Economics for CIE IGCSE Students

Revision book

Basic Economic Problem: Talk like an Economist • Utility: happiness, satisfaction, welfare or benefit• Profit: payment for enterprise, reward for risk, revenue – cost• Scarcity: excess demand at price=0, so we have to choose• Opportunity Cost: the alternative given up when we choose• Free good: plentiful good without opportunity cost • Economic good: scarce good with opportunity cost. But varies eg

water

Factor of production

(FOP)

Description Example Payment Provided by

Land Natural resource Oil, Fish Rent Landowner

Labour Human resource Factory worker Wage Worker

Capital Man-made resource

Machine Rent/interest Capitalist

Enterprise Ideas / putting together other FOP

Businessperson Profit Entrepreneur

Basic Economic Problem: Economic Concepts

• What is economics about ? “How to allocate limited resources to provide for unlimited wants”

• What questions help answer that ? What / How / For whom to produce

• Microeconomics looks at parts of an economy like what ? Labour and other resources

• Macroeconomics looks at the whole of an economy like what ? Economic growth

Basic Economic Problem: Scarcity and Choice

The basic economic problem is that people want more than they have but there is scarcity: not enough resource to make more products for everyone.

Because of this scarcity, all people have to make choices.

Examples:

A government must decide whether it wants a new school or a new warplane because it can not get enough resources to make both.

OR ?

When making choices, we assess the opportunity cost or the alternative forgone

The opportunity cost of taking action is what we could have got if we had taken an alternative action

The opportunity cost of making a product is another product we could have made with the resources used

which can be

•Primary Sector: taking raw materials or land from nature, eg farming, mining

•Secondary Sector: using resources to make goods eg car manufacturing

•Tertiary Sector: using resources to provide services eg selling goods, teaching

Basic Economic Problem: Production

Resources are combined to satisfy wants and needs. This is called production

Sectoral Shift

As an economy develops, its production moves from primary to secondary to tertiary.

This happens because as efficiency increases not so many resources are needed to fulfil primary and then secondary sector needs. People can then work to provide services instead.

Production can also be:

Labour Intensive or Capital Intensive based on the resource it uses most

Test Yourself

1. Explain the term opportunity cost and discuss why an increase in spending on police and armed forces may result in an opportunity cost. [4] (S2009)

2. After studying for your Economics qualification you have to decide whether to leave school and find a job or enrol at a college for more specialised training. What factors might you consider when making your decision? [5] (W2009)

3. Explain with the use of one example what is meant by a natural resource of a country. [3] (S2008)

4. Discuss which factor of production might be most significant in the operation of a luxury hotel. [4] (W2005)

Allocation of Resource: Market Function

The market is nature’s way of answering the economic problem

Individual people, or the Private Sector, decide what to make, for profit; and what to buy, for satisfaction.

This, in turn, decides how much resource should be used for each product.

So the market decides resource allocation without anyone planning it. This is a Market Economy.

Decisions about resources are made by individual people.

They might want the government, or Public Sector, to make fewer undesirable products like illegal drugs, or to make more desirable products like economics lessons.

Market Economies lead to inequality and pollution.

Command Economies lead to inefficiency.

A system where the market decides resource allocation for some products and situations, and the government decides it for others, is called a Mixed Economy.

Centrally Planned (or Command) Economy: people do not always let the market decide. In some cases they prefer a government to decide how much resource to use for a product.

Test Yourself

1. Distinguish between the private sector and the public sector of an economy. [3] (S2006)

2. Discuss the disadvantages of allocating resources through the public sector. [7] (S2006)

3. Explain the most important features of ‘the market system’. [4] (W2001)

4. Describe what is meant by a mixed economy. [4] (W2009)

Allocation of Resource: Demand & Supply & Determinants

Demand means the quantity of a product consumers are willing and able to buy at each price

This quantity changes with •population•environment•fashion •Income•law •the availability and price of substitutes and complements, among other things

Supply means the quantity of a product producers will supply at each price

This quantity changes with •population•environment and weather•law and taxes, •resource availability and cost•producer substitutes (what else could those resources make), among other things

Equilibrium is where the quantity supplied is equal to the quantity demanded

all product is sold and no resources are wasted.

