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Economics Paper 1 – EC
Distinguish between decreasing returns to scale and the law of diminishing returns. - definitions of decreasing returns to scale and the law of diminishing returns theory of costs, particularly short run and long run, with reference to fixed and variable costs diagrams to show a long run average total costs curve with increasing, constant and decreasing returns to scale, and diminishing returns to one factor of production in the short run examples such as agricultural labour or natural monopoly. Using diagrams, compare and contrast the market structure of monopoly with that of perfect competition. - definitions of monopoly, perfect competition theory of the firm, how both monopoly and perfect competition have their advantages and disadvantages in terms of efficiency, price and output diagram to show the possible market outcomes under monopoly and perfect competition examples of natural monopolies, agricultural markets synthesis and evaluation (compare and contrast). Factors considered may include: the effects on efficiency, welfare effects, price and output, research and development and economies of scale. Points of comparison could be that they both profit maximise and can both make abnormal profits in the short run. Candidates may obtain level 3 where they have discussed the two market structures in terms of their respective advantages and disadvantages. Level 4 is for those who compare and contrast. Explain the factors which might influence the cross price elasticity of demand between different products. - definitions of cross price elasticity of demand theory to include explanation of formula, significance of positive and negative coefficient of cross price elasticity. Emphasis is likely to be on complements and substitutes. diagrams to show markets where the change in price of one good influences demand for another good positively (substitutes) or negatively (complements) examples of substitutes, complements and unrelated goods. Examine the importance of income elasticity of demand for the producers of primary products, manufactured goods and services. - definitions of income elasticity of demand, primary products
theory of the importance of income elasticity for producers of primary products, manufactured goods and services diagrams to show the effect of differing coefficients of income elasticity of demand examples of different types of primary products, manufactured goods and services synthesis and evaluation (examine). Examination may include: knowledge that a change in income will have differing effects on the three types of products specified in the question necessitating different strategies for the producers of these products, for example, diversification, value added. Using a diagram, describe how expansionary monetary policy might be used to close a deflationary (recessionary) gap. - definitions of expansionary monetary policy, deflationary (recessionary) gap theory of the mechanism through which expansionary policy can help close a deflationary gap diagram to show expansionary monetary policy shifting the AD curve with effects dependent on the shape of the AS curve (neoclassical/Keynesian) examples of policies which might be used such as reducing the rate of interest. Discuss why, in contrast to the monetarist/new classical model, an economy can remain stuck in a deflationary (recessionary) gap according to the Keynesian model. - definitions of monetarist/new classical model, deflationary (recessionary) gap, Keynesian model theory of why deflationary (recessionary) gaps can persist according to the Keynesian model whereas they cannot in the monetarist/new classical model diagrams to show monetarist model and Keynesian model examples such as Japan in the 1990s synthesis and evaluation (discuss). Discussion may include: the Keynesian argument that deflationary (recessionary) gaps persist because of the inability of wages and prices to fall and the Keynesian assumption that the AS curve has a long, horizontal section meaning that equilibrium GDP is lower than potential GDP. In the monetarist model, wages and prices are assumed to be flexible, allowing markets to clear thus maintaining full employment of resources. Explain how labour market reforms may be used to promote economic growth. - definitions of labour market reforms, economic growth
Discuss the effectiveness of government policies (legislation and regulation) to reduce monopoly power.
