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1 ECONOMIC SYSTEMS
Determining what to produce?
1. What to produce
2. How to produce
3. Whom to produce
Market: An arrangement where consumers and producers of a good and service come and
exchange.
Price Mechanism: When the demand and supply determines the price of a commodity
Advantages of the market system:
1.
2.
3.
4.
Market Failure: When markets fail to produce goods and services worthwhile , and decisions
of producers and consumers that result in wasteful or harmful activities
Market problems and how mixed economies solve market problems:
Market system
Firms only produce profitable goods and
services
Firms only supply goods to consumers who
can afford it
Resources only employed it its profitable
Mixed system
Government provides public goods
Government provides public and merit goods
at low cost/free
Government can provide jobs in public
sectors and provide welfare payments to
unemployed or low incomes
Harmful goods may be produced if its Charge high taxes on such goods or ban it
profitable
Producers and consumers ignore the harmful Introduce laws and regulations to stop this
effects on the environment
Some firms may dominate the market supply Regulates or breaks up the monopolies
How government interventions can be bad?
1. Taxes can distort market signals and reduce work incentive
-Less money for hard work, increase prices
2. Laws and regulations increase production cost and reduces the supply
-Health, safety, employment, environmental, consumer protection increases
production cost
3. Public sector maybe be inefficient and produce poor quality goods and services
Demand Curve:
-Downward sloping
-Price rises, demand falls
-Price and quantity move
in opposite directions
Extension of demand:
when quantity demanded
increases with a fall in
price, with no other factor
affecting demand
Contraction of demand:
Opposite of extension
Ceteris paribus: All other factors remain unchanged
and
QnQ
1 oo
PED=
PnP
1 oo
Supply
Factors:
1. Time
-Takes more time to get more things
2. Availability of Resources
-If a production wants to expand it
needs more factors of production
3. Subsidies: Private sector firms are not interested in producing external benefits for
other because they are not paid for them. Subsidies help to reduce their production
cost and thus make it profitable to produce the goods and services(buses)
Government policy and conflicts of Interest: Taxes, subsidies and laws and regulations can
also influence consumer demand where these have external cost and benefits (cigarette tax or
vaccine subsidies). However when government intervention occurs, it may create conflicts
of interest. (Higher taxes on income for subsidised buses good for middle income people, but
for high income people higher taxes are bad and they may not benefit as much from buses)
Arguments for and against conservation:
NO
Free market encourages the most efficient
use of resources through price mechanism;
firms that waste resources face higher costs
and are not able to compete with more
YES
If prices are too low to cover external cost
then taxes can help to raise prices and reduce
demand.
efficient ones.
Conserving resources leave them idle, thus
Medium of Exchange
Measure of Value
Store of Value
Means of deferred payment(Can pay later, credit cards)
Acceptability
Durability
Portability
Divisibility
Scarcity
Money Supply- Cash or notes circulating and deposits in banks and other financial
institutions.
Types of banks:
Functions of Commercial banks:
1. Accepting deposits of money and savings
2. Helping customers make and receive payments
3. Making personal and commercial loans(Overdraft- over withdrawing and Mortgage4.
5.
6.
7.
Time rate
Piece rate
Fixed annual rate
Performance related payment
wages/salaries
bonuses/commission
pension
holiday entitlement (fringe benefits)
proximity to home
promotion prospects
working conditions
Canteen/social facilities.
Disadvantages
Relies on others to produce goods and
services
Doing the job for many years can be boring
and stressful
Skills and occupations can become outdated
Types of Unions
1.
2.
3.
4.
Collective bargaining:
When trade unions and employers negotiate
Trade unions will argue for improved wages and other working conditions when:
1.
2.
3.
4.
5.
Union representation:
1. Closed shop: Employees must join a union as a condition for working there
2. Open shop: Can employ union or non-union members
3. Single Union agreement: An employer agrees to a single union representing all its
employees
-Advantages:
1.
2.
