The allocation of resources

• Anchor. “Own price moves you along; everything else moves the line.” If you remember one sentence from this chapter, that is the one — more of Topic 2 rests on it than on any other single idea, because every diagram in the topic depends on getting it right.
• Anchor for the eight causes. Income, Substitutes, Complements, Tastes, Advertising, Population, Expectations — and the weather or interest rate that a particular market happens to care about. Every one of them is not the price of this good, which is exactly why every one of them shifts the curve.
• Anchor. When the two shifts push quantity the same way, quantity is certain. When they push price the same way, price is certain. Write the certain one first, then say: “the effect on X depends on whether the increase in demand is larger than the increase in supply”.
• Anchor. Too much, too little, none at all, and held back. Four consequences, four quantities. Demerit and external costs give too much; merit and external benefits give too little; public goods give none at all; monopoly holds output back.
• Anchor: four drawn, five written. Drawn — maximum price, minimum price, indirect tax, subsidy. Written — regulation, privatisation, nationalisation, direct provision, quotas. If you find yourself drawing a diagram for privatisation, you have left the syllabus.
• The five checks that catch almost every arithmetic error. (1) Percentage changes use the original value as the denominator. (2) An elasticity uses two points on the same curve. (3) The consumer and producer shares of a tax must add to the tax. (4) Tax revenue and subsidy cost use the new quantity, not the old. (5) A shortage or a surplus is a quantity with units.
• The chapter in one line, for the walk to the examination hall. Own price moves you along; everything else moves the line. Shifts change P and Q; elasticity decides by how much. Where the market gets the quantity wrong, that is market failure — and every cure has a cost.

• 2.1.1 — Define a market, give product and factor examples, and describe the roles of buyers and sellers.
• 2.2.1 — Define demand, build market demand from individual demand, and draw and interpret a demand curve.
• 2.2.2 — Explain what causes an extension and a contraction of demand, and show each on a diagram.
• 2.2.3 — List the causes of an increase and a decrease in demand and draw the resulting shifts.
• 2.3.1 — Define supply, build market supply from individual supply, and draw and interpret a supply curve.
• 2.3.2 — Explain and draw an extension and a contraction of supply.
• 2.3.3 — List the causes of an increase and a decrease in supply and draw the resulting shifts.
• 2.4.1 — Explain how the price mechanism answers what, how and for whom to produce.
• 2.4.2 — Define market equilibrium and identify it from a schedule and from curves.
• 2.4.3 — Define market disequilibrium and show a shortage and a surplus on a schedule and a diagram.
• 2.5.1 — State what happens to price and quantity when demand or supply shifts, in all four single-shift cases.
• 2.5.2 — Explain the effect of a price change on sales, and show a change in market conditions on a diagram.
• 2.6.1 — Define price elasticity of demand.
• 2.6.2 — Calculate PED and interpret all five values, each with its demand curve.
• 2.6.3 — Explain the determinants of PED.
• 2.6.4 — Show the relationship between PED, consumer expenditure and firms' revenue, as a calculation and on a diagram.
• 2.6.5 — Explain the significance of PED for consumers, workers, producers/firms and government.
• 2.7.1 — Define price elasticity of supply.
• 2.7.2 — Calculate PES and interpret all five values, each with its supply curve.
• 2.7.3 — Explain the determinants of PES.
• 2.8.1 — Define the market economic system.
• 2.8.2 — Argue for and against the market economic system.
• 2.9.1 — Define market failure.
• 2.9.2 — Define all ten associated terms, from public good to monopoly.
• 2.9.3 — Explain the causes of market failure.
• 2.9.4 — Explain the consequences of market failure as a misallocation of resources.
• 2.10.1 — Define the mixed economic system.
• 2.10.2 — Argue for and against the mixed economic system.
• 2.10.3 — Define, draw where required, and argue both sides of all nine intervention measures.

Section 2.9 gave the reason. A pure market supplies no public goods, too little of merit goods, too much of demerit goods and goods with external costs, and lets monopolies restrict output. A pure command economy loses the price signals that tell anyone what is wanted and the profit incentive that keeps costs down. Every real government therefore intervenes in some markets and leaves others alone, and the interesting question is never “market or state” but “how much, where, and with which instrument”.