This is the market’s way to answer the economic problem of scarcity.

The price adjusts to reach this quantity. The market then uses enough resource to make this quantity for efficient resource allocation

Test Yourself1. Explain, using a demand and supply diagram, what is likely to

happen in the market for air travel as a result of increased delays at airports. [4] (W2009)

2. Identify a complementary (jointly demanded) good or service industry connected with cruise ships and discuss the possible employment prospects in that industry as a result of the increase in airport delays. [6] (W2009)

3. Explain the difference between an equilibrium price and a disequilibrium price. [4](W2006)

4. Identify three causes of a change in the demand for a good. [3] (W2002)

Allocation of Resource: Price Elasticity of Demand (PED) & Supply (PES)

PED:The responsiveness of quantity demanded to changes in price.

% QDx / % Px△ △

What decides this? The determinants are: time, necessity, habit, price as % of income, substitutes

Elasticity: The responsiveness of one variable (V1) to changes in another (V2)Formula: % V1 / % V2△ △

Elastic demand:

↓ price→↑revenue

Inelastic demand

↑price→↑revenue

PES:The responsiveness of quantity supplied to changes in price.

% QSx / % Px△ △

What decides this? The determinants are: time, factors of production, other products supplier could make

Inelastic supplyElastic supply

Test Yourself1. Define what is meant by price elasticity of demand and

explain how it is calculated. [3] (W2002)

2. Discuss whether the demand for chocolate is likely to be price elastic or price inelastic. [7] (W2009)

3. Use the concept of elasticity of demand to discuss how indirect taxes may be used by a government to (i) increase its revenue, (ii) decrease imports. [4] (W2005)

4. Explain the concept of price elasticity of demand. Choose two goods and explain why they might have different price elasticities of demand. [6] (W2005)

Allocation of Resource: Market Failure

What is it ? The market does not allocate resource effectively

Externalities: Costs and benefits affecting people who aren’t involved with producing or consuming a product, where

private+external = social (costs/benefits)

Merit goods: products with external benefits which we should allocate more resource for, eg medicine, books

Demerit goods: products with external costs which we should allocate less resource for, eg cigarettes, polluting products

How does it happen ?

Public goods: which 1) can not be used up and 2) people can not be stopped from using, eg police and lighthouses, so businesses will not provide them.

Non-sustainability: businesses may use up resources gaining growth and profit now, but reducing future life quality.

Inequality: The market fails if some people are poor and lack food whilst others have all they want.

Monopoly: limits output to increase profit. What should we do ?The government can intervene and change the resource allocation for example by controlling production, taxing the rich and feeding the poor.

Test Yourself1. Discuss whether a country should conserve or use its

resources. [5](W2009)

2. Explain what is meant by (i) external cost, [2] (ii) social benefit. [3](W2002)

3. Sometimes the government provides services in an economy, sometimes the private sector provides services. Explain why it is that the government provides some services. [6](S2004)

4. Some countries have now prohibited smoking in public areas in buildings. Use the concepts of private and social costs and benefits to explain this policy. [6](S2009)

Role of the Individual: Money Functions

What is money?

A medium of exchange (can be used to buy things)

A store of value (for saving)

A unit of account (to measure value)

We use money so we don’t have to barter ie swap or trade one item for another.

Otherwise we have to find someone with what we want who wants to trade it for what we have (a double coincidence of wants)

What features should money have ?

Acceptable, durable, portable, scarce, divisible

Who controls the money supply? The Central Bank in a country. It includes the printing of money and overseeing the whole financial system including the high street banks

Banks, stock markets and insurance companies also serve the financial system by channeling money from savers to businesses for investment or buying capital

Test Yourself1. Explain why some people prefer to keep money in cash

and current accounts in banks even though other accounts earn more interest. [5] (W2001)

2. Outline the functions of a central bank. [4] (W2008)

3. Analyse how a central bank might influence consumer saving. [6] (W2008)

Role of the Individual: Work Choices & Context

The price of labour is decided by supply and demand

Supply: depends on skills, experience & education needed as well as the conditions and location of the job.

Demand: depends on the productivity of labour (how much product it can make) and the price of the product.

