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IGCSE Economics

Economics - The study of how scarce resources can be allocated to satisfy peoples unlimited wants.
Scarcity - When there are not enough resources to satisfy our wants and needs.
Resources - The inputs that are used in the production process to produce goods and services. These
are also called Factors of Production. Resources are limited.
Capital - Human-made goods that are used in the production of other goods. Payment
comes in Interest
Entrepreneurs (Enterprise) - The person who takes the risk and has the skills to combine the
other factors of production to produce goods and services. Payment comes in Profit
Labour - Human work or effort and the people who offer their services to businesses in
exchange for wages. Payment comes in Wages
Land - Any resource that exists as part of a natural process. Can be renewable or nonrenewable. Payment comes in Rent
Geographical mobility the resource is capable of changing location
Occupational mobility the resource is capable of changing use
Opportunity Cost - The next best alternative foregone e.g. Mary could buy lettuce or chips with her
$5 and she chose chips. Lettuce would be Marys opportunity cost.
Production possibility curve - a curve showing the maximum output of 2 products and combinations
of these products that can be produced given existing resources and technology.

This company used to produce 8


Computers and 35 Books (A) with the
resources it had, but now it sells only 5
computers but 60 books (B).

Therefore, this business has an


opportunity cost of 3 computers as it
decided to make more books.

Consumer people or firms who need or want goods and services


Producers use resources to make goods and services to satisfy consumers needs and wants
Wants what we desire but do not necessarily need to survive e.g. games, bags
Needs what we must have in order to survive e.g. food, clothing, shelter
Renewable resources resources that will regenerate naturally within a reasonable time frame e.g.
Fruit, Trees, Vegetables
Non-renewable resources resources that will not regenerate naturally within a reasonable time
frame e.g. Coal, Oil, Ores
Free good goods that are available without limits e.g. air, sunlight
Economic good goods that are scarce in comparison to peoples wants and need and therefore
must be paid for e.g. television, paper, electricity
Public (collective) good goods that are non-excludable and non-rival
Non-excludable once paid for, it is impossible to stop people from using the good or service. This
creates the free rider problem
Non-rival consumers do not have to rival each other for use of the good; it will not run out
Merit good a commodity or service that is regarded by society or government as deserving public
finance e.g. education
Demerit good a commodity or service that is regarded by society or government as not deserving
public finance e.g. cigarettes, alcohol
Consumer good goods that are used and paid by individuals or groups in the household sector
Normal goods - goods we demand more of as our income increases e.g premium steak
Inferior goods - goods we demand less of as our income increases e.g second hand goods, budget
brand goods
Durable goods goods that can be used more than once
Non-durable goods goods that are perishable and do not last very long
Positive good beneficial to society e.g. clean water, medicine
Negative good a cost to society e.g. pollution, waste products
Disposable Income the money remaining after taxes are paid. If taxes increase, disposable income
decreases
Semi-finished goods goods that are used to produce other goods e.g. leather, wool

Demand - The quantity of a good or service that a consumer is willing and able to purchase at
various prices at a certain time.
Law of Demand - as price increases, quantity demanded decreases, ceteris paribus and vice versa.
Demand Schedule a table showing the quantity of a commodity consumers are willing and able to
buy at a range of prices.
Demand Curve - a graph showing the quantity of a commodity consumers are willing and able to buy
at a range of prices.
Market Demand - the total demand that all the individual consumers in the market are willing and
able to buy at various prices.
What changes demand? (Non-price factors of Demand)

Taste - things we like. They may be influenced by fashion, values, media, weather, seasons.
Income - the money we gain from labour. When we earn more income we are more able to
purchase goods and services, therefore we demand more normal goods, and demand a
lesser amount of inferior goods.
Complements - a good which is used in conjunction with another good
Substitutes - a good which can be used in place/instead of another.

Supply The quantity of a good or service that a producer is willing and able to produce at various
prices at a certain time.
Law of Supply as price increases, quantity supplied increases, ceteris paribus and vice versa.
Supply Schedule a table showing the quantity of commodity producers are willing and able to
produce at various prices
Supply Curve a graph showing the quantity of a commodity producers are willing and able to
produce at various prices
Market Supply the total supply that all the individual producers in the market are willing and able
to produce at various prices
What changes supply? (Non-price factors of Supply)

Productivity output per unit of input


Environmental natural conditions which affect output
Taxes payments made to govt., Subsidies payments from govt. to firms for support
Restrictions on trade Tariffs = tax on imports; Quotas = restriction on number of imports
Other related goods different goods that can be produced using same resources/inputs
Legal rules and regulations set by the government
Costs of production costs that a firm/producer incurs during the production process

Making a Curve:

Title - Who, What, When


Origin - Your graph must start from zero
Axes - Price on vertical, Quantity on horizontal (must be labelled)
Do the D/S Place a D or S next to the line to show it is a demand curve or a supply curve
Scale - Graph must be even and consistent
Movements along the Curve:

A movement along the Curve occurs when a price factor changes


Draw dotted lines from both points to the axes
Draw arrows from the dotted lines to show the movement
Label the dotted lines: P, P1, Q, Q1, with P1 and Q1 on the dotted lines with new point
Shifts of the Curve:

A shift of the curve occurs when a non-price factor changes


A shift to the left means the Demand/Supply has decreased
A shift to the right means the Demand/Supply has increased
Draw dotted lines from where the change has occurred to the new axes
Draw arrows from the line indicating where the line has shifted
Label the new line D1 or S1 and Label the new and old quantities Q1 and Q

e.g.

P
P1

P
D
D1
Q

Q1

Q1

Decrease in Price

P1

Decrease in Demand

P
D

D
Q1 Q

Increase in Price

D1

Q1

Increase in Demand

Price Elasticity of Demand - measures the responsiveness of the quantity demanded of a good or
service to a change in its price
Elastic Demand a change in price brings about a large change in the quantity demanded. These
have a coefficient greater than 1
Inelastic Demand a change in price brings about a small change in the quantity demanded. These
have a coefficient between 0 and 1

Inelastic Demand

PED =

Elastic Demand

% Change in Quantity
Demanded
% Change in Price
Factors of Price Elasticity of Demand

Proportion of Income small proportion = inelastic; large proportion = elastic


Addictiveness addictive = inelastic; not addictive = elastic
Necessity or luxury necessity = inelastic; luxury = elastic
Time period short time period = inelastic; long time period = elastic
Substitutes not many substitutes = inelastic; many substitutes = elastic

Price Elasticity of Supply - measures the responsiveness of quantity supplied of a good or service to
a change in its price
Elastic Supply when quantity supplied changes by a smaller percentage than price. These have a
coefficient greater than 1.
Inelastic Supply - when quantity supplied changes by a greater percentage than the change in price.
These have a coefficient between 0 and 1

Inelastic Supply

PES =

Elastic Supply

% Change in Quantity
Supplied
% Change in Price
Factors of Price Elasticity of Supply

The cost of altering its supply not easy to produce = inelastic; easy to produce = eslatic
The ability to store the good not storable = inelastic; storable = elastic
Time long time to produce = inelastic; short time to produce = elastic

Special Price Elasticity Curves


Perfectly Elastic - a change in price brings about an infinite response (a tiny price change will cause a
huge change in quantity demanded/supplied) giving a coefficient of infinity ()
Perfectly Inelastic a change in price brings about no response (even if price drastically changes,
Qd/Qs will stay the same) giving a coefficient of 0
Unitary Elasticity - this occurs when a percentage change in the price results in an equal change in
demand giving a coefficient of 1.
Perfectly
Inelastic

Perfectly Elastic
Unitary
Elasticity

Revenue
Total Revenue total receipts of a firm from the sale of any given quantity of a product
Total Revenue = Price x Quantity
Inelastic Demand
If price increases, the quantity demanded will
decrease a little

TR1 < TR2

If price decreases, the quantity demanded will


increase a little

TR2 < TR1

Elastic Demand
If price increases, the quantity demanded will
decrease by a lot

TR2 < TR1

If price decreases the quantity demanded will


increase by a lot

TR1 < TR2

Market a place/situation where buyers and sellers exchange goods


Resource Market where money is exchanged for inputs
Goods Market where output is exchanged for money
Price Equilibrium the price where quantity supplied and quantity demanded are equal
Surplus when the quantity supplied exceeds the quantity demanded. In order to sell the excess
stock, the producers lower the price and therefore raising the consumers demand. These market
forces keep bringing the price down until equilibrium is reached and the market is cleared.
Shortage when the quantity demanded exceeds the quantity supplied. Consumers who have
missed out on the good, bid the price up so producers increase the quantity supplied due as the
good is now more profitable. These market forces will push price up until equilibrium is reached and
the market is cleared.
e.g.

800 200 = 600

Surplus

At $7, there is a surplus of


600 as producers are
producing more than
demanded.

Equilibrium

At $3 there is a shortage of
600 as producers are
producing less than
demanded.

