ZNOTES.

ORG

UPDATED TO 2022 SYLLABUS

CAIE AS LEVEL
ECONOMICS
SUMMARIZED NOTES ON THE THEORY SYLLABUS
CAIE AS LEVEL ECONOMICS

1.4. Resource Allocation in Different

1. Basic Economic Ideas and Economic Systems & Issues of
Resource Allocation Transition
Different economic systems answer the 3 basic economic
1.1. Scarcity, Choice & Opportunity Cost questions
differently.
Note, that mixed economics try to gain advantages
The fundamental economic problem: of scarcity arises and avoid
disadvantages of both market and planned
due to
unlimited human wants of consumption exceeding economies.
finite economic resources
for production.
Consumption: is process by which consumers satisfy their Question Market economy Planned economy
wants. Cost-benefit
What to produce Price mechanism
Production: is process of creating goods and services in analysis
an
economy Least cost
Economic goods – these are goods which require How to produce Directives to SOEs
combination
resources to be
produced and obtained and therefore
For whom to
have an opportunity cost.
Allocative mechanism will be Purchasing power Vulnerable groups
produce
used to allocate such goods. Ex. cars.
Free goods – these are goods which do not require any
Comparison between market & planned economies:
resources
to be produced and obtained and therefore are
abundant and have no
opportunity cost. Ex. sunlight. Feature Market economy Planned economy
Ceteris paribus is a Latin word meaning ‘all other things Ownership Private State
being
equal’ Decision Consumers Governments
Needs are necessary, wants are not. Mechanism Price mechanism Directives to SOEs
Thus, choices have to be made at all levels
Key sector Private Public
Consumers – maximum satisfaction.
Producers – maximum profit.
Public
Absent Present
Governments – maximum benefits. goods
Choice: is the need to make decision about the possible Profit
Present Absent
alternative uses of scarce resources due to scarcity. It motive
gives
rise to the concept of opportunity cost and the 3 Other Free enterprise, private Central, collectivist,
basic economic
problems. names enterprise, laissez faire state-owned.
Opportunity cost: is the cost of choosing something in Examples USA North Korea
terms
of the benefit derived from the best alternative
forgone. Note that in reality, all economic systems are mixed.
Economic resources/factors of production: are inputs SOE: State-owned enterprise.
available for production of goods and services.
Market economy
1.2. Positive and Normative Statements Advantages Disadvantages
Efficiency Information failure
Statement Basis Type
Public goods not provided
Positive Facts Objective
Consumer sovereignty Merit goods under-consumed
Normative Value judgments Subjective
Demerit goods over-
consumed
Value judgments: reflect particular beliefs, while facts: are
Quick response Negative externalities
evident to all.
Unemployment of resources
Profit incentive Factor immobility
1.3. Factors of Production
Market power abuse
Factor Definition Reward Maximizes producer and
Advertising distortion
Land Natural resources Rent consumer surplus

Labour Physical and mental human effort Wage Too much consumer goods

Capital Man-made resources Interest Government freedom Poor lack purchasing power

Enterprise Production organization, risk-bearing Profit Inflation

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Planned economy Point shifting occurs owing to allocative efficiency.

Advantages Disadvantages Production point shifting from C to F requires a
reallocation of
resources to capital goods and factor
Provision of public goods No incentives
mobility determines the speed
of this. This would act as
Merit goods encouraged Low production an investment, shifting the PPC to the
right. This indicates
Demerit goods discouraged Low competition, low efficiency economic growth.
Full cost-benefit analysis Bureaucracy Factor mobility: is extent of reallocation of resources or
Full employment Unresponsive ease
of moving factors of production.
Investment: is expenditure of capital goods, both fixed and
Wasteful duplication avoided Too much of capital goods
working.
Vulnerable groups protected Lack of consumer sovereignty Economic growth: is an expansion in the productive
capacity in
an economy.
Transitional economy: is one which is in process of (Lowering of long-run average cost, i.e., LRAC ensures
changing
from a planned economy to a mixed economy this.)
where market forces have
greater importance. Other causes of PPC shifting right:
Issues of transition: New resources.
Inflation. Increased labour supply.
Industrial unrest. Improvements in human capital.
Fall in output. Improved resource management.
Unemployment. Privatisation.
Balance of payments’ deficit. Straight PP line indicates constant opportunity cost which
Reduction in welfare services. is
next to impossible.
Curved PP line indicates increasing opportunity cost which
1.5. Production Possibility Curves occurs when the extra production of one good involves
ever-increasing sacrifices of another as less suitable
Production possibility curve: is one which joins together the economic
measures have to be diverted into the
different combinations of products that can be produced in an production of the former,
increasing marginal cost and
economy,
over a period of time, given existing resources and decreasing productivity.
technology.
1.6. Money
Money: is anything which is universally acceptable as a
means of
payment for goods and services. Most money,
except coins is ‘legal
tender’ for settlement of debt.
Functions:
Medium of exchange.
Measure of value.
Standard for deferred payment.
Store of value.
Characteristics:

Acceptability. Scarcity.
Divisibility. Stability of supply and value.
Portability. Recognizable.
Durability. Uniformity.

