AQA Economics AS Level Technocrat Notes The Operations of Markets and Market Failure PDF

Year 1 (AS) - ECONOMICS
The Operation of Markets and Market

Failure
By The Technocrat Team
AQA
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CONTENTS
Notes
OUR MISSION 2
HOW TO USE OUR GUIDES 3
3.1.1 Economic methodology and the economic problem 6
Economic methodology 6
The nature and purpose of economic activity 6
Economic resources 7
Scarcity, choice and the allocation of resources 7
Production possibility diagrams 7
3.1.2 Price determination in a competitive market 9

The determinants of the demand for goods and
Services 9
Price, income and cross elasticities of demand 11
The determinants of the supply of goods and
services 17
Price elasticity of supply 18
The determination of equilibrium market prices 21
The interrelationship between markets 23
3.1.3 Production, costs and revenue 25
Production and productivity 25
Specialisation, division of labour and exchange 25
Costs of production 26
Economies and diseconomies of scale 27
Average revenue, total revenue and profit 28
3.1.4 Competitive and concentrated markets 29
Market structures 29
The objectives of firms 30
Competitive markets 30
Monopoly and monopoly power 30
The competitive market process 32
3.1.5 The market mechanism, market failure and

Government failure 32
How markets and prices allocate resources 32
The meaning of market failure 33
Public goods, private goods and quasi-public goods
Positive and negative externalities in
Consumption and production 33
Merit and demerit goods 34
Market imperfections 35
An inequitable distribution of income and wealth 36
Government intervention in markets 36
Government failure 46
BREAKDOWN OF EXAMINATION 49
THE KEY TO DOING WELL 49
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3.1.1 Economic methodology and the

Notes economic problem
3.1.1.1 Economic methodology

 Economics is a social science so human society
and relationships are the focus. In this area
Economics focuses on the allocation of
resources.
 Microeconomics is the study of smaller
markets like the housing market.
 Macroeconomics is the study of the market in
aggregate via markets on a national and global
level.
 A system in which resources are allocated is an
economy.
Positive and Normative Statements

 There are positive and normative statements in
economics with positive statements being a fact
and normative being an opinion (value
judgement). For instance, Normative would be,
increasing government spending is the
government’s best option during a recession.
While positive would be, CPI inflation was
2.7% in October 2012.
 The use of the word unfair or fair in a statement
shows us that the statement is opinion based and
thus normative.
 Positive statements are objective and can be
tested or proven to be true or false.
 Normative is Subjective.
3.1.1.2 The nature and purpose of

economic activity
 The central purpose of economic activity is the
production of goods and services to satisfy
consumer needs and wants.
 The main Economic questions are what to
produce, how to produce it and who is to benefit
from the goods and services produced.

Notes 3.1.1.3 Economic resources
 Resources are organised into land, labour, Capital

and enterprise. These are known as the factors of
production.
 These resources are scarce.
3.1.1.4 Scarcity, choice and the

allocation of resources.
 The fundamental economic problem is scarcity

and this results because we are faced with finite
resources and unlimited wants.
 Because of scarcity, choices must be made as to
how resources are allocated against a range of
other possible uses. Therefore, resources carry
an opportunity cost in their use.
 Opportunity cost is the next best
alternative/alternatives forgone.
3.1.1.5 Production possibility

diagrams
 The Production possibility diagram (PPF) is a
diagrammatic representation of the maximum
potential of an Economy when Resources are
completely and efficiently employed for two
goods or services.
Output
of
A
Onions D
Y Z
Output of Carrots
Figure 1: PPF Diagram

 Point A and B are on the curve and so both of these

Notes different combinations of Carrot and Onion output are at
the highest level of efficiency for the Economy. These
Points are productively efficient.
 Productive efficiency is when we can’t produce any more
goods without sacrificing the production of carrots or the
onions.
 Not all points on the PPF boundary possess

Allocative efficiency.
 Allocative efficiency is when goods are allocated to
represent what consumers want. For instance, point B
is on the boundary but may not represent what
consumers want in the Economy and so is
allocatively inefficient.
 The PPF also shows Opportunity cost. For instance,
by switching output from B to A, we produce more
Onions and this results in an opportunity cost of YZ.
 Law of diminishing returns can be applied to the
PPF. For example, by producing more carrots we
squander an increasing output of Onions just to
obtain a diminishing additional output of Carrots.
The same concept can be applied in reverse. These
trade offs explains the Bowed shape of the PPF.
 Point D is unattainable because it’s beyond the
boundary.
 Whilst point C is produced where there is
underutilisation of factors of production in the
economy such as unemployment of labour.
Therefore, resources are being used inefficiently.
Output
of
Onions
Output of Carrots
Figure 2: PPF Diagram 2

Notes  Economic Growth is represented by a shift

outwards. Negative Economic growth is
represented by a shift inward.
 Economic growth caused by:
 Improvements in Technology E.g.
Agricultural methods such as
genetically modified Carrots and
Onions making them immune to pests.
 Improvements in Factors of production
efficiency behind the creation of
Carrots and Onions.
 Negative Economic growth caused by:
 Natural disasters E.g. Wildfire burning
the Onion and carrot crops.
3.1.2 Price determination in a competitive
market
3.1.2.1 The determinants of the demand

for goods and services
 Demand is the quantity of a good or service
that consumers in the market can buy for a
given price. This can be plotted on a graph as
demonstrated by figure 3.
 Demand is downward slopping because at
lower prices this good becomes more attractive
to consumers and so more consumers buy the
product.
Price A
Figure 3: Demand Curve Quantity

Notes  Movement from B to A is a contraction in demand.

