Sie sind auf Seite 1von 117

Factors of production

Exam Questions and Answers

Marginal Physical Productivity


Definition = The extra output produced when an additional unit of factor of production is employed.

Factors that can influence MPP


1. Quality / Specialised nature of the factors. If the quality of the factors used improves then they become more efficient and additional output will be produced. 2. Training/Education provided for the factors. If the factors are trained they become more skilled resulting in increased efficiency and more output. 3. Expertise of the entrepreneur. If the entrepreneur is expert in organising the production unit then each factor will be more productive and work to their maximum efficiency. 4. Law of Diminishing Marginal Returns. As each additional unit of a factor is used a point will be reached where the additional output produced will decline.

Marginal Revenue Productivity (MRP) of a factor of production


MRP: The extra revenue earned when an additional unit of a
factor of production is employed.

MRP = MPP X MR(Marginal Revenue) [Price per unit] Factors that can influence MRP
1. The productivity/ commitment of the factor. The more productive each additional factor employed is then the more MRP that factor will earn. The more conscientious a person is then the more productive that person will be. 2. The selling price of the output. If the selling price obtained on the market is rising or constant (and not falling) then the higher will be that factors MRP. 3. The Law of Demand. On the market, the law of demand dictates that in order for more to be bought then price must be reduced this affects the MRP obtained by the firm.

Factors that can influence MRP


4. Quality / Specialised nature of the factors/Unique talent. If the quality of the factor used improves then that factor may become more efficient and so additional output will be produced, resulting in increased MRP. 5. Training/Education provided for the factors. If the factor is more highly trained / has attained a good standard of education then it may become more skilled, resulting in increased efficiency and more output. 6. Expertise of the entrepreneur. If the entrepreneur has expertise in organising the production unit, then each factor may be more productive and work to its maximum efficiency. 7. Law of Diminishing Marginal Returns. As each additional unit of a factor is used a point will be reached where the additional output produced will decline and so MRP will decline.

Difficulties that may arise in measuring MRP.


1. Not all factors produce physical output. Where services are provided no physical output is produced and so MRP cannot be measured. 2. Output not sold in the market place. In the public sector where output is not sold in the market it is difficult to calculate MRP. 3. Combination of capital and labour to produce additional output. It is difficult to measure the contribution of each individual factor.

Economic Rent
Any earning of a Factor above its supply price / transfer earnings.
E.g. Pro Footballer currently earning 1,000,000 a year as a player with his club. If his next most highly paid employment is a TV Pundit earning 100,000, he is said to be earning an economic rent of 900,000 a year. E.g. I own a piece of land which I am willing to lease to a local farmer for 10,000 a year. If demand for land in the area rises and the farmer pays me 15,000 a year. I am said to be earning an economic rent of 5,000.

Transfer Earnings of a factor of production

Ways a Factor of Production can earn an Economic Rent?

Derived Demand

Derived Demand of Labour

Land

Land

Demand for Land


Commercial Rent - This is the price paid for leasing / renting a factor of production normally land or premises. It is the demand for land that really determines the rent for land as it is fixed in supply. The demand for land is determined by its MRP. If the MRP of land increases then the demand for land will also increase, thus increasing rent and vice versa.

Rent
As the demand for land increases, rent increases
Rent

S
D3 P2 P1 P3

D1
D2 D1 D3

As the demand for land decreases, rent decreases Q

D2
Quantity

12

Land and Economic Rent


Economic rent is any payment above the supply price of a factor of production. Land is a gift of nature.

Therefore, to mankind in general it has no supply price.


Thus, any payment made by mankind for land must be economic rent.
13

Industries Competing for Land and Transfer Cost


The transfer cost of a factor of production is the minimum payment that must be made to transfer a factor from one industry or activity to another. If land is to be transferred from one industry to another, then the minimum payment for the land is its transfer cost. This is its supply price. Therefore, only any payment above its transfer cost would constitute economic rent.

14

The Individual and Economic Rent


It is assumed that people act rationally. An individual when acquiring land will pay only the minimum price that guarantees that the land will be supplied to him or her. Thus he or she is paying only its supply price. Therefore, no part of the payment made by an individual for land would constitute economic rent.
15

Supply Curve of Land

Reasons why price of land for housing developing has fallen over the last few years?