Advantages over barter:

Avoids double coincidence of wants.
Permits evaluation.
Enables giving change.
It is also known as production transformation frontier,
Eases saving.
boundary or
a production transformation curve. It
Barter: is the direct exchange of one product for another.
demonstrates the ideas of
choice, trade-offs and
It
was used before money.
opportunity cost.
Point inside curve indicates unemployment and point on Cash + Bank deposits = Money
curve shows
full employment. This is productive
efficiency. Cash: includes the notes and coins in an economy. It is the
most
liquid form of asset.

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Bank deposits: are money held in accounts with a financial Schedules: lists these relations while curves: graphically
institution, e.g. bank, building, society, etc. represent them.
Liquidity: refers to the extent and ease of converting a Notional demand/supply: isn’t backed up by ability to
non-cash asset into cash. pay/sell but effective demand/supply is.
Near money: or ‘quasi-money’ are non-cash assets that Individual: refers to a certain producer/consumer in the
can be
quickly and easily converted into cash. market: which is an arrangement for buyers and sellers to
Cheques: are written instruction to a financial institution trade.
to
pay an amount of money from an account. So, they are Products in joint demand/supply: are produced/consumed
means of
payment through bank deposits, not money. together.
Products in alternative demand/supply: are those whose
1.7. Classification of Goods & Services consumption/production reduces need/availability of the
other.
Opportunity Multi-purpose products have composite demand.
Free- Products which help in producing other product have a
Good cost & Rivalry Excludability Rejectability
rider demand
derived from the product produced.
scarcity
Note: As income rises, demand of normal goods rises,
Free ✗ ✗ ✗ ✓ ✗
inferior good falls.
Economic/
✓ ✓ ✓ ✗ ✓
Private
Public ✓ ✗ ✗ ✓ ✗

2. The Price System & the

Micro Economy
2.1. Price mechanism
It is the means through which scarce resources (factors of
production) are allocated in a market economy.
Signaling – prices act as a signal to both producers and
consumers. Ex. if there is excess demand for a product
due to a fall in quantity, this indicates to the producer that
they must supply more of the product in the market. In
turn, if consumers withhold their demand, it signals to the
producers that they must lower price and in turn produce
less.
Rationing – if a producer wants to retain exclusivity for
their product, they may limit the supply of the product in
the market, thereby driving its price up and in turn
restricting its demand.
Transmission of preferences – this means that if
consumers do not buy a particular product because they
don’t like it, or it is not priced to their liking, then this
message is transmitted back to the producer.

Contractions/Extensions of demand/supply: are

2.2. Demand and supply movement along curves
due to changes in price, while:
Shifts of demand/supply: are movements of the whole
Demand/supply: is the quantity of a product that
curve due to
changes in conditions.
consumers/producers are willing and able to buy/sell at
Their effects on equilibrium price, quantity and revenue
various prices per period time, ceteris paribus.
will depend
on degree of shifting and price elasticity of
Note that demand & supply are also referred as market other curve.
forces or
the invisible hand.
Laws of demand: Rise in price, fall in demand and vice Demand conditions Supply conditions
versa
Disposable income Costs of production
Laws of supply: Rise in price, rise in supply and vice versa
Price of related products Price of related products.

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Demand conditions Supply conditions PED conditions PES conditions

Taste and fashion Climate & technology Time period Time period
Population structure Government regulations No. Of substitutes Availability of resources
Price speculation Availability of resources Degree of necessity Spare capacity/stocks
Income distribution Taxes and subsidies Durability No. of firms in market
Taxes and subsidies Competitor actions Proportion of income Allocative efficiency of factors

png)**
2.4. Interaction of Demand & Supply,
2.3. Price Elasticity, Income Elasticity & Market Equilibrium & Disequilibrium,
Cross-Elasticities of Demand, and Price and Consumer & Producer Surplus
Elasticity of Supply Prices:

Elasticity: is responsiveness of quantity Signal surpluses/shortages.