- definitions of monopoly power and legislation (anti-monopoly, anti-collusion, merger prevention etc.) and regulation (lower prices and larger quantities for consumers, fair prices for natural monopolies)
- theory of how a monopolist's control of price or output might be reduced by legislation or regulation in the interests of the consumer
- diagram to show a comparison of monopoly and perfect competition; diagram to illustrate price regulation showing monopoly charging a price which is equal to average cost
- examples of legislation, regulation, and also other solutions such as nationalization, privatization and trade liberalization
- synthesis and evaluation (discuss). Discussions may include: effectiveness of policies against the sources of monopoly power, eg reduction of legal barriers to entry, control of anti-competitive behaviour. Where natural monopoly occurs, restrictive policies might not be in the consumer's interest. Government policies might be rendered less effective by globalization. Government policies might move a market from monopoly towards a market structure which gives rise to allocative efficiency. Using diagrams, explain how the incidence of an indirect tax may be affected by the price elasticity of demand. - definitions of an indirect tax, price elasticity of demand, incidence of taxation
- theory of how relative price elasticities influence the proportionate sharing of an indirect tax burden between producers and consumers
- diagrams to show incidence of an indirect tax on consumers and producers for goods with elastic and inelastic demand curves, showing that the more elastic the demand, the greater the incidence on the producer, and vice versa
- examples of goods with differing price elasticities of demand and the resulting differences in their incidence of taxation. To what extent might the problems of negative externalities of consumption be resolved by the use of indirect taxation? - definitions of negative externalities of consumption, indirect taxation
- theory of externalities with its implications for overconsumption/
under-pricing and the opportunity to attempt to correct misleading market signals through an indirect tax
- diagrams to show a negative externality of consumption being abated by the use of indirect taxation
- examples of (demerit) goods, with negative externalities of consumption, which are subject to indirect taxes
- synthesis and evaluation (to what extent). Consideration of the merits of the statement may include: the difficulty of setting indirect taxes at the correct level to reduce the negative externality to the social optimum/redress specific damage. Candidates may choose to set this response in the context of market failure. Explain why the market system may not result in an equitable distribution of income. - definitions of market system, equitable distribution of income
- theory of why market systems may not result in an equitable distribution of income, for example private ownership of factors of production in the face of minimal intervention by the government may lead to unequal returns
- diagram to show an indicator of income equality/inequality, ie a Lorenz Curve diagram or a diagram showing income distribution by quintiles, deciles etc
- examples of economies with more unequal distribution of income, (eg Brazil), or less unequal distribution of income (eg Sweden). Evaluate government policies to promote equity in terms of their effects on efficiency in the allocation of resources. - definitions of equity, efficiency in the allocation of resources
- theory of how government policies (taxation, government expenditure on merit goods and subsidies and transfer payments) may promote equity but possibly reduce efficiency in the allocation of resources
- diagrams to show indirect taxes and subsidies and their implications for efficiency in the allocation of resources
- examples of government policies to promote greater income equality in
a definition of market failure a definition of negative externalities examples of negative externalities an explanation of over-provision at the free market price in the case of negative externalities Answers may include: use of diagram(s) to illustrate the above. Evaluate three policies that governments might implement to reduce negative externalities associated with the environment. - Answers may include: an explanation of negative externalities associated with the environment (e.g. pollution, climate change, deforestation, over-fishing) an explanation of three appropriate policies, such as legislation, taxation, tradable permits, extension of property rights, international cooperation an evaluation of each of the three policies chosen. Effective evaluation may be to: consider short-term versus long-term consequences examine the impact on different stakeholders discuss advantages and disadvantages prioritize the arguments. Explain how supply-side improvements to an economy may be achieved through the use of taxes and government spending. - Answers should include: an explanation of "supply-side improvements" use of AD/AS diagrams an explanation of how taxes and government spending may be used to affect AS, e.g. through:
- greater government spending on healthcare, education and training
- less government spending on benefits
- a reduction in income tax to increase work incentives
- lower corporation tax to encourage investment
- lower indirect taxes to reduce business costs. Answers may include:
distinction between SRAS and LRAS. Evaluate the use of supply-side policies to reduce unemployment. - Answers may include: a definition of unemployment a definition of supply-side policies examples of supply-side policies the concept of a natural rate of unemployment the importance of the different types of unemployment, e.g. demand deficient, frictional and structural an explanation of how supply-side policies may work to reduce unemployment in the longer term use of AD/AS analysis, showing LRAS shifting to the right an assessment of the effectiveness of such measures unemployment beyond the control of national governments, e.g. arising from demand-side shocks or international recession consideration of the use and effectiveness of alternative short-term demand-side measures to reduce unemployment, i.e. fiscal and monetary policies an evaluation of the effectiveness of particular supply-side policies, e.g.:
- taxcuts
- cutsinwelfarebenefits
- education and training/retraining
- privatization/deregulation
- tradeunionpolicies. Effective evaluation may be to: consider short-term versus long-term consequences examine the impact on different stakeholders discuss advantages and disadvantages prioritize the arguments. Explain two factors which may cause a depreciation of a country's exchange rate. - Answers should include: a definition of exchange rate an explanation of depreciation
a definition of economic growth an explanation of reasons for differences which may include: - naturalfactors
- human factors
- physical capital and technological factors
- various institutional factors. Answers may include: illustration of growth using a PPC diagram reference to the Harrod-Domar growth model effects on growth of different strategies, e.g. export-led versus import substitution reference to the compound nature of growth in the effects of varying growth rates over time examples of particular countries. Evaluate the role of foreign direct investment in assisting a developing country to achieve greater growth and development. - Answers may include: a definition of development a definition of growth an explanation of FDI a distinction between growth and development MNCs as the main agents of FDI FDI and the impact on AD and AS FDI as part of a market-led/outward-orientated growth strategy FDI and the distribution of income and wealth FDI and the creation of "dual" economies FDI as part of IMF/World Bank structural adjustment programmes, including privatization of utilities the impact of FDI on employment FDI and multiplier/accelerator effects the impact of FDI on rural/urban migration FDI and the tax base FDI and the destination and use of profits