Reasons why price of land for housing developing would rise?

Labour

Labour
Labour Force

Why might a Business increase their labour?

Labour and the Wage Rate


The return to labour is called wages. Wages are the price of labour. The wage rate is the price of one man-hour's labour. Therefore, like all prices, wages are determined by the interaction of the supply of and the demand for labour.
21 Wage rate

WR D

Man hours

The Demand for Labour


We have already seen that the demand for a factor is determined by its MRP and that its demand curve is a downward sloping one.
Wage rate

WR2

Thus the demand curve for labour is the normal downward sloping demand curve.

WR1

Q2

Man hours

Q1

22

Labour and Economic Rent


Quasi-rent is economic rent earned by labour in the short run. This happens when the demand for that form of labour is temporarily greater than its supply. Rent of ability is economic rent earned by labour in the long run. It happens when an individual has a unique talent for which there is a great demand.
23

Minimum Wage + Benefits

Why Businesses Do not want to increase the minimum wage?

Economic Advantage and Disadvantages of Reducing the Minimum Wage

Economic Advantage and Disadvantages of Reducing the Minimum Wage

Effects of an increase in Minimum Wage on the following

Reasons why different categories of workers are paid at different wage rates

MRP of Labour

Developments other than a fall in MRP that would result in a firm reducing its no. of employees

The Labour Force and the Supply of Labour


The labour force is the number of people working plus the number of people available for (willing to) work at the existing wage rate. The supply of labour is the labour force multiplied by the number of hours worked by each individual. The supply of labour is determined by the effect the wage rate has on:
the number of people in the economy in the 16 to 65 year age bracket the number of these willing to work the number of hours worked by these people.

31

Positive and Negative Wage Effect


As the wage rate changes it can have a positive or negative effect on the supply of labour. A positive wage effect means that the supply of labour will change in the same direction as the wage rate change that is, as the wage rate goes up the supply of labour also goes up, and vice versa. A negative wage effect means that the supply of labour will change in the opposite direction to the wage rate change that is, as the wage rate goes up the supply of labour goes down, and vice versa.

32

Supply Curve of Labour in a particular firm

Wage Effect on Number of People Aged 1665 in the Economy


This is always positive. As the wage rate increases immigration occurs and as it decreases emigration occurs. Ireland is a classical example of this phenomenon. This would result in an upward sloping supply curve.
Wage rate

WR2

WR1 S

Q1

Q2

Man hours

34

Wage Effect on Number of People Willing to Work


This is always positive because, as the wage rate increases:
More married women return to work. Some people come off the dole as the gap between the dole and the wage rate increases. Some people stay at work for a longer period to increase their pensions.

Wage rate

WR2

WR1 S

Again this leads to an upward sloping supply curve.

Q1

Q2

Man hours

35

Wage Effect on Number of Hours Worked


The wage effect on the number Wage rate of hours worked by individuals can be negative or positive. It is positive if people prefer an WR2 increase in wealth to an increase in leisure time. In this case it will again lead to WR1 an upward sloping supply curve.

Q1

Q2

Man hours

36

Wage Effect on Number of Hours Worked


It is negative if people prefer more leisure to more wealth that is, if they want to enjoy the wealth they already have. This can lead to a backward bending supply curve for labour when the wage rate reaches a very high level.
37 Wage rate

WR2

WR1 S
Man hours

Q2

Q1

Why might a worker choose to work less hours?

Overall Effect of a Wage Change


With two (definitely) positive effects of the wage rate on the supply of labour and only one possible negative effect, the overall effect of a change in the wage rate is positive. Thus as the wage rate increases the supply of labour also increases, and as it decreases the supply of labour also decreases. Thus the supply curve of labour is the normal upward sloping supply curve.
Wage rate

WR2

WR1 S

Q1

Q2

Man hours

41

The Equilibrium Wage Rate


The equilibrium wage rate is that wage rate that brings about an equal supply of and demand for labour. (Here shown as 10.)
Wage rate

10 D

Q1

Man hours

42

Wage Rate Above the Equilibrium Rate


The wage rate sometimes exceeds the equilibrium rate.

