Chapter 1: The Basic Economic Problem
Definition: The economic problem arises from the conflict between unlimited human wants and limited resources (scarcity).
The fundamental economic problem forces societies to make choices about:
- What to produce? Which goods and services should be made?
- How to produce? Using which methods and resources?
- For whom to produce? Who gets the output?
Key Concept: Opportunity Cost
The value of the next best alternative forgone when making a choice. Because resources are scarce, choosing one option means giving up another.
The value of the next best alternative forgone when making a choice. Because resources are scarce, choosing one option means giving up another.
Practice Question: Which combination of terms gives the general definition of the economic problem?
Correct Answer: D
The economic problem is fundamentally about scarcity - unlimited wants but limited resources to satisfy them. Options A, B, and C are specific examples or consequences of scarcity, but D provides the general definition.
Practice Question: An unemployed worker accepts a job. Which of the following is the opportunity cost of this decision?
Correct Answer: C
Opportunity cost is the next best alternative forgone. By taking a job, the worker gives up leisure time (assuming leisure was the next best alternative to working). The income from the job (B) is the benefit, not the cost.
Additional Practice: A hospital cannot treat all the people that need treatment. This is an example of:
Correct Answer: C
The hospital has limited resources (doctors, beds, equipment) but unlimited wants/needs (all patients requiring treatment). This mismatch is scarcity - the fundamental economic problem.
Exam Tip: When answering questions about opportunity cost, always identify the specific alternative that is given up, not just "money" or "time." For example: "The opportunity cost of building a new school is the hospital that could have been built instead."
Chapter 2: Demand and Supply
Demand: The quantity of a good or service consumers are willing and able to buy at a given price in a given time period.
Supply: The quantity of a good or service producers are willing and able to sell at a given price in a given time period.
Law of Demand: There is an inverse relationship between price and quantity demanded (ceteris paribus - all other things being equal).
Law of Supply: There is a positive relationship between price and quantity supplied (ceteris paribus).
Practice Question: What would not cause a shift in the demand curve for a good?
Correct Answer: C
A change in the price of the good itself causes a movement along the demand curve, not a shift of the entire curve. Options A, B, and D are all factors that shift the demand curve (changes in income, prices of related goods, and tastes).
Practice Question: In 2010, floods caused severe damage to wheat production. How would this be shown on a market demand and supply diagram for wheat?
Correct Answer: B
Floods damaging wheat production reduce the supply of wheat at every price, shifting the supply curve to the left. There's no mention of changes in consumer preferences or other factors affecting demand, so the demand curve remains unchanged.
Additional Practice: What is an example of complementary demand?
Correct Answer: C
Complementary goods are used together. Televisions require electricity to function, so they are complements. Buses and bus fares are not complementary goods (fares are the price of using buses). Cotton and cotton seed, and wood and sawdust are examples of joint supply, not complementary demand.
[Demand and Supply Diagram - Price on vertical axis, Quantity on horizontal axis]
Demand curve slopes downward, Supply curve slopes upward
Equilibrium where they intersect
Demand curve slopes downward, Supply curve slopes upward
Equilibrium where they intersect
Chapter 3: Price Elasticity of Demand and Supply
Price Elasticity of Demand (PED): Measures the responsiveness of quantity demanded to a change in price.
Formula: PED = (% Change in Quantity Demanded) / (% Change in Price)
Formula: PED = (% Change in Quantity Demanded) / (% Change in Price)
Price Elasticity of Supply (PES): Measures the responsiveness of quantity supplied to a change in price.
Formula: PES = (% Change in Quantity Supplied) / (% Change in Price)
Formula: PES = (% Change in Quantity Supplied) / (% Change in Price)
PED Values:
• PED > 1: Elastic demand (responsive to price changes)
• PED < 1: Inelastic demand (unresponsive to price changes)
• PED = 1: Unitary elastic
• PED = 0: Perfectly inelastic
• PED = ∞: Perfectly elastic
• PED > 1: Elastic demand (responsive to price changes)
• PED < 1: Inelastic demand (unresponsive to price changes)
• PED = 1: Unitary elastic
• PED = 0: Perfectly inelastic
• PED = ∞: Perfectly elastic
Practice Question: A company decided to reduce the price of its product by 10%. What would happen?