demanded/supplied
to a change in price, income or prices Ration resources to uses.
of related products. Transmit preferences by encouraging producers to
Note: It is a numerical measure of the inverse of the produce according
to consumer demand.
gradient,
so lower elasticity gives steeper curve.
Limitations of elasticities:
Irrelevant and unreliable data
Unrealistic assumptions
Omission of Total Cost
Omission of Production Capacity

Elastic >1 Perfectly elastic ∞ Horizontal line

Inelastic <1 Perfectly inelastic 0 Vertical line
Such PED gives rectangular

Unitary =1;
hyperbola, i.e. change in 3. Government
demand/supply doesn’t affect
revenue. Microeconomic Intervention
(−)ve; used to inspect
PED = % change in QD 3.1. Maximum and Minimum Prices
revenue and tax
/ % change in P
effects.
MAXIMUM PRICES MINIMUM PRICES
(+)ve; indicates
PES = % change in QS Max. price control: is where a Min. price control: is where a
allocative efficiency
/ % change in P price ceiling is established price floor is established
and need to expand.
below equilibrium price, above equilibrium price,
YED = % change in QD (−)ve – inferior creating a shortage. creating a surplus.
(+)ve – normal good
/ % change in income good
Cheap essentials Demerit goods
XED = % change in QD
(–)ve – Rent control Proper wages
/ % change in P (+)ve ­– substitutes
complements Restriction of fares Import reduction
(another)
More affordable to the poor PED dependent
Queueing Unemployment
Corruption Smuggling
Black market Inefficiencies

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Indirect tax
Economic stability Regressive
May not discourage effort Inflationary
Difficult to evade Reduce consumer surplus
Can be adjusted quickly Move demand abroad
Discourage imports Distort choice
Discourage demerit goods Effect depends of PED

Aims of taxes Canons of taxes

Demerit goods Cost
Income distribution Efficiency
Release resources Equity
Discourage imports Transparency
Demand/supply management Convenience

Impact of tax: refers to unit on which a tax is levied.

Incidence of tax: refers to burden of taxation.
Specific tax: is paid in fixed amount.

3.2. Taxes, Subsidies and Transfer

Payment
Fiscal Levied on/
Shift Burden/Benefit
measure Given to
Direct tax Income D← Consumer
Elastic demand –
Indirect tax Expenditure S←
producer & converse
Subsidy Consumer D→ Consumer Ad valorem tax: on consumption, is paid as percentage of
value of product.
Inelastic demand –
Subsidy Producer S→
consumer & converse

Note: Specific measures cause

parallel shift, ad valorem ones
non-parallel.
Direct tax
Advantages Disadvantages
Economic stability May discourage:
Progressive Saving
Certain & convenient Effort

Indirect tax
Redistribute income Risk-taking

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Certain goods and services that ought to benefit the

public are
under-provided, or under-consumed in the
economy.
Direct provision of goods and services in the form of merit
and
public goods are a solution to this issue.

3.4. Nationalisation & Privatisation

Nationalisation: is a process whereby private sector firms
become part of the public sector of economy, with state
involved in
direct provision of goods and services.
The converse is: Privatization: which is achieved by sale
of
assets, deregulation, outsourcing & franchising.

Nationalisation
Advantages Disadvantages
Economies of scale Inefficient
Reduce income inequality Non-competitive
Average rate of tax: is the average percentage of total Private monopoly prevented Political-mileage
income
that is paid in taxes.
Avoids wasteful duplication SOE monopoly
Marginal rate: is the proportion of additional income that
is taken in income tax. Limited scope for increase in
CBA involved
Marginal rate of taxation: is the addition to tax paid out
of long term investment
change in income.
Privatisation
Advantages Disadvantages
Economic efficiency Private monopoly
Government revenue One off income generated
Growth by investment Regulations needed
Lower price Unemployment
Enterprise encouraged Wasteful duplication

Government failure: occurs when government

intervention reduces
economic performance rather than
increasing, thus failing to correct
market failure, due to:
Imperfect information
Policy conflicts
Political mileage
Corruption
Transfer payment: is a govt. provided benefit to poor
units,
without protective effort; so funds shift from
taxpayers to
recipients.
4. The Macro Economy
Means-tested benefit: is paid to units whose income is
below a
level. 4.1. Aggregate Demand & Aggregate
Universal benefit: is paid to units without income
reference.
Supply Analysis
Poverty-trap: is a situation in which an individual has
work-
Macroeconomy: is the economy as a whole.
disincentive, as additional income will be taken away as
taxes & lost benefits. Aggregate demand (AD): is the total
spending on an
Negative income-tax: is a system which brings together economy’s goods and services, at a given price level
in a
payment
of tax and receipt of benefits thus, making given time period.
markets more flexible by
removing poverty-traps. Total spending in an economy in a certain time period
In consists of Consumption, Investment, Government
spending and Net Exports (C+I+G+(X-M))
3.3. Direct Provision of Goods & Consumption – spending by households and other
Services consumers. Depends on income levels, interest rates,