3.
4.
Savings
Delayed consumption until some later time.
Why people save?
1.
2.
3.
4.
For consumption
High saving interest rates
Consumer confidence in jobs
Availability of saving schemes
Interest rates
Wealth(more willing can easily repay)
Consumer confidence in job
Ways of borrowing and availability of credit
SOLE TRADER
Business owned by one person
ADVANTAGES
Sole trader business organization is easy to
set up
Sole trader is very personal one( with
customers)
Sole trader has full control over the business
DISADVANTAGES
Has unlimited liability
A sole trader has full responsibility for
managing the business
Sole trader lack capital(Hard to expand, lack
of money)
DISADVANTAGES
Partners can disagree
General partners have joint unlimited liability
Partnerships lack capital
DISADVANTAGES
Limited companies have to disclose financial
information(competitors find out and
expensive to make)
They cannot sell their shares publicly(less
money for expansion)
DISADVANTAGES
It is expensive to form a public limited
company
They are required to publish detailed annual
reports and accounts
Public shareholders have to hold Annual
General meetings(AGM)(expensive and time
consuming
Management diseconomies(Communication
problems between different parts and layers
of the company)
Vulnerable to take overs(more than 50%
shares)
Divorce of ownership from control
MULTINATIONAL CORPORATIONS
Advantages:
1. Reach more consumers globally
2. Avoid trade barriers by setting up operations in countries that apply tariffs and quotas
to import some multinationals
3. Minimize transport cost by locating plants in different countries to be nearer to
consumers/suppliers
4. Minimize wage cost by putting factories in low wage countries
5. Raise significant capital for expansion, research and development and to employ
workers with the highest skills
6. Scale of productions allows it to lower average cost
Impact on economies:
1. Increase investment in new business premises and technologies.
2. Provides jobs for local workers
3. Brings new knowledge and skills into a country which can help domestic firms
improve their own productivity
4. Pay taxes on their profits which boost government revenues
5. Increase export earnings through international trade
Problems they create in host countries:
1. Exploit workers in low wage economies
2. Natural resources exploited and the environment damaged
3. Profits may be switched between countries to avoid taxes
COOPERATIONS
Firm owned, controlled, and operated by a group of users for their own benefit. Each
member contributes equity capital, and shares in the control of the firm on the basis of onemember, one-vote principle (and not in proportion to his or her equity contribution).
Two main types:
1. Worker cooperatives
2. Consumer cooperatives
Worker Cooperatives (owned by workers)
ADVANTAGES
Popular with workers because they are in
charge, encourages them to work harder
because they can take part in decision
making and running the business
Workers receive the profit they make, based
on dividends on the basis of equal share or
according to how much money they put in
DISADVANTAGES
Hard to raise capital, have to borrow from
banks. Thus they remain small.
Retail Cooperatives (Retailing businesses run for the benefit of their customers) (Managers
run the organization)
Principles:
1.
2.
3.
4.
PUBLIC SECTOR
Types:
1. Central government authorities(Decisions on political, economic and other national
issues)
2. Local government authorities(Implement national policies)
3. Government agencies(Administration of government functions)
4. Public corporations(business like organization to operate under government control)
DISADVANTAGES
Work becomes boring
Workers may feel alienated
Products become too standardized
Total cost
Total Output
Revenue earned
Number sold
Number of employees(small<50)
Organization(Different levels)
Capital employed
Market share
Types of competition:
1. Price competition
2. Non-price competition(quality or advertising)
Advertising:
1. Involves the creation of consumer wants(Persuasive or informative)
2. Can create powerful brand images and consumer loyalties
3. Advertising can reduce competition
Is advertising wasteful:
1. Using resources for advertising is wasteful
2. Duplication of effort and resources are wasteful.
PRICING STRATEGIES
Factors that influence pricing decisions:
1. Level and strength of consumer demand
2. Amount of competition from rival producers to supply a market
3. Cost of production and level of profit required
Demand-based strategies:
1. Price skimming(Uses high price initially when it is a new or improved product,
charges high prices to recover development cost )
2. Penetration pricing(Setting prices low to encourage more consumers and increase
loyalty)
Competitive pricing strategies
1. Destruction pricing(Setting price often below cost in order to destroy sales of other
competitors)
2. Price Wars(continually reducing prices lower than competitors)
3. Price leadership(when the largest market share lowers or raises the price and everyone
else follows)
Cost-Based pricing
Price = (Total cost/Total output) + mark-up profit
MARKET STRUCTURES (characteristics of the market, usually on supply side)
Examining competition:
1. Amount of control a firm has over the total market supply
2. Amount of influence a firm has over market price
3. Freedom of new suppliers have to enter the market
Perfect Competition: No one firm or consumer has powers to influence market price, they
are all price takers and any firms that raise the price would lose to producers and go out of
business. Unable to lower price below either because it will lose too much money. (Does not
exist)
Features:
1. Price and non-price competition
2. Pursue different pricing strategies based on amount of competition
3. Product features and brand images will be highly differentiated and wide range of
product designs
4. Market share and profits of competing businesses will vary over time as new business
enters and inefficient firms are forced to close
Imperfect competition: when one firm has a degree of control over price
MONOPOLY
ADVANTAGES
May be more efficient in production because
of scale of production
Monopoly may still face competition from
overseas
May still charge low prices as they fear new
firms may enter
May re-invest its profits in new inventions
and better products
DISADVANTAGES
Less consumer choice
Lower output and higher prices
Lower product quality
X-inefficiency(No competition therefore they
use less effort to ensure resources are used in
the most efficient way)
Need for regulation
ARTIFICIAL
Restriction on supplies
Predatory pricing
Exclusive dealing
Full line forcing
Construction firms benefit from contracts to build schools and other buildings
Office equipment manufacturers benefit from spending on equipping public offices
Farms may benefit from agricultural subsidies to increase their production of food
Power companies earn revenue from electricity supplied for street lights
The defence industry benefits from orders for defence equipment
Public sector workers use their incomes to buy goods and services from businesses
Aggrega
=
te
Demand
Exports-Imports
1. The amount consumers have to spend on goods and services depend on their level of
disposable income after income taxes have been deducted
2. Taxes on profits will affect the amount of money firms have to invest in new
productive capacity and their demand for labour
3. Increasing public expenditure can boost total demand and therefore stimulate higher
output and employment in a n economy
4. As interest rates rises consumers may save me and /or borrow less to spend on
consumer goods and services. This may also encourage investments from overseas. As
interest rates fall firms may borrow more to invest
Two types of demand-side policies: Fiscal and Monetary
Fiscal Policy
(Involves varying the overall level of public expenditure and/or taxation in an economy to
manage the AD and influence the level of economic activity)
Expansionary fiscal policy: If a government wants to increase AD in the economy to boost
employment and output it can increase its expenditure and/or reduce taxation.
This leads to:
Firms: Cutting taxes on profits provide firms with an incentive to increase output and
investments in new productive capacity.
People: Cutting taxes on personal income encourages people to participate and motivate them
to increase their productivity
Expansionary fiscal policies are implemented during a recession or economic downturn.
Budget: An expansionary fiscal policy usually means running or increasing a budget deficit.
If public expenditure exceeds total revenue the budget will be deficit and the government will
have to borrow money to finance it.
Contractional Fiscal Policy: Aims to reduce pressure on prices in the economy by cutting
aggregate demand through a reduction in public expenditure and/or by raisin g total taxation.
Effect: Fiscal policy can affect the distribution of income. Increased taxes may be placed on
those with the highest incomes and the money raised used to finance more public services
and increased welfare for the lowest incomes
Contractionary policy reduces employment and decreases growth in output
Budget: A budget deficit will be cut or may go into surplus if tax revenue exceeds public
spending
When exchange rate falls in one country, transactions with other international countries will
become more expensive. Therefore imported goods will become more expensive which will
negatively impact its country balance of international payments and cause inflation to occur.
