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ECONOMICS Definitions 1. Economics: It is the study on how human kind fulfills its wants which are unlimited with the resources that are limited. 2. Scarcity and choice: Human wants are unlimited but resources to satisfy those wants are scarce therefore we have to make a choice between our wants and desires. 3. Opportunity cost: the next best alternative sacrificed .Example if a man has to choose between a mobile and a laptop both costing the same, and he chooses the laptop, then his opportunity cost is the mobile phone. 4. Consumer goods-those goods that give us direct satisfaction or We buy them for their own sake 5. Capital goods: Those foods that give us indirect satisfaction. We buy them for the sake of other goods example factory machinery. 6. Merit goods: Those goods which are beneficial not only for their consumer but also for third parties e.g. Vaccines against contagious diseases. 7. Demerit goods: those goods which are harmful for third parties e.g. Tobacco alcohol. 8. Giffen goods: Those goods those demand rises when price rises e.g. Luxury cars, shares, land etc. 9. Inferior goods: Those goods whose demand falls when income rises eg Public transport. 10.Normal goods: Those goods whose demand falls when price rises and demand rises when income rises. They have a negative P.E.D and a positive Y.E.D 11.The stages of production: Primary production: The extraction of raw materials from natural resources e.g. agriculture, fishing , mining Secondary Production: the processing of raw materials into finished goods e.g. Food processing, garments, manufacturing, construction. Tertiary production: the production of services e.g. Transportation, banking, insurance etc.
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12.Public goods: those goods which are free for all, non excludable and non rivaled e.g. street lighting. 13.Factors of production Land: All natural resources e.g. fields, lakes mines etc The cost of land is known as rent Labor: All human efforts both mental and physical e.g. doctors, fisherman. The cost of labor is known as wage Capital: All man made resources e.g. buildings and machinery. The cost of capital is known as interest rate. Entrepreneur/enterprise: The risk bearer of production: who monitors and supervises production, work e.g. sole-proprietor. The reward for entrepreneur is known as profit. 14.Labor intensive industries: Those industries which are highly dependent on labor e.g. agriculture 15.Capital intensive industries: Those industries which are highly dependent upon capital e.g. textiles. 16.Automation: The transition from labor intensive to capital intensive industries. 17.Investment: The creation of capital 18.Savings: An increase in one’s wealth which normally occurs when income exceeds expenditure.
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Economic Growth 1. Economic Growth :A rise in living standards which is measured by the annual % increase in the real GDP 2. Standard of living: The quality of life enjoyed by an average individual in terms of income, consumption etc. 3. Recession: A fall in the living standards which is measured by the annual % decrease in real GDP Methods of achieving Economic growth 1. 2. 3. 4. 5.
Education Investment Technology Healthcare facilities Others: There are many other ways of achieving economic growth such as exploitation of natural resources, reduction in corruption etc.
Advantages of Economic growth 1. Rise in living standards 2. Rise in government income Disadvantages of Economic growth 1. Rise in social costs (public nuisances) e.g. pollution congestion, deforestation etc. 2. It might lead to unemployment: (Technology and inferior goods) 3. Rise in imports: Money goes out of the respective countries.
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Privatization Private Sector Ownership →owned by individuals Controlled by board of directors Financed by owners through shares Profit maximization is the primary motive. Public welfare is secondary Quality of output is better due to profit making motive
Public Sector Owned by the government Controlled by cabinet of ministers Financed by government through taxes Social welfare is primary. Profit is secondary Quality of products is arguably poor
Privatization: The transfer of property from the public sector to the private sector e.g. British Airways Advantages of Privatization: 1. Rise in government income: When the government privatizes something the government receives money from the people who buy it. The government can use this money for the country’s welfare 2. Improvement of quality of output: Advantageous for consumers 3. Wages are normally higher in private sector: advantageous for employees Disadvantages of privatization 1. For the government :It loses control over key resources 2. For consumers: Prices are higher due to profit motive 3. For employees :Jobs are less secure and more stressful
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Externalities 1. Externalities: The effects on third parties External cost (or negative externality) 1. Private costs: When an individual performs an economic activity he or she incurs certain costs known as private costs 2. External cost: The cost incurred by a third party is known as external cost 3. Social cost :the cost incurred by the whole society is known as the social cost Social cost = Private Cost + External Cost External benefits or positive externalities 1. Private benefit: When an individual performs an economic activity he or she enjoys certain benefits known as private benefit 2. External benefit: The benefit enjoyed by a third party is known as external benefit 3. Social Benefit: The benefits enjoyed by the whole society are known as a social benefit. Social benefits =Private benefits + External Benefits Remedies to externalities 1. cost. 2. 3. 4.