While movement from A to B is an expansion in
demand. Never use the words increase or decrease to
describe these changes. These are movements or
expansions or Contractions.
Price
D2
D1
D3
Figure 4: Demand Curve shifts Quantity

 The Shift Outward from D1 to D2, represents an
increase in demand.
 While Shift inwards from D1 to D3, represents a
decrease in demand.
Factors which determine the demand for a good or service.
 Use RITSEN acronym.
RITSEN
Rural - Related goods
Idiot - Income
Turkeys – Tastes
Start - Season
Exciting - Expectations
Novels - Number
 Related goods:
 Price of substitutes – expensive
substitute means that demand for the
product will shift outward. For
example, the new apple laptop is too
expensive so more people may choose
to get HP laptops instead.
 Price of complements – cheap
complements means that the goods
price will increase due to the outward
shift in demand. Like cheap printer ink
meaning shift forward in demand for
printers.
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Notes  Income – Generally, when income is higher

more people will have additional cash available
to bid the price of goods up by shifting the
demand curve out.
 Tastes (or fashion) – Once a good becomes
more popular or preferred amongst the
population. Demand will shift. For example, the
recent surge in Segway popularity meant higher
prices.
 Season (or weather) – Price of coats are
typically more expensive during the winter
because of the shift in demand.
 Expectations- For example, buyers in the
market feel that the price of the good in the
market will go up. Will buy more in
anticipation and later sell at that higher price to
make a profit. This is a common strategy in
financial markets.
 Number- Number of buyers increasing means
an increase in demand.
Factors influencing consumer behaviour (Not to be
confused with determinants of demand)
 Price- the lower price means more spending.
 Income-higher income usually means higher
spending.
 Wealth- those who are wealthy tend to be able
to spend more and so are likely to spend more.
 Price of substitutes – when substitutes are
cheap the consumer will buy the substitute
instead.
 Price of Complementary goods- For instance,
when printer ink is cheap, then the consumer is
more likely to buy a printer.
 Individual preferences -if you have a certain
preference for a product you tend to buy more
of it. These preferences can be influenced
through marketing and advertising
Social factors
 We maintain buying habits which occurred when
we were growing up. In other words we continue
buying brands/goods our parents bought for us.
 Social roles and status – commonly seen with
luxury brands. E.g. A CEO buying a Ferrari to
convey their status and importance.
Emotional factors
 Positive images and feelings associated with a
brand yields higher consumer loyalty. E.g.
Brands sometimes attach a comical character to
their brand, a good example is Go compare.

 Narrative behind the good/brand. If

Notes
consumer cares deeply for what it represents
then they will buy more of it. E.g. Apple
IPhone and the Steve Jobs story behind it.
3.1.2.2 Price, income and cross elasticities

of demand.
MUST MEMORISE ALL FORMULAS BELOW!!!
ADVISIBLE TO ANNOTATE THE DIAGRAMS
BELOW FURTHER YOURSELF!!!
Price Elasticity of demand (PED)
 PED is the sensitivity of quantity demanded
once price is changed.
Formula for Price elasticity %∆𝑄𝐷

of demand (PED):
%∆𝑃
 Because the demand curve is downward
slopping it means that the answer for PED
will be negative.
Elastic Demand Curve
Price
A2
A1
Quantity
Figure 5: Elastic demand curve
 PED<-1. (e.g. -2 is elastic)

 It’s described as elastic as you can see, the
consumer is highly sensitive to a change in
price. Since, Quantity demanded moves by a
greater proportion compared to the proportion
price moves by.
 The fact the percentage change of quantity
demanded is larger than the percentage change
of price explains why PED is less than -1 if you
look at the formula.
 Shallow gradient.
 With increases in price, total revenue decreases.
Hence, A1>A2

Total Revenue = Total Expenditure

Notes
Think of Total expenditure as how much all consumers
spent in total. While total revenue is how much all the
suppliers are getting in total.
Inelastic Demand Curve
Price
A2
A1
Quantity
Figure 6: Inelastic Demand curve
 PED >-1
 It’s described as inelastic as you can see,
the consumer has extremely low
sensitivity to a change in price. Since,
Quantity demanded moves by a smaller
proportion compared to the proportion
price has moved by.
 The fact proportion (percentage) of
quantity demanded is smaller than the
proportion (percentage) of price explains
why PED is smaller than -1 if you look at
the formula.
 Steep gradient
 With increases in price Total revenue
increases. Hence, A2>A1.
Unitary Elasticity
Price
A2
A1
Quantity
Figure 7: Unitary Demand Curve

Notes  PED=-1
 Each percentage change in price is matched by an
equal percentage change in quantity.
 Changes in price in any direction leads to no
change in TR. Hence, A1=A2.
Perfectly Inelastic
Price
A2
A1
Quantity
Figure 8: Perfectly Inelastic Demand Curve
 Perfectly inelastic
 PED=0
 Consumers are completely not sensitive to
changes in price. Still demanding the same
quantity regardless the price
 TR increases with price. A2> A1.
Perfectly Elastic
Price
A1 = ∞
Quantity
Figure 9: Perfectly Elastic Demand Curve
 Perfectly elastic
 PED= -∞
 At a single price consumers will buy an
infinite quantity.

Notes  TR is infinite for a given price because

consumers are buying an infinite quantity. TR
is 0 at all other prices.
Income elasticity (YED).
 In Economics Y is used as a symbol for Income.

 YED is the sensitivity of quantity demanded
once a change in income has occurred.
Normal Goods
Y D
QD
Figure 10: Normal Good Demand Curve
 YED= positive because it slopes upwards

 Increases in incomes causing increase in
demand. E.g. Luxury products like
Burberry Bags
Inferior Goods
D
QD
Figure 11: Inferior Good Demand Curve
 YED= negative because it slopes downwards

 Inferior goods. Increase in incomes causing
decrease in demand. Tesco Brand Beans.