To counter this, the government will raise its interest rates in order to raise the exchange rate.
This happens because wealthier residents from other countries will buy more of that countrys
currency to store money in that countrys bank.
If interest rates were lowered, it would reduce the cost of overseas residents buying goods
from their country which can increase exports and boost output and employment
SUPPLY SIDE POLICIES
Supply side policies target economic growth, they aim to boost productive potential and
increase the aggregate supply. Expanding AS will help to reduce inflationary pressures on
prices from rising AD, provide additional employment and boost production of goods and for
exports. Overall, supply side policies can help to achieve all the macroeconomic objectives of
a government at the same time
1) Selective tax incentives
-High rates on personal incomes reduce people incentives to work and entrepreneurs to start
new firms. Therefore cutting taxes on earnings and profits can positively impact on
productive efforts of workers and firms.
-Granting tax reliefs also encourages firms to invest in new plant and equipment to expand
their productive potential
2) Selective subsidies
-Financial assistance paid to businesses by a government to help meet cost. Helps expand
output and reduce market price. Often used to support faming, to fund investments in new
technologies and to help small business grow
3) Improving education and training
-In order for firms to be successful in competing in international markets they need to have
highly trained and skill workforce.
-A well-educated land trained workforce can raise labour productivity and will be better able
to adapt to new production methods and technologies. Governments can assist by providing
training programmes, funding universities and providing more accessible education.
-Restrictions on the supply of labour to an occupation will force up the market wage and
result in fewer jobs. Governments can introduce laws and regulations to reduce the power of
trade unions to strike and demand unreasonable wages
-Laws on minimum wages can be used to encourage people to work. Some firms cut jobs as
their cost of production increases
5) Competition policy
-Monopolies that dominate the market are large and powerful and may use their market
power to restrict competition, charge igh prices and earn excessibe profits. Laws and
regulations can be used to fine firms that are anti-competitive and force them to break up to
smaller firms
6) Removing trade barriers
-A national government may seek to protect its domestic firms and labour forced from
competition overseas
7) Privatization
- T ownership of a business, enterprise, agency, public service property from the public sector
(the state or government) to the private sector (businesses that operate for a private profit) or
to private non-profit organizations.
UNIT 5.2 TAXES
Uses:
1. To finance government expenditure. One of the most important uses of taxes is to
finance public goods and services, such as street lighting and street cleaning.
2. To reduce consumption of goods that creates negative externalities.
3. To control the amount of imported goods i.e. tariffs
4. Used as a part of fiscal policy to control aggregate demand in the economy.
5. To control income inequality
6. Protect the environment
DIRECT AND INDIRECT TAXES
Advantage and disadvantage of direct taxes.
ADVANTAGE
High revenue yield
Used to reduce inequalities in incomes and
wealth
Based on ability to pay(Family
commitments/dependants)
DISADVANTAGE
Reduce work incentives
Reduce enterprise incentives
ADVANTAGE
DISADVANTAGE
Tax Evasion
Cost Effective
Expand tax base
Used to target specific products and activities
Easy to adjust tax rates
Inflationary
Regressive
Revenues are less certain and predictable
Encourage tax evasion(smuggling to avoid
tax)
UNIT 6.1-INFLATION
Inflation: A general and sustained rise in the level of prices of goods and services
How to measure inflation
Measured by
1. A base year or starting point is chosen. This becomes the standard against which price
changes are measured.
2. A list of items bought by an average family is drawn up. This is facilitated by the Living
Costs and Food Survey.
3. A set of weights are calculated, showing the relative importance of the items in the average
family budget - the greater the share of the average household bill, the greater the weight.
4. The price of each item is multiplied by the weight, adjusting the item's size in proportion to
its importance.
5. The price of each item must be found in both the base year and the year of comparison (or
month).