Legalization: Making certain rules in order to prevent external Indirect taxes Fines Subsidies for goods which have external benefits
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Multinational Companies (MNC) 1.
MNC : A company that operates in more than one country e.g. KFC Advantages of MNC locating in other countries 1. Cheap raw materials 2. Cheap/Skilled labor 3. Larger Market Advantages enjoyed by the country 1. 2. 3. 4.
Rise in country’s output: There is no taxes or import cost Creates employment Rise in government income Rise in competition which will result in lower price and better quality
Disadvantages to a country 1. Domestic firms suffer from foreign competition 2. Rise in social costs 3. Profits are remitted abroad Reasons for government intervention in the location of a firm 1. To reduce social costs 2. To reduce unemployment Productivity: The output for a given amount of input Ways to improve productivity of a firm 1. By training the workers 2. Better technology 3. Incentives/Bonus/Promotions
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4. Better Working conditions (The same way we increase economic growth example education, health care and investment)
Inflation Inflation: A persistent and general increase in the price level Inflation rate: The percentage amount by which the price level rises in a year Real Income: Income adjusted with the rate of inflation e.g. If a man's income rises by 10% and the inflation rate is also 10% then his real income remains unchanged. Effects of inflation 1. Fixed income earners suffer from poor living standards (less consumption results in low standards of living) 2. Fall in the real savings and investment 3. Fall in exports and rise in imports 4. Money loses its value. At times of inflation money loses its value for which it cannot fulfill its functions properly. It cannot measure the value of other goods accurately. People feel reluctant to give loans because debtors gain and creditors lose. 5. Investors benefit from higher profit Causes of inflation 1. Demand Pull inflation
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2. Cost pulled inflation: When basic costs of production rise, the price of finished goods are also increased, leading to inflation. As a result workers demand higher wages causing inflation to rise further. Monetary policy: The government’s policy in which it uses interest rates to manage the economy Fiscal policy: The government’s policy in which it uses its income and expenditure to manage the economy. Remedies to inflation Monetary policy: 1. By raising interest on savings 2. By raising interest on loans Fiscal policy: 1. By increasing direct tax(this method is very popular for the government) 2. By reducing indirect taxes(this method is very unpopular for the government) 3. By giving subsidies in order to reduce prices(this method is very unpopular for the government) Formulas CPI = Consumer price index Rate of inflation: CPI1-CPI2 ×100% CPI1 Real income: CPI1× Present income CP2 8
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Real income: Present income × 100 100+r (Where “r” is the rate of inflation) Construction of the RPI/CPI/price index: 1. The basket of 650 goods must be determined. 2. The weitages must be assigned to each good depending upon how frequently we use them. 3. A base year is selected and the weighted average price is calculated after collecting price from sellers
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Unemployment Unemployment: Unemployment occurs when those who are eligible to work are not engaged in productive activity Types/Causes of unemployment 1. Structural unemployment: Caused by the decline of a major industry. 2. Cyclic unemployment Recession/Poverty→Fall in demand→Fall in production→Unemployment 3. Frictional unemployment: One might be temporarily unemployed when switching from one job to the other. 4. Voluntary unemployment: Some people are unemployed simply out of reluctance to work. 5. Seasonal unemployment: Certain occupations have seasonal demand. 6. Residual unemployment: Some people are unable to work due to physical or mental handicaps. Effects of unemployment 1. Fall in living standards 2. Fall in government income and rise in government expenditure 3. Rise in social problems such as crime 4. Wages will fall Methods of measuring unemployment 1. Labor force survey/ILO method: A survey is taken on a quarterly basis to count the number of people unemployed. 2. Claimant count method: Those who come to collect JSA are counted as unemployed. This is done on a monthly basis Remedies to unemployment Monetary policy 1. By reducing interest on savings 10