• 1. Saying a price rise “shifts the demand curve” A change in the good's own price is a movement along the curve. Nothing else. If the curve moved every time price changed, the curve would have no meaning. Only a non-price factor — income, substitutes, complements, tastes, advertising, population, expectations — shifts it.
• 2. Saying an increase in demand “increases supply” An increase in demand raises price, and the higher price causes an extension of supply along the existing supply curve. The supply curve does not move. Writing “supply increases” here reverses the whole logic of the diagram and invalidates every step of reasoning that follows it.
• 3. Treating a negative PED as “elastic” PED is always negative for a normal downward-sloping demand curve, because price and quantity move in opposite directions. The sign tells you the direction, not the size. Ignore it and compare the number with 1: \(-0.5\) is inelastic, \(-2\) is elastic.
• 4. Saying a firm should always cut price to sell more Cutting price raises revenue only when demand is elastic. Where demand is inelastic, a price cut sells a few more units and loses money on every one of them, so revenue falls. “Sell more” and “earn more” are different claims.
• 5. Saying an indirect tax raises price by the full amount of the tax Price rises by less than the tax unless demand is perfectly inelastic. The producer absorbs the rest out of the price received. The share the consumer pays is larger the more inelastic demand is — and that sentence, used properly, is what turns a statement about the tax into an analysis of it.
• 6. Putting a maximum price above equilibrium, or a minimum price below it An effective maximum price sits below the equilibrium and causes a shortage. An effective minimum price sits above it and causes a surplus. Set on the wrong side of equilibrium, a control simply does nothing, because the market is already trading at a legal price.
• 7. Defining a public good as “a good provided by the public sector” A public good is defined by two properties: it is non-rival and non-excludable. Governments provide many goods — state schooling, public hospitals, subsidised buses — that are rival and excludable and are therefore not public goods. They are merit goods or ordinary private goods that the state has chosen to supply.
• 8. Drawing a diagram for market failure or for monopoly This syllabus requires no diagram for market failure (2.9) and none for competitive markets or monopoly (3.7). Explain the misallocation in words, using private, external and social cost or benefit. A diagram imported from another qualification answers a question this syllabus does not ask, and costs you minutes you need elsewhere.
• A ninth, quieter one. Do not write “demand is wanting something”. Demand requires willingness and ability to pay. A person who wants a car but cannot afford one contributes nothing to demand, and the difference between a want and effective demand is the first mark on many definition questions.
• This matters in Topic 3, where the whole of wage determination is a demand and supply diagram with “wage rate” on the vertical axis and “quantity of labour” on the horizontal axis. Get the habit right here.
• The vocabulary is examined. The syllabus words are extension and contraction of demand. “Increase” and “decrease” are reserved for shifts. Writing “demand increased because the price fell” describes a shift you did not mean and contradicts your own diagram.
• Where the wording goes wrong. Students write “supply increased because the price went up”. It did not. Quantity supplied extended along an unchanged curve. “Supply increased” means the curve shifted right, which needs a non-price cause such as lower costs or better technology.
• “Demand rose, so supply rose” It did not. An increase in demand shifts D right; the new intersection is at a higher price; and the higher price causes an extension of supply — a movement up the unchanged S curve. Supply itself has not changed, because nothing about costs, technology, taxes or the number of firms has changed. Write it as a chain and the error becomes impossible: D shifts right → at the old price there is a shortage → price rises → supply extends along S → new equilibrium at higher P and higher Q.
• Two words to get right. The gap is a quantity, so describe it as “a shortage of 200 kg”, never “a shortage of $2”. And the adjustment happens through movements along both curves — neither curve shifts, because nothing but the price has changed.
• Always use the original value as the denominator unless a question instructs otherwise. Dividing by the new value gives a different answer and is the single most common arithmetic error in this topic. In the example: \(2 \div 8\), not \(2 \div 10\); and \(300 \div 2{,}000\), not \(300 \div 1{,}700\).
• Three errors this clinic is designed to kill Dividing by the new value. A price rise from $8 to $10 is \(2 \div 8 = 25\%\), not \(2 \div 10 = 20\%\). The original value is the base. Calling \(-2\) “more inelastic” than \(-0.5\) because it is more negative. Compare sizes: 2 is bigger than 1, so \(-2\) is elastic; 0.5 is smaller than 1, so \(-0.5\) is inelastic. Stopping at the number. A calculation is not an answer until you say what the number means. Finish the sentence: “…so demand is price inelastic, and a price rise would therefore raise the firm's revenue.”
• The unitary case is the one to memorise. Any straight line through the origin has \(\text{PES} = 1\), however steep or shallow it looks, because along it quantity is always the same multiple of price, so both change by the same percentage. This is the opposite of the demand case, where the unitary curve is a rectangular hyperbola rather than a straight line.
• No real economy is a pure market system. The pure market system is a model used to isolate what prices alone can and cannot do. Every actual economy has a government that taxes, spends and regulates — which is the point 2.10 starts from. Do not name a real country as an example of a market economic system.
• Two definitions that must not drift A public good is not “a good the public sector provides”. It is defined by non-rivalry and non-excludability. A state school place is rival (one child takes it) and excludable (entry can be refused), so it is not a public good — it is a merit good that the state has chosen to supply. Social cost is not the external cost. Social cost is the sum of private and external. If a journey costs the driver $5 and imposes $3 of congestion and pollution on others, the private cost is $5, the external cost is $3, and the social cost is $8.
• Remember what is not asked for here. No demand and supply diagram, no marginal cost curves, no welfare triangle. The syllabus asks for definitions, causes and consequences in words. The strongest answers in 2.9 are written chains that use private, external and social cost or benefit precisely, and stop there.
• Strictly, there are two limiting cases in which the price rises by the full tax: perfectly inelastic demand, and perfectly elastic supply — in both, one side of the market cannot retreat, so it absorbs all of the change. In the mirror case of perfectly elastic demand the price does not rise at all and producers bear the whole tax. Every ordinary diagram lies between those extremes, so “price rises by less than the tax” is the answer to give unless a question puts you in one of the limiting cases.
• Four more that show up in diagrams rather than in sentences The equilibrium point drawn near the crossing rather than on it. If your dashed lines do not start exactly where D meets S, the price and quantity you read off are wrong, and the marker is reading a number, not an intention. The shifted curve not parallel to the original. A shift changes the position, not the slope. A curve that fans out is a different claim — usually an accidental one about elasticity changing. A tax drawn as a rotation. A specific tax shifts supply up by the same vertical distance at every quantity. A widening gap is an ad valorem tax, which is a different question. Unitary demand drawn as a straight line. Unitary elastic demand is a rectangular hyperbola, because only a curve holds \(P \times Q\) constant. Unitary elastic supply, by contrast, is a straight line — through the origin.
• One habit that fixes several of these at once. After writing any answer in this topic, read it back and underline every use of “demand” and “supply”. For each one, ask: do I mean the whole curve, or the quantity at one price? If you mean the quantity, the words are “quantity demanded” or “quantity supplied”, and the change is an extension or a contraction. Half the errors in this list are that one slip.