Shortage

200

800

Change in Equilibrium:

A change in the Equilibrium occurs when Demand or Supply has increased or decreased.
From both Equilibriums, draw dotted lines to both axes
Label the new points PEq1 (on Price Axis) and QEq1 (on Quantity axis), and the old points PEq,
and QEq
Draw arrows from the old points to the new points (e.g. QEq to QEq1)
Draw arrows from the old Equilibrium to the new Equilibrium

Producers
Private Sector where scarce resources are owned by private individuals and are used in order to
maximise profit
Firms businesses owned by individuals or groups in the hope of making profit
Voluntary Organisations driven by the fact that there is a need in the community they can
satisfy
Public Sector Producers: where scarce resources are owned by the government and are used to
produce goods and services that they believe are good for the country
Central Government These are the elected representatives who meet in Parliament and
are concerned with the country as a whole. They are not driven by profit. They may provide
goods and services e.g. public health and education.
Local Government These are made up of officials and representatives that are elected by
local communities. They provide public goods for the local area to look after the local
peoples welfare e.g. libraries, swimming pools.
Economic Systems
Free Market Economy when the private sector decides on the three economic questions. They will
only produce goods and services that people will want to buy in the hopes of gaining a profit.
Advantages
Disadvantages
The consumer is sovereign. The market will
Scarce resources will only be employed if there is
provide goods depending on what the customers a profitable use.
demand.
The market responds quickly to changes in
Not all goods and services are provided in the
demand.
free market e.g. public goods
Efficient use of resources, better machinery and
The effects of production on society and the
better methods are encouraged.
environment (such as pollution) can be ignored
High incomes provide an incentive for people to
There may be encouragement to buy harmful
work hard and for entrepreneurs to set up and
goods (such as drugs and weapons). The
expand business
government has to pass laws to stop this.
Merits of the Market System
Resources are allocated by price If the demand increases, price is increased and producers
will allocate more resources to the production of this good.
Competition and Incentives In a free market there are many firms competing with each
other for market share and profits. This encourages innovation. Innovation will result a wide
variety and high quality of goods being produced
Allocative Efficiency when resources are allocated towards goods that reflect consumer
demand. This consumer is said to be sovereign
Productive Efficiency In a free market, firms will produce at the lowest possible cost per
unit to earn high profits and avoid being pushed out of the market.
Dynamic Efficiency arises when resources are used efficiently over time. The profit
incentive will drive firms to innovate and continue to develop new, improved products that
consumers desire

Market Failure
Market Failure where the market mechanism fails to allocate resources efficiently. It occurs where:

Differentiation of goods and services; tricking the consumers into paying for the good
o Branding: designer labels cost three times as much but may not be that much better
o Labelling and Product Information: may be inaccurate
Market Power; other firms cannot enter in market, main firms can abuse price raise
o Monopolies where one firm is the sole supplier of a product.
o Oligopolies where there are a few firms who supply the product.
Insufficient quantity of goods and services provided
o Public goods may not be provided at all
o Merit goods may be provided but be charged high prices or shortage
o Demerit goods will be provided but will be over demanded and over produced
External costs and benefits exist
o External Costs/Benefits the costs or benefits to a third party due to the consumption
and production activities of others
o Private Costs/Benefits the costs or benefits on those who are directly involved in the
decision to produce or consume a product
o Social Cost = private cost + external cost
o Social Benefit = private benefit + external benefit
o Uneconomic use of resources if the social costs exceed the social benefits
Inequality exists; if without skill, one will find themselves unemployed
o Poverty
o Unequal distribution of factor ownership
o Unequal distribution of income
o Large income and wealth gap
Measures to correct Market Failure

1. Laws and Regulations


o The Government can intervene by making it so producers may not charge above a
maximum price or below a minimum price
2. Subsidies
o The Government offers subsidies to encourage production of merit goods so they take
into account external benefits.
3. Taxation
o The Government will place tax on demerit goods so they take into account external
costs.
o On goods with inelastic demand, the price change will not affect it that much and
consumers will still wish to purchase the good. Therefore Indirect taxes are ineffective
on goods that have inelastic demand.
o On goods with Elastic demand, the price change will affect it a lot and consumers will no
longer wish to purchase the good. Therefore Indirect taxes are effective on goods that
have Elastic demand.

Mixed Economy when the public sector and private sector decide on the economic questions for
them solely. They do not have much influence over each other.
Employment In a mixed economy, the government can create jobs and provide incentives
to private firms to employ people. If it were a free market economy, there would be high
unemployment from market economies.
Provision of Public Goods In a mixed economy, the Government raises tax to provide
public goods. If it were a free market economy, they would not be provided as it would be
impossible to pay.
Harmful Goods In a mixed economy, the government can make the production and
consumption of harmful goods illegal or make it less attractive to use the good by placing a
tax on it.
Social Costs In a mixed economy, the government can use laws, taxes and fines to prevent
firms from polluting the environment. If it were a free market economy, the costs to society
(such as pollution) can go un-checked in a market economy because private firms will only
take into consideration their own costs of production.
Equity - in a mixed economy the government can provide benefits or free healthcare for
those that cannot afford to pay. If it were a market economy, many people on low incomes
would be unable to buy many of the goods and services provided.
Planned Economy when the public sector decides on the three economic questions. There are no
private firms and very little consumer choice.

Allocation of Resources

Money Usage

Sources of Income

Advantages

Disadvantages

Public Sector
Public Goods
Merit Goods
Supporting vulnerable groups
Helping private sector industries
Managing the economy
Cover losses incurred by SOEs
Taxation this depends on the
willingness of consumers to pay, rates
in other countries, income of the
country and the reactions of firms and
workers to tax changes
Privatisation raises revenue in the
short term but if the asset was
profitable
Borrowing from Overseas this will
depend on the governments credit
worthiness at home and abroad
Ensures resources are allocated to
merit goods/public goods
Ensures fewer resources are allocated
to demerit goods

If firms know the government is


paying, no incentive to keep costs
down
State Owned Enterprises may lack
expertise to complete projects on
time
Time consuming decision making

Disadvantages of Consuming Resources


Burning of fossil fuels for energy release harmful
emissions.
Deforestation destroys natural habitats for
animal and plant species
Pesticides and fertilisers used in crop production
have polluted rivers and waterways clean
water supplies are becoming short in supply
Overfishing has depleted fish stocks and harmed
other marine animal populations
Growing air pollution has increased breathing
problems for many people

Private Sector
Private Goods
A mixture of merit and demerit goods

Profits this will depend on how


profitable the business is
Loans this will depend on the firms
credit worthiness and size

Resources are used to produce goods


and services of a high quality
Low cost methods of production are
used, less waste of resources
Higher levels of productivity,
therefore more output gets produced
in less time
The firm may be a monopoly and
therefore have less incentive to keep
costs down. Resources will be wasted
Resources may be over allocated to
demerit goods and under allocated to
merit goods

Advantages of Consuming Resources


Employment rates will increase with higher rates
of production and consumption
The government will earn more tax revenue with
higher production which can be used to finance
new facilities for education and healthcare etc.
As some resources become low in supply, the
cost of these will increase forcing firms to look
for alternative means and methods anyway
The trade position of the country may improve

Money a unit of measurement that allows us to value different goods.


Functions of Money

Deferred Payment allows for purchases on credit (loans) that can be paid back later
Unit of Account money can be used to measure value
Medium of Exchange money can be used to carry out transactions between buyers and
sellers. People are happy to accept it and know they can use it to buy something else.
Store of Value money can be kept and used later and still retain its worth
Characteristics of Money

Scarce An increase in money supply can lead to a decrease in its value. For money to be
valuable, it must remain scarce
Portable It must be easy to carry
Acceptable It is given legal status by the government
Recognisable It must be easily recognized, yet forgery must be difficult. Copying will cause
problems with money supply
Durable It must be long lasting so it can be saved
Divisible It must be easily divided up into small amounts for smaller transactions
History of Money

1. Self-sufficiency everything that someone needed, they produced themselves. However it was
difficult to produce everything they needed as people had different skills,
2. Specialisation when a person or group focuses on producing one main good or service.
However, people were no longer independent and they had to trade with each other to get
everything, thus people became Interdependent.
3. Barter exchanging goods and services for goods and services. However Barter required a
double coincidence of wants and people did not have a proper exchange rate and had no proper
value of each good. It was also difficult to save goods and for people to bring all their goods and
services to markets to trade.
4. Commodity Money earliest form of money was goods e.g. pots, shells, etc. People were willing
to accept goods in exchange for their produce.
5. Precious Metals precious metals such as gold, and silver were scarce enough to make them
possible money. Weighing and cutting tools were necessary so rates of exchange could be
fixed. Portability was a major problem.
6. Coins precious metals of predetermined weight were moulded and stamped with the face of
the ruler and the coins value. To stop shaving the edges of the coins ribbed coins were
developed. Rulers would often debase the value of by mixing cheap metals with them, resulting
in the precious metal content of coins to be virtually worthless today but people still accept such
coins because they are generally acceptable.
7. Goldsmiths first paper money was issued by goldsmiths, who accepted deposits of precious
metals for safe-keeping in return they issued paper receipts to the owner. The receipts were
then often exchanged for goods or services.
8. Banks Goldsmiths gave receipts for deposited precious metals and would be accepted as
payment as the first paper money.