Correct Answer: C
If demand is elastic (PED > 1), a price reduction leads to a more than proportional increase in quantity demanded, increasing total revenue. Profits (B) depend on costs as well as revenue. Quantity sold would increase, not decrease, if demand is inelastic (D).
Practice Question: The table shows four people's demand for t-shirts at two prices. Who has the most elastic demand for t-shirts when the price rises from $10 to $15?
[Table: Price $10 → $15]
Elsa: 15 → 2 units (86.7% decrease)
George: 6 → 3 units (50% decrease)
Hamid: 3 → 1 unit (66.7% decrease)
Shara: 5 → 4 units (20% decrease)
Elsa: 15 → 2 units (86.7% decrease)
George: 6 → 3 units (50% decrease)
Hamid: 3 → 1 unit (66.7% decrease)
Shara: 5 → 4 units (20% decrease)
Correct Answer: A (Elsa)
Price increase = (15-10)/10 × 100 = 50% increase
Calculate % change in quantity demanded for each:
Elsa: (2-15)/15 × 100 = -86.7% (PED = 1.73)
George: (3-6)/6 × 100 = -50% (PED = 1.0)
Hamid: (1-3)/3 × 100 = -66.7% (PED = 1.33)
Shara: (4-5)/5 × 100 = -20% (PED = 0.4)
Elsa has the highest PED (most elastic).
Calculate % change in quantity demanded for each:
Elsa: (2-15)/15 × 100 = -86.7% (PED = 1.73)
George: (3-6)/6 × 100 = -50% (PED = 1.0)
Hamid: (1-3)/3 × 100 = -66.7% (PED = 1.33)
Shara: (4-5)/5 × 100 = -20% (PED = 0.4)
Elsa has the highest PED (most elastic).
Additional Practice: A bus company knows that demand for travel before 09:00 hours is inelastic and that after 09:00 hours it is elastic. How is the company certain to increase total revenue?
Correct Answer: B
When demand is inelastic (before 09:00), increasing price leads to an increase in total revenue because the percentage fall in quantity demanded is less than the percentage increase in price. After 09:00, with elastic demand, they should reduce fares to increase revenue.
Exam Tip: Remember the relationship between elasticity and total revenue:
• If demand is ELASTIC: Price ↓ → Total Revenue ↑; Price ↑ → Total Revenue ↓
• If demand is INELASTIC: Price ↓ → Total Revenue ↓; Price ↑ → Total Revenue ↑
• If demand is ELASTIC: Price ↓ → Total Revenue ↑; Price ↑ → Total Revenue ↓
• If demand is INELASTIC: Price ↓ → Total Revenue ↓; Price ↑ → Total Revenue ↑
Chapter 4: Market, Mixed, and Planned Economic Systems
Market Economy
Resources allocated by price mechanism. Private ownership of factors of production. Consumers sovereign.
Features: Profit motive, competition, consumer choice.
Mixed Economy
Combines market forces with government intervention. Both private and public sectors.
Features: Government provides public goods, regulates private sector, redistributes income.
Planned Economy
Government makes all economic decisions. State ownership of resources.
Features: Central planning, production targets, government sets prices.
Practice Question: What can be found in a mixed economy but not in a market economy?
Correct Answer: A
A national economic development plan indicates government intervention in the economy, characteristic of mixed economies. Market economies rely primarily on price mechanism without central planning. Unequal distribution (B), price mechanism (C), and private ownership (D) exist in both market and mixed economies.
Practice Question: Malaysia is a mixed economy. Which statement about a mixed economy is necessarily correct?
Correct Answer: B
A defining characteristic of mixed economies is that the government provides public goods (non-excludable, non-rivalrous) and may provide merit goods (goods with positive externalities). The other options are not necessarily true for all mixed economies.
Additional Practice: Which pair of economic institutions is most likely found in a market economy?
Correct Answer: C
Stock exchanges facilitate private investment and capital raising for companies. Monopolies can exist in market economies (though regulated in mixed economies). Free hospitals (A), public corporations (B), and government schools (D) suggest state provision more characteristic of mixed economies.
Chapter 5: Market Equilibrium and Disequilibrium
Market Equilibrium: When quantity demanded equals quantity supplied at a particular price. There is no tendency for price to change.