FDI and the allocation of scarce resources (towards MNC production rather than the needs of the population) the impact of FDI on the environment FDI and the vulnerability of the host country to global cities examples from particular countries. Effective evaluation may be to: consider short-term versus long-term consequences examine the impact on different stakeholders discuss advantages and disadvantages prioritize the arguments. Explain the importance of price elasticity of demand and cross-elasticity of demand for business decision-making. - Answers should include: a definition of PED a definition of XED the link between PED, price changes and changes in total revenue the importance of XED in terms of changes in price of substitutes and complements examples of PED and XED in real life (products with high/low elasticities; products related are complements or substitutes). Answers may include: an explanation that PED and XED are extremely difficult to accurately measure in reality use of diagrams to show the relationship between PED, price changes and changes in total revenue use of diagrams to illustrate the complement/substitute relationship. Studies have shown that the demand for tobacco tends to be highly price inelastic. Evaluate the view that governments can best reduce smoking by substantially increasing taxes on cigarettes. - cigarettes as an example of market failure having the characteristics of demerit goods use of an MSC/MSB diagram to show the negative externalities associated with the consumption of cigarettes, candidates may use a simple supply and demand diagram an explanation of inelastic demand and the implications for a tax on cigarettes; low PED means a tax may not lead to a significant decrease in quantity of cigarettes demanded distinction between inelastic demand for tobacco in general and elastic demand for particular brands the incidence of taxation may be considered
the implications of using higher interest rates in dealing with cost inflation other measures to deal with inflation, e.g. supply-side policies the problem of time lags interest rates as a highly flexible tool of economic policy the distributional impact of higher interest rates on savers and borrowers overall assessment. There has been an increasing trend in different parts of the world for countries to engage in economic integration through the formation of trading blocs. Using suitable examples, explain the different types of trading bloc that may be formed. - Answers should include: an explanation of economic integration through trading blocs an explanation of free trade areas an explanation of customs unions an explanation of common markets suitable examples. Answers may include: an explanation of preferential trading areas an explanation of complete economic integration an explanation of progress towards monetary union. Evaluate a country's decision to join a free trade area (FTA). - Advantages: possibility of economies of scale larger export market increased competition leads to efficiency and lower prices in the long run productive and allocative efficiency possibility of increased foreign investment as a way to get inside market greater consumer choice of products transfer of labour and capital within the free trade area fosters political stability trade creation. Disadvantages: increased competition can force inefficient domestic producers out of the market
domestic workers may be unemployed competition may only exist in the short run. In the long run, firms may merge to keep control of their markets and an oligopolistic or monopolistic market structure in the free trade area can result. Higher prices may be the outcome the transfer of resources within the free trade area may not be even can damage multilateral trading negotiations (WTO). Explain the difference between economic growth and economic development, and how each of these may be measured. - Answers should include: a definition of economic growth a definition of economic development an explanation that economic growth is a quantitative concept whereas economic development is more qualitative an explanation that economic growth is measured by the increase in real national income over a period of time, whereas economic development, in addition to the latter, could also include a whole variety of other measures such as schooling, life expectancy, provision of healthcare, income distribution, political freedoms etc. (just a few examples would suffice). Answers may include: a production possibility diagram to illustrate the difference between economic growth and economic development a mention of specific indices such as the HDI or HPI. Evaluate the view that the best way that developed countries can help the growth and development process of very poor, highly indebted countries is through a general cancellation of debts. - a definition of developing, highly indebted countries examples of such countries arguments for debt cancellation in terms of the problems of debt, e.g. the opportunity cost of debt repayments, the impact on development, the gearing of the economy towards exports, the potentially serious implications of the problem on absolute poverty arguments against debt cancellation,. e.g. the danger of moral hazard, debt forgiveness and the creation of a dependency culture, the rewarding of irresponsible governments and penalizing of committed ones, debt as one of just many causes of poverty in developing countries alternatives to debt cancellation such as aid or trade agreements the role of the IMF and World Bank, e.g. through structural adjustment programmes
Explain why a country may wish to reduce its unemployment rate. - an explanation of the unemployment rate an explanation of the types or components of unemployment an explanation for wishing to reduce unemployment in terms of the various costs of unemployment. This may include the impact on:
- the unemployed themselves e.g. reduced income, stress levels, self-esteem
- societye.g.poverty,crime,vandalism
- economy as a whole e.g. actual output is less than potential output (to the left of the LRAS curve); or economy is at a point inside the PPC
- opportunity cost of government spending on unemployment benefits, less tax revenues available for other purposes a government might wish to reduce unemployment in order to raise tax revenue. Evaluate the likely effects on the economy of relying on demand-side policies to reduce the unemployment rate. - an explanation of the use of interest rates to reduce the unemployment rate an explanation of the use of increased government spending/lower taxation levels to reduce the unemployment rate an explanation of the linkage between lower interest rates and AD an explanation of the "crowding out" effect resulting from government borrowing to increase government spending an explanation of the linkage between increased government spending and lower taxation and AD a consideration of the suitability of demand-side policies for different types of unemployment the impact on output, growth, inflation and the balance of payments use of AD/AS diagrams AD moving to the right causes inflation on the vertical part of the AS curve the inappropriateness of lower interest rates/higher government spending/ lower taxation in dealing with real-wage or natural unemployment demand-side measures effective against demand-deficient unemployment supply-side measures to deal with unemployment the problems associated with increased government spending (running a budget deficit) the problem of inelastic response of consumption and investment to lower interest rates the problem of time lags.