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tax rates, etc. A major part of AD. Fiscal drag: is pushing of income into higher tax brackets
Investment – expenditure made by firms in terms of by inflation.
capital equipment. Depends mostly on profits and Inflationary noise: is confusion over relative prices.
interest rate, corporation tax rates, etc Causes of inflation:
Government spending – total spending by the Cost-push inflation: is caused by increases in costs of
government on both consumer and capital goods. production decreasing aggregate supply, e.g.
Depends on tax revenue collected. Wages rising by more than productivity.
Net exports – exports minus imports. Depends on Raw material costs rising (especially imported ones).
inflation rates domestically and abroad, exchange Increase in indirect/corporate taxes.
rates, etc Rise in profit margins.
Aggregate supply (AS) is the total output produced in an
economy within a given time period.
Shifts in the LRAS curve
AS, in the long run may increase due to:
Increase in quantity of resources:
Net immigration
Increase in retirement age
More women entering the labour force
Net investment
Discovery of new resources
Land reclamation
Increase in quality of resources:
Improved education and training
Advances in technology

4.2. Inflation
Demand-pull inflation: is caused by increase in aggregate
Inflation: is a sustained increase in general price levels in demand
unmatched by equivalent rise in aggregate
an
economy over a given time period, causing a fall in supply, e.g.
purchasing power
of a currency. Consumer boom.
Creeping inflation: has a low rate. Money supply growing faster than output (monetarist)
Hyper-inflation: has an exceptionally high rate of inflation, Growing budget deficit.
which may result in people losing confidence in currency. Increase in net exports.
Inflation rate can be measured by (CP I ) or (RP I ):
Selecting a stable base year for comparison.
Carrying out surveys to find spending patterns.
Attaching weights to products to indicate relative
importance.
Finding out price changes.
Multiplying weights by price changes.
Deflation: is a sustained decrease in general price levels
in an
economy over a given time period, causing a rise in
purchasing power
of a currency.
Disinflation: is a fall in the inflation rate.

Causes Inflation Deflation

Good AD ↑ AS ↑
Bad AS ↓ AD ↓

Money values: are of prices operating at the time. Consequences of

Real values: are adjusted for inflation. disequilibrium
Real values = nominal values * price index of base year
Domestic External
(100)/price
index of current year
Menu costs: are incurred by firms for having to change
prices.
Shoe-leather costs: are incurred by firms moving money
for
high-interest.

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Consequences of Smuggling, black market

disequilibrium
Change in exchange rate 4.4. Exchange Rates
both appreciation &
Change in money supply depreciation naturally and Factors determining exchange rate:
artificial devaluation & Balance of payments disequilibrium – Deficit causes
evaluation. reduction.
Confidence & FDI levels Government pressured to Inflation rate – High rate reduces confidence, hence
change, leading to changes in change protectionist demand.
AD, employment, growth etc measures. Foreign direct investment – Inflows increase rate.
Speculation – Acts in a way to aggravate problem.
Changes in standard of living
Purchasing power parity: is a way of comparing
owing to different access of
international
living standards by using an exchange rate
imports.
based on amount of each
currency needed to purchase
Change in government policies some basket of products.
Nominal exchange rate: is price of one currency in terms
Disadvantages Advantages of
another.
Reduction in net exports. Trade-weighted exchange rate: is price of one currency
Stimulate output
against a
basket of weighted currency.
Unplanned redistribution of Real effective exchange rate: is a currency’s value in
Reduce burden of debt
income terms of
its real purchasing power.
Fiscal-drag Prevent some unemployment
∴ Real effective exchange rate =
Factors effecting extent of Nominal exchange rate×Domestic price rise
Inflationary noise Foreign exchange rate
consequences
​