People decide what work they want to do according to:

Wage factors: the money (weekly wage or monthly

salary) they can earn.

Non-wage factors: the

convenience of the job

(hours, distance, safety)

and the benefits such as

perks, holidays and pension.

Wage differentials

The level of pay is affected by :

Sectors:public / private, primary / secondary / tertiary, age, experience, degree of specialisation, talent, qualifications, location, discrimination

Role of the Individual: Labour Market

Wages may not be decided purely by the free market as intervention comes from:

Governments may also impose minimum wages to help workers.

However these may push up wages so that supply exceeds demand and surplus labour or unemployment results

Trade Unions intervene using collective bargaining and industrial action such as strikes, picketing and work to rule.

They try to improve work conditions and benefits as well as pay.

+ they can improve worker relations and productivity

- they push up wages and costs for firms

Test Yourself1. Describe how a person’s income is likely to change

during their life. [3] (W2008)

2. Discuss what might determine why one job is paid more than another. [7] (W2008)

3. State three factors that might determine an individual’s choice of occupation. [3] (W2004)

4. If a company is large and employs many people it often has to deal with trade unions. What is a trade union and what is its role in an economy? [6] (W2007)

Role of the Individual: Save or Spend Choice

Disposable income is what is left for spending after tax

People can choose to spend or save.

Saving often increases with age, income and interest rate.

Expectations for the future also affects peoples’ decisions

People may choose to borrow using credit cards, mortgages and overdrafts or other bank loans so they can spend more than their income.

Borrowing increases current consumption and sacrifices future consumption

Saving reduces current consumption and allows more future consumption

Income affects spending and saving decisions. High income people spend and save

more money in all than others, but it is still a lower percentage of their income.

Test Yourself1. Discuss what motives consumers have for deciding

whether to spend or save. [6] (S2002)

2. Analyse why different income groups have different spending patterns. [6] (W2009)

3. How might a reduction in interest rates on credit card borrowing affect the way that people choose to save or spend? [6] (W2007)

4. How might inflation affect a person’s spending, saving and borrowing? [10] (S2009)

The Firm: Business Structures

Sole proprietor / trader One person owns and manages a business eg store

Partnership: from 2 to 20 partners own and manage a business eg doctors, law firm

Ltd Company Ownership & management separate, can sell shares for funding, profit paid as dividend to shareholders. limited liability, 2 types:

Private Company (Ltd): sells shares to friends

Public Company (PLC): sell shares on stock exchange

Cooperative: common interest groups own and run business to serve their interests

Public Corporation: Business owned by state and run by managers chosen by government

Limited Liability: Business owners can only lose money they invested in the firm. This reduces risk and so makes investing more attractive.

Multinational: Business producing using resources in more than one country. They get access to markets and resources and can bring money, resources and knowledge to a country but is working in its own interest, not that of the hosts.

Test Yourself1. State four ways in which multi-national companies can

help developing countries such as Bangladesh. [4] (W2006)

2. What is meant by ‘labour-intensive’ production? [2] (S2004)

3. Is intervention by a foreign multi-national always beneficial for a country? [6] (W2008)

4. Discuss what might happen to costs if a firm replaces labour with machines. [6] (W2006)

The Firm: Business Structures

Nationalisation: when the government takes over a business. It may cut prices and increase output but is often inefficient .

Privatisation: when a state owned industry is sold to private owners, to avoid public loss or to make the business more efficient.

Firms size can be measured by number of staff, turnover (revenue), market share (%), or capital employed (asset value)

Firms generally aim to maximise profit and may choose to do this by growing through

Natural Growth: reinvesting profits, or

Integration, by Takeover or Merger

Integration can be:

Horizontal: joining competitors

Backward Vertical: joining suppliers

Forward Vertical: joining customers

Lateral / Conglomerate: joining unrelated firm

The Firm: Costs (Money paid to produce)

and Revenues (Money received for product)

What is the goal of most firms ?