Disequilibrium Situations:
• Shortage (Excess Demand): Qd > Qs at current price → Price rises
• Surplus (Excess Supply): Qs > Qd at current price → Price falls
• Shortage (Excess Demand): Qd > Qs at current price → Price rises
• Surplus (Excess Supply): Qs > Qd at current price → Price falls
Practice Question: The table shows the price of, demand for and supply of X per week. What will be the effect if the government imposes a minimum price of $40 per tonne?
[Table: Price $20: Demand 16, Supply 10
Price $30: Demand 12, Supply 12 (Equilibrium)
Price $40: Demand 10, Supply 14]
Price $30: Demand 12, Supply 12 (Equilibrium)
Price $40: Demand 10, Supply 14]
Correct Answer: C
At $40, quantity supplied (14 tonnes) exceeds quantity demanded (10 tonnes), creating a surplus of 4 tonnes. A minimum price (price floor) set above equilibrium creates excess supply.
Practice Question: In a market there is a shortage of a good. What change would cause the market to come to an equilibrium?
Correct Answer: D
A shortage exists when price is below equilibrium. As price rises, quantity demanded falls (movement along demand curve) and quantity supplied rises (movement along supply curve), eliminating the shortage.
Additional Practice: In 2008 inflation was close to 100,000% in Zimbabwe. The government imposed maximum prices on a range of products. This caused price rises amongst those goods sold unofficially or illegally. What could explain this?
Correct Answer: A
Maximum prices (price ceilings) set below equilibrium create shortages (excess demand). When goods are scarce in official markets, black markets emerge where prices are higher. The price controls increase demand (by making goods appear cheaper) while reducing supply (producers get less).
[Market Equilibrium Diagram]
Show equilibrium at intersection of D and S
Show surplus when price above equilibrium
Show shortage when price below equilibrium
Show equilibrium at intersection of D and S
Show surplus when price above equilibrium
Show shortage when price below equilibrium
Chapter 6: Role of Markets in Allocating Resources
Resource Allocation: How an economy distributes its scarce resources among alternative uses to produce goods and services.
Functions of the Price Mechanism:
1. Signalling: Prices provide information about scarcity/abundance
2. Incentive: Prices motivate producers and consumers
3. Rationing: Prices allocate scarce goods to those willing/able to pay
1. Signalling: Prices provide information about scarcity/abundance
2. Incentive: Prices motivate producers and consumers
3. Rationing: Prices allocate scarce goods to those willing/able to pay
Practice Question: What is meant by an equilibrium price?
Correct Answer: B
The equilibrium price is where quantity demanded equals quantity supplied. At this price, there is no excess demand or supply, so no market forces pushing the price up or down.
Practice Question: Water is a scarce resource in Singapore. Which method would be least successful in tackling its water scarcity?
Correct Answer: A
Exempting large families from water taxes encourages MORE water consumption, worsening scarcity. The other options either increase supply (B, D) or reduce demand through higher prices (C).
Additional Practice: The market for a good was in equilibrium. A change occurred which resulted in a new equilibrium with a higher price for the good and a lower quantity traded. What change would have caused this?
Correct Answer: C
A leftward shift in supply (decrease in supply) causes price to rise and quantity to fall. A leftward demand shift (A) causes price and quantity to fall. A rightward demand shift (B) causes price and quantity to rise. A rightward supply shift (D) causes price to fall and quantity to rise.
Exam Tip: When analyzing market changes, always:
1. Identify which curve shifts (Demand, Supply, or both)
2. Determine direction of shift (left = decrease, right = increase)
3. State the effect on equilibrium price and quantity
1. Identify which curve shifts (Demand, Supply, or both)
2. Determine direction of shift (left = decrease, right = increase)
3. State the effect on equilibrium price and quantity
Key Concepts Summary
Scarcity & Choice
- Unlimited wants, limited resources
- Opportunity cost
- PPC shows trade-offs
Demand
- Law of Demand
- Factors shifting demand
- Movement vs. shift
Supply
- Law of Supply
- Factors shifting supply
- Market equilibrium
Elasticity
- PED and business decisions
- PES and time period
- Total revenue relationship
Market Systems
- Market vs. mixed vs. planned
- Price mechanism functions
- Government intervention
Exam Skills
- Define key terms
- Draw and label diagrams
- Apply concepts to examples
- Calculate and interpret PED/PES