1. Trade unions will not allow wage rates to fall in reaction to market forces. If the demand for labour decreases unions refuse to take wage cuts. 2. In order to ensure industrial peace the government and the Social Partners have entered into national wage agreements. Each of these resulted in wage increases: e.g. Towards 2016.
Continued ..
43

Wage Rate Above the Equilibrium Rate


3. As part of the above agreements social welfare benefits have also increased; therefore, employers have to offer higher wages to attract some people off the dole. 4. Those people who are in work do not want to see their real wages decreasing; therefore, they have sought and received wage increases to compensate for inflation. 5. Many people who are in employment have very scarce skills resulting in the supply of that particular form of labour being less than the demand for it this means that these people can earn economic rent.

44

Factors which influence the supply of labour to the Irish Economy

In recent years these have been rising, acting as a deterrent for people to join the work force

Factors which Influence the efficiency of Labour as a Factor of Production

Why do people who train longer receive higher wages?

Economic Consequences of a fall in the demand for labour


Pressure on wage levels to fall Employers are forced to reduce wage levels in order to keep people in work. Emigration Due to a fall in the demand for labour , people have to leave to find work in other countries. The Level of wealth in the Economy falls less people are working therefore people have less income available to spend. Economic Activity falls people have less money available to spend in shops and on services. Less Income Tax Revenue for the Government Less money available for the Government to spend on essential services such as health and education. Increase in Government Expenditure on unemployment benefits and allowances puts pressure on the government expenditure as more people are signing on to the live register Increase in Taxes Income taxes increase in order to supplement the loss of income tax of people out of work and pay for social welfare system.

Economic Consequences of an increase in the demand for labour

Occupational mobility of labour


Definition: the ability/ease of a worker to move from one job to another. Factors which influence it: 1. Availability and access to affordable education courses 2. Availability and access to training, re-training courses and courses to update skills. 3. Government policies which aid mobility i.e. work permits; elimination of language /cultural barriers; offering internship programmes. 4. Reduced barriers for entry to some occupations e.g. journalism; medicine, teaching etc.

Geographical mobility of labour


Definition: the ability/ease of a worker to move from one area to another. Factors which influence it: 1. Housing. Increase the availability of affordable housing in those areas of shortages. 2. Educational facilities. Improve the availability of educational facilities to ease concerns of parents. 3. Social infrastructure. Improve the social infrastructure so as to make the areas more appealing for families e.g. shops, parks, leisure facilities. 4. Supports by Government. The government might provide adequate supports so as to entice people to move e.g. help with re-location costs etc. 5. Information / Knowledge: Provide up-to-date information on the possibilities of moving. Improve knowledge on the opportunities available for mobility.

Occupational and Geographical Mobility of Labour


At a time of full employment in a country it is important that there should be the maximum Geographical mobility and Occupational mobility.

Restrictions on the Mobility of Labour


1. Trade union barriers (for example, closed shop policy). 2. Labour lacks the skills required in areas where jobs are available. 3. Lack of housing or social facilities in areas where jobs are available. 4. Lack of knowledge of availability of jobs. 5. Language/cultural barriers may restrict international mobility. 6. Reluctance to leave home environment, or to disturb childrens education, etc.
53

Derived Demand of Labour

Wage Drift

Cyclical Unemployment

Forms of Unemployment
Frictional unemployment: people unemployed between jobs when one industry is declining while another is starting up. Seasonal unemployment: lack of demand at particular times of the year leads to short-term lay offs. Structural unemployment: industries that were major employers have gone into decline and there is no longer any demand for the skills of the old employees. Institutional unemployment: this arises when there are obstacles to the mobility of labour, or when the incentives to work are decreased.

55

Forms of Unemployment
Disguised unemployment: people who do not register on the live register but who are available for work. Underemployment: this is where someone is employed just to give that person an income, but he or she does not add to the total output of the firm (for example, a son employed in the family firm). Cyclical unemployment: associated with a general fall in the level of demand during a decline in the trade cycle.

