods and services from a command economy uncompetitive in the world market, hampering economic growth.

• Income inequality. While a market economy can create greater economic growth, it tends to increase the income gap. This is because resources allocated through the price system mainly produce for those who can pay, leaving those who cannot marginalised. With a large income gap, the lower-income group can be exploited and bullied into working at meagre wages. This is because the poor desperately need jobs to bring food to the table.

A command economy allocates resources according to the needs of the entire nation. Without private property rights, there is no income inequality. The welfare of all people will be taken care of since the planning committee allocates resources.

• Wasteful competition. advertising and marketing to sell products. This is because many other firms are producing similar products. Such competition can be wasteful, as advertising does not improve the welfare of society and having too many small firms producing duplicates makes exploiting scale in production more difficult.

A command economy, through central planning, enjoys greater economies of scale in production. It does not produce many different makes of cars, for example, and instead concentrates production on only one make. A command economy is also less wasteful, as there is no need to expend resources on advertising.

• Merit and demerit goods. production of merit goods and an over-production of demerit goods due to imperfect information. Resources will not be adequately allocated to produce the appropriate amount of merit and demerit goods, leading to an inefficient outcome in the market.

A command economy is more likely to produce merit and demerit goods in the right quantity. A planning committee can direct resources to produce enough merit goods, while curbing the over-production of demerit goods.

KEYWORD

Income gap is the unequal distribution of income among individuals or groups in a society

KEYWORD

Economies of scale refer to the lowering of cost per unit in largescale productions

Go to page 30 to learn about merit and demerit goods in more depth.

THE ECONOMIST’S MIND

Can we have the cake and eat it too?

Many of you may think: why do we not only have a mixed economy system? After all, we can have the best of both worlds and enjoy the combined strengths of a market and a command economic system!

The fact is, combining both allocative mechanisms means having to deal with the problems inherent in both. The economic system that a nation adopts is determined by many factors such as politics, history, culture, technology and economy. Today, we seem to lean towards a central planning system—where a government plays a more significant role in an economy—since the 2008 global financial crisis and the 2020 COVID-19 pandemic.

What economic questions must be answered in a barter economy, a market economy and a command economy? A command economy generally experiences lower economic prosperity than a market economy. What are the possible

Why is competition considered wasteful to advocates of a command economy?

4. What are the common criticisms of a market economy?

5. Scandinavian countries have the highest tax rates in the world. They also have public provisions of education, healthcare and public transportation, and heavily subsidised childcare and housing. Do these factors limit economic growth? What are the benefits of such a system?

Answers to these questions can be found on the Sunway University Press website.

1.5 Production possibility curves

Definition of the production possibility curve (PPC)

Economists use the production possibility curve (PPC) model to illustrate the concepts of scarcity, choice and opportunity cost. The PPC is a curve that shows the various combinations of two goods that an economy can produce with a fixed quantity of resources.

The assumptions for this model are as follows:

• Resources are limited.

• The economy can produce only two goods.

• It is a closed economy

• Factors of production are not equally productive.

• The state of technology is constant.

Figure 1.2 is an illustration of the PPC model. All points on the PPC show the combinations of two goods that can be produced when all resources are used. Points within the PPC show the combinations of outputs when some resources are not utilised.

Point A in Figure 1.2 is a combination that an economy is unable to produce. This means the economy lacks resources to produce any combination beyond the PPC. Thus, point A illustrates the concept of scarcity.

Point B and point C, or any point on the PPC, represent the alternatives available to an economy. This means the economy can choose to produce at

Production possibility curve (PPC) has always been a popular examination topic. Pay heed to the reasons for the shape and shift of the curve.

KEYWORD

A closed economy is one where there is no trade with other countries

Figure 1.2 Production possibility curve (PPC)

KEYWORD

point B or point C, depending on whether it wants to produce more capital or consumption goods. Points B and C therefore illustrate the concept of choice.

Moving from point B to point C, the increase in consumption goods is achieved by forgoing an amount of capital goods. The capital goods forgone represent the opportunity cost of producing extra units of consumptions goods.

Shape of the PPC

The PPC is concave to the origin due to increasing opportunity costs. This is

In Figure 1.3, additional units of consumption goods are represented by the arrows on the x-axis. When more and more consumption goods are produced, more and more capital goods are given up, and vice versa. The opportunity cost of each extra unit of consumption goods therefore rises. This also shows the concept of increasing marginal rate of substitution

For example, resources such as land are suited only for some types of production. Some land may be more suitable for planting watermelon, while others mango. If resources are to be taken out from the production of one good for another, the least productive factor will be taken out first, followed by the second and the third least productive. Hence, opportunity cost increases.