Cross Elasticity of Demand (XED)

Notes
 Cross elasticity of demand is the sensitivity

of quantity demanded of one good (good x)to
a change in price of another good (good y).
XED Formula =
%∆𝑄𝐷 𝑜𝑓 𝑋
%∆𝑃 𝑜𝑓 𝑌
Complementary Goods
Price
Of Y
Quantity Demanded Of X
Figure 12: XED Curve
 Complements are goods which go well
when used together. E.g. Printers and printer
tonner.
 Complementary goods have a downward
slopping curve and so have a negative XED.
Essentially meaning that once one good
increases in price the demand for the other
one will fall.
 Complements are in joint demand
D
D
Weak Complements - Strong (Close)

Big changes in price of complements - a small
one good leads to small change in price leads
movement in quantity to a big change in
demanded of the other. quantity demanded of
the other good.
Figure 13: Comparisons of type of complements

Substitutes Goods
Notes
Price D
Of Y
Quantity Demanded Of X
Figure 14: Substitute goods XED demand
curve
 Substitutes are goods that can be used
instead of the other. E.g. Samsung phone
vs IPhone.
 The curve is upward slopping and so
increases in price of good X will lead to
an increases in quantity demand of good
Y. Therefore, XED is Positive.
Strong (Close) Weak substitutes - a

Substitutes - a small big change in price of
change in price of one one good leads to a
good leads to a big small change in
change in the price of quantity demanded.
the other good.
Figure 15: Comparisons of type of complements
Unrelated Goods
D
Figure 16: Unrelated goods diagram

Notes  Unrelated Goods. Changes in price of one

good doesn’t lead to a change in quantity
demanded of the other good. E.g. Price of
Pencils against the demand for Chocolate.
 XED of 0.
3.1.2.3 The determinants of the supply of

goods and services
 Supply curve shows the relationship between

price and quantity supplied.
Why do Supply curves slope upwards?
 It’s more expensive for firms to produce at

higher outputs so they must raise their price
in order to cover this.
 Higher prices means higher profits,
providing an incentive to increase
production
Price S
Quantity
Figure 17: Supply curve
Factors shifting the demand curve are determinants of
supply
 Use WTGNCP acronym.
Wiggly - weather
Tigers - technology
Gouge – government
intervention
Naked – Number of firms
Chimps - Costs
Properly – Productivity

Notes Price S2
S1
S3
Quantity
Figure 18: Supply curve shifting
 Weather- E.g. Natural disasters will destroy the

yield of crops and so shift the curve to S2.
 Technology- Advancements in technology will
mean output will increase. E.g. New genetically
modified crop or new irrigation system. Curve
shifts from s1 to s3.
 Government intervention- Subsidies and
indirect taxes. Subsidies are a government
grant given to producers so they can afford to
produce from s1 to s3. While an indirect tax is a
charge imposed on producers so they can’t
afford to produce to s1 so shift to s2.
 Number of firms- Increase in the number of
firms will cause s1 to shift to s3. While decrease
will cause s1 to shift to s2.
 Costs- Increases in costs will mean the firm will
have to pull back to s2 from s1. While decreases
in costs will cause a shift to s3.
 Productivity- Productivity is how much a firm
can produce with its given inputs (factors of
production) for a given period of time (usually
recorded in hours). Improvements in tech also
mean productivity gains. But productivity can
be improved through government policy
(subsidies) and specialisation by the firm.
Shifting the curve to S3.
3.1.2.4 Price elasticity of supply

 PES is the sensitivity of quantity supplied with
respect to quantity demanded.
%∆𝑄𝑆
PES Formula =
%∆𝑃
 Supply curves are upward slopping. Meaning PES
is positive
Elastic Supply Curve

Notes
Price
Quantity supplied
Figure 19: Elastic Supply Curve
 Elastic supply curve

 Pes>1
 Producers are sensitive to changes in price.
Supplying a comparatively larger amount
extra amount with small price increase.
Inelastic Supply Curve
Price S
Quantity supplied
Figure 20: Inelastic Supply Curve
 Inelastic supply curve

 Pes<1
 Producers are not sensitive to changes in
price. Supplying a comparatively smaller
extra amount with large price increase.

Perfectly Inelastic Supply Curve

Notes
Price
S
Quantity supplied
Figure 21: Perfectly Inelastic Supply Curve
 Perfectly Inelastic supply curve

 Pes=0
 Producers are completely not sensitive to
changes in price. Supplying the same amount
regardless of price changes.
Perfectly Elastic Supply Curve
Price
Quantity supplied
Figure 22: Perfectly Elastic Supply Curve
 Perfectly elastic supply curve

 Pes=∞
 Producers supply an infinite quantity at a
certain price.

Unitary supply curve

Notes
Price S
Quantity supplied
Figure 23: Unitary supply curve
 Unitary elastic supply curve

 PES= 1
 Means that a percentage change in price
is matched by an equal percentage in
supply.
3.1.2.5 The determination of equilibrium

market prices
Price S
Pe
Qe
Quantity
Figure 24: Price mechanism/ Market rate
 The intersection of demand and supply is

known as the price mechanism. Price here
is at Pe (equilibrium price) along with Qe
(equilibrium quantity). The equilibrium
price is known as the market clearing
price as well.

Notes Excess Demand
Price S
Pe
P1
Q1 Qe Q2
Quantity
Figure 25: Excess Demand
 The market is at disequilibrium at price

P1. Since, there is excess demand of the
space between Q1 and Q2. Price will be
bided upwards which results in a
contraction in demand from Q2 to Qe.
While the higher price forces an extension
of supply from Q1 to Qe.
Excess Supply (Glut)
Price S
P1
Pe
Q1 Qe Q2
Quantity
Figure 26: Glut
 The Market is at disequilibrium at price P1. Since,
there is excess Supply (glut) of the space between
Q1 and Q2. Since, the good is not scarce it means
that price will have to fall in order to find buyers
and so there is an extension in demand from Q1 to
Qe. While producers supply less due to lower price
causing a contraction in supply from Q2 to Qe.
Eventually reaching the lower equilibrium price.