Banks
Commercial Banks private sector banks which aim to make profit by providing a range of banking
services. Their functions are:
To accept payments: people can deposit their money into a Current or Savings Account.
To lend: banks make profit from charging higher interest rates on borrowing than saving.
People can borrow from banks in the form of Overdrafts and Loans.
To enable customers to make payments: there is a range of ways people can receive money
and make payments e.g. credit card
Exchanging foreign currency
Storing important documents of customers
Providing advice: e.g. completing tax forms, and the purchase and sale of shares
Selling insurance
Current Account easily accessible account for everyday use
Savings Account interest is paid and funds are not easily withdrawn
Overdrafts customers can exceed their account limit up to an agreed amount
Loans money borrowed for a particular purpose and paid back over a certain time period and
when taken out, customers are usually required to provide collateral.
Collateral something pledged as security for repayment of a loan, to be forfeited in the event of a
default.
Central Banks government owned banks which aim to maintain stability of the national currency
and money supply. There functions are:
To act as a banker to the Government
To act as a banker to Commercial Banks: Commercial Banks have accounts at the central
bank to settle debts between each other and draw out cash
To act as a lender of last resort: the central bank will lend to banks which are temporarily
short of cash
To manage national debt: when government debt builds up, the central bank can issue
government securities e.g. government bonds
Holds the countrys reserves of foreign currency and gold
Issue bank notes: to central bank both prints and destroys notes
Operates monetary policy: this involves controlling the money supply to influence interest
rates to keep inflation low and steady.
Mortgages borrowing to purchase land/property that is secured against the land/property
Islamic Banks specialise in banking services that are compliant with Sharias Law which forbids
interest charges and payments. Instead they charge fees and share profits.
Investment Banks specialise in helping large firms raise finance from the stock market

Stock Exchange
Shares a unit of ownership interest in a corporation or financial asset. People buy them because of
the dividends, capital gain and to influence the running of a company.
Stock Exchanges an organization for the sale and purchase of shares and other securities
Listed/Quoted Companies companies who sell shares to generate finance
Stock Brokers those who trade on stock exchanges
Functions of Stock Exchanges:
To provide a market enabling individuals, firms and governments to buy and sell shares on
the global stock market
To enable companies to grow by merging or taking over another company
Mobilising savings for investment
To supervise the conduct of firms and brokers. Any firm that wishes to be quoted on the
stock market has to meet certain requirements such as providing a range of information for
prospective buyers
To provide up to date information on the market price of different stocks
Bear Market when share prices are falling
Bears someone who sells shares expecting their price to fall
Bullish Market when share prices are rising in general
Bulls someone who buys shares expecting their price to rise
Factors that Affect Share Prices
Takeovers buying up shares to gain control of a firm will usually drive up the price
Interest Rates if increased, people will want to save more in banks so less money is
available for investment in shares. If people are saving more, they are spending less. This will
reduce profit for firms; share prices for firms will decrease.
Profit record a firm with high/rising profits will see an increase in their share price
Issue of new shares an increase in the supply of shares of a firm will decrease the share
price
Government policy if governments cut corporate taxes, firms will have lower costs of
production. If governments cut income taxes, consumer expenditure will increase
Dividends and Yields
Dividend a share in the profits of a company that is earned by a shareholder. They can be
expressed as the nominal price or market (current) price of the share.
Nominal Price the price at which the share was issued
Yield the dividend expressed as a percentage of the market price and represents the return on the
money paid for a share.

Occupations and Earnings


What influences a persons choice of occupation?

Wage Factors firms advertise a wage rate for jobs to attract people to supply their labour.
They can be paid for in many ways:
o Time rate rate of pay per hour worked
o Piece rate rate of pay per unit of output produced. A worker who produces lots of
output will earn more than worker who does not. This can be used to create an
incentive for workers to increase productivity.
o Fixed annual rate/salary an agreed amount between the employer and employee
will be divided into equal monthly/fortnightly payments regardless of the number of
hours actually worked.
o Performance related payments usually offered to individuals or teams or workers
who are highly productive. The more sales someone makes, the more commission.
Non-wage Factors some jobs dont necessarily offer high wages yet people are still
attracted to them for other reasons such as:
o Work Environment, Travel Distance/Benefits, Job Security, Training Opportunities,
Qualifications required, Holidays, Fringe Benefits, Pension Entitlement, Job
Satisfaction
Why do some occupations earn more than others?

Different abilities and qualifications some jobs (e.g. an accountant) require more training
and qualifications than those that dont. As supply is likely to be more limited due to the
necessity of training, the wage will be higher.
Dirty/Risky jobs and unsociable hours this type of work usually offers a high wage to
attract a supply of labour.
Job Satisfaction a job that is viewed by many as a rewarding occupation (e.g. nursing),
attracts a large supply of labour. This results in low market wage rates.
Lack of information about jobs and wage some workers may work for less than they could
in other jobs as they are unaware of better paid jobs elsewhere.
Labour Mobility when workers can move easily between countries. If a worker can move
easily, they can easily move to the job that offers that most pay.
Changes in Earnings Over Time

Entry to the workforce: A young employee will receive relatively low earnings, This is largely
because of a lack of work and skills and experience. They can gain skills through
apprenticeship, management training schemes or other training opportunities.
Skilled workers: The more experience an employee has, the more opportunities there are to
increase earnings as the more skilled a worker becomes, the greater the demand: more
skilled employees will be in shorter supply and they will be able to command higher
earnings. Higher wages must be offered to attract highly skilled workers.
End-of-career empoyees: Employees may not keep up to date with changing trends or
technologies and therefore have outdated skills, and there wages may decrease. Due to
their long-time commitment to a business, they may continue to get high wages.

The Labour Market


Demand for Labour
Firms need labour to produce goods and services
for consumers.
Influenced by the amount of output workers can
produce and the amount its sold for
The higher the wage is the more expensive it is
for firms to higher labour, therefore when wage
increases, quantity demand for labour
decreases

Supply of Labour
The supply of labour for a job will depend on
how many people are willing to do that job.

It is likely as the wage rate increases, more


people are attracted to doing the job, therefore
when wage increases, quantity supplied of
labour will increase

Wages ($)
S
Wage that will
be offered in
the market
D
Quantity
Differences In Earnings Between Groups

The Public-Private wage gap


o Public Sector may be expanding and therefore causing more demand for labour,
causing wages to be high. It may also be contracting causing less demand for labour,
causing wages to be low. There may be a greater supply of labour due to non-wage
factors of choosing an occupation and thereforefore wages will be low.
o Pirvate Sector will offer high wages to attract the most skilled individuals who can
work as efficiently as possible. However, a large number of unskilled labour is in the
private sector and thus earn low wages due to the large supply and small demand.
Wages in private sector may also appear lower as fringe benefits are no included.
The Male-Female wage gap
o Females generally work in lower paying jobs and often take breaks to raise children
which limits career progression
o Males generally work full time rather than part-time to look after children
The Skilled-Unskilled wage gap
o In LEDCs many low-skilled workers are willing to work for low wages.
o In MEDCs firms are competing for skilled workers and offer high wages to attract
them
The Industry wage gap
o Agricultural Industry: In many Asian and African countries, there is a surplus of
agricultural workers, resulting in low wages
o Manufacturing Industry: This is bigger than agricultural industry, resulting in more
demand for labour and therefore higher wages
o Services Industry: This has the highest demand for workers, thus the highest wages.

Trade Unions
Trade Unions an association which represents the interests of a group of workers. It exists to
negotiate on behalf of their members. There are four types:

Craft Unions they represent workers with particular skills e.g. plumbers and electricians
working in different industries.
General Unions they represent workers with a range of skills in a range of industries
Industrial Unions they represent workers in a particular industry e.g. railways
White Collar Unions represent professional workers e.g. teachers, pilots
Functions of Trade Unions

Negotiate wages and other non-wage benefits on behalf of their members


Provide educations and training schemes
Protect workers rights
Provide recreational facilities
Fixing national minimum wage
Why will workers make wage claims?

Workers working harder and have increased productivity


The firm is making higher profits
Maintain wage differentials e.g. if a Nurse gets paid 60% the Doctors pay, and the Doctors
get a pay rise, Nurses will want a pay rise to be back at 60% and restore the differential.
Keep up with the cost of living (inflation).

Collective Bargaining the process of negotiating wages and other working conditions between
union members and employers. Collective bargaining exists as individual employees may not have
the skill, time, willingness or bargaining power to negotiate with employers
Factors affecting the strength of a trade union

Number of members more members means more funds to finance activities


High level of output and activity when output and incomes are high, firms compete for
existing workers. Therefore they are more willing to agree to union requests.
High level of skills unions representing skilled workers are in a better negotiating position
as it is costly to replace skilled labour
Consistent demand for the product unions representing workers who produce goods and
services essential to consumers and where there are few substitutes in a strong bargaining
position.
High level of public support if the public supports employees, the firm may lose credibility

Arbitration needed when trade unions and employers fail to resolve a dispute. The Government of
an independent third party will join negotiations.