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2. By reducing interest on loans Fiscal policy 1. By reducing direct taxes 2. By reducing indirect taxes
Specialization Specialization/Division of labor: When large complex operation is broken down into smaller simpler tasks, and each task is performed by an individual worker, the division of labor is said to occur. Example in a pin factory one worker cuts the wire, another straightens it, and another sharpens it and so on until a complete pin is made Advantages of specialization 1. Greater skill through practice 2. No time is wasted since tools are switched over and over again 3. Less training time required Disadvantages of specialization 1. Monotony and boredom 2. Interdependence 3. Increased risk of unemployment
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Globalization Globalization: The integration and interdependence between economies Reasons for Globalization 1. Growing MNC’s 2. The development of technology 3. Better transportation networks 4. Removal of trade barriers: rise in imports and exports thus leading to more interaction Disadvantages of globalization 1. Rise in social costs 2. Interdependence 3. Exploitation of underdeveloped countries Advantages of globalization (for developed countries) 1. Higher GDP and employment 2. Lower prices 3. Greater choice of goods Advantages of globalization (for underdeveloped countries) 1. Higher GDP and employment 2. Higher taxes for the government 3. Transfer of technology Foreign aid: Money given to a country on generous terms. These are of few types 1. Grants. Money given to a country which is not taken back 2. Tied aid: Money given to a country subject to certain conditions 3. Low interest loans :Loans given with little or no interest 12
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Population 1. Optimum population: An ideal population size at which the country’s resources are properly utilized 2. Life expectancy: The average number of years a person is expected to live. 3. Working population: those who are eligible to work and are above school leaving age(15 years) and below retirement age (60 years) 4. Dependant population: Those who are not eligible to work and have to depend upon the working population. They are normally below school leaving age and above retirement age. 5. Dependency ratio: The average number of people dependent upon each worker Dependency ratio: Dependant population Working population 6. Ageing population: When the average age of a country’s population rises it is said to have an ageing population. 7. Birth rate: The average number of births for a thousand people in a year. 8. Death rate: The average number of deaths for a thousand people in a year. Causes of a rise in population 1. High birth rate: Poor family planning, early marriages, less use of contraceptives. 2. Low death rate: Better medical facilities, better living standards, lower crime rates. 3. High immigration: Better living standards, lower unemployment, lower inflation etc. 4. Low emigration: Better living standards, lower unemployment, lower inflation etc.
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Causes of a fall in population 1. Low birth rate 2. Low death rate 3. Low immigration 4. High emigration Effects of a rise in population 1. Rise in demand: Causing Inflation 2. Rise in congestion and crowd leading to housing shortages and utility shortages 3. Unemployment causing wages to fall Causes of high dependency ratio 1. 2. 3. 4.
High birth rate Low death date Low immigration of young workers High emigration of young workers
Effects of high dependency ratio 1. Change in pattern of demand: Those goods demanded by youngsters and elders will rise in demand 2. Labor shortages causing wages to rise 3. Fall in government income 4. Rise in government expenditure such as schools, pensions etc.
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Underdeveloped country
1. High birth rate 2. High death rate 3. High dependency ratio
Developed country
1. 2. 3. 4.