Consumption goods

Figure 1.3 PPC with increasing opportunity costs

Marginal rate of substitution is the rate at which one good is substituted with another

If resources are equally productive, then the PPC would be a straight line or, in mathematical terms, linear. A linear PPC shows a constant marginal rate of substitution or simply constant opportunity costs, as seen in Figure 1.4.

Causes and consequences of shifts of a PPC

Over time, the PPC may shift outwards. An outward shift means the productive capacity of an economy has increased. Economists term this ‘economic growth’, which is illustrated in Figure 1.5.

There are a few reasons for an outward shift to happen:

• Increase in the labour force. An influx of foreign workers can cause the labour force to expand. Higher birth rates can also increase the size of the labour force in the long term.

Figure 1.4

A linear PPC with constant opportunity costs

Figure 1.5

An outward shift of the PPC

• Training and education. A skilled and educated workforce can raise productivity in an economy.

• Advancement in technology and increase in investment. These will cause the capital stock of an economy to increase. With more capital goods, the productivity of workers will also increase.

• Increase in land resources. An example is the discovery of new minerals such as oil, coal or iron.

• Increase in transportation and telecommunication infrastructure. Examples include new highways, more efficient airports, sophisticated ports, and high-speed fibre-optic broadband. Such infrastructure lowers the cost of doing business, making an economy more efficient and

In unusual circumstances, the productive capacity of an economy may fall, leading to an inward shift of the PPC. Natural disasters, war, pandemics, and a lack of investments in capital goods are some causes of this phenomenon. With natural disasters, workers may perish, and capital goods and infrastructures may be destroyed. An inward shift of the PPC is seen

Combinations within the PPC

An economy that produces a combination within the PPC implies two things. First, the economy is not using all of its available resources. This means some resources are left idle or unemployed. Second, an increase in the output of one good will not incur any opportunity cost for the other good.

Consumption goods

Figure 1.6

An inward shift of the PPC

REVIEW QUESTIONS

1. Describe the factors that can lead to an outward and inward shift of the production possibility curve (PPC).

2. How can the concept of opportunity cost be explained in the PPC model?

3. What is the difference between economic growth and economic recovery? Use the PPC model to explain your answer.

4. Assuming an economy produces only cars and clothes, explain, using diagrams, what happens to a country’s PPC when:

• New machinery is purchased to produce cars.

• The level of unemployment is reduced.

• Labour joining the workforce is better educated.

• More women enter the workforce.

Answers to these questions can be found on the Sunway University Press website.

Figure 1.7

A combination within the PPC that incurs no opportunity costs

Figure 1.7 illustrates a movement within the PPC (point A to point B) which incurs no opportunity costs in capital goods. This means the production of consumption goods does not require capital goods to be forgone.

COMMON ERRORS

Students often confuse free goods with public goods Note that public goods are economic goods, while free goods are not.

1.6 Classification of goods and services

Free goods and economic goods

Goods are classified into two categories—free goods and economic goods. Free goods are goods that are unlimited in supply. Since they are not scarce, there is no opportunity cost. The air we breathe and the sunlight we enjoy are examples of free goods.

Economic goods meanwhile are goods that are limited in supply. The consumption of these goods will incur an opportunity cost. Wood, for example, is limited in supply. Water, which used to be a free good several hundred years ago, is now scarce and has become an economic good.

We can further divide economic goods into public goods and private goods. The two essential characteristics of public and private goods are rival and

Students often make the mistake of defining public goods as something that a government provides. While it is true that most public goods are, that is only sometimes the case! A government can, and often does, pay private firms to provide goods like streetlights. We determine whether a good is public or private based on the key characteristic of rival and excludable characteristics discussed. The question of who provides the good is irrelevant.

Table 1.1 on the next page summarises the characteristics of public and

Characteristics

Public goods Private goods

Non-rival. Consumption by one does not reduce the amount available for the next person.

Example: Television broadcast.

Watching television will not reduce the amount of broadcast available for the next viewer.

Non-excludable. good is provided, the next person cannot be stopped from using it.

Example: Streetlights. Streetlights on public roads are either provided to all users or none at all. You cannot be stopped from enjoying them.

Other examples Lighthouses and radio transmission.

The free-rider problem is inherent in public goods due to the non-exclusive characteristic.

Additional information

Since you cannot be stopped from using a provided good, most will wait for someone else to pay for the good and be a free rider.

Rival. Consumption by one reduces the amount available for the next person.

Example: Public buses.

When you board a 20-seat public bus, the number of seats available for the next person is 19.

are all examples of private goods, not public goods.