Benefits of a Trade Union to employers

Short Time Consumption it is cheaper for firms to negotiate with a union than with
individual workers as it is less time consuming
Increase in Productivity Unions encourage workers to undertake education and training.
This encourages productivity.
Reduction in Conflict provided outlets for workers to channel their anger.
Industrial Action

Overtime ban workers refuse to work more than their normal hours
Strike workers withdraw labour
Go-slow working deliberately slowly to reduce production
Work To Rule workers deliberately slow down production by following every rule and regulation
Effects of Industrial Action on:

Firms
o Higher costs, less output, less revenue and lower profits
o Lose customers to rival firms
o Damages the firms reputation
Union Members
o Employees will lose pay and may even lose their jobs due to a decrease in demand
for their product caused by losing customers
Consumers
o Unable to obtain goods and services they need
o Pay higher prices if firms pass on their increased costs
Union Influence the Supply of Labour

Unions can restrict the entry of new workers by insisting that new workers have high
qualifications or skills
Closed Shop all workers in a place of work must belong to a trade union. This is outlawed
in a number of countries.
Open Shop where firms are able to employ workers that are or are not involved in a trade
union.
Single-union Agreement where a firm agrees a single union can represent all its workers.
Because this will give considerable bargaining power to a union, a firm will only agree to this
in return for commitments by the union on pay, productivity improvements and not to
strike.

Consumers
Spending the purchase of goods and services to satisfy wants and needs and to improve standards
of living. It is influenced by:

Disposable Income when consumers have higher incomes, they are likely to spend more.
Wealth the more wealthy a person is, the higher their spending will be.
Consumer Confidence if consumers are confident about their jobs and future income, they
are encouraged to spend more now. It can change over an economic cycle.
Interest Rates when interest rates are high, consumers are more likely to save than spend
Taste, Age, Gender, Family Circumstances, Religion

Savings a reduction in the use of disposable income now to use at a later time. People save
because of:

Consumption people may save now to make big purchases in the future
Interest Rates when interest rates are high, people earn more interest from saving so
people will save more
Consumer Confidence if people believe circumstances will change they will save more now
Availability of saving schemes the more ways to save, the more likely people are to do so

Borrowing the lending of money or items to someone else and paying them back later. People
unable to repay their debts are declared bankrupt or insolvent. Their personal assets may get
repossessed by the lenders or creditors.
Why do people borrow?

To finance necessities or luxuries


To purchase houses when people buy houses, they typically take out a mortgage to do so.
However, property is an asset so it can be considered a form of saving.
To start a business entrepreneurs will borrow money to start their business and will repay
the loan with future revenue
To fund education and training schemes people will borrow for these and repay the loan
with a higher income job in the future, which they get from their new skills.
Factors that influence borrowing

Interest Rates when interest rates are high, the cost of borrowing is high and loans will
take longer to pay. People are therefore less likely to borrow.
Wealth wealthy people may be more likely to borrow for certain purchases as they are
confident in their ability to repay the debt they can sell off assets if needed. A bank is also
more willing to lend to wealthy individuals as they are less likely to default on the loan.
Consumer Confidence confidence in a persons future financial situation will influence
their decision to borrow.
Availability of Credit the more available credit is the more likely people are able to
borrow. These days, people can organise overdrafts and loans over the internet and can also
buy goons on hire purchase in easy monthly instalments.

Business Organisations
Sole Trader/Proprietor a business organisation owned and controlled by one person. It may
employ other people to work in the business but will only ever have one owner.
Advantages
It is easy to set up. Most sole traders need little
capital to start up with. This is because they have
few legal formalities, modern technology has
reduced the cost of set up and it can be run from
home.
It is a personal business. The owner has close
contact with customers and staff meaning they
can easily find out peoples wants.
The sole trader is their own boss so can make all
the decisions on their own and will receive all
the profits.

Disadvantages
Sole traders lack capital. It is difficult to expand
as sole traders may have little capital, used up
their loans and find it difficult to raise finance
through savings. Banks consider sole traders
risky as they face competition.
Unlimited Liability. If the sole trader is unable to
repay any business debts, they are personally
responsible for these and may lose possessions.
Full responsibility for the business. The sole
trader is responsible for running the business.
This means working long hours

Partnerships a legal agreement between two or more people (usually no more than twenty) to
own and run a business jointly and to share any profits.
Advantages
It is easy to set up. As with a sole trader, there
are few legal requirements in drawing up a
partnership agreement. Most partnerships are
not required to publish annual financial accounts
Partners can invest new capital to finance
expansion. New partners can buy shares in the
ownership of the business which can be used to
expand the business in return for a share of the
profits which motivates owners to work hard.
There are more ideas and skills than a sole trader

Disadvantages
Partnerships lack capital. Many countries place a
limit on the number of partners allowed in a
partnership. With fewer people able to put
forward capital, expansion can be difficult
General partners have joint unlimited liability. As
with a sole trader, general partners may lose
personal possessions if the business is unable to
repay its debts. Each partner can be held
responsible for the actions of other partners.
Slow decision making due to disagreements.
Some may be more lazy/inefficient than another.
Sleeping Partner a partner who usually supplies the business with capital, however they do not
have an active role in running the business. These have limited liability.
Joint Stock Companies people and organisations who invest in shares become part owners of the
company. They can sell stocks/shares to raise capital.
Private Limited Companies have one or more shareholders but can only sell shares to people that
are known to the existing shareholders.
Advantages
Easy to raise finance. Compared to a sole trader
or partnership, private limited companies can
raise finance more easily through sale of shares.
Only the board of directors, as elected by
shareholders (not shareholders), are concerned
with everyday management.
Limited Liability. Only the money invested is at
risk of being lost.

Disadvantages
Cannot sell shares to the public. Shares can only
be sold privately and will place a limit on the
amount of finance able to be raised.
Required to disclose financial information. In
some countries, they are required to publish
details of their financial performance by law.

Public Limited Companies has at least two shareholders and can sell shares to anyone through a
stock exchange.
Advantages
Shares can be sold publicly. This allows the
company to raise large amounts of finance to
fund its operations
Shares can be advertised. This can be published
in newspapers and magazines. This creates
interest and attracts many investors.

Disadvantages
Expensive to form. Many legal documents and
company investigations are needed. Advertising
of shares can also be costly.
Management diseconomies. Disagreements
between managers and owners can occur and
slow down decision making.
Must hold Annual General Meetings. These are
held to keep shareholders informed of the
position of the business. These can be expensive
and time consuming to set up.
Vulnerable to takeovers. Original owners may
lose control of their company if one company
buys the majority of the shares.
Divorce of ownership from control.
Owners/shareholders can lose control of the
company e.g. large shareholders can out vote
minor shareholders
Required by law to publish detailed annual
reports and accounts

Multinational Corporations a firm that has business operations in more than one country, but
usually has its headquarters based in one country. Advantages of being a multinational corporation
include:

A large market will increase revenue


Can avoid trade barriers by setting up operations in countries that impose tariffs and quotas
Minimise transport costs by producing in countries close to resources or consumer markets
Minimise wage costs by producing in countries with low wages
Can raise large amounts of capital for expansion, research and development or attract highly
skilled labour
Reduce the average cost of producing each unit of output because they produce on such a
large scale
Positive Economic Impacts
Increase investment in modern equipment and
cutting edge technologies
They provide jobs and incomes for local workers
They bring new knowledge and skills which can
help domestic firms to improve their own
productivity
They pay tax on profits which boosts
government revenue
They can increase export earnings through
international trade

Negative Economic Impacts


Some multinationals may exploit workers in lowwage economies
Natural resources can be exploited and cause
damage to natural environments
Multinational may use their power to obtain
generous subsidies and tax advantages from
governments.
Profits may be switched between countries so
that multinationals avoid paying taxes
Local firms may be pushed out of the market as
they are unable to compete

Cooperatives business organisations owned and controlled by a group of people to undertake an


economic activity for mutual benefit. There are two types of cooperatives.
Worker cooperatives the people who work in the business own it, make the decisions and
share the profits
Consumer cooperatives retail enterprises owned and controlled by their customers
Advantages
Owned and controlled by members
Members of consumer cooperatives enjoy profit
dividends or lower prices
Workers in worker cooperatives take business
decisions and share profits
Members have limited liability

Disadvantages
May be badly run as workers have little business
experience
May find it difficult to attract new members and
raise additional capital for the business
Many consumer cooperatives have been forced
out of business by larger companies

Public Sector Organisations organisations owned and controlled by governments


Advantages
Decisions are based on social costs and benefits
Will not abuse market power
Planning and coordination of an industry is
easier if it is done by one party
Industries which provide basic necessities e.g.
healthcare will charge low prices if run by the
government

Disadvantages
Can be difficult to manage and control
May become inefficient and produce low quality
products and charge high prices as there is no
competition
Will need to be subsidies if they are making
losses. Government revenue used for subsidies
will have an opportunity cost