New Equilibrium
Notes
Price S1
S2
P1
P2
Q1 Q2
Quantity
Figure 27: New equilibrium supply shift
 Shift in supply leads to a new

equilibrium of Q2 and P2.
Price S
P2
P1
D2
D1
Q1 Q2
Quantity
Figure 28: New equilibrium
 Shift in demand leads to new equilibrium

of Q2 and P2
3.1.2.6 The interrelationship between

markets
 Changes in one market can affect other
markets.
Joint demand/Complements
P2 S P2 S
1 1
P1 D2 P1 D2
D1 D1
Q1 Q2 Figure 29: Joint demand Q1 Q2

Printers Printer Ink

 Demand for printers is joint with the demand for

Notes
printer ink. Where demand results from the joint
same group of buyers who all demand more ink
due to demanding more printers.
Derived Demand
P2 S P2 S
1 1
P1 D2 P1 D2
D1 D1
Q1 Q2 Q1 Q2
Cars Figure 30: Derived Demand Steel
 Demand for steel is derived from the demand

for cars. Because steel is used in the
manufacturing of cars. So the supplier of cars is
buying more steel in order to produce more cars
to fulfil the demand shift.
Composite Demand
 Demand for a good results because of the goods

multiple uses. For instance, steel can be used to
make cars and cutlery.
Joint Supply
S S
P2 2 S 2 S
P2
1 1
P1 P1
D D
Q1 Q2 Q1 Q2
Figure 31: Joint Supply
Cotton plant Cotton clothes
 Supply of a good originates from the supply

of another good.

3.1.3-Production-Costs-and-
Notes
Revenues
3.1.3.1 Production and Productivity

 Production is the conversion of factor of
production inputs into final output.
 Productivity - output produced per a factor
input or/and per hour.
 Labour productivity - output produced per a
worker or/and per number of hours worked.
3.1.3.2 Specialisation, division of labour
and exchange
Benefits of Specialisation and Division of Labour
 Division of labour – When the production

process is broken into its constituent parts,
where each individual with in a production
process occupies a specific role. Each
Individual in the production process is
undergoing specialisation.
 Productivity increases so more is produced per
an input. Cost of production per a unit is lower.
 Quality of the good improves as workers
become an expert in their particular role.
 Consumers benefit from lower prices being
passed on because the firm now has lower cost
of production.
 Less time wasted switching between tasks also
means productivity is higher. For instance, if one
person was doing the whole production process
they will waste time switching their task and so
less output results.
Disadvantages
 Monotony and boring nature of the job. Leading to
increased absenteeism.
 The Economy is vulnerable to structural
unemployment because labour is too
overspecialised. Where shifts in the National and
Global Economy could mean that the person can’t
transfer their skills to the new available jobs.

Notes 3.1.3.3 Costs of production

 The short run is when one factor of production
input is variable while all other factor of production
inputs are fixed.
 In the long run all factor of production inputs are
variable.
 Variable costs (VC) are costs which change with
output E.g. Utility bill
 Fixed Costs (FC) stay constant with output. E.g.
Rents
 Total costs (TC) are all the variable costs along
with all the fixed costs.
Total Costs (TC) = Variable Costs (VC) + Fixed Costs (FC)
Average Costs (AC) =

𝑇𝐶
𝑄
Costs
AC
Quantity
Figure 32: Average Cost Curve
 Notice the Shape of the Curve is U shaped

 This is the Shape of AC in the short run
 Shape of the long run average cost (LRAC)
curve is determined by economies and
diseconomies of scale

Notes 3.1.3.4 Economies and diseconomies of

scale
Benefits from Economies of scale: Really Fun
Mums Try Making Pies.
(Really) Risk Bearing – Firms employ diversification

of their product range. E.g.
(Fun) Financial – Larger Firms are perceived as less
likely to Fail by financial institutions and so receive
low interest loans and other forms of cheaper finance
(Mums) Marketing – Marketing budget per a unit falls
as output increases
(Try) Technical/Technology based – Larger Firms can
afford the very best technology
(Making) Managerial – additional managers can be
added and allocated to a specific area or job. Resulting
in efficiency gains through specialisation
(Pies) Purchasing/Monopsony power – Larger firms
are able to put downward pressure on the price of
supplies because they have more bargaining power.
Internal diseconomies of scale think CM (Coordination and

Motivation)
 Coordination – the inner workings of the firm

become too complex for the managers. It’s harder to
make sure the inner workings of the firm are working
together (coordinating) effectively.
 Motivation – more output means more employees.
Employees become demotivated as they feel
insignificant to the firm (or lost in the crowd).
Productivity suffers as a result.
Internal Economies of scale
Costs
Internal
Internal diseconomies
Economies of scale
of scale
Minimum
Quantity
Efficiency
scale Figure 33: labeled AC Curve

Notes External Economies of Scale.
External
diseconomies
of scale
Costs
LRAC
LRAC
LRAC
Quantity
Figure 34: labeled AC Curve 2
External
Economies
of scale
 Occur as a result of improvements or deterioration

with in an industry. E.g. Government spending on
improving infrastructure like more productive power
plants. Results in long run costs for all surrounding
retailers being lower. Moving the retail LRAC down
for the area.
3.1.3.5 Average revenue, total revenue

and profit
 Average Revenue (AR) is how much
consumers pay per a unit
𝑇𝑅
Average Revenue (AR) =
𝑄
 Total Revenue (TR) is how much a firm gets

from the sale of its products.
 Total Revenue (TR) = Price (P) x Quantity (Q)
 Profit= TR - TC

Average Revenue Curve

Notes
Revenue
D is for Demand curve for the
firm’s goods.
AR=D=P
Quantity
Figure 35: AR Curve
3.1.4 Competitive and concentrated
markets
3.1.4.1 Market structures

 There is a range of market structures. Perfect
Competition, Monopoly, Monopolistic
Competition and oligopoly.
Ways to distinguish between market structures:
Acronym= NED.
Number of Firms
Ease of entry (barriers to entry) - into the
market for new firms
Least Degree of product differentiation

competitive  Pure Monopoly - Unique product almost
impossible entry one firm.
 Oligopoly - Few firms’ quite different hard
entry.
 Monopolistic competition - slightly
different products less firms than perfect
competition but more than oligopoly easy
entry.
Most
 Perfect Competition - completely identical
competitive
products very easy entry many firms.
3.1.4.2 The objectives of firms

 Objective of a firm influences how it behaves.
 Profit – this is typically the most important
objective for the majority of firms.