56

Measuring Unemployment
People are said to be unemployed only if they are not working but are actively seeking employment. The live register is a list (register) of all those people who are not working and who sign a register each week in order to claim some social welfare benefit. The quarterly National Household Survey (QNHS) sets out to establish the number of people who are not working but who are actively seeking work. For this reason it gives a more accurate figure for unemployment than the live register.
57

Weaknesses of the Live Register as a Measure of Unemployment


1. Some people who sign on the live register do so only to get the dole and are not actively seeking work. Therefore, they are not unemployed. 2. Some people may be signing on the live register and working in the black economy. 3. Part-time workers may sign on for the days they are not working. Therefore, they are not unemployed. 4. Some people sign on only for credits towards their old age pension. Again, these people are not unemployed. 5. Some people do not sign on even though they are actively seeking work because they are not entitled to any benefits. These people are not counted as unemployed.
58

Causes of Recent Immigration


Increased awareness of employment opportunities in Ireland. Membership of the EU. Irelands social welfare system. Stricter immigration controls in other countries. Recruitment by public and private bodies. Lower personal tax rates. Perceived better quality of life in Ireland. Humanitarian factors.
59

Economic Consequences of Immigration

Negative Pressure on provision of state services. Drain on government finances. Possible exploitation of immigrants. Increased dependency ratio in long run. Increase in racism.

Positive Increased demand for goods and services. Improved dependency ratio initially. Reduction in labour shortages. Greater utilisation of resources. New skills and traditions come into the country.

60

Public Sector
Public Services are Labour Intensive (require a lot of labour) and as a consequence the public sector wage bill accounts for a significant proportion of government current spending. Why might MRP (Marginal Revenue Productivity) not be a suitable method for setting wages in the public sector?

Alternative way of determining wage levels in the public sector?

Ways to Reduce the Public Sector Wage Bill?

Capital Anything man made used to create wealth

Capital Anything man made used to create wealth

Fixed Capital = The stock of fixed assets e.g. Plant, Equipment, Tools Social Capital = The assets/wealth owned by the community/society in general e.g. Hospitals, Parks, Roads Private Capital = capital owned by individuals and companies Capital Stock = value of capital goods in existence at any given time. Gross Capital Formation = total money spent on capital goods in any given period. Depreciation = loss in value of capital goods in any given period. Net Capital Formation = Addition to capital stock in any given period.

Capital Stock
Capital Stock at 1/1/10 (a) Add Gross Capital formation to 31/12/10 Total Less Depreciation Capital Stock at 31/12/10 (B) Net Capital Formation : (B) (A) 1,000,000 500,000 1,500,000 300,000 1,200,000 200,000

Capital Stock has increased by 200,000. This is the net capital formation. It is the same as gross capital formation minus depreciation.

Capital Formation: Money Spent on Capital Goods


Capital is wealth used to create more wealth.
Capital formation (spending on factories, machines, etc.) requires savings We earn all our Income (Y) from the fact that people consume the goods and services we produce (consumption C) and from the fact that employers who have invested money employ us (investment I)

Thus All income (Y) is derived from investment (I) and consumption (C): Y=I+C
We all dispose of that same income by spending some of it (Consumption C) and saving the rest of it (Savings S)

Thus All income is disposed of through consumption and saving (S): Y=C+S Therefore:

I+C=C+S
Therefore:

I = S (INVESTMENT depends on SAVINGS)


NOTE: This doesnt mean that all savings will be invested but simply that there must be savings for investment to take place

Following on: Capital and Savings


This means that the maximum level of investment is dependent on the level of saving. Therefore, people must refrain from spending some of their income so that money will be available for investment.

The reward for saving is interest.


68

Savings
Savings = owners of capital who receive interest. The decision to save is made by individuals. Income is not spent E.g. Income of 100 less Spending of 80 = Savings of 20

The Reasons People Save


To purchase some expensive item in the future: set aside a certain amount of their income each week or month E.g. New Car For thrift purposes to restrict there saving in line with a prudent budget (avoid wasteful impulse buying). To earn interest financial institutions offer interest on money saved incentive for people to accumulate wealth. For precautionary purposes - if an unforeseen event occurs they have money to meet this cost. E.g. Washing Machine Breaks Down To provide for retirement weekly income will decrease when you retire to prevent any drastic fall in standard of living people refrain from spending part of their income while they are working to have it available when they retire (Contribution to a Pension scheme)
70