Effect of changing
Investment discouragement Cause of inflation
exchange rates –
Unemployment Rate of inflation Domestic
Cost-wage spiral Stability
Menu costs Expectancy Aspect Effect
Shoe leather costs Comparability
Depreciation will
make imports more
4.3. Balance of Payments Inflation expensive.
(Imported cost push
Balance of payments: is a record of a country’s economic inflation)
transactions with the rest of the world over a year. It Appreciation will
consists of:
make exports more
Unemployment
expensive reducing
Current account: Financial account:
AD.
Visible trade in goods
Depreciation will
Invisible trade in services Direct investment
reduce terms of
Income, e.g. profits, Portfolio investment
trade, leading to
interest Reserve assets Economic growth
economic growth if
Current transfers (no Other investment
Marshall-Lerner
exchange involved)
condition holds.
Capital account: Balancing item:
(+) |
Capital transfers
Net errors and omissions
Nonfinancial assets
4.5. Principles of Absolute and
Money into country, credit (+)
Note: Comparative Advantage
items, e.g. export.
Money out of country, debit Absolute advantage: is the ability to produce more of a
(−) items, e.g. import. product
than another country using same amount of
resources.
* Financial account:
* Hot money flows
* Lack of business Comparative advantage: is ability to produce at lower
confidence
* Balancing item:
* Imperfect information
* opportunity cost.

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Trading possibilities curve: is the consumption

possibilities of
rations post specialization and trade at any
term of trade.

5. Macroeconomic Policies
4.6. Protectionism
5.1. Macroeconomic aims
Protectionism: is an action designed to help domestic
Full employment
products
from foreign competition by reducing
Low and stable inflation
international trade.
Balance of payments equilibrium
Measures include: Sustained and steady economic growth
Tariffs (tax) Embargoes (bans) Stable exchange rate
Sustainable economic development
Voluntary export restraint
Quotas (limits)
(agreed limit)
Foreign currency exchange Red tape (administrative
5.2. Types of policies
control delays)
Fiscal policy
Export subsidies Dirty float exchange rate It involves the use of taxation and government
spending to influence AD
Free trade Protectionism Expansionary/reflationary fiscal policy – lower taxes,
Foreign products within reach Avoids over specialization higher
government spending
Greater variety Improve terms of trade Deflationary/contractionary fiscal policy – higher
taxes, lower
government spending
Importing raw materials Strategic industries
A budget is a government’s estimates for its revenue
Better quality Declining/sunset industries and spending
More sales Infant/sunrise industries Budget deficit – expenditure exceeds revenue
Economies of scale Prevent dumping Budget surplus – revenue exceeds expenditure
Larger market Reduce current account deficit Balanced budget – revenue equals expenditure
Only a short-term measure, households and firms will
Greater competition Raise revenue
go back to
older spending patterns once
Lower price Protect employment
implementation of these policies is
stopped.
Spread of ideas & technology Retaliation Raising taxes can create disincentive to work, lowering
labour force
and productive capacity, increasing
unemployment, lower GDP lowering
economic growth
Tariffs may not be possible in a trade block. May even
provoke retaliation. Domestic firms may become
dependent
Workers press for higher wages, wage-price spiral,
cost push
inflation
Skilled workers may emigrate
May increase AD, demand-pull inflation
Firms may become dependent, complacent

Monetary policy

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It involves the use of interest rates, money supply and Corporate tax – depends on confidence levels
exchange
rates to influence AD
Expansionary monetary policy – lower interest rate, Expenditure switching policies
increase money
supply, currency depreciation Measures designed to encourage consumer to switch
Contractionary monetary policy – increase interest to domestic
products rather than foreign produced
rate, lower money
supply, currency appreciation ones
Money supply can be controlled through the changes Ex. protectionism measures like tariffs
in the cash
reserve ratio (CRR)
Expenditure reducing/dampening policies
Difficult to control money supply
Measures designed to lower domestic demand
Interest rates have a time lag of 12-18 months
Ex. higher income tax, interest rate
Interest rates are uncertain
Higher interest rate can have negative effect on
unemployment,
economic growth
Lower interest rates will lower hot money flows into
the country
Higher interest rate will discourage FDI
Higher ROI will not guarantee fall in consumer
spending as
commercial banks may not pass on the
higher interest rate
Fixed exchange rate, interest rate rises will cause
currency
appreciation leading the government to sell
its currency to go back
to the fixed level

Supply-side policy
They are designed to increase AS
Increased spending on education and training
Deregulation & Privatisation
Direct tax cuts
Subsidies
Spending on infrastructure
Trade union/labour market reforms
Reduction in welfare payments
Only effective in the long run, have a time lag
Uncertain outcomes
Privatisation & deregulation – may develop
monopolies
Subsidies – may not be passed to consumers
Education & training – only works if quality improved
Spending on training will reduce costs only if
productivity rises
greater than wage rates

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Economics

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