• All candidates take both papers, and all candidates are eligible for grades A* to G. There is no tiered entry in this qualification: every candidate sits the same two papers, and no part of Topic 2 is reserved for one group of candidates rather than another. Examinations are available in the June and November series, and also in the March series in India.
• Across the whole qualification the weighting is AO1 43%, AO2 47%, AO3 10%. Analysis is the single largest component, which is why every explanation in this chapter is written as a chain rather than a statement.
• Read the Paper 1 column again: it carries no AO3 at all. Evaluation is assessed only on Paper 2, where it is worth 15%. A multiple-choice item therefore never rewards a judgement — it rewards the knowledge or the analysis that reaches the one correct option — and the two-sided discussions in this chapter are practice for Paper 2 Section B, not for Paper 1.
• DRAW — for every diagram. Draw and label the axes with the variable and the good. Record the original position: curves labelled, equilibrium marked, dashed lines to both axes. Add the change: the new curve, parallel to the old, with an arrow showing the direction. Write the result: the new price and quantity, and what happened, in words.
• FIND — for every calculation. Formula written out. Insert the numbers. Number with units or sign. Decide what it means for the question asked.
• DEAL — for every discussion. Define the key term. Explain one side with a chain. Argue the other side with a chain. Land a judgement that names the condition on which the answer turns.