Low birth rate Low death rate Low dependency ratio Ageing population
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Taxation 1. Direct taxes: Tax on ones income e.g. Income tax, corporation tax etc. 2. Indirect taxes: Tax on one's expenditure e.g. VAT, sales tax, tariffs etc. 3. Disposable income: Income remaining after compulsory deductions such as direct taxes 4. Progressive tax: A tax system in which the rich pay a higher rate of tax, direct taxes are normally progressive Example of progressive tax When income: £10,000; Tax rate: 15% When income £15,000; Tax rate: 20% 5. Proportional tax: When the rich and poor pay the same amount of tax. Direct taxes sometimes can be proportional When income £10,000; Tax 20% When income £20,000; Tax 20% 6. Regressive tax: When the rich pay a lower rate of tax than the poor e.g. indirect taxes are normally regressive When income £10,000; Tax 20% When income 20,000; Tax 10% 7. The national budget: The government’s financial plan for the forthcoming year. 8. Budget surplus: When the governments income exceeds its expenditure for the year 9. Budget decficit: When the government’s expenditure exceeds its income. 10.National debt: The total amount of money the government owes Main sources of government income 1. Indirect taxes: More than half of government income in Bangladesh come from indirect taxes 2. Direct taxes: Almost three fourths of the government income in Bangladesh comes from direct and indirect taxes combined. The
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largest taxpayer in Bangladesh is Telenor, previously however it was British American tobacco 3. Revenue from sale of services: 4. Foreign aid Main forms of government expenditure 1. 2. 3. 4. 5.
Education Defense Health care Infra structure Agriculture
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GDP 1. GDP: the total money produced by a country in a year. Drawbacks of GDP: 1. It focuses on the money value of output rather than the quality of output. The quality of output is a major factor affecting living standards. A country can have a high GDP even when its goods are of low quality because of the high price. 2. Distribution of income: The GDP shows the overall income of a country but it doesn’t show the distribution of income without which living standards will be difficult to assess country may have a high GDP but an uneven distribution of income. In such cases some will have a high living standard while some would have a low living standard. 3. Other aspects of life: Literacy rates aren’t included in the GDP.Isssues such as theses are not addressed by the GDP for which we cannot fully comprehend a country’s living standards. HDI: It is the indicator of living standards which is constructed by including the income per head, adult literacy rate and life expectancy
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Economies of Scale Economies of Scale: Advantages enjoyed by a firm through growth normally such advantages lead to a fall in long term average costs Examples of internal economies of scale 1. Purchase in economies: When a firm grows in size it requires large amount of raw materials. As a result it can obtain bulk purchase discounts 2. Technical economies: As a firm grows it uses moiré technical machinery. Such machinery makes the firm more productive. For example a machine may cost 5 times as much than a simple machine but it is 20 times more productive. As a result production becomes comparatively cheaper 3. Financial economies: A large firm can normally obtain finance at a lower cost. For example they can obtain bank loans at cheaper interest rates because of their reputation and reliability 4. Managerial economies: A firm’s success often depends on the quality of its mangers. Larger firms normally attract better managers and thus can become more successful. 5. Risk bearing economies: When a firm diversifies into the production of various types of goods, its risk of losses will reduce. This is because if it suffers losses from one product it can recover that loss from the profit of another product. Diseconomies of scale: The disadvantages of growth of a firm. As a result of this it faces a rise in long run average costs Internal economies of scale: The advantages which arise from the growth of a firm itself External economies of scale: These are those advantages which arise from the growth of a whole industry. Problems of growth (Diseconomies of scale) 1. Management problems
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2. Regulators: When a firm grows in size it may become a threat to other firms, for this reason the OFI may intervene to rectify the problem. For example if a merger exceeds 25% market share it might be blocked by the competition commission Horizontal merger: When two or more firms producing related goods and operating at the same stage of production come under unified control. The merger of two banks Vertical merger: When two or more firms producing related goods but operating at different stages of production come under unified control. For example the merger of an oil extraction company and oil refining company Conglomerate/diversification: When two or more firms producing unrelated goods come under unified control e.g. a Garments manufacturer merging with a bank. Advantages of Horizontal merger: 1. Economies of scale 2. Fall in competition Advantages of vertical merger 1. Economies of scale 2. Better control over sources of supply: Vertical merger normally consist of two firms who are at different stages of production. Quite often these firms are supplying raw materials to each other, thus if they merge they are having control over their own raw materials Advantages of conglomerate 1. Economies of scale Advantages of small firms 1. Requires less capital 2. Requires very little space 3. It can produce those goods which have a limited demand 20