 Survival – key tactic for start-ups and firms

suffering during Economic recessions and
Notes
downturns. This involves making sure costs are
kept down otherwise they will go out of
business.
 Growth – it comes in two forms, organic and
inorganic. Inorganic Involves growing by
acquiring companies. While Organic is through
expanding output to achieve gains in
economies of scale.
 Increasing Market Share – this may be
through selling each unit at a price equal to the
cost for the unit (Limit pricing) or through
selling the unit at a loss (Predatory pricing).
Meaning the percentage of total sales in the
market the firm commands increases (this is
also known as an increase in market share).
 Other Firms also have other objectives. E.g.
Environmental sustainability and
Philanthropy based
3.1.4.3 Competitive markets
Perfect Competition
 Completely identical (homogenous) products

 Very easy entry meaning profits are low.
Since, once profits appear, they are taken up
by new entrants.
 Many firms with a small market share each
 In markets with Perfectly Competitive Firms
the price of the good is determined by the
interaction of demand and supply. Firms are
Price Takers (they can’t set the price of the
product itself only respond to it) as a result.
3.1.4.4 Monopoly and monopoly power

Monopoly Power
 Monopoly power is said to occur when a firm

has a significant market share. In the UK,
market share of 25% or more for firm means
that it has monopoly power. So the firm in
question is referred to as being a monopoly.
However, the market structure the firm is in
will not be called Pure Monopoly but will
most likely be an Oligopoly market structure.
Monopoly power is influenced by:
 Number of firms in the market- the lower

the number of firms the stronger the
monopoly power

 Advertising- more advertising means

Notes
consumer loyalty increases the stronger
monopoly power
 Degree of Product differentiation –
more differentiated the stronger the
monopoly power
Exploitation of the consumer by a Pure Monopoly or a
Firm with a Monopoly power.
 Pure Monopoly (Sometimes referred to as just
monopoly) is when there is only one firm in
the market.
 The Pure Monopoly market structure is vulnerable
to exploitation of the consumer by the firm. Also,
Markets containing Monopolies or one Monopoly
(a firm with 25% market share or more) are said to
have monopoly power and so also have the same
problem but not to the same extent as a pure
monopoly.
 Due to no competition or low competition it
means the firm has strong price setting abilities.
Exploitation may come in the form of setting high
prices in order to achieve the objective of high
profits. While, they stop innovating efficiency
gains and quality gains due to a limited number of
threats or no threats to their profit. So a
misallocation of resources in this market occurs.
 While in competitive markets like perfect
competition firms have no price setting abilities
and so they can’t increase price without going out
of business. Also, there are many competitors so
the firm strives for innovation in efficiency and
quality. Efficiency gains means profits are higher
due to lower costs. While quality gains means the
product becomes differentiated and so allows
some price setting ability. Thus they increase their
price and so the profits.
 However, Monopolies may benefit our economy
due to their large economies scale allowing them
to in fact innovate more and invent. In the hope
of increasing their future profits. But also
bringing benefits through Really Fun Mums Try
Making Pies.
 Understandably not many pure monopolies exist.
But there are many firms with monopoly power.

3.1.4.5 The competitive market

Notes
process
Firms don’t just compete on the basis of price
they compete on quality, gains in efficiency
(lower costs), and quality of the service
provided.
 Monopoly power may result in consumers
being exploited as stated before.
3.1.5 The market mechanism, market failure
and government intervention in markets.
3.1.5.1 How markets and prices allocate

resources
Price S2
S1
P2
P1
Pe
D2
D1
Quantity
Figure 36: Price Mechanism
 Price mechanism acts as a rationing, incentive
and signalling device to buyers and sellers in a
market economy. In an effort to solve the
fundamental economic problem of scarcity In a
market economy.
 Rationing device – When supply shifts inwards
it shows that there are less of the product
available and so price increases from Pe to P1
meaning demand is rationed off to a lower
quantity from Qe to Q1.
 Incentive device – Demand shifts from D1 to
D2 and acts as an incentive to increase supply
from Qe to Q2 for Firms.

 Signalling – the price mechanism acts as a signal

Notes for firms and consumers to exit and enter the
market. For instance, the shift from S1 to S2
means consumers should leave the market. While
the shift from D1 to D2 means suppliers should
enter the market.
 In general economic Incentives influence what,
how and to whom goods are produced.
3.1.5.2 The meaning of market
failure
 Market failure is when the price mechanism
leads to a misallocation of resources.
 Misallocation of resources - is when resources are
allocated inefficiently and not in the best interests
of the Economy.
 Complete market failure – is where there is a
missing market.
 Partial market failure – where the market exist but
contributes to resource misallocation. E.g.
Externalities.
 Public goods, Monopoly, Positive and negative
externalities, other market imperfections,
Inequalities in distribution of income across the
economy are examples of market failure.
3.1.5.3 Public goods, private goods and
quasi-public goods
Public Goods
Pure public goods possess the traits of being non-rivalry
and non-excludable.
 Non-rivalry – once consumed by the first

consumer, the amount available doesn’t
diminish for the 2nd consumer and so on. Hence
why non-rivalry is sometimes referred to as
non-diminishability.
 Non-excludability – once the good has been
produced it’s impossible to prevent others from
consuming the good as well and so benefit from
it. Hence you can’t EXCLUDE any additional
people from consuming it.
 Free rider problem – Since, public goods are
non-excludable, it’s not possible to charge the
other consumers who are benefiting from it as
well if one consumer was to pay for it by
themselves. Therefore, there is no incentive
for anyone to pay for it. Resulting in a missing
market and thus market failure. E.g. national
defence adheres to this problem.