Privatisation the sale of public sector assets to the private sector


Benefits
Private sector producers are motivated by profit
and are therefore more efficient
Private sector firms more likely to invest and
encourage economic growth
Goods will be produced at lower costs and sold
for lower prices
Goods will reflect consumer sovereignty

Non-Benefits
In the absence of competition, private firms may
exploit market power
Private firms dont consider external costs or
benefits
The enterprise may have been a good source of
revenue for governments. Profits from the SOEs
could have been used to fund other areas of the
economy

Stages of Production
Primary Sector involved in the collection and extraction of raw materials e.g. Agriculture, Mining,
Forestry, Fishing, Quarrying
Secondary Sector processes the raw materials into semi-finished and finished goods e.g. leather
hides leather handbags
Tertiary Sector provides services e.g. banking, insurance, tourism, education, advertising

Productivity
Productivity the amount of output that can be produced from a given amount of input/resources
PRODUCTIVITY =
Labour Productivity the amount of output that can be produced from a given amount of labour
AVERAGE PRODUCTIVITY OF LABOUR =
Production the act of processing raw materials. Production is measured in units of output
Labour-Intensive firms that use more labour than capital
Capital-Intensive firms that use more capital than labour
Factors that influence the demand for Capital and Labour

The Productivity of Labour and Capital when there is a high productivity of capital or a low
productivity of labour, there is a higher demand for capital and lower demand for labour,
and vice versa.
Market Prices for Labour and Capital Labour and Capital are substitutes so when the price
of labour increases, the demand for capital increases and vice versa.
Profit Levels if profit levels are high, they are able to buy expensive capital which is more
efficient than labour, therefore demand for labour will decrease and demand for capital will
increase
Business Confidence If a firm has high business confidence, meaning confidence in
business for the future, demand for both labour and capital will increase and vice versa.
Demand for Goods and Services when there is a high demand for goods and services,
there is a high demand for labour and capital as the firm will want to produce as much of the
good as possible so they can earn a higher total revenue through the sale of more output
and therefore gain more profit
Interest Rates when interest rates are high, loans are more expensive to pay off and
therefore firms are less willing to get loans for expensive capital. This causes demand for
capital to decrease and demand for labour to increase.
Factors that influence Land

Productivity the greater the output from land the higher will be the demand for it
Location city centre sites can attract a large number of customers so there is a higher
demand for land there and therefore rent increases
Country Wealth as countries become richer, the demand for water increases. Water is
needed for domestic, agricultural, industrial, and energy production purposes

Costs of Production
Fixed Costs costs which do not change with output. These must be paid even when output is zero
e.g. electricity bill, rent
AVERAGE FIXED COSTS =
Variable Costs costs of variable factors that do change with output. E.g. wages, raw materials
AVERAGE VARIABLE COSTS =
Total Costs all costs required in the production process
TOTAL COSTS = Fixed Costs + Variable Costs
Average Costs the cost required to produce one unit of output
AVERAGE COSTS =
Revenue total receipts of a firm from the sale of any given quantity of a product
TOTAL REVENUE = Price x Quantity
AVERAGE REVENUE PER UNIT =
Profit/Loss how much money the firm has made once costs of production have been taken into
account
PROFIT/LOSS = Total Revenue Total Cost
Breaking Even the level of output where total revenue is equal to total cost
Total Costs
Total Revenue
$
Variable Costs

Break Even
Point
Fixed Costs
Output

Long Run Average Cost Curve a graph showing the average costs of a business or firm in the long
run. These curves are U-shaped because as firms increase their scale of production they will first
experience economies of scale. After reaching a certain level of output they will experience
diseconomies of scale.

Economies of Scale
Economies of Scale when average costs decrease as a result of producing on a large scale
Internal Economies of Scale average costs per unit decrease as scale of production is expanded
within a firm.

Purchasing Economies larger firms buy their supply in bulk. Suppliers generally offer price
discounts for bulk purchases as delivery is cheaper.
Marketing Economies large businesses may buy their own vehicles for distribution. This
will reduce costs as they do not have to pay the profit margin or another firm. Fixed costs
will be spread over a larger amount of output.
Financial Economies large firms can generally borrow money at lower interest rates as
banks view them as less risky than small firms.
Technical Economies large firms generally have sufficient finance for investment in new
machinery, training/recruiting skilled workers, and research and development.
Risk-bearing economies as larger firms tend to have more customers, they are safe from
being too reliant on one customer. Diversification allows large firms to spread their risk over
a range of products.

External Economies of Scale when the expansion of an entire industry benefits all firms within that
industry

Access to a skilled workforce Large firms may have access to a skilled workforce because
they can recruit workers trained by other firms within the industry
Ancillary firms firms which develop and locate near large firms in particular industries to
provide them with specialised equipment and services
Joint Marketing Benefits firms locating in the same area well known for producing high
quality produce may benefit from reputation
Shared infrastructure the growth of one industry may persuade firms in other industries to
invest in new infrastructure
Diseconomies of Scale

Diseconomies of Scale when firms experience an increase in average costs as they try to increase
production and expand too much and too quickly

Management Diseconomies if a firm has offices in different locations, produce many


products and have many different layers of management, this can slow down the decision
making process
Labour Diseconomies large firms generally employ computer-controlled equipment and
machines. Workers operating this machinery may become bored and become less
productive.
Agglomeration Diseconomies this can occur when a company merges with too many
different firms at different stages of production. It can become difficult to coordinate all
different activities of the merged firms.

Goals of Producers

Profit Maximisation
o Profit is maximised when the gap between total revenue and total cost is maximised.
Firms can achieve this by reducing costs (by training workers or upgrading equipment) or
increasing revenue (by raising price or increasing demand).
Growth
o Firms try to increase their size and share of the market, typically by providing goods at a
lower price than their competitors and will contribute to the goal of profit maximisation
Social Responsibility
o Some firms may choose to donate to charities or ensure they source their materials from
countries who produce goods fairly e.g. using child labour
Environment
o Some firms may use production methods that conserve the natural environment. This
may increase costs, but is likely to also increase revenue as consumers are becoming
increasingly concerned with buying environmentally friendly products

Profit Satisficing sacrificing some profit to achieve other goals


Effects of changes in profits
Increasing Profits
Make it easier for a firm to obtain external
finance e.g. shareholders are more likely to want
to buy shares/banks are more likely to give loans
Provide firms with more finance to update their
capital equipment and technology
May attract more experienced
workers/managers/directors to the business
May encourage other firms to enter the market

Decreasing Profits
If the decrease in profit is short lived, it may not
have significant impact
Firms may have to lower production, or stop
production altogether
Firms may find ways to cut costs e.g. letting go
of workers

Size of Firms

Number of Employees
o Small Firms generally have less than fifty employees
o Large Firms may employ hundreds or thousands of workers
Organisation
o Small Firms owners and employees carry out all function between them
o Large Firms divided up into specialised departments to carry out different
functions
Capital Employed
o Small Firms generally have little amounts of capital due to lack of finance
o Large Firms more capital means a firm can increase its scale of production
Market Share the share of total market sales for a good that one firm is able to capture
o Small Firms difficult to keep up with output of large firms so small market share. If
market is small, then a small firm may be able to gain a large market share.
o Large Firms have the ability to produce large amounts of output

Growth
Internal Growth a firm expanding its scale of production through an increase in factors of
production, financed by profits, loans and the sale of shares
External Growth integration through a merger or takeover
Merger one or more firms agree to join together
Takeover one company buys enough shares in another company so it can take overall control
Horizontal Integration a merger/takeover of firms that produce the same type of good or service
Advantage
Fixed costs spread over a larger number of units
average costs decrease
More specialised machines and labour
Bulk buying

Disadvantage
Larger firms may dominate the market and
abuse market power

Vertical Integration a merger/takeover of firms at different stage of production

Forward integration when a firm in an initial sector joins with a final sector e.g. primary
sector secondary sector, secondary sector tertiary sector
Backward integration when a firm in a final sector joins with an initial sector e.g. tertiary
sector secondary sector, secondary sector primary sector

Advantage
Firms can ensure they have access to raw
materials
Firms can ensure they have access to sales
outlets

Disadvantage
May be management problems operating in a
new sector of economy

Conglomerate (Lateral) Integration a merger/takeover of firms making different products


Advantage
Diversification if demand for one product
decreases, firm can still earn profit from another
product

Disadvantage
Management problems in producing a range of
products

Why do some firms remain small?