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Advantages of the economy (small firms) 1. They are normally labor intensive 2. Creates less social costs
Competition Competitive markets: A market in which there are many buyers and sellers, the goods do not differ much and there are no entry barriers Advantages of competition 1. Low price 2. Better quality 3. Wider choice Disadvantages of competition 1. Wastage of expenditure through advertisement, packaging etc. 2. Uncertainty for producers Monopoly: A single firm dominating the whole market. This can even happen if a firm has 25% of the market or more. Monopoly often setup entry barriers to prevent firms from entering into the market Advantages 1. Economies of scale Disadvantages 1. Exploitation of customers through higher prices and poor quality 2. Lack of innovation Oligopoly: When few firms dominate the industry, they also setup certain entry barriers to prevent other firms from entering. If the firms get into collusion/conspiracy they can charge higher prices from their customers Advantages of oligopoly 1. Stable prices(Only possible if there is no collusion) 2. Better in quality Disadvantages of oligopoly 21
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1. Danger of collusion
Production Possibility Frontier (PPF) PPF: It is a diagram that shows a country’s productive potential with its existing resources
The PPF shifts outward if there is an increase in the country’s resources or if there is an increase in the efficiency of existing resources e.g. Investment, technology, education In other words the PPF will shift outward if there is economic growth in the country Draw what will happen to the PPF if 1. There is a rise in the resources used to produce tanks 2. Fall in the efficiency of the use of resources used to produce roses 3. There is a rise in the resources for roses and a fall in the resources for producing tanks 4. There is a fall in the level of education 5. There is a rise in capital investment
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Costs and revenues Total cost: The total expenditure incurred in producing a certain level of output Fixed Cost + Variable cost Average cost: The cost Per Unit AC = TC Q Fixed Cost: The cost that remains constant whatever the level of output. E.g. Rent, depreciation Variable Cost: The cost that varies with the level of output e.g. wages, raw material costs etc. Average cost: Average Fixed Cost + Average Variable Cost Total revenues: The total income earned selling a certain level of output Average revenue: The income per unit Average revenue = Total Revenue Quantity
Total cost
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Fixed cost
Average Cost
Variable cost
Example
From the Example diagram, calculate 1. Fixed Cost 2. Variable Cost for 100 units 3. Average cost for 100 units 4. Average Variable cost ANSWERS 1. 10,000 25
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2. 15,000 3. 25,000/100 = 250 4. 15000/100 = 150 Total Revenue
Average Revenue
1. Fixed cost 2000 2. Average cost 5000-2000/1000 = 3 3. Average cost : 5000/1000 = 5
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International Trade 1. Dumping: To sell goods to foreign countries below the cost price. The EU dumps sugar to Africa. Advantages of free trade 1. The country earns money from abroad 2. Creates jobs 3. Economies of scale 4. Wider variety of choice: A country cannot produce all sorts of goods. So it has to import goods to satisfy people 5. Rise in competition Disadvantages of free trade 1. Depletion of a country’s resources 2. Outflow of money to other countries 3. Competition is harmful for domestic firms Trade Barriers/restrictions/anti dumping measures 1. Tariffs: It is a tax imposed upon imported goods. E.g. in Bangladesh Tariffs are unto 300% upon imported cars. This is the most popular trade barrier 2. Quotas: Physical limit on the level of imports entering a country. 3. Trade embargo: A complete ban on imports e.g. a trade embargo exists between Israel and Arab countries. 4. Subsidies: The government can give subsidies to domestic industries. So that the price of domestic goods fall. As a result people will import less. However this is unpopular for the government Balance of payments, current account: A record of the inflow and outflow of money of a country, arising from trade Visible trade: Export of goods – Import of goods Invisible Trade: Export of services – Import of Services
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#The UK has a deficit on its visible trade but yet a surplus on in Balance of payments current account, explain why? ANSWER: The Surplus in invisible trade was so much that it covered the deficit. Exchange rates: The price of one currency in terms of another Effects:
World trade Organization The WTO is a multi lateral body who aims to promote trade within its member country. It forms trade agreements between countries and resolve trade disputes. In other words it aims to increase trade liberalization (free trade) Trade blocs: A group of countries who form an agreement to promote trade among each other. They do this by removing tariffs among each other, imposing common external tariffs against outsider countries allowing the free movement of labor e.g. the European Union, ASEAN, NAFTA etc #In the following examples which currency has depreciated 1. 2007 £1 = € 1.7 2008 £1 = €1.8 €, Euro depreciated 2. 2002 $1 = DM 0.67 2003 $1 = DM 0.58 $, Dollar depreciated 3. 2010 €2 = ¥3.8 2010 €1 = ¥2.2 28
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¥, Yen depreciated
Demand and Supply
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Certain Factors that affect demand 1. 2. 3. 4. 5.
