Monday, June 6, 2016

The Most Common Errors Found in Paper 3 (9708) of CIE A Level Economics (8pm tonight, Malaysian time)

Chapter 1: Basic Economic Ideas and Resource Allocation
  1. Unable to clearly distinguish between productive efficiency and allocative efficiency. The former happens when a firm is producing at the lowest cost possible. This is achieved when MC = AC. The latter happens when a firm is producing output that is valued by the consumers. If this happens, P = MC or AR = MC or MB = MC
  2. Not being aware that all points on the PPC are productively efficient. However, it is possible that there can be only one point on the PPC which is allocatively efficient. It is also possible that NONE of the combination of two goods along the PPC can be regarded as allocatively efficient (refer to North Korea that focuses only on producing guns and nuclear. NONE of these two is wanted)
  3. Unaware that social efficiency, MSB = MSC can only be achieved once all negative/ positive externalities have been taken into account
  4. If P > MC, then the firm should produce more output. By contrast, if P < MC, then efficiency can be improved if the firm produces less (Basically, ‘no one’ values the good as indicated by lower MB than MC)
Chapter 2: The Price System and the Micro Economy
Theory of Firms 
  1. Unable to perform calculations involving the AFC, AVC, AC and MC
  2. Unaware that MC is actually the gradient of TC curve while MR is the gradient of TR curve (Mathematically, MR = change in TR/ change in quantity. This is equivalent to gradient where m = change in y/ change in x. Ever wonder why MR = 0 when TR is maximised?)
  3. Frequently mixed up between profit maximisation (MC = MR), revenue maximisation (MR = 0) and sales maximisation (AC = AR)
  4. Unaware that in an imperfect market, the only way for the output to be increased is for the price to be lowered
  5. Most are unable to answer questions pertaining to the interpretation of diagrams. One of the reasons I notice is that, candidates do not practice sufficiently and have adequate understanding of the nature of each type of cost and revenue curve
  6. Weak when it comes to the calculation of returns to scale. Instead of calculating and comparing the percentage of change between input and costs, candidates compare the difference in input against the costs (The key here is PERCENTAGE)
  7. Always forget the fact that PED = 1 when TR is maximised
  8. Unaware that a firm can still continue operating despite making a loss. It will only cease production when it cannot cover its own TVC. This can be written as P < AVC or TR < TVC
  9. Thought that only perfectly competitive firms produce homogenous goods. This is not true. Oligopoly firms can also produce identical goods. Consider water, gas and electricity firms. They are very big, few in number and yet produce almost similar goods
  10. Forget one of the assumptions of price discrimination and that is MC must equal to MR in both markets
  11. Forget that PED > 1 when price is increased and PED < 1 when price is decreased. This supports the analysis of the kinked demand curve. Firms shouldn’t attempt to alter prices as it will cause their TR to fall
  12. The most striking feature for a perfectly competitive firm is homogenous products, for a monopolistic firm is differentiated products, for an oligopoly would be high interdependence and monopoly is unique products
  13. A perfectly competitive firm is both productively and allocatively efficient only in the LR. In the short run, it is productively inefficient. However, generally/ theoretically, all imperfect market firms are thought to be both productively and allocatively inefficient in both short-run and long-run
  14. Unaware that MC depends on VC and not FC. So, when there is a change in the FC, value of MC will remain unchanged    
Theory of Cardinal Utility
  1. Forget the fact that utility can only be maximised when two conditions are met. First, all the allocated money income must be spent. Second, MU per dollar for all the goods must be the same (in reality, this is not necessarily)
  2. Weak when it comes to questions involving the budget line. Candidates almost always unable to determine the direction of money income and the price of a good given that the budget line has shifted in the mentioned position
  3. Income effect and substitution effect of a price change for both normal and inferior good
Chapter 3: Government Microeconomic Intervention
  1. Not familiar with the concept of demand for labour. Do take note that DL = MRPL which can be broken down into MPL x MR. This means demand for labour will increase if productivity increases, there is a higher price for the final product and also if there is a rise in the demand for the final product (refer to the formula while going through this three. It will make much more sense)
  2. MRPL = MPL x MR. This is the universal formula to calculate marginal revenue product of labour. However, in the case of perfectly competitive labour market, MR can be replaced with P because of the assumption of homogenous goods. For a monopsonist labour market, one CANNOT replace MR with P
  3. Unaware that MCL = MRPL means profit maximising quantity of labour. In theory, firms will use such an approach to determine the number of workers to be hired so that profits can be maximised. Do take note that labour is just like any other input. They contribute to both cost and revenue. Under theory of firms, MC = MR means quantity of output to be produced so that profits can be maximised
  4. Not being aware that trade unions are more successful in bargaining for a higher wage in a monopsonist labour market than perfectly competitive (Easier to be seen and understood if you compare the diagrams for both situations)
  5. Always make mistakes for questions involving transfer earnings and economic rent
    Chapter 4: The Macro Economy

    1. Not familiar with the multiplier formula. Do take note that k = 1/ (1-mpc) or k = 1/ mpw since mpw + mpc = 1 or k = change in national income/ change in injection (also the deflationary gap)