A small market if there is only a small number of customers there is no point in expansion
Limited access to capital small firms find it difficult to get loans from banks as they cant
compete with larger firms
New technology has reduced scale of production needed easier for small firms to get
access to modern equipment and internet allows firms to reach suppliers and customers
worldwide
Personal Preference expansion can be time consuming and stressful or require more skills

Market Structures
Perfect Competition a market structure with the highest level of competition.
Monopoly a sole supplier of a product. It is formed through mergers/takeover, access to resources,
or if a firm has been very successful in cutting costs and responding to changes in consumer
demand, making it able to drive competitors out of the market.
Structure
Product
No. of buyers and sellers

Share of market
Entry into Market

Perfect Competition
Homogenous
Many are perfectly
informed of business
activity
Small
Free

Exit out of Market

Free

Price Maker/Taker

Price Taker will not


raise price as sales will
be lost to their
competitors
Normal
Competition gives
incentive to be
productive and efficient
Many firms wanting
same resources

Profits for Firm


Efficiency

Access to Resources

Monopoly
Only supplied by one
One

100%
Difficult to enter because of legal barriers,
new firms unable to compete, expensive to
set up firms, existing brand loyalty
Difficult to leave because of long-term
contracts to provide a product of because
Sunk costs cant be recovered if firm leaves
industry.
Price Maker changes in supply affect
market price

Supernormal
Absence of competition can lead to
inefficiency
Can gain access to all resources. Government
can make it illegal for other firms to enter the
market and a patent can stop other firms
from producing the product.

Macroeconomic Aims of the Government


Macroeconomics concerned with the whole economy (not just individual producers and
consumers)
1. Full Employment when people who are willing and able to work can find work. People who do
not want to work are not part of the labour force e.g. children, students, housewives
UNEMPLOYMENT RATE =
2. Price Stability encourages greater economic growth and prevents a countrys products from
losing international competitiveness. If people can anticipate what the price level is going to be
they will not act in a way that will cause prices to rise. A common target for inflation is between
1-3%.

3. Economic Growth when there is an increase in the output of the economy and in the long run,
when there is an increase in the economys productive potential
Aggregate Demand the total demand for an economys products
AGGREGATE DEMAND = Consumer Expenditure + Investment + Government Expenditure + Export
Receipts Important Payments (AG = C + G + I + X M)
Aggregate Supply the total output of producers in the economy. The AS curve starts out as elastic
as the economy has many unemployed resources, letting them increase production without raising
prices. The AS curve becomes more inelastic as the economy approaches full employment of
resources as firms will have to compete with each other for the use of resources, impacting prices.
Actual (short run) economy growth there is an increase in the output of the economy
Price
Level

Capital
Goods

200
100

AS

A
AD
100

200

Consumer Goods

At point A, 100 capital goods and 100 consumer


goods are being made. At point B, 200 capital
goods and 200 consumer goods are being made.
The countrys output has increased.

AD1

Real GDP
When Aggregate Demand increases, it shifts to
the right. This causes the countrys output to
increase.

Potential (long run) economy growth the total output of the economy has increased
Price
Level

Capital
Goods

PPC PPC1
Consumer Goods
The productive potential of the economy has
increased. This can be achieved through a rise in
the quality or quantity of factors of production.

AS

AS1

AD
Real GDP
The maximum output that the economy can
produce (AS) has increased.

4. Balance of Payments a record of a countrys economic transaction with the rest of the world.
In the long run, governments want export revenue and import payments to be equal.
This is because if import expenditure exceeds export revenue the country will go into debt, and
if export revenue exceeds import expenditure, consumers will not be enjoying as many products
as possible as standard of living is lower.
5. Redistribution of Income governments can redistribute money from the rich to the poor
through taxation (rich are taxed more than poor) and spending (government can spend more to
provide more benefits to the poor).
Conflicts between Government Aims
Full employment vs. Price Stability policy measures to reduce unemployment, can increase
inflation. E.g. the Government may raise expenditure on pensions to raise consumption. Firms will
increase production to meet extra demand and more jobs are created. However the increased
aggregate demand may lead to higher inflation.
Balance of Payments vs. Economic Growth policy measures to reduce expenditure on imports may
reduce economic growth. E.g. the government may raise income tax to reduce household
expenditure on imports. Less disposable income may also cause demand for domestic products to
decrease causing a fall in aggregate demand and therefore economic growth.
A governments choice on which aim to pursue will depend on: the relative size of the problem, the
consequences of the problem, and the degree of concern from the countrys citizens.
Macroeconomic Policies
Fiscal Policy refers to changes in government spending and taxation.
Expansionary/reflationary fiscal policy involves increasing expenditure and/or decreasing taxation.
This helps to achieve:

Economic Growth firms are able to produce more due to paying less tax
Full Employment more jobs available due to increased business activity wanting labour
Price Stability during a recession the government will wants people to buy more
Balance of Payments if economy has been in state of surplus for a long time, lower taxes
may encourage consumers to buy more imports
Redistribution of Income government spending could be spent on supporting the poor

Contractionary/deflationary fiscal policy involves decreasing expenditure and/or increasing


taxation. This helps to achieve:

Redistribution of Income more money given to the government to give to the poor
Full Employment with more from the government, the poor could get trained to get a job
Price Stability during an inflation of prices, the government will want to lower prices
through less demand for the product
Balance of Payments if economy has been in a state of shortage for a long time, higher
taxes may encourage consumers to buy less imports

Monetary Policy includes changes in the money supply and interest rates.
Demand for Money
MSd

MS

MSi

Interest
Rates

MD
Quantity of Money
Expansionary/reflationary monetary policy involves lowering interest rates or increasing the
money supply. This helps to achieve:

Price Stability during a recession, the Government will want people to buy more by
lowering the interest rates so people save less
Economic Growth firms can borrow more and increase the level of output
Full Employment firms will require more demand with an increase in output

Contractionary/deflationary monetary policy involves increasing interest rates or lowering the


money supply. This helps to achieve:

Price Stability during an inflation of prices, the Government will want to reduce the prices
by having more people save than spend

Supply-side policies designed to increase the productive potential of the economy. E.g. education
and training will increase labour productivity, reforming trade unions may make labour more
productive, and privatisation may increase productive capacity as private firms generally invest more
and work more efficiently than State Owned Enterprises.
Increasing the effectiveness of Macroeconomic Policies

Multiple Policies governments should use one policy measure for each of its objectives
Accurate Information a vital piece of information is the size of the multiplier effect of any
increase in aggregate demand. This is when the final impact on aggregate demand is greater
than the initial change
Quick Implementation of Policies if policies are delayed, economic activity can change and
the policy may no longer be useful

Taxation
Progressive Tax takes a higher percentage of the income or wealth of the rich
Proportional Tax percentage paid in tax stays the same as income or wealth change
Regressive Tax percentage paid in tax falls as income or wealth rises
Qualities of a good Tax

Equity the amount of tax people/firms have to pay should be based on their ability to pay.
A rich person has a greater ability to pay tax than a poor person.
Certainty a tax should be easy to understand
Convenience a tax should be easy to pay
Economy the cost of collecting a tax should be less than the revenue it generates
Flexibility it should be possible to change the tax is economic activity changes or
government aims change
Efficiency a tax should improve the performance of markets, or at least not reduce the
efficiency of markets.

Direct Tax a tax that is taken directly from income, profits and wealth
Impact of Direct Taxes

Advantages
Redistribution of income and wealth

Good source of tax revenue


Many are progressive and help to reduce
inequalities in incomes after tax
They take into account peoples ability to

pay

Disadvantages
If set too high, can discourage effort,
enterprise and saving
High tax rates can also encourage people to
work harder if they have fixed financial
commitments
High taxes on income earned from saving
reduce the return on saving therefore
people will save less.

Indirect Tax a tax paid by consumers when they buy goods and service e.g. GST

Advantages
Easy and cheap to collect
A wide tax base. Anyone who buys goods
and services will pay some indirect taxes.
Can be used selectively to achieve aims e.g.
reduce consumption of alcohol
Harder to evade and easier to adjust
Useful source of income in countries where
it is difficult to raise income

Disadvantages
Are regressive and fall proportionately more
heavily on the poor
Increased indirect taxes increase prices
Can lead to workers asking for wage
increases, thus costs of production would
increase so inflation can occur
Tax revenues are less certain because they
depend on spending patterns

Incidence of Indirect Taxes


Inelastic Demand

Elastic Demand
S1

Price

S1

Price
S

P1
P

P1
Consumer
Producer

Consumer
Producer
D

D
Q1Q

Q1

Quantity

Quantity

With Inelastic Demand, the producers are able to With Elastic Demand, the producers cannot
increase the price of their product without much increase the price of their product without the
change in the quantity demanded. This increase quantity demanded increasing a lot. Therefore
in price would make the consumers pay a higher the producers must pay for the majority of the
proportion of the indirect tax.
tax by themselves.
Key:
Government Tax
Per Unit Amount of
Revenue
Tax

Inflation
Inflation a general increase in prices and fall in the purchasing value of money.
Demand-Pull Inflation occurs when aggregate demand exceeds current supply in the economy.
Increased aggregate demand
does not always cause
inflation. If the economy is
producing low levels of output
and has lots of spare capacity,
there will be no impact for the
price level, yet output can
increase.

As resources begin to get used


up, firms are in greater
competition with each other
for the use of them. Increases
in aggregate demand will
therefore increase the price
level but also increase output.

Price Level

Price Level
AS

If the economy is at full


capacity, an increase in
aggregate demand will only
cause an increase in the price
level, and no extra output can
be made.