Factors that Affect the Level of Saving


The level of income people on low incomes need to spend all their income to meet the cost of their daily needs and wants. Therefore they cannot save. Conversely people on high levels of income can save a lot of their money Higher level of income the greater potential to save. The rate of interest the opportunity cost of not saving increases as the rate of interest on savings increases. Therefore as rates of Interest increase people are enticed to save more. The level of social welfare benefits, particularly old aged pensions: If old age pensions provided by the state are big, there is less incentive for people to save money for retirement and visa versa. (dangerous assumption to make during working life no guarantee over time) The level of tax on interest on savings: DIRT If the level of tax on savings increases this has the same effect as a reduction in the rate of interest and so will discourage savings. The rate of inflation (may result in negative interest rates): the rate of inflation may result in negative interest rates. If the rate of inflation is greater than the rate of interest, money saved will lose some of its purchasing power. This could discourage people from saving as people may decide to spend the money while purchasing power is at its greatest.

Paradox of Thrift
Marginal Propensity to Save = the tendency to save a given percentage of the last increase in income. Sometimes an increase in the marginal propensity to save (MPS) can lead to a decrease in the level of demand in the economy. This in turn can lead to a decrease in the level of income, as fewer people are employed. An increase in the MPS can also lead to a possible decrease in the actual level of savings.

Investment
Investors = Users of Capital who pay interest. The decision to invest is made by producers / firms. Production of Capital Goods / Additions to Capital Stock E.g. Purchase of new machinery by a firm

Capital Widening = an increase in the use of capital which leaves the ratio of capital to labour unchanged
The amount of capital per worker remains unchanged. An increase in capital stock which leaves the capital / labour ratio unchanged. E.g. Period 1: 4 machines & 4 men Period 2: 8 machines & 8 men Normally happens during economic development of a country

Capital Deepening = increase in use of capital which increases the ratio of capital to labour.
Making a greater quantity and quality of capital goods available to each unit of labour throughout the economy. The amount of capital increases resulting in more capital per worker in the economy. E.g.
Period 1: 4 machines & 4 men Period 2: 12 machines & 8 men

Normally associated with Economic Growth as distinct from economic development.

Marginal Efficiency of Capital (MEC)

Factors that Influence MEC Cost of Capital Goods - higher the cost, the longer to pay back, therefore the less profitable as more revenue is used to repay loan Rate of Interest (the price of capital) If the interest rate increases capital goods become more expensive. Selling Price of the good being sold if this decreases (competitors lowered their price) , then total revenue falls. Therefore purchase of additional capital stock becomes less attractive and existing capital less profitable. Fall in Productivity of extra capital as existing capital goods get older their productivity may decrease . Capital Widening and Deepening

Capital Investment
Reasons why investment is important for the Irish economy? E.g. More factories = More Wealth 1. Increased productive capacity Greater investment allows the country to produce more output / it replaces worn-out capital resources. 2. Increased labour productivity E.g. Man can dig a much bigger area with a JCB than with his hands

More investment allows labour to become more efficient. Investment allows workers to use more up-to-date capital goods, making them more efficient. 3. Increased employment E.g. More people employed to make and distribute products Extra investment increases aggregate demand resulting in the demand for more employees to meet this additional demand for goods & services. 4. Increased GNP Increased investment leads to higher GNP, greater demand, increased spending and a higher standard of living. 5. Investment generates future wealth for the economy Investment into the economy means that we are safeguarding the future wealth creating capacity of the country, by ensuring that we have capital goods in the future. 6. Increased Government Revenues An increase in investment will increase economic activity. This will generate additional revenues for the government for use within society. E.g. Extra PAYE for employee, VAT from sales, Corp Tax from profits

Factors that currently influence the level of investment in the Irish economy
1. Rates of interest / Cost of borrowing As rates of interest increase, the cost of borrowing increases. Thus the lower will be the profit earned. Hence investment will fall / MEC may fall. 2. Business people's expectations E.g. If Profits are expected, Increased investment in area Currently many business people are pessimistic about the economy and so they are less likely to invest. Irish business people are more pessimistic about the future for various reasons: potentially higher tax rates in Ireland; higher interest rates; poor economic growth rates. 3. Government economic policies E.g. Grants/ Low Corp Tax atmosphere conductive to Investment If government policy is favourable towards investment then investment tends to rise. Examples of favourable policies currently include: attractive state grants; a policy to maintain corporation tax at current levels; continued development of infrastructure etc. The government policy to provide additional training places; reduced VAT for some industries and reduced PRSI for additional workers hired may help attract investment into Ireland. 4. The international economic climate Ireland is an open economy, which relies on foreign investment. If the international economic climate is in a slump then this may result in a fall in demand which will cause Irish businesses to suffer. E.g. If Level of Demand and Income abroad is increasing encourage firms to invest in export-orientated industries thus increasing investment.