    2. Not knowing how to interpret two or three or four sector model of economy. For instance, when the question says ‘a close economy with no government’, that indicates a 2-sector economy

    3. Unaware that mpc is actually the gradient of consumption function and mps is the gradient of savings function (Anything with the term ‘marginal’ indicates gradient)

    4. Not knowing the fact that low income people/ jobless people typically have higher mpc than the higher income group

    5. Unfamiliar with the reasons as to why the AD is downward sloping. The fall in price level will lead to an expansion of AD while an increase will cause AD to contract. This is due to the wealth effect, interest rate effect and international trade effect

    6. Not knowing that actual growth is actually a rise in AD and potential growth is when there is a rise in LRAS/ PPC

    7. Widening gap between potential output and actual output will lead to rising unemployment. Just imagine that there are more people coming into the labour market and yet spending into the economy is weak

    8. Shift if SRPC is always due to changing expectations of rate of inflation. This is related to the monetarist view. When people re-enter the job market, they expect higher pay to compensate for the rise in inflation. However, they only have money illusion in the short-run. Once they are aware that the higher wage costs are being passed on, they will soon find themselves not being better-off than before. Some of these people will quit their job and become unemployed. There is an incentive to do so if they feel that they are better off with jobless benefits. By then, the SRPC has shifted up and to the right. Likewise is true

    9. Typically, many candidates are unaware that interest rates will always influence the exchange rate and net exports. A rise in interest rates will attract inflows of hot money. This causes higher demand for local currency and hence an appreciation. This however, raises imports and reduces exports and hence worsening of trade deficit

    10. NRU is related to supply side unemployment. This will include voluntary, structural, frictional and real wage unemployment

    11. An economy which saves and invests less on capital goods in the present will likely to experience lower potential growth in the future

    12. Unable to determine decisively on factors that can influence money demand and money supply under the theory of loanable funds. Discovery of oil reserves will increase the demand for loanable funds because firms will need to raise their investment if they want to extract more oil. Information like falling aps means supply of loanable funds will fall

    13. Many candidates are unfamiliar with the concept of automatic stabiliser and how it stabilises the economy by ‘smoothing out’ fluctuations in income. It basically prevents recession from worsening via the automatic provision of benefits to jobless people. It also prevents an economy from overheating when people automatically pay more tax once they have higher income. Don’t forget that income tax is progressive in nature. All these are AUTOMATIC and do not require discretionary/ active government interventions

    14. Surprisingly many candidates thought that a rise in economic growth will lead to development. This may or may not happen. So the best definition for development is an improvement in wellbeing/ better welfare/ quality of life. Lookout for the keywords

    15. Unaware that nominal GDP is also known as money GDP as well as GDP in current prices

    16. Forget the fact bond prices and interest rates are inversely related. When one increases, the other one has to decrease. A good example is the bond issued by the Greek government. Due to its poor financial health, influential credit rating agencies have classified their bonds as junk. This indicates poor ability to repay back their debts. As a result, demand for their bond decreases. This causes the interest rates to skyrocket. When you look at it, it is quite logical. The government has to entice lenders with a higher rate of interest. Otherwise, no one would want to buy their bonds or lend money to them

    17. Confuse between active and idle money balances. Active is for transaction and precautionary purposes while idle is for speculative purpose 

    Chapter 5: Government Macroeconomic Intervention

    1. Not knowing that higher government expenditure on healthcare/ education/ public transport, lower income/ business tax rate and greater investment actually contribute to higher AD/ demand-pull inflation in the short-run. However, in the long-run they cause the LRAS to increase/ cost-push inflation to fall

    2. Many candidates thought that there are only four macroeconomic goals. In fact there are actually eight. The other goals which are equally important but not that frequently tested are reduction of budget deficit/ national debt, stable exchange rate, cleaner environment and reduction in income inequality (a micro and macro topic)

    3. Unfamiliar with conflicts of macroeconomic objectives. Theoretically, higher economic growth conflicts with low inflation, BOPs in equilibrium, cleaner environment and reduction in income inequality

    4. Unfamiliar with certain macroeconomic terms. For instance, expansionary fiscal policy is the same as reflationary fiscal and loose fiscal

    5. Thought that the only monetary policy is reduction in interest rates. This is not true. Control of money supply, manipulation of exchange rate and change in cash reserve requirement/ cash ratio are also part of monetary tools

    6. Unaware that government spending and taxation can be both fiscal and supply-side measures. They are distinguished by their own transmission mechanisms
    Important notes:
    1. It is highly possible that new contents of the syllabus will make its way into the paper. New topics that can be tested are like Game Theory, Lorenz curve, ordinal theory of utility and how utility can be maximised
    2. Up to date I realise that many candidates aren't aware that behavioural economics have actually become part of the new syllabus. Generally, students need to know terms like habitual behaviour, bounded rationality, anchoring, framing and herd instinct. They are necessary to be included considering that many of the traditional theories of consumer behaviour can no longer explain why most of us are in fact irrational. It is also to take into consideration the changing dynamic of the consumer market

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