Price Level
AS

AS

AD1
AD
AD1
AD
AD

AD1
Real GDP

Real GDP

Real GDP

Cost-push Inflation occurs when the price level is pushed up by increases in the costs of
production. Firms will increase their prices to maintain their profit margins.
AS1

AS

AD

Monetary inflation occurs when an economy increases the money supply. It can be classified as a
form of demand-pull inflation. Increases in the money supply cause a decrease in interest rates.
Decrease in interest rates cause an increase in aggregate demand.
Quantity Theory of Money Money Supply x Velocity of Circulation = Price Level x No. of
Transactions
Velocity of Circulation how many times $1 travels around the economy
Harmful Effects of Inflation

The value of money decreases in the case of hyperinflation, value of money decreases so
severely and people may lose confidence in the currency
Redistributes income workers with strong bargaining power may be able to negotiate
wage increase, while those with few skills may be unable to get pay rises. Borrowers pay
back less in real terms than what they borrowed. High income earners can take steps to
avoid the effects of inflation.
Extra costs on firms time spent anticipating future price changes and reprinting prices
Shoe leather costs these are costs involved with moving money between financial
institutions searching for interest rates above inflation rates
Decreases business confidence fluctuating inflation rates affect firms confidence about
the future. This affects investment decisions and may stagnate long run economic growth.
May harm the balance of payments position if a country has high levels of inflation, their
exports will be expensive. This makes them lee competitive and sales overseas will decrease.
As imports are cheaper, consumers will want to buy these over domestic goods.
Beneficial Effects of Inflation

May encourage firms to expand a low, stable level of demand-pull inflation makes firms
optimistic about future sales
Can prevent unemployment workers may accept a percentage increase in their wages less
than the percentage increase in the price level. This will ensure firms maintain profit margins
and keep employees.

Prices
Price Indices used to show the change in the general price level over time. The two main types of
price indices are The Consumer Price Index and The Retail Price Index.
Consumer Price Index a measure of price inflation affecting consumers. It is calculated from the
movement in the average price of a basket of goods and services purchased by the typical
household in a country from a sample of different retail outlets.
Constructing a Price Index
1. Select a base year this is a standard year with no dramatic changes in price. The base
year is always allocated a value of 100.
2. Find out how households spend their money this is done by a government administrated
Family Expenditure Survey. Certain goods and services are selected to make up the
basket. Weights are allocated to reflect the proportion of income spent on each good or
service.
3. Find out price changes this is done by government officials gathering information from
companies, outlets etc. Government then creates estimates of price changes based on this
information
4. A weighted price index is constructed
PRICE INDEX =
5. Calculate the rate of Inflation
INFLATION RATE =
Example:
Year
Base Year

Year 2

Products
Food
Travel
Clothing
Food
Travel
Clothing

Average Price
$60
$20
$40
$70
$40
$48

Weighting
60%
10%
30%
60%
15%
25%

Weighted Average Price


0.60 x $60 = $36
0.10 x $20 = $2
0.30 x $40 = $12
0.60 x $70 = $42
0.15 x $40 = $6
0.25 x $48 = $12

Price index
Inflation rate

Total WAP
$36 + $2 + $12
= $50
$42 + $6 + $12
= $60

Employment
Unemployment not having work, but currently actively seeking work
Unemployment rate the number of people in the labour force who are unemployed
Labour force the employed and the unemployed
Labour force participation rate the number of people of working age who are in the labour force
LABOUR FORCE PARTICIPATION RATE =
Factors influencing the size of the labour force
Wages high wages will act as an inventive to seek work
Social attitudes more accepting countries will have larger labour forces
Provision for the care of children and the elderly greater provision of these services will
increase the size of the labour force
The proportion of school leaves who go for higher education more school leaves in higher
education will decrease the size of the labour force in short term, but long term the labour
force will be of higher quality and more productive
Changing Patterns of Employment

Industrial Structure as economies develop, employment moves from the primary sector to
the secondary sector and finally to the tertiary sector
Employed vs. Self-Employed in many countries people work for someone else. However
the number of self-employed workers is rising.
Private Sector vs. Public Sector Employment the proportion of workers in the public and
private sector may vary from time to time. A major reason people may like to work in the
public sector is because it often has greater job security and higher non-wage benefits. A
major reason for the decline in the proportion of public sector workers is privatisation.
Types of Unemployment

Frictional Unemployment occurs when it takes time for the labour market to match available jobs
with those seeking work e.g. redundant workers, people joining labour market for the first time
Cyclical Unemployment involuntary unemployment due to a lack of aggregate demand
Seasonal Unemployment occurs when people are unemployed at certain times of the year,
because they work in industries where they are not needed all year round e.g. tourism, fruit picking
Structural Unemployment arises from changes in the structure of the economy e.g. consumers
demand move away from domestic firms and toward more competitive foreign producers, the good
is not demanded anymore
Technological Unemployment workers are made unemployed as they have been replaced by
machinery and technology in modern production

The Measures of Unemployment


The Claimant Count measures those people who are receiving the unemployment benefit
Advantages

Disadvantages
Some people may falsely collect the benefit
A number of unemployed may not collect the
benefit e.g. people on government training
schemes, people with a spouse who earns over a
certain level of income

Cheap and quick

Labour Force Survey a document created by the International Labour Organisation to measure
unemployment
Advantages
Can be used for international comparisons
More accurate measure of unemployment

Disadvantages
Takes time to collect
Accuracy can depend on:
How questions are phrased and interpreted
Whether the survey sample is representative
of the labour force as a whole

Measures to reduce Unemployment


1. Frictional Unemployment increase labour mobility or increase the incentive to work
2. Structural Unemployment increase labour mobility or encourage firms to move to areas of
high unemployment
3. Cyclical Unemployment government will raise aggregate demand by reducing income tax
or increasing expenditure
Consequences of Unemployment

On the Unemployed
o A fall in income
o A loss of self-worth
o A decline in the mental and physical health
o May have an adverse effect on the education of the children of the unemployed e.g.
cannot afford to pay for education beyond school leaving age
o A reduction in chances of being employed in the future. The longer people are
unemployed, the more they lose out on training with new methods and technology.
On the Economy
o Less goods and services are produced as the economy is not using all of its resources
o Government tax revenue falls
o Incomes and firms profits fall
o Expenditure on unemployment benefits increased. Opportunity costs incurred
o Possible increased health spending due to poorer mental and physical health
o Rising levels of crime

Gross Domestic Product


Gross Domestic Product the total output produced in a country. Methods to calculate GDP include:

The Output Method measures GDP by adding up the output produced by all industries in
the country. Output must not be counted twice e.g. the output of the car industry includes
the output of the steel and tyre industries also. To avoid this, only the added value will be
included in the calculation of GDP
The Income Method measures all incomes which have been earned in producing the
countrys output. Transfer payments and unemployment benefits are not included.
The Expenditure Method measures all the expenditure on the countrys finished output

Added Value the difference between the sales revenue received and the cost of raw materials used
Nominal GDP GDP is valued in terms of current prices. It does not take into account inflation and
therefore may overestimate changes in output.
Real GDP GDP is valued in real terms e.g. the effect of inflation has been removed
Measuring Welfare
Welfare well being of different individuals or countries
Recession a period of negative economic growth at the trough of the trade cycle. A recession is
usually defined as two consecutive quarters of negative economic growth.
GDP per capita measures the average income per head or per person
Advantages
Takes into account population changes

Disadvantages
Does not take into account what people can buy
with their income
Does not take into account the distribution of
income

Human Development Index takes into account gross national income per capita, education
(measured by average years of schooling) and health (measured by life expectancy).
Advantages
Can be used to make international comparisons

Disadvantages
Fails to take into account other factors
measuring welfare such as environmental
quality, crime rates and political freedom

Genuine progress Indicator takes the following items into account however may be trying to
measure too much at once or many of the measures depend on individual opinions

Average income, debt and distribution of income


Pollution, noise and traffic levels
Physical health and mental health
Social aspects e.g. crime rates, divorce rates
Political religious and individual freedoms

Economic Growth Cycles

Economic boom (or peak) aggregate demand sales and profits peak. There is low
unemployment or even a shortage of labour. There may be rising inflation as aggregate
demand exceeds currently supply. With rising inflation, consumer confidence and spending
may eventually begin to decline.
Economic recession (or downturn) there is a slowdown in economic activity. Demand for
goods and services fall, sales of firms decline. Firms cut back production and workers are
made redundant.
Economic recovery (or upturn) business and consumer confidence starts to recover.
Spending begins to rise, as does sales and profits for firms. Output levels start to increase
and firms begin to employ more workers.
Development
Characteristics of Developed and Developing Countries

Developed
High incomes
High living standards
High levels of Productivity
High levels of investment
High proportion of workers employed in the
tertiary sector

Developing
Low incomes and savings per head
Low life expectancy
Low levels of capital goods
Low levels of education and healthcare
Narrow range of exports (mostly primary
products)
High infant mortality rate
High rate of employment in the primary sector
High rates of population growth