There has been an increasing trend in different parts of the world for countries to engage in economic integration through the formation of trading blocs. Using suitable examples, explain the different types of trading bloc that may be formed. - Answers should include: an explanation of economic integration through trading blocs an explanation of free trade areas an explanation of customs unions an explanation of common markets suitable examples. Answers may include: an explanation of preferential trading areas an explanation of complete economic integration an explanation of progress towards monetary union. Evaluate a country's decision to join a free trade area (FTA). - Advantages: possibility of economies of scale larger export market increased competition leads to efficiency and lower prices in the long run productive and allocative efficiency possibility of increased foreign investment as a way to get inside market greater consumer choice of products transfer of labour and capital within the free trade area fosters political stability trade creation. Disadvantages: increased competition can force inefficient domestic producers out of the market domestic workers may be unemployed competition may only exist in the short run. In the long run, firms may merge to keep control of their markets and an oligopolistic or monopolistic market structure in the free trade area can result. Higher prices may be the outcome the transfer of resources within the free trade area may not be even can damage multilateral trading negotiations (WTO).
explanation of term market structure identification of the different types of market structure, i.e. perfect competition, monopoly, monopolistic competition and oligopoly explanation that there are no barriers to entry in perfect competition linkages between no entry barriers and perfect competition and monopolistic competition explanation that entry barriers exist in the other market forms linkages between the existence of entry barriers in monopoly and oligopoly and market structure Evaluate the view that monopoly is an undesirable type of market structure. - definition of monopoly at least one appropriate diagram comparisons between monopoly and perfect competition, e.g. price usually higher and output lower allocative and productive inefficiency failure by monopolist to produce at the socially optimum level of output lack of choice for consumers lack of innovation and higher unit costs because of absence of competition possibility of lower unit costs and prices owing to economies of scale long run dynamic efficiency in monopoly benefits of natural monopoly benefits to some consumers of monopolistic price discrimination potential competition and contestable markets Explain why a government might find it difficult to maintain a low rate of inflation as the economy approaches full employment - definition of inflation and full employment use of the Phillips Curve (PC) to illustrate the trade off between full employment and price stability (short-run and/or long-run). A relevant diagram referring to AD/AS is also acceptable explanation of the PC relationship in terms of possible demand pull factors explanation of the PC relationship in terms of possible cost push factors explanation in terms of AD/AS analysis explanation in terms of the natural rate of unemployment
Evaluate the proposition that the priority in economic management should be the maintenance of low unemployment. - explanation of economic management in terms of fiscal and monetary policies support of the proposition in terms of the costs of high unemployment, e.g. the economic, social, financial and personal costs use of long run PC and the concept of the natural rate of unemployment to illustrate the possible inflationary implications other possible policy conflicts, e.g. with the balance of payments and economic growth the importance of the other goals of economic policy, i.e. low inflation, economic growth and a satisfactory balance of payments significance of the use of supply-side policies Explain the various factors which may affect an exchange rate in a floating exchange rate system. - definition of exchange rate and floating exchange rate system explanation in terms of the demand for, and supply of, a currency an appropriate diagram trade flows capital flows/interest rate changes changes in the level of national income inflation speculation use of foreign currency reserves significance of purchasing power parity Evaluate a government decision to adopt a floating exchange rate as opposed to a fixed exchange rate system. - distinction between a floating and fixed exchange rate system support of the decision in terms of the possible advantages of floating/disadvantages of fixed exchange rates, which may include
- benefits of market forces setting exchange rates rather than governments
- no need to keep substantial foreign exchange reserves
- impact on domestic economic policies
- automatic adjustment of the balance of payments
- possibility of forward trading to hedge against currency movements
- greater incidence of crises under fixed schemes