Notes Private Goods
 Private goods- complete opposite of

public goods because they display
characteristics of rivalry and excludability.
 Technological change has allowed for
more goods to become private as well. E.g.
television broadcasting is now excludable.
Quasi-Public Goods
 Quasi-public goods (Quasi means “kind of

but not really”) – This is where a private
goods have partial public goods elements.
E.g. partial non-rivalry or/and partial
excludability. For instance, Public roads
some people can be excluded through toll
booths. While another example are public
beaches in which the amount available
decreases once the first person starts using it
and so one.
3.1.5.4 Positive and negative externalities

in consumption and production
Externalities exist when there is a divergence between private
and social costs and benefits.
 Negative externalities – occur from over production

of the good. Essentially, the actions of the price
mechanism resulted in firms becoming incentivised to
produce the good at a quantity that is bad for our
society. Hence, there is a misallocation of resources
and so market failure. E.g. In some countries there is a
serious overproduction of cars because of the price
mechanism and this results in the negative externality
of global warming (very fossil fuel intensive to create
cars). Remember this cars example is for negative
externalities of production.
 Positive externalities – occur from under production
of the good. Essentially, the actions of the price
mechanism resulted in firms not being incentivised
enough to produce the good to a socially optimal
level. Hence, there is a misallocation of resources and
so market failure. E.g. without government
intervention education fits into this category.

Notes 3.1.5.5 Merit and demerit goods

 The classification of Merit and Demerit goods
depends upon a value judgement (opinion based).
 Merit good – e.g. Education. Suffers from market
failure through positive externalities of consumption.
Essentially, it’s not consumed enough.
 Demerit good – e.g. Cigarettes. Suffers from market
failure through negative externalities of consumption.
It is consumed too much.
 Imperfect information is where there is an unequal
level of knowledge of the good or service in question
between the consumer and the producer.
 Under provision of merit goods and over-provision of
demerit may result from imperfect information.
 In developing countries many of the consumers there
lack the knowledge of the dangers of cigarettes and so
there is overconsumption of cigarettes.
 There is the problem of under provision of the merit
good of pensions because of imperfect market
knowledge. Where the consumer of the pension under
estimates how much they will need for retirement or
doesn’t invest at all. Leading to a missed positive
externality of consumption and so market failure.
3.1.5.6 Market Imperfections
Imperfect Information
Imperfect information is where there is an unequal

level of knowledge of the good or service in
question between the consumer and the producer.
 Imperfect market knowledge – it leads to

market failure through the under provision
of merit goods and the overprovision of
demerit goods. Imperfect market
knowledge also results in missing markets.
E.g. this may occur for the market of
second hand goods like cars. Where
consumers don’t know which cars are
faulty (Lemons) and which ones are good
and so set a price that doesn’t incentivise
owners of good second cars to enter the
market. Realising the cars present are
mostly faulty, demand retreats to a level
that not even faulty suppliers will accept.
The market disappears as a result and so
results in market failure.

Notes  Pure Monopoly and Monopoly power – The

Pure Monopoly market structure is vulnerable
to exploitation of the consumer by the firm.
Also, Markets containing Monopolies or one
Monopoly also have the same problem but not
to the same extent. Due to no competition or
low competition it means the firm has strong
price setting abilities. Exploitation may come
in the form of setting high prices in order to
achieve the objective of high profits. While,
they stop innovating efficiency gains and
quality gains due to a limited number of
threats or no threats to their profit. So a
misallocation of resources in this market
occurs.
Immobility of factors of production
 Mobility of factors of production is the ability

for factor inputs to change between Uses.
Mobility of labour is the ability for labour to
change between jobs. Therefore, when factors are
said to be immobile they are not able to change
between uses.
 Geographical immobility – Factor inputs are
unable to move from one location to the next. In
the case of labour, geographical immobility may
be because the worker wants to stay with their
family or they can’t afford the house in the new
location.
 Occupational immobility – Factor inputs unable
to move from one use to the next. In the case of
labour, the workers are unable to switch their job.
For labour this is caused by poor education and
training.
 Geographical and Occupational immobility
means that the markets for the factor of
production in question doesn’t operate efficiently.
E.g. the labour market becomes inefficient.

Notes 3.1.5.7 An inequitable distribution of

income and wealth
 In the absence of government intervention, the

market mechanism is likely to result in a very
unequal and inequitable distribution of income
and wealth.
 In a market economy, an individual’s ability to
consume goods and services depends upon their
income and wealth and an inequitable
distribution of income and wealth is likely to
lead to a misallocation of resources and hence
market failure.
 Progressive taxes and government spending are
used to reduce inequality. E.g. Progressive tax is
where the rich is taxed more than the poor.
While government spending redistributes
through giving poor unemployed people
benefits.
3.1.5.8 Government intervention in

markets
 The existence of all the previously stated forms

of market failure provides an argument for
government intervention.
 Governments influence the allocation of
resources in a variety of ways, including
through public expenditure, taxation and
regulations.
 Governments have a range of objectives and
these affect how they intervene in a Mixed
economy to influence the allocation of
resources.
Indirect taxation This is specific tax
S2 + Tax
Price S1
P2
P1
Q2 Q1
Quantity
Figure 37: Specific Tax