Profit maximisation = make as much profit as possible

But they may only: Break Even: When total revenue = total cost

Cost Type Explanation

Total All Cost

Average Total Cost / Quantity

Fixed Cost that does not change with Quantity and is paid even if output = 0

Variable Cost that changes with Quantity

Revenue Type

Explanation

Total All Revenue

Average Total Revenue / Quantity

As a firm increases its output, total cost usually rises, but average cost may rise, stay constant or fall

The Firm: Market Structures

Some businesses like haircutting suit small firms, others like making ships or electricity are best done by large firms

As firms get bigger they can benefit from economies of scale where costs fall with specialisation, production lines, bulk buying and cheap credit or borrowing

But if firms get too big they may get diseconomies of scale where inefficiency increases costs

Perfect competition many firms which have little market power, must follow the market price and make low profit

Monopoly one firm which controls the market

Benefits: economies of scale, money for research to make new productsProblems: they can charge high prices and make unfair profits

Test Yourself1. How do some firms become large? [4] (W2005)

2. Discuss how a supermarket might benefit from economies of scale. [6] (W2005)

3. Why might a company have an increase in revenue and a fall in profits at the same time? [2] (W2002)

4. What is meant by fixed cost, variable cost and average total cost? [4] (W2006)

The Government

.

Governments get

income from taxes

These can be

Direct: paid on income, profit or cash

Indirect: paid on products eg sales tax

Progressive: higher income higher rate

Regressive: lower income lower rate

Proportional: fixed rate

These add to business costs.

If the government gives money to producers to reduce costs it is called a subsidy

In an economy the government is:

An employer

A producer of goods and services

A policy maker

It aims to ensure:

Full employment

Price stability

Growth (of GDP)

Equality

Foreign balance

It uses policies that include:

Demand side: Fiscal (tax and spending) or

Monetary (money supply and interest rates)

Supply side: reduce intervention

Trade policy: protection, exchange rates

The Government: Macroeconomic Models

Circular Flow DiagramAggregate Demand /

Supply DiagramBusiness Cycle

We use economic models to simplify and present ideas about the real economy. The government can then use them to predict the effect of events and policies.

Test Yourself1. Discuss how some aims of government policy might

conflict with each other. [6] (S2007)

2. Discuss how a government might influence private producers. [8] (S2007)

3. Using examples, describe the difference between direct and indirect taxes. [4] (S2008)

4. How might a reduction in taxation help any two macro-economic aims of a government? [6] (S2008)

Economic Indicators

What is it ? A sustained increase in the general level of prices.

How is it measured ? By comparing the price of an index (the price of a basket of goods such as the Consumer Price Index) from one year to the next.

What makes it happen ?

Demand Pull = An increase in the money supply or an increase in demand for products.

Cost Push = An increase in the cost of resources used for production.

Why is it a problem ? Money loses value and

Becomes dysfunctional, people and businesses

get worried, governments and borrowers gain

whilst others lose, resources get wasted

What should governments do ? Demand side : Print and/or spend less money, raise direct taxes. Supply side : Make resource markets work better.

Economic Indicators

What is it ? When people are willing and able

to work but have no job

How is it measured ? By counting tax or

welfare data, by survey

Why is it a problem ? People lose income and

skills and get depressed

Society wastes resource. Areas get poorer, crime occurs

What should governments do ?

Demand side : Print and/or spend money, cut taxes.

Supply side : Make resource markets work better.

What makes it happen ?

Natural Unemployment: Seasonal, Frictional (between jobs), Structural (change in products and production methods)

Cyclical Unemployment: A fall in demand for products and labour in recessions

Economic Indicators : GDP

What is it ? The total output from inside a country in a year

How is it measured ? By counting income or spending

or total product, which should all be equal.

What is the goal ? Governments want to increase GDP so the country gets more income and gets richer. This is called economic growth.

What other measures are there ?

Real GDP per Capita: The total inflation

adjusted output of a country per person

GNP Gross National Product: Total output in a year from resources belonging to the people of a country.

Human Development Index (HDI) :

Shows the standard of living based on

education and life expectancy as well as income

Test Yourself1. Explain how different types of unemployment may

be caused and consider which might be the most serious. [10] (S2007)

2. Explain what is meant by GDP. [3](S2005)

3. What might be the result of a general increase in the level of consumer spending in an economy? [4] (S2008)

4. What is meant by inflation? [4] (S2009)

Development: Population

Population data includes the Dependency ratio or how many people depend on each worker. There are a lot of dependents in countries with many old or young people who can not work. That slows development because they use resources. A low dependency ratio helps an area to develop

The birth rate is also important. If it is higher than the death rate then the population may be growing which gives more labour to make things, but also more need for food.