Absolute Poverty occurs when people do not have access to basic food, clothing and shelter
Relative Poverty occurs when people are poor relative to others in the country
Policies to reduce poverty
Improving the quantity and quality of education can improve job prospects and potential
earnings of the poor and their children
Increasing aggregate demand this will increase employment opportunities
Introducing or raising minimum wage this will increase income levels for workers
Encouraging more MNCs to set up in the country this will create more employment
opportunities
Providing or increasing state benefits the elderly/sick/disabled may have no way of
earning an income and may not have any savings to support themselves. Benefits will help
remove them from absolute poverty

Factors that affect population growth


Birth Rate
Living Standards people living in poor
conditions want large families to help them earn
money. They will have more children when some
die young due to poor conditions.
Contraception increased use of contraception
prevents pregnancies
Custom and Religion many people in less
developed countries hold beliefs that will not
allow use of contraception
Female Employment females may not want to
take time off work to have children
Marriage many people have children when
they are married

Death Rate
Living Standards better conditions can improve
life expectancy, however many fatty foods,
smoking and lack of exercise can worsen life
expectancy
Medical advance and health care better health
care has increased life expectancy
Other factors natural disasters, wars and
escalating violence

Net Migration the difference between inward and outward migration to and from a country.
Age distribution refers to the percentage of the population in each age group. The age structure of
a population can influence its dependency ratio.
DEPENDENCY RATIO =
Sex Distribution the ratio of females to males in a population. The sex ratio can be affected by
wars, government policies, and life expectancy.
Geographic Distribution refers to where people live. The geographic distribution can be influenced
by climate and urbanisation.
Occupation Distribution refers to the types of jobs people do
Effects of Population Changes
Benefits of Increasing Population
Size of Markets increase firms can take a
greater advantage of economies of scale
Extra demand is generated this will stimulate
investment and may improve technology
An increase in the labour force this may lead
to an increase in output levels and therefore
standard of living
Country can make better use of its resources

Increase in factor mobility increase in people


that are familiar with new ideas and methods

Disadvantages of Increasing Population


Famine Concern if a country is overpopulated
and agricultural productivity is low
Overcrowding greater pressure on housing and
traffic congestion
Pressure on employment opportunities a large
influx of unskilled labour may push wage rates
down, government may have to train labour
Environmental Pressure damage to wildlife
habitats, water shortages, depletion of nonrenewable resources
Balance of Payments pressure more imports
may need to come into the country to cope with
extra demand
Restrictions on Improving Living Standards
resources may be directed more towards the
provision of goods and services

International Trade
Free Trade when countries are free to export their goods to overseas and import goods from
overseas with no restrictions. Benefits of free trade include:

Countries can benefit from specialisation. If each country specialises in the good they are
best at producing, total world production will increase.
Increased consumer choice. Consumers have the choice of domestic goods and foreign
goods
Increases competition and efficiency. As domestic producers now have to compete with
foreign goods, this will encourage them to become more efficient and invest in research and
development to produce better quality goods.

Protectionism when a government restricts free trade by imposing import/export controls.


Protectionism is used to:

Protect infant industries. Infant industries are new industries which are just getting started.
By intervening them and reducing competition from foreign goods, this allows them to
develop competitiveness.
Protect domestic firms from dumping. Dumping is when countries sell goods at a price
below cost in order to eliminate competitors.
Protect against the exploitation of labour. Countries may impose trade barriers against
countries that use cheap labour in order to make those goods less competitive.
Correct a trade imbalance. If a country is in deficit due to importing more than it is
exporting, it can place import controls on imports to reduce import payments.
Retaliate against other countries. If one country imposes a trade barrier on another country,
they are likely to impose trade barriers against the other country also.
Methods of Protectionism

Quotas a limit on the number of imports


Export Subsidies subsidies to exporting firms to make goods more competitive overseas
Embargos a complete ban on imports of a particular product/ country
Exchange Control limiting access to foreign currency
Tariffs taxes on imports
Balance of Payments

Balance of Payments - a record of a countrys economic transactions with the rest of the world. The
Balance of Payments is made up of three accounts:

The Current Account


Trade in goods
Trade in services
Income
Current transfers

The Capital Account

The Financial Account

Capital inflows

Investment

Capital outflows

Net errors and


omissions

Debit Item an outflow of money from a country


Credit Item an inflow of money into a country

Trade in Goods (Visible Trade)


Trade in Services (Invisible
Trade)

Income

Current Transfers

Capital Account

Financial Account

Example of Debit Item


Import of computers from USA
Purchase of an airline ticket
from a foreign airline is an
import
Interest paid to foreign holders
of deposits in domestic
financial institutions
Immigrants working in NZ send
earnings back to their country
of origin
Increasing numbers of New
Zealand families take up
Australian citizenship and
transfer assets there.
Venture finance capital lent to
a company in Samoa

Example of Credit Item


Export of meat to USA
Domestic financial institution
raises a loan for a foreign firm.
The fees charged on this service
is an export
Dividends paid on foreign
shares held by domestic
residents are a credit item
Australia sends foreign aid to
NZ to help with the repairs of
the Christchurch Earthquake
Increasing number of foreigners
take up New Zealand
citizenship and transfer assets
here.
Loan given to New Zealand by
Japanese bank

Capital Account involves the transfer of ownership of fixed assets and the gaining or disposal of
non-financial assets
Financial Account this section records the forms of investment overseas by domestic residents and
the inward flow of investment funds from foreign residents. This flow gives rise to money flows in
the income component of the current account. Net errors and omissions is used as a balancing item.
Trade Surplus - more inflows than outflows
Trade Deficit more outflows than inflows
Net Errors and Omissions ensures debit and credit items are equal
Causes of Balance of Payments Disequilibrium
1. Appreciation the price of our exports increase and the price of our imports increase.
Current account will move towards a deficit.
2. Depreciation the price of our exports decrease and the price of our imports increase.
Current account will move towards a surplus
3. The economy has a high propensity to import goods consumers in developed countries
like to buy large quantity of consumer goods. These may have to be imported to meet
demand. Developing countries have limited domestic production and therefore have to
import goods such as raw materials and manufactured goods.
4. There is a lack of confidence in the economy this will reduce the amount of foreign
investors and will also reduce demand for exports.
5. The economy is experiencing and expansion period consumers experience increased
spending power and spend more on imported goods than domestically produced goods.

Exchange Rates
Supply of a Currency locals wanting foreign currency
Demand of a Currency foreigners wanting local currency
Floating exchange rate determined solely by the forces of demand supply of the currency.
Advantage
Can eliminate a current account deficit

Disadvantage
Can fluctuate, making it difficult for firms to plan
ahead

Depreciation when a countrys currency decreases in value. It occurs when there is a decrease in
demand for the currency or an increase in supply of the currency.
Appreciation when a countrys currency increases in value. It occurs when there is an increase in
demand for the currency or a decrease in supply of the currency.

Accepted Region

Managed Floating Exchange Rates the exchange rate is generally determined by the flows of
demand supply of a currency. However, governments can intervene when necessary.

If the exchange rate is within the accepted


region, the government will not intervene.
If the exchange rate moves outside of the
accepted region, the government will intervene.

Revaluation increase in the value of the economy. If market forces are pushing down the value of
the currency, the government can buy back the currency using foreign reserves, raise the rate of
interest, or restrict the amount of currency on the foreign exchange market.
Devaluation decrease in the value of the economy. If market forces are pushing up the value of the
currency, the government can lower the rate of interest or sell more of its currency on the foreign
exchange market.
Fixed exchange rates the government fixes their domestic currency to another currency or bank of
foreign currencies and will intervene to maintain this fixed value. If market forces put pressure on
the exchange rate to change, the government will intervene to return it back to its desired value.
Advantage
Firms buying and selling products abroad know
exactly the amount they will pay and receive in
terms of their own currency

Disadvantage
If the government cannot maintain an exchange
rate at a given parity it might have to change its
value.

Specialisation
Specialisation when a country/firm/worker focuses on the production of one good/a certain group
of goods
For the Worker/Individual:
Advantages
Allows individuals to make the best use of their
skills and abilities
Skills continually improve through the repeated
practice of them
Skilled employees generally earn more than
unskilled employees as they are likely to be more
productive

Disadvantages
Individuals must rely on others the produce the
goods and services they want but cant produce
themselves
Doing the same job for many years can become
boring and decrease job satisfaction
Skills and jobs can become outdated and
unwanted. These people will lose their jobs and
will have to retrain to gain new skills
If demand for the good they specialise in
decreases, they will have difficulty finding jobs

For the Country:


Advantages
Countries produce the good they are most skilled
at. They can benefit from economies of scale,
and receive higher profit margins on the exports
they sell.
Countries develop a reputation. When countries
become skilled at their specialised good they
become known for it and establish loyalty

Disadvantages
Can lead to overdependence. If countries only
produce a small amount of goods they are
dependent on other countries to meet the rest
of their needs. If another country fails to
produce these goods there will be shortages of
goods in the country.

For the Firm:


Advantages
Firms develop a reputation. When countries
become skilled at their specialised good they
become known for it and establish loyalty

Disadvantages
Resources needed to produce sole good may be
scarce
Risk cannot be spread over multiple goods

For Consumers:
Advantages
Higher quality goods at lower prices

Disadvantages
Less variety of goods in the market