Notes  This is a specific tax

 Example of a specific tax is an excise duty
and it’s the same regardless the price of the
good. Since, it’s set at the same price per a
unit. Hence, why the curve with the tax is
parallel to the original one.
 Government may impose a tax on demerit
goods to reduce consumption in order to
correct the negative externality market
failure. Since, Quantity consumed shifts
from Q1 to Q2.
Ad-Valorem
S2 +AD Valorem
Price
S1
P2
P1
D1
Q2 Q1
Quantity
Figure 38: Ad-Valorem Tax
 E.g. VAT Current Vat is 20%

 This is set at a percentage of the price of
the good. In the case of the UK 20% of the
goods price is added onto it. Meaning that
at higher price levels there is a greater
divergence between the taxed price level
and the non-taxed one. Meaning that as
price increases the supply curve divergence
increases.
 With goods like petrol, Vat is placed on top
of a specific tax (in this case it’s excise
duty). Meaning that quantity consumed is
pushed back further.

Notes
Inelastic PED
S2
Price
S1
P2 Consumer paid
P1 Supplier paid
D1
Q2 Q1
Quantity
Figure 39: Tax Burden 1
 Burden of the tax mainly falls on

the consumer.
 Consumer paid + supplier paid =
government revenue
Elastic PED
S2
Price
S1
P2
Consumer paid
P1
Supplier paid
D1
Q2 Q1
Quantity
Figure 40: Tax Burden 2
 Burden of the tax mainly falls on

the producer.
 Consumer paid + supplier paid =
government revenue

Notes Price
S1
S2 +Subsidy
Producer benefit P3
P1
P2
D1
Consumer benefit
Q1 Q2
Quantity
Figure 41: Subsidy
 Governments utilises subsidies to encourage

consumption of merit goods.
 Consumer benefit + Producer benefit =
Government expenditure
Inelastic Demand Curve

Price S2
S1
P2
P1
D1
Q2 Q1
Quantity
Figure 42: Subsidy Burden 1
Elastic Demand Curve
S2
Price
S1
P2
P1
D1
Q2 Q1
Quantity
Figure 43: Subsidy Burden 2

Notes  Consumer benefit is larger for inelastic PED.

While Supplier benefit is larger for elastic
PED.
 Additional quantity consumed is larger for
elastic PED and so the government has to
spend a smaller amount of money to correct
an elastic merit good’s market failure.
Price Controls
Minimum Pricing
Price
S1
P2 Minimum
Price
P1
D1
Q2 Q1 Q3
Quantity
Figure 44: Minimum Price
 National minimum wage is an example of

a minimum price. Minimum wages attempts
to correct the market failure of inequality by
increasing the income of the poorest
workers and so their ability to consume
goods and services in the economy.
 However, it can lead to higher
unemployment as demonstrated by the
excess supply of Q2 to Q3 and so there will
be more people without an income and thus
inequality rises. This is an example of
government failure.
 This market distortion of excess supply
results in dumping of the surplus product
elsewhere. Externality simply transferred
elsewhere. This is also an example of
government failure.

Notes
Minimum Pricing and Elasticity
Price S1
P3
P2
P1
D
1
Q2 Q1 Q3
Quantity
Figure 45: Minimum Price and Elasticity
 Excess supply can be altered depending on the

elasticity of the demand and supply curves.
Notice how an inelastic demand and supply
curve only leads to a small level of excess
supply compared to the previous diagram.
 Extent of the excess supply also depends on how
high the government sets the minimum price. P3
min price results in more excess supply.
Maximum Price
Price
S1
P1
Maximum
P2 Price
D1
Q2 Q1 Q3
Quantity
Figure 46:Maximum Price
 Encourages the consumption of a merit goods, thus

produces the positive externality. E.g. housing, if a
maximum price is set for rents it now means that
housing is now affordable. However, there will be
excess demand and many people will miss out,
even those who could have afforded the market
rate, thus they argue is this a fair policy

Notes  Setting a maximum price for housing also

reduces inequality. By allowing poor people’s
spending power in the housing market.
 Maximum prices prevent monopolies from
exploiting consumers by preventing them from
raising their prices. However, still doesn’t solve
the problem of potential lack of innovation.
Maximum Price and Elasticity
Price S1
P1 Maximum
P3 Price
D
1
Q2 Q1 Q3
Quantity
Figure 47: Maximum Price and Elasticity
 Excess demand can be altered depending on

the elasticity of the demand and supply
curves. Notice how an inelastic demand and
supply curve only leads to a small level of
excess demand compared to the previous
diagram.
 Extent of the excess demand also depends on
how low the government sets the maximum
price.

Notes Buffer stock
Price
S1
P2
P1
P3
D1
Q2 Q1
Quantity
Figure 48: Buffer Stock
 Government agency buys and sells the good

to keep it with in the price band between P2
to P3. Without government intervention the
price may fall below the band or stay way
above the higher band.
 Aims to secure the income of producers and
to insure that consumers are paying an
affordable price. Correcting inequality
market failure.
Tradable Pollution Permits (carbon emissions
trading)
Market for pollution permits
Price
S1
P1
D1
Q1
Quantity
Figure 49: Permit Market
 Pollution permits are tradable licenses allowing

firms to pollute to a certain amount (measured in
carbon emissions). If they exceed this set amount
without having the amount of permits allowing for
that, they will face a fine.