Factors that currently influence the level of investment in the Irish economy (Continued)
5. The Marginal Efficiency of Capital The greater the potential MEC for any possible investment project then the more likely the investment will take place. 6. Stability in the banking sector The policy of the state to stabilise the banking sector should help the flow of credit, and so encourage risk taking. 7. The cost of capital goods The greater the cost of capital goods the lower the profitability of the investment, hence investment tends to fall. 8. Availability of a skilled English speaking workforce The workforce is English speaking which may attract investment. People have time to re-train during the current period of unemployment. Ireland currently has a pool of highly skilled workers. 9. State of Technology As technology improves more goods can be produced at a lower average cost, thus increasing profits leading to more investment. 10. Domestic Environment If the general level of demand and the general level of income in the domestic market are increasing, new firms will be encouraged to set up to meet this domestic demand leading to more investment.

Economic advantages and possible economic disadvantages of investing in public transport, rather than investing in the construction of new roads.

Economic advantages and possible economic disadvantages of investing in public transport, rather than investing in the construction of new roads.

Influences on Investors locating in Ireland

Influences on Investors locating in Ireland

Reduce Capital Gains Tax Businesses which are set up to be sold for a profit after a short time must pay CGT on the profit made from selling the firm. If CGT is high these people will be Reluctant to invest Low Corp Tax Rates As Corporation Tax (tax on company profits) decreases it makes for a better return on capital invested , therefore encouraging more investment

Grants When the government gives a grant to a firm , this reduces the amount of money which must be invested in the business, increasing the return on the capital which it actually invests. Makes it more attractive for firms to invest. - Similarly if the government took shares in the business the firm would have to provide less capital, it would reduce the amount of money which the firm must raise.

Theories on Interest Rates


There are two theories on interest rates:

1. The Loanable Funds Theory


(The Classical Theory)

2. The Liquidity Preference Theory


(The Keynesian Theory)

84

The Loanable Funds Theory


This states that the rate of interest is determined by the interaction of the supply of and the demand for money. Here the supply means the amount of money being saved with the financial institutions. The demand means the demand for loans from the financial institutions.
85

Supply of Money (Loanable Funds)


This theory states that if the supply of savings (money) into the financial institutions is not sufficient to meet the demand for loans, then the banks will increase interest rates to attract more savings and vice versa.

86

Supply of Money (Loanable Funds)


Thus the supply curve of money is the normal upward sloping supply curve.
Interest rate

R2

R1 S

Q1

Q2

Money

87

Demand for Money (Loanable Funds)


This theory states that the demand for loans decreases as the rate of interest increases. This happens because when interest rates increase the price that is, the cost of borrowing increases. It also assumes that the demand for loans will increase when interest rates decrease as the price that is, the cost of borrowing goes down.
88

Demand for Money (Loanable Funds)


Therefore the demand curve for money is the normal downward sloping demand curve.
Interest rate

R2

R1

Q2

Q1

Money

89

S = D for Loanable Funds


Thus the rate of interest will settle at the rate that brings about an equal supply of and demand for money (that is, loanable funds). This happens at the point where the demand and the supply curves intersect.
Interest rate

D S

10%

S D
Q1
Quantity of money

90

Criticism of the Loanable Funds Theory


1. It assumes that savings will automatically increase as interest rates increase.
This is not always true as people can only save if their income is big enough to allow them to do so.