Table 1.1

Characteristics and examples of public goods and private goods

Merit and demerit goods are forms of market failure. Essay questions on them are often linked to government microeconomic intervention.

KEYWORD

Imperfect information is a type of market failure whereby parties to a transaction do not have the same amount of information about a particular good.

Merit and demerit goods

Merit and demerit goods are private goods and are rival and excludable in nature. Both goods can be provided by the private sector. However, when merit and demerit goods are left entirely to the market, they will be underand overprovided due to imperfect information

Imperfect information results in consumers not being fully aware of the benefits of merit goods such as education, insurance and healthcare. The benefits are likely to be appreciated fully only retrospectively. At the point of purchase, some consumers may choose not to buy or consume a merit good, leading to under-consumption. A similar issue arises for demerit goods. When a person consumes alcohol, he is rarely aware of the damage alcohol does to his health in the long term. This leads to over-consumption.

the meaning and examples of merit and Demerit goods

Goods that are socially undesirable and overprovided in the market.

Alcohol and cigarettes.

Overprovided in the market economy due to imperfect information.

Underprovided or overprovided?

consumers do not have full knowledge of the benefits of merit goods, they are not likely to consume them sufficiently.

Example: Parents may not fully appreciate the benefits of sending their children to school if the school charges high fees.

This is because consumers do not know enough about the adverse effects of smoking and alcohol consumption on their health.

Example: Smokers are not fully aware of the harmful effects smoking can bring to their health in the long term.

Table 1.2 below summarises

Table 1.2 Definition and examples of merit goods and demerit goods

REVIEW QUESTIONS

1. Why are merit goods under-consumed and demerit goods overproduced in a market economy?

2. Can you think of examples of goods that were free goods several hundred years ago but have now become economic goods?

3. Which of the following items are public goods and which are private goods? Explain your answers.

• Public telephone.

• Public bus.

• Public toilet.

• Armed forces.

• Streetlights.

4. Can a government provide economic goods?

5. Is it possible for the private sector to provide public goods?

Answers to these questions can be found on the Sunway University Press website.

PAST-YEAR QUESTIONS

(a) Explain, with the help of examples, how imperfect information among consumers affects their consumption of merit goods and demerit goods.

(b) Discuss why in most mixed economies, resources are mainly allocated using market forces and the price mechanism.

Cambridge International AS & A Level Economics 9708 Paper 21 Q2 a & b, October/November 2020

(a) Explain, with the aid of a production possibility curve (PPC) diagram, why scarcity makes choice inevitable for firms and how each choice has an opportunity cost. [8]

(b) Discuss the view that the only goods a government should produce are public goods. [12]

Cambridge International AS & A Level Economics 9708 Paper 21 Q2 a & b, May/June 2020

1.

2.

3. (a) Explain, with the help of diagrams, how (i) constant and (ii) increasing opportunity costs determine the shape of an economy’s production possibility curve. [8]

(b) Discuss what the most significant issues of transition are that a country will face as it moves from a planned economy to a mixed economy. [12]

Cambridge International AS & A Level Economics 9708 Paper 21 Q2 a & b, May/June 2019

4. (a) Outline the functions of the factor enterprise in a modern economy, and explain how enterprise responds to a rise in the demand for a good. [8]

Discuss why some goods and services are provided by private enterprise and others are provided by the government in a mixed economy. [12]

Cambridge International AS & A Level Economics 9708 Paper 21 Q3 a & b, May/June 2016

Explain the difference between private goods and public goods, and why it is possible for a business to make a profit in the supply of private goods but not in the supply of a public good. [8]

Discuss the view that a market economy is always preferable to a planned economy because of the existence of the price [12]

Cambridge International AS & A Level Economics 9708 Paper 21 Q3 a & b, May/June 2014

Answers to these questions can be found on the Sunway University Press website.

FURTHER READING

Bootle, R. (2019). The AI economy: Work, wealth and welfare in the age of the robot. Nicholas Brealey.

Brafman, O., & Brafman, R. (2008). Sway: The irresistible pull of irrational behavior. Doubleday & Co.

Buchholz, T. G. (1990). New ideas from dead economists: An introduction to modern economic thought. Plume Books.

Harari, Y. N. (2015).

Harford, T. (2017). Riverhead Books.

Klein, G., & Bauman, Y. (2010). (Volume I: Microeconomics)

Klein, G., & Bauman, Y. (2010). (Volume II: Macroeconomics)

Landsburg, S. E. (1993). everyday life. Free Press.

Varoufakis, Y. (2013). how capitalism works—and how it fails Trans.). Farrar, Straus and Giroux.

Wheelan, C. (2002). W. W. Norton & Company.