Notes  Governments will give firms a set amount of

permits at the start which can be traded between
firms who have surpluses and those who don’t
using the market mechanism.
 It aims to use the market mechanism to incentivise
firms to pollute less and invest in carbon efficient
technology. Therefore, working to reduce negative
externalities from the consumption of fossil fuels.
Disadvantages of Pollution Permits
 Problem if the price of a permit is set too high. It

will account for too much of their cost of
production and thus stifle investment.
 If set too low. It will account too little of their cost
of production for the firm to worry about and so
there is little incentive for them to stop polluting.
State Provision
 State provision of education which is a merit good

and so produces positive externality.
 NHS is an example of a merit good in the section of
healthcare. This produces positive externalities of
consumption. One example is less sick days from
work meaning your employer benefits as well.
 State may provide education on the dangers of
smoking. E.g. through NHS adverts. Thus
consumption of cigarettes decreases which reduces
negative externalities of consumption.
 Government also provides the merit goods of
pensions and council housing.
Regulation
 Minimum school leaving age to increase

consumption.
 Age to buy cigarettes and to buy alcohol.
 Anti-trust laws to prevent monopolies
exploiting. Where they face fines or may even be
broken up to smaller firms.

Notes 3.1.5.9 Government Failure

 Government failure occurs when government
intervention in the economy leads to a
misallocation of resources.
 Inadequate information, conflicting objectives
and administrative costs are possible sources of
government failure.
 Governments may create, rather than remove,
market distortions.
 Government intervention can lead to unintended
consequences.
 Even when there is market failure, government
intervention will not necessarily improve
economic welfare.
 Consumers and producers may not have access
to the same information and this may contribute
to markets operating inefficiently.
Unintended Consequences
 Consumers and producers don’t always act as

government intended.
 For instance, a Black Economy (a secret illegal
market) for housing and drugs allowing for
organised crime syndicates to become more
powerful. More Powerful gangs means more harm
to society.
 Cigarette smuggling is another common black
market.
 An unintended consequence for permits are firms
stock piling permits and not changing their attitude
to pollution.
Administrative costs
 Subsidies are expensive.
 Buffer stocks are expensive.
 Regulation is expensive to police.
 Pollution permits are expensive.
 These present an opportunity cost to the
government’s spending. Could the money have been
better spent? E.g. Spent on Hospitals instead.
Inadequate Information
 Government themselves may not have perfect
information about the market compared to
producers and consumers.

Notes Some economists argue this is especially the case

when comparing their knowledge to Firms who
operate every day in their market and so must know
the market better than anyone else. For example,
governments may over price pollution permits or
act too aggressively to a monopoly which could
mean less efficiency and less innovation for
consumers to enjoy.
Conflicting Objectives
 Governments want to increase welfare for

consumers. However, intervention may lead to
less welfare through allocative inefficiency but no
intervention may also lead to less welfare through
the persistence of a negative externality.
 For instance, setting a maximum price for house
rents leaves excess demand and so there is
allocative inefficiency which means less
consumer welfare. However, not acting will mean
that they miss the opportunity to yield positive
externalities.
 Conflict is also present with how to treat pure
monopolies and monopoly power. With the
potential for monopolies to increase consumer
welfare through their economies of scale but also
to destroy it by setting high prices and becoming
complacent.
 Therefore, acting too stringently against a
monopoly you can miss out on consumer welfare
but also if they leave it alone, consumer welfare
may get harmed.
Market distortions
 Minimum price, maximum price, buffer stock

schemes, taxation and subsidies all manipulate the
market price away from they would have otherwise
been. Therefore, Incentives, signals and rationing are
distorted.
 For Minimum price there is excess supply as the
firms are incentivised to produce more than
consumers want. This is allocatively inefficient. For
maximum price there is excess demand, this shows
that rationing has been distorted which is also
allocatively inefficient.

Notes  Taxation and subsidies damages the ability for

markets to signal. As more firms enter a
subsidised market while more firms leave a taxed
one. Therefore, causing allocative inefficiency
and so resulting in dissatisfied consumers.
Unequal access to Information
 Unequal access to information for producers and

consumers means that imperfect information is
inevitable and all its consequences along with it.
Governments are rarely successful in striking this
balance.

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AQA Economics AS Level Technocrat Notes The Operations of Markets and Market Failure PDF

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Year 1 (AS) - ECONOMICS

The Operation of Markets and Market

By The Technocrat Team

3.1.2 Price determination in a competitive market 9

3.1.4 Competitive and concentrated markets 29

3.1.5 The market mechanism, market failure and

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Notes from Text book/

Effective Personalised Notes

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Text book/Revision Guide

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Silly mistakes, omitted terminology and incorrect definitions are

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Understanding Technocrat Notes’ Content

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3.1.1 Economic methodology and the

3.1.1.1 Economic methodology

Positive and Normative Statements

3.1.1.2 The nature and purpose of

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Notes 3.1.1.3 Economic resources

 Resources are organised into land, labour, Capital

3.1.1.4 Scarcity, choice and the

 The fundamental economic problem is scarcity

3.1.1.5 Production possibility

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 Point A and B are on the curve and so both of these

 Not all points on the PPF boundary possess

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Notes  Economic Growth is represented by a shift

3.1.2.1 The determinants of the demand

Figure 3: Demand Curve Quantity

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Notes  Movement from B to A is a contraction in demand.

Figure 4: Demand Curve shifts Quantity

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Notes  Income – Generally, when income is higher

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 Narrative behind the good/brand. If

3.1.2.2 Price, income and cross elasticities

Formula for Price elasticity %∆𝑄𝐷

Elastic Demand Curve

 PED<-1. (e.g. -2 is elastic)

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Total Revenue = Total Expenditure

Inelastic Demand Curve

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Notes  TR is infinite for a given price because

Income elasticity (YED).

 In Economics Y is used as a symbol for Income.

 YED= positive because it slopes upwards

Figure 11: Inferior Good Demand Curve

 YED= negative because it slopes downwards

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Cross Elasticity of Demand (XED)

 Cross elasticity of demand is the sensitivity

Weak Complements - Strong (Close)

Figure 13: Comparisons of type of complements

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Strong (Close) Weak substitutes - a

Figure 15: Comparisons of type of complements