Saving The population and culture also helps to determine how much of what is made is consumed or used up. The rest can be saved, it can be traded for other products or used for investment which means buying capital or man-made resource or even schools and hospitals. This increase in resources means an economy can develop and enjoy a better standard of living.

Development

Other factors influence the level of development in an area: Geography, politics, culture, climate, resource endowment, population age size and density

Sectoral shift: As an economy develops, people move from primary to secondary and then tertiary sectors. This is because 1) Increases in efficiency means less labour is needed for food and other basic need so it can be used elsewhere, and 2) with development people have enough necessities and want other things like education, football matches and art so they will pay labour to make those products

What is it ? It describes the standard of living or the quality of life

Many factors can be measured to see the level of development in an area: Income, education, life expectancy, freedom, technology, healthcare, equality, nutrition

Governments can set policies to support development. These might include: population controls, laws to help businesses, government spending on infrastructure including roads and buildings like airports

Test Yourself

1. Discuss why many countries aim to increase economic growth. [4] (S2009)

2. How might a government affect economic growth in a country? [8] (W2007)

3. What determines the change in the size of a country’s total population? [3](S2002)

4. How may living standards between countries be compared? [10](W2009)

International Economics: Trade

Specialisation: different countries, people or areas have different resources and so are better at making certain products.

This is called comparative advantage. They should specialise in making these items and trade them with other place for items they are not good at making.

Switzerland could make chocolate and export it in exchange for imports of coffee from Vietnam. Then there is more for everybody.

Increased trade supports Globalisation where there is more communication and standardisation and it seems like the world is getting smaller.

With trade, countries get more efficient because:

• They are making what they are good at

• They can practice and get even better at that product

• They might get economies of scale in that product

• Competition from other countries encourages efficiency

• New ideas come from other countries with trade

• People have more choices of product

How: do countries protect themselves and stop trade? They use

Quotas: limits on the number of imports of a product

Tariffs: taxes on imports

Subsidies: money for their own producers to make it cheaper

International Economics: Protection

Why: Some countries want to protect themselves from imports from other countries because:

They want to keep jobs for their own workers

They want their own businesses to sell more and make more profit

They don’t want to depend on other countries

They don’t like the country they buy products from

They want to maintain their foreign balance of trade

The WTO aims to support and encourage free trade to help development but some countries say the WTO is unfair and helps the rich countries more than poor ones

The balance of payments is a country’s account with the rest of the world. It includes the financial, capital and current accounts

Current Account: counts the net (total inflow minus total outflow) cashflow for:

Visible trade or trade in goods

+

Invisible trade or trade in services

+

Transfers gifts or payments made not for trade or debt

+

Income from Investment in other countries

International Economics: Foreign Balance

The current account balance can be:

Surplus if more money flows in than out, leading to saving

Deficit if more money flows out than in, leading to debt

Balanced if money flows in and out are equal

An exchange rate is the rate at which one currency can be exchanged for another. Exchange rates might be Floating where the rate is decided by the free market forces of supply and demand, or:Fixed where the government controls the rate by buying or selling currency, orManaged float where the government controls a floating rate if it moves too much

International Economics: Exchange Rates

Floating exchange rates might appreciate (rise) if many people want to buy that country’s products or hold its money, or depreciate (fall) if people do not want the products or money of a country.

If a currency appreciates, the products of that country will get more expensive and so people may not buy them and it could lead to a trade deficit

If a currency depreciates, the products of that country will get cheaper and so people may buy more of them and the country’s foreign balance can improve.

Test Yourself

1. Explain what is meant by a visible trade deficit and identify in which part of the balance of payments the deficit would be recorded. [3] (S2004)

2. Discuss what might lead to an improvement in the balance of payments of a country. [6] (S2005)

3. Discuss the consequences for an economy if its currency ‘was gaining strength.’ [5] (W2004)

4. Distinguish between a tariff and a quota. [4] (S2009)

5. Why do countries trade with each other? [6] (W2009)