IGCSE Economics Economics - The - The study of how scarce resources can be allocated to satisfy people’s unlimited wants. Scarcity - When - 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 nonnon renewable. 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 - The next best alternative foregone foregone e.g. Mary could buy lettuce or chips with her $5 and she chose chips. Lettuce would be Mary’s 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
A
computers but 60 books (B). Therefore, this business has an B
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 people’s 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 - goods we demand more of as our income increases e.g premium steak Inferior goods - 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 income decreases Semi-finished goods – goods that are used to produce other goods e.g. leather, wool
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 people’s 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 - goods we demand more of as our income increases e.g premium steak Inferior goods - 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 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 - as price increases, quantity demanded decreases, 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 - a graph showing the quantity of a commodity consumers are willing and able to buy at a range of prices. Market Demand - the - 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 aste - things we like. They may be influenced by fashion, values, media, weather, seasons.
Income ncome - 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 omplements - a good which is used in conjunction with another good
Substitutes ubstitutes - a good which can be used in place/instead place/instead of another.
Supply – The quantity of a good or service that a producer is willing and able to produce at various v arious 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 Tariffs = = tax on imports; Quotas 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 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, Q 1, with P1 and Q 1 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 Q 1 and Q
e.g.
P
P
P1 D
D1 Q
Q
Q 1
Decrease in Price
P1
D
Q
Decrease in Demand
P
P D
D Q 1 Q
Increase in Price
Q
D1
Q 1
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.
S
800 – 200 = 600
Surplus
7
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 Shortage
3
producing less than demanded. D
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 Q Eq1 (on Quantity axis), and the old points PEq, and Q Eq
Draw arrows from the old points to the new points (e.g. Q Eq to Q Eq1)
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 people’s 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 o
Monopolies – where one firm is the sole supplier of a product. 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 o
and production activities of others 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 Social Benefit = private benefit + external benefit
o
Uneconomic use of resources – if the social costs exceed the social benefits
o
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
Public Sector Public Goods Merit Goods
Private Sector Private Goods A mixture of merit and demerit goods
Supporting ‘vulnerable’ groups
Helping private sector industries Managing the economy Sources of Income
Cover losses incurred by SOE’s 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
Profits – this will depend on how profitable the business is Loans – this will depend on the firms ‘credit worthiness’ and size
depend on the governments ‘credit worthiness’ at home and abroad
Advantages
Ensures resources are allocated to merit goods/public goods Ensures fewer resources are allocated to demerit goods
Disadvantages
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
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 it’s 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 country’s 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 Sharia’s 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 person’s 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 o
incentive for workers to increase productivity. Fixed annual rate/salary – an agreed amount between the employer and employee
o
will be divided into equal monthly/fortnightly payments regardless of the number of hours actually worked. 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 don’t 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 don’t. 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 In LEDC’s many low-skilled workers are willing to work for low wages. o o
In MEDC’s 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
o
demand for labour and therefore higher wages 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 Doctor’s pay, and the Doctor’s 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 firm’s 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 o
Unable to obtain goods and services they need 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 person’s 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 don’t 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 o
Small Firms – generally have less than fifty employees 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 can’t 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
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 can’t be recovered if firm leaves
Price Maker/Taker
Profits for Firm Efficiency
Access to Resources
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
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 country’s 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 economy’s productive potential
Aggregate Demand – the total demand for an economy’s 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 Capital
Price
Goods
Level
B
200 100
AS
A AD 100
200
Consumer Goods
AD1
Real GDP
At point A, 100 capital goods and 100 consumer
When Aggregate Demand increases, it shifts to
goods are being made. At point B, 200 capital goods and 200 consumer goods are being made.
the right. This causes the country’s output to
increase.
The country’s output has increased.
Potential (long run) economy growth – the total output of the economy has increased Capital
Price
Goods
Level
AS
AS1
AD
PPC PPC1 Consumer Goods
Real GDP
The productive potential of the economy has
The maximum output that the economy can
increased. This can be achieved through a rise in
produce (AS) has increased.
the quality or quantity of factors of production.
4. Balance of Payments – a record of a country’s 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 government’s 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 country’s 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 people’s 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
S
P1 P
P1 Consumer
P
Consumer Producer
Producer
D D Q 1Q
Q 1
Quantity
Q
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
As resources begin to get used
If the economy is at full
does not always cause inflation. If the economy is
up, firms are in greater competition with each other
capacity, an increase in aggregate demand will only
producing low levels of output
for the use of them. Increases
cause an increase in the price
and has lots of spare capacity,
in
level, and no extra output can
there will be no impact for the price level, yet output can
therefore increase the price
aggregate
demand
will
be made.
level but also increase output.
increase. Price Level
Price Level AS
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 firm’s 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
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
Weighting 60% 10% 30% 60% 15% 25%
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 f oreign 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 A loss of self-worth
o
A decline in the mental and physical health
o
o
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 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 firm’s 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 country’s output. Transfer payments and unemployment benefits are not included.
The Expenditure Method – measures all the expenditure on the country’s 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
Q uotas – 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 country’s economic transactions with the rest of the world . The Balance of Payments is made up of three accounts:
The Current Account Trade in goods
The Capital Account
The Financial Account
Capital inflows
Investment
Capital outflows
Net errors and omissions
Trade in services Income Current transfers
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 country’s 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 country’s currency increases in value. It occurs when there is an increase in demand for the currency or a decrease in supply of the currency. 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.
n o i g e R d e t p e c c A
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.