2. It assumes that savings will automatically decrease as interest rates decrease.


This is not always the case as interest is not the only factor to influence savings.
91

Liquidity Preference Theory of Interest Rates


This states that the rate of interest is determined by the interaction of the supply of and the demand for money. The demand for money means the reasons people want to hold on to money rather than make it available for investment. The supply of money refers to the amount of money in circulation.
92

The Supply of Money


The supply of money is fixed by the central bank at any given time. Thus the supply of money is not affected by changes in the rate of interest. Therefore, the supply curve of money is a straight vertical line.
93 Interest rate

R2

R1

S Q
Quantity

The Demand for Money


People demand money for three reasons:

1. The transaction motive.


2. The precautionary motive. 3. The speculative motive.

94

The Transaction Motive


This means that people want to hold on to money to satisfy their day-to-day needs and wants. The amount held for this purpose is determined by their income and the value of their daily transactions and is not affected by interest rates.

95

The Precautionary Motive


This means that people want to hold on to money for emergency situations. A pessimist will hold on to large sums, believing in Murphys Law. An optimist will hold very little for this purpose. An optimist will also be slightly influenced by the rate of interest.
96

The Speculative Motive


This means that people want to hold on to money to have it available for any business opportunity that might arise. These people are motivated by the prospect of making money. Thus, as the rate of interest increases the opportunity cost of holding money increases.

Thus, as interest rates increase less money is held for this purpose.
97

The Demand for Money


The demand for money for the transaction motive is not affected by the rate of interest. The demand for money for the precautionary and speculative motives is affected by the rate of interest. The demand for money will therefore decrease as the rate of interest increases, provided incomes are firstly sufficient to meet normal needs and wants.
98

Demand Curve for Money


The demand curve for money is the normal downward sloping one, showing that the demand for money decreases as interest rates increase and vice versa.
99 Interest rate

R2

R1

Q2

Q1

Money

Supply and Demand Curves


Now superimpose the demand curve for money onto the supply curve of money to establish the equilibrium rate of interest.
Interest rates

5%

Quantity of money

100

Supply of and Demand for Money


The supply of money is fixed at any given time. Thus the only variable is the demand for money. Therefore, it is the demand for money that determines interest rates at any given time. This is shown on the diagram on the next slide. Remember it is only the demand for money that can change at any given time.
101

Supply and Demand Curves


Interest rates

S
D3

R3 R1 R2

D1
D2 D1 D3

D2
Q
Money

102

Other Factors Affecting Rate of Interest


These are in addition to the loanable funds theory and the liquidity preference theory. The European Central Bank sets base rate of interest at any given time. Rate is determined by the requirements of the EU economy in general. Any change in the Irish base rate is a reflection of the rates charge by National Central Banks which are members of the EU. The short-term facility rate rate of interest which the central bank charges commercial banks when it grants them short term loans. If the STF Increased, then the commercial Banks Pass this increase into their customers in form of increased rates of interest. The degree of risk to the lender Banks charge 3 different rates of interest depending on the customers credit status. These are AAA (lowers rate), AA (next lowest) and A (highest). The last is the most common. The degree of liquidity of the loan relative ease in obtaining instant repayment of the loan at any given time. When somebody obtains a mortgage from a financial institution, the institution hold the deeds of the house (as security) and can sell it to obtain any outstanding debt. Unsecured Loans carry higher rates of interest. The rate of inflation: as it increases, people tend to save less due to fears of negative interest rates. To overcome this fear banks tend to increase interest rates as inflation increases to encourage a steady flow of savings The demand for loans: If there is a shortage of funds in the financial institution relative to the demand for loans, then the supply of demand ensure that interest rates increase and visa versa.

Enterprise

Enterprise

Enterprise is Unique for the following reasons

Do all Entrepreneurs earn the same level of Profit? Why?

Reasons why Entrepreneurship is important to the development of the Irish Economy

Reasons why Entrepreneurship is important to the development of the Irish Economy (continued)

Factors which Encourage Enterprise

Insurable Risks
Those risks which can be mathematically estimated and an entrepreneur can insure against occurring and An insurance policy can be purchased to provide compensation in the event of loss. Examples 1. Theft of stock or cash. 2. Fire to premises/ damage to stock caused by fire. 3. Accidents to members of staff. 4. Accidents to members of the public / public liability etc.

Non Insurable Risks


Those risks which the entrepreneur cannot insure against

Role of Profits in promoting development in a modern market economy

Role of Profits in promoting development in a modern market economy

Privatisation
Potential Privatisation in State Energy Firms Bord Gais, ESB

Advantages of Privatisation

Disadvantages of Privatisation