Population Income Price of substitutes Price of complements Other factors such as weather, fashion events
Certain factors affecting supply 1. Change in cost of production 2. Entry/exit of firms 3. Indirect taxes/VAT 4. Subsidies 5. Others such as weather, technology Price Elasticity of Demand (PED): The responsiveness of demand to a change in price PED = %Change in demand %Change in Price Income elasticity o demand: The Responsiveness of demand to a change in income YED: %Change in demand %Change in income Price Elasticity of supply (PES): The responsiveness of supply to a change in price PES
% Change in Supply %Change in Price
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If elastic
1. The Demand curve is flat 2. When price rises revenue falls 3. When price falls revenue rises
If Inelastic
1. The demand curve is steep 2. When price rises revenue rises 3. When price falls revenue falls
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Indirect taxes
The VAT per unit is the vertical distance between the two supply curves
#what is the VAT per unit = £7 #what is the VAT incurred by the government = 7×100 = £700
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#What is the: a) Previous price and new price b) The VAT per unit c) The total income of the government d) PED when the price is rising e) The total revenue previously f) The total revenue presently g) Using your answers from ‘e’ and ‘f’ say whether price is elastic or inelastic ANWERS a) Pervious price : £40 New price: £50 b) Vat per unit : 50-35=15 c) 1050 d) %change in demand = -30 %change in supply = 25 = -1.2 e) Total revenue = 40×100 = £4000 f) Total revenue = 50×70 = £3500 g) As price rose and revenue fell it is elastic
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Subsidies
Money given from the government to producers
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Factors determining the exchange rate 1. The level of exports: When we export goods foreigners demand our currency to pay for the exports as a result when our exports rise the exchange rate rises and when our exports fall the exchange rate falls. 2. Tourism: When tourists enter our country they demand our currency because whatever they buy in our country has to be paid in our currency. Thus if the number of tourists rise the exchange rate will also rise and when the number of tourist fall the exchange rate will also fall. 3. Interest rates: If the interest rate rises in our country then people from all over the world would like to save in our country. But to do this they have to first convert the money into our currency. Thus the demand for our currency will rise and the exchange rate will also rise. Likewise when the interest rate falls the exchange rate will also fall.
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Economic Systems 1. Planned/ Command Economy: It is an economic system in which the government takes the major economic decisions on what to produce, how to produce and how to distribute. Distribution is normally done on an equal share basis This system is strongly criticized because it lacks freedom of choice and enterprise and the level of motivation is low e.g. The USSR 2. Free market economy: It is an economic system in which the people have the freedom to choose what to produce, how to produce and how to distribute. Production and distribution is normally done according to the price mechanism However market failures may arise, market failure means the price mechanism is unable to allocate the resources efficiently, this happens due to externalities. 3. Mixed economy: It is an economic system where both the government and market forces play important roles. Certain resources are controlled by the government (the public sector) which is used to provide social welfare, on the other hand certain resources are owned by individuals (the private sector) which are allocated according to the price mechanism. Here competition takes place and owners try